South Africa - the post-apartheid economic miracle

Within the span of a decade, South Africa has revitalised its previously sanctions-gripped apartheid economy, restructured state institutions to improve the delivery of public services and established a competent macroeconomic policy framework. The International Monetary Fund (IMF) describes South Africa's socio-economic gains since democratisation as simply 'remarkable'.

Recent growth performance has been robust and the near-term outlook is broadly favourable, with economic activity supported by prudent policies and a positive environment for exporters. Consequently, the rainbow nation is enjoying its longest expansion on record, largely thanks to rising consumer spending, improving investment and a recovery in the manufacturing sector despite the strength of the rand.

Recent data confirms that South Africa achieved 28 consecutive quarters of positive growth, its longest business cycle upswing in 60 years. Rand Merchant Bank commented: "This economy is going great guns. It confirms what many have felt and data like the business confidence index has been indicating for some time."

According to the IMF, gross domestic product (GDP) grew in real terms from an annual average of 0.8% during the final decade of apartheid to a respectable annualised 3% average growth in the past 10 years. The nation's revival is all the more impressive when set against a background of socio-political stability.

Economists are generally upbeat about the sustainability of South Africa's recent growth. Riaan le Roux of Old Mutual reckons: "Another year of 4%-plus growth is very possible in 2006, as long as things do not go wrong globally or inflation pressures do not force the Reserve Bank to tighten policy aggressively."

Last year's growth was estimated at between 4.4-5%, the highest since 1984. Encouragingly, GDP per capita is now slowly rising because the economy is finally on a structurally higher growth path with the annual growth rate since 2002 averaging at 4%.

Despite these advances however, huge challenges remain. Unemployment still affects nearly 26% of the workforce and the acute income and wealth disparities inherited from the apartheid era still persist. The HIV/Aids epidemic is also inflicting untold human suffering and uncounted economic costs. About one in every six adults is thought to be HIV/ Aids positive, and life expectancy is markedly declining.

The authorities have undertaken long-term programmes to tackle the country's dire social problems which, if left unsolved, could undermine the country's growth prospects through an adverse impact on labour productivity.

Powerful growth momentum

The Medium-Term Budget Policy Statement, presented last October, aims to overcome mass unemployment and abject poverty by injecting a powerful growth momentum. It projects annual growth of 4.5% over the next five years before expanding to 6% between 2010 and 2014.

Finance Minister Trevor Manuel explained his policy as "a focus clearly on accelerating growth... [which] makes a redistribution of wealth and income possible through the process of development and not at its expense". He added that "several infrastructure sectors are critical for long-term growth and lowering the costs of doing business".

Government plans to invest about R200bn ($31.4bn) over the next five years on infrastructure projects, as well as improving public services at municipal level - notably in the education and health sectors. But robust growth requires progress on important areas including reducing skills shortages, tackling market efficiencies, improving infrastructure, stimulating technological innovations, raising the overall savings rate, as well as improving the climate for private sector investment.

After decades of isolation, the economy appears well positioned to achieve long-term growth targets. On the external trade front, other mineral-rich African countries could learn from South Africa's trade flows. Since the mid-1990s, the structure of trade has become more diversified, reflecting an increase in manufactured exports and lower dependence on primary commodity exports.

A more balanced economy has facilitated a gradual liberalisation of the country's currency controls, leading to greater domestic and foreign investment. As one banker remarked: "The political situation is stable. More people understand the country. It is well researched, with strong infrastructure and a strong financial system."

A recent law permits unit trusts and commercial banks to invest 3% of their total financial assets offshore, or 40% of their regulatory capital. But one-half of banking capital must be invested within the African continent.

The National Treasury estimates that capital outflows could reach R20bn ($3.1bn) as banks take advantage of the new law. The 2006/07 budget is expected to lift the annual R750,000 ($11,792) limit on the amount that individuals can freely invest overseas without official approval.

Currency stability

The rand, Africa's most liquid-tradable currency, has doubled in value since its historical lows of 13.89:$1 in December 2001. Last year, the 12-month moving average was R6.362:$1, compared with $6.459:$1 in 2004. It has proved resilient against major currencies, making forex hedging easier for investors and issuers of corporate bonds.

The rand is a popular hedging tool for international financiers. The average daily trade has surged since 1998 to almost $14bn. A resilient currency reflects healthier economic fundamentals - notably a manageable external debt of $29.5bn at the end of last year, representing 12.4% of GDP. Other economic factors contributing to the rand's strength include sizeable official reserves of $20bn (including gold); a modest 2005/06 budget deficit expected at 1% of GDP; and benign inflationary pressures with core inflation (exeluding mortgage payments) capped within the South African Reserve Bank (SARB) 3-6% target band. Most economists expect inflation to average 5% this year.

It is no surprise that South Africa's sovereign credit rating has improved steadily in recent years. Global ratings agencies such as Standard & Poor's (S&P) and Moody's Investors Service rank the country as a lower-risk investment grade, or BBB+/Baa2 borrower, with positive outlook. The next credit upgrade could be an 'A' investment grade status, on a par with many East Asian economies.

The risk of a steep depreciation of the rand is negligible although an overvalued rand does cause problems for exporters. In fact, a stronger unit in the past two years has dented corporate earnings in rand terms and caused further job losses in mining and manufacturing sectors. As Lesetja Kganyago, director-general of the National Treasury observes: "The volatility of the currency cannot be good for business planning."

Monetary policy is tilting towards a tightening cycle. The SARB governor, Tito Mboweni, warns: "It is now a question of when, not if, rates will go up." The benchmark repo rate (set by the SARB) could remain at 7% in the near-term, with a possible 0.5% hike in the second half of 2006. On the plus side, the US Federal Reserve Board has signalled its tightening cycle may soon end, easing pressure on other emerging-market central banks (including SARB) to address declining interest rate differentials versus US dollar money rates. Looking ahead, South Africa's interest rates are unlikely to rise steeply given the government's emphasis on economic growth and sustained job creation.

A bull market

The broader market, as measured by the Johannesburg securities Exchange (JSE) AllShare Index rose 44% last year, hitting new highs of 18,312 on 27 December 2005. The index was up 25% in US dollar terms. Financial and industrial shares that are sensitive to the local economy outperformed export-oriented manufacturing stocks - although the top 20 resource stocks gained a whopping 68% thanks to strong rallies in metal markets, especially gold, platinum, copper, zinc and iron ore.

Falling interest rates and strong global commodity prices have supported the markets in the past two years. As the prime rate, that is the interest rate set by South African deposit banks, fell steeply from 17% in September 2002 to its current 10.5%, corporate earnings rose because of cheaper borrowing costs and buoyant consumer spending. Retailers and banks have provided healthy returns to investors in recent years.

Another supportive factor for South Africa's stocks is the strong interest of emerging-market funds resulting in increased capital inflows. Between January and October 2005, net purchases by foreign investors totalled R46bn ($7.23bn), up from R33bn ($5.10bn) in 2004.

The JSE, arguably the most sophisticated of the developing world's bourses, appeals to foreign investors. It uses the London Stock Exchange Electronic Trading Service (Set) system. Further relaxations of forex controls should encourage more foreign portfolio investments into South Africa in 2006. The markets are not generally perceived as being overvalued as the price/earnings ratio on the benchmark JSE All-Share Index at the end of last year was 14.2 times earnings, with dividend yield averaging 2.6%.

The price/earning ratio is the measurement of ordinary share price to earnings per share (EPS) over a rolling 12-month period. The higher the ratio, the higher the market expectations of future earnings growth. According to US investment bank Merrill Lynch, the average EPS of major South African companies will increase by 15% over the next 12 months. Investors can find excellent value in JSE-listed companies. Real growth in corporate earnings and dividends could exceed current projections if the economy grows at an annual 6% over the medium term.