Its not all doom and gloom for South Africa, say investors

There are still reasons to be positive about South Africa’s economy, says Andrew Rymer, a senior strategist and Robert Davy, an equities fund manager for emerging markets at Schroders.

Although the country is plagued by high-interest rates, soaring inflation and load shedding that is slashing through growth expectations, reform progress by President Cyril Ramaphosa has been incrementally positive – even if slow, they said.

“In the near term, the main risk is from further power sector stress and the wider ramifications for the economy and corporate earnings.”

“Signs of a potential easing in the power crisis are on the horizon, but uncertainty remains, and this is a story for 2024 onwards. Eskom has already warned of severe shortfalls in power generation for the next 12 months. Politics presents some medium-term risk due to elections in 2024,” the group added.

Both Rymer and Davy said that the strength of the private sector should not be underestimated.

As a result of widespread pessimism, equity market evaluations and the currency are currently very cheap – making it a favourable investment.

The two experts from Schroders said that South Africa had enjoyed an improvement in terms of trade as a result of higher commodity prices since 2020, and the country’s national budget for February was relatively positive in that it showed signs of a longer-term commitment to fiscal consolidation – including a three-year debt relief plan for Eskom.

Regarding the improvement in terms of trade, the group said that this had driven the current account from a deficit to a surplus in 2022 and helped tax revenues, which was supportive of the fiscal accounts.

“South Africa’s debt-to-GDP ratio has climbed to around 70%, and the budget projects this to peak in 2025/6 at almost 74%. This is because Eskom debt is added over three years; excluding Eskom debt, the ratio has already peaked,” said the group.

The two did, however, note that commodity prices are deteriorating and the global economic cycle is fading – impacting the country’s current account deficit.

They added that although there are a handful of positive developments, the tax and expenditure figures are yet to prove optimistic.

Rymer and Davy said that investors must attempt to look through low growth expectations.

In the final quarter of 2022, GDP growth was lower than anticipated at 0.9% year-on-year and decreased by 1.3% on a quarter-on-quarter basis.

The deterioration of the electricity situation led to more power outages, which impacted economic activity, said Schroders.

Last year saw the highest number of blackouts in South Africa’s history, and it’s possible that Q1 of this year was even worse.

The group added that growth expectations for 2023 are sub 1%, with Eskom dragging down consumption and business activity.

Despite this, the outlook into 2024 and 2025 is more optimistic amid signs of improvement in the electricity supply and as the global economy recovers.

Following the South African Reserve Bank’s (SARB) surprising 50 basis point hike, the group said the rate cycle also appears to be peaking.

“Inflation should resume its move lower in the coming months as base effects ease,” Schroders said.

Regarding domestic energy constraints, the group said the private sector has picked up the slack and is investing heavily in independent electricity generation.

Davy reports that there has been a massive push to invest in power following the scrapping of licence requirements for private power generators over 100MW and new plans to double renewable energy procurement.

The country’s budget granted Eskom R254 billion in debt relief with the condition that the company collaborates with the private sector to run power plants and transmission networks.

This will enable the company to focus on transmission, which is a key bottleneck, said the two.

Although these reforms are positive in the long term, it will take time for private capacity to become operational, they added. The power crisis is expected to continue in 2023, especially during the southern hemisphere winter, but it is expected to improve in 2024 as more private power comes online and two new Eskom units function at full capacity.

This combination of factors should result in a reduction in load shedding by 2025.

Looking at the country’s valuation, it is cheap relative to its history. The group added that the rand is also relatively cheap currently.

The currency is around 30% below its historical average since January 1995 on a real exchange rate basis, and 13% on a last five-year basis.

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