South Africa May Join the Vanguard of Developing Markets
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The uniting of Brazil, Russia, India, and China under the acronym BRIC constitutes an acknowledgment of the significant role that developing economies are likely to play in future global growth and investment opportunities. BRIC encapsulates the importance of the three largest developing countries (Brazil, India, China) and stresses the notability of economic transitions in formerly socialist countries such as Russia. But as interest in BRIC has heated up, Africa—traditionally a central topic in economic development work—has been conspicuous by its absence. In many ways, however, the nation of South Africa can be thought of as the African BRIC: all in all, it’s just another BRIC in the emerging market wall.
South Africa is Africa’s single largest economy and fourth most populous country. Its economy in 2008 was larger than the next two largest economies (Nigeria and Angola) combined. The per capita GDP (gross domestic product) of about $10,000 in 2008 (see Table 1) is the third highest in sub-Saharan Africa, following Equatorial Guinea and Botswana. South Africa’s technological and industrial base is one of the most sophisticated on the continent, and it has an enviable road and transport system.
Table 1: Comparative National Statistics, South Africa versus BRICs, Nigeria, and the US
Sources: population, age, education, GDP, and GDP/capita estimates from the CIA World Factbook, May 18, 2009; corruption data from Transparency International’s 2008 Corruption Perceptions Index, May 18, 2009; economic freedom scores from the Heritage Foundation’s 2009 Index of Economic Freedom, May 19, 2009.
There is serious inequity in the distribution of economic benefits. However, the government’s Black Economic Empowerment program has begun to address some of these inequalities.
Most of the country lies below the Tropic of Capricorn and has a relatively temperate climate. During the colonial era, the similarities between South Africa’s and Europe’s climates and soils facilitated the transplantation of various European technologies and agricultural practices into South Africa. This is one reason why colonial South Africa attracted such a large European population, many of whose descendants remained in Africa.
In the 1940s and 1950s, the sizeable minority white population (about 20% in 1911; approximately 10% today) pressed to institutionalize a legal framework creating the notorious apartheid system that was finally rejected and dismantled only in the 1990s. While there is no defending apartheid, the approximately 60 years of independent white rule did have some positive consequences in terms of retaining the human capital required for building the industrial base and for establishing a fairly sophisticated banking and financial system, relatively effective rule of law, and a working parliamentary democracy.
Under apartheid, native African and other nonwhite populations benefited little from either South Africa’s rule of law or its parliamentary democracy. However, the relatively peaceful political transition dismantling apartheid essentially extended these benefits to the full population. As a result, the business climate is one of the most open on a continent of nearly 50 countries. South Africa ranks second only to Botswana on the Heritage Foundation’s 2009 Index of Economic Freedom.
South Africa is well known internationally as a gold, platinum, and commodities producer, but nearly two-thirds of its GDP is in fact driven by the service sector, with about 30% coming from industry and less than 4% from agriculture, tasty wines notwithstanding. Even 30 years ago, services were the largest single economic sector, and agriculture’s contribution was already minimal. The service sector has increased its dominance in the economy since then, but the overall structure of GDP has not changed qualitatively for several decades.
Figure 1 shows the evolution of South African GDP from 1980 to 2008. Consumption constitutes over 70% of the economy, and government spending is moderate at about 15%. Fixed business investment accounts for about 15% as well. The overall expense structure of GDP has remained fairly consistent over the last 30 years, although after 2004 South Africa’s small trade surplus turned into a small trade deficit (approximately 3.3% of GDP in 2008). Figure 2 shows real GDP growth and CPI (consumer price index) inflation rates from 1981 to 2008, and reveals that although South Africa has been growing, it has started to struggle with inflation.
Figure 1: South African GDP by Component, 1980–2008 (real GDP, using 2005 USD)
Source: Economist Intelligence Unit, May 13, 2009.
Figure 2: Economic Growth and CPI Inflation in South Africa, 1981–2008
Source: Economist Intelligence Unit, May 13, 2009.
Until the 1980s, South Africa pursued an ISI (import substitution industrialization) strategy that concentrated on protective tariffs and other foreign exchange controls to create domestic industries. Because South Africa’s approach was less reliant than other ISI programs on the creation of large state enterprises and monopolies, the liberalization and structural adjustment policies of the late 1990s were less of a shock to South Africa’s economy than they were to the economies of many emerging markets. South African firms did have to innovate in order to compete internationally, but local executives already had substantial market experience, and many have successfully adapted to the new system.
The legacy of apartheid has created a dual economy. A small, primarily white minority has access to infrastructure and services that more or less match those in any developed country. A large, mostly black African population lives in conditions more typical of developing countries, with poor infrastructure and services, underemployment, and limited access to health care. Overall, circumstances for the underprivileged tend to be better than in most of Africa, but the contrast between developed and undeveloped areas of the country is still quite marked.
The correlation of race and class differences makes the potential for interracial violence a risk that requires constant monitoring. So far, racial tensions have been largely moderate, in part because black Africans have controlled the government since the mid-1990s without engaging in expropriatory redistribution programs. In addition, ethnic tensions are more multidimensional than simple black–white distinctions, and include regional ethnic cleavages.
Moderate rates of economic growth—averaging 3%–5% for most of the period since 1994—have helped soothe social tensions by allowing South Africans to divide a growing pie. The present downturn, the first since the end of apartheid, will be an important test for newly elected president Jacob Zuma and his African National Congress.
South Africa has a small but growing black middle class, a source of national optimism, even if its growth has been slower than hoped. The Black Economic Empowerment affirmative action program is more aggressive than similar policies in the United States and elsewhere in promoting black Africans to economically relevant positions. Many white South Africans have felt that this significantly curtails their economic opportunities at home and have moved abroad. This exodus of highly trained white South Africans raises concerns that a “brain drain” may limit the country’s economic competitiveness moving forward, particularly in the high-end service sectors.
Although South Africa’s infrastructure is among the best in Africa, it has suffered from underinvestment in recent years. The most obvious example is the electricity infrastructure: underinvestment in new generating capacity resulted in rolling blackouts across the country in 2007 and 2008. The interruptions inhibited, among other things, mining operations, helping to push world gold prices higher as investors feared large drops in new supply. The blackouts were blamed on insufficient capital investment linked to failed efforts at privatizing the power industry.
South African companies are frequently called on to provide human capital and technological capacity for economic development efforts in neighboring countries. The telecom sector has grown rapidly as the opportunity for technological leapfrogging in communications has expanded all over Africa.
The South African rand (ZAR) is one of the most actively traded emerging market currencies. Historically, the rand has had an unusually large following as an attractive alternative to European and American currencies, and has often been considered safer than other emerging market currencies because of South Africa’s large gold reserves, gold production, and developed and orderly banking system.
Figure 3 shows the value of the rand in terms of euros and dollars over the last 10 years. For most of that time, it has hovered in the range of six to eight rand per dollar (0.125–0.166). But in 2001 and again during the current crisis it weakened to as low as 12 rand per dollar.
Figure 3: South African Rand (ZAR) versus Major Currencies, January 1999–May 2009
Source: Bloomberg, May 18, 2009.
The recent weakness (and subsequent strength) in the rand can be attributed to portfolio investment flows, the flight to US Treasuries, and heightened risk aversion in the present crisis. The ZAR’s weakness around 2001 is harder to explain, however. It is most likely related to lack of confidence in then-president Thabo Mbeki, possibly triggered by his aggressive denial (later retracted) that AIDS is a real problem in South Africa. The rand’s early slide begins only a month or two into his presidency, suggesting that it can be highly sensitive to South African politics.
South Africa’s stock market has performed more or less in line with other emerging markets over the last 10 years, as shown in Figure 4, which compares the growth of the MSCI South Africa gross return index in US dollars with other market indexes. Figure 4 indicates that South Africa did underperform somewhat during the peak of the emerging market and commodities boom, a drag likely linked to the rolling power outages mentioned above.
Figure 4: Relative Equity Index (Standard Core), January 1998–April 2009
Source: Bloomberg, May 16, 2009.
Figure 5 and Table 2 provide greater detail on South Africa’s equity performance and its quantitative features. Figure 5 shows that South Africa’s risk–return characteristics are very similar to those of BRIC and emerging market indexes. The case for South Africa is improved somewhat by remembering that the competing indexes are more diversified than South Africa alone, and should therefore have lower total risk.
Figure 5: Equity Risk–Return Chart, MSCI Total Return Indexes, Standard Core Returns in USD, January 1998–April 2009
Source: Bloomberg, May 16, 2009.
Table 2: Quantitative Returns Analysis for Equity Indexes, January 1998–April 2009
Source: Bloomberg, May 16, 2009.
Table 2 provides further quantitative information, first comparing South Africa and other indexes using the world return as a benchmark, then looking at South Africa’s performance benchmarked to the other indexes. The table shows that South Africa has many characteristics of a solid BRIC. In fact, it appears to be a little less risky (measured with either beta or total risk) than the BRIC economies.
South Africa is slightly less correlated with world markets than the BRIC or emerging markets indexes, and more correlated than the frontier markets index. In addition, South Africa’s markets display unusually low monthly autocorrelation, suggesting that they are more efficiently priced than many other markets.
South Africa can certainly be construed as an African BRIC. It is the dominant economy of its region, has a relatively developed physical and financial infrastructure, is relatively open to the world economy, and has a risk–return profile with attractive correlation and efficiency characteristics.
A few key differences, however, distinguish South Africa from the BRICs proper. At around 45 million, its population is more modestly sized. The portion of South Africa’s labor force that can offer substantial value is not as highly trained as China’s, India’s, or Russia’s. And South Africa is not currently a net exporter.
South Africa obviously has its own unique political risks. Growth decelerated in 2008 and may turn negative in 2009 for the first time in 17 years, even as inflation runs above 6%. With president Jacob Zuma taking office during the most painful economic period since the end of apartheid, it may be difficult to resist political pressures to expropriate and redistribute, or to pursue heterodox policies to maintain political control of a country in economic pain. It is still too early to tell how those pressures will play out, but investors will need to monitor them carefully.
–Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Consulting, an independent consulting firm specializing in quantitative, emerging market, and SRI research and strategy.