Statement by Fundi Tshazibana, Alternate Executive Director, Edgar Sishi, and Felicia Dlamini–Kunene, Senior Advisors to the Executive Director for South Africa July 1, 2016

South Africa has made considerable economic and social strides since 1994, but faces significant challenges. Deep-rooted structural problems-infrastructure bottlenecks, skill mismatches, and harmful insider-outsider dynamics-have kept unemployment and inequality unacceptably high. Also, a confluence of external and domestic shocks, combined with heightened governance concerns and policy uncertainty, have weighed on confidence and growth. Though private balance sheets are still strong, vulnerabilities are elevated.


South Africa has made considerable economic and social strides since 1994, but faces significant challenges. Deep-rooted structural problems-infrastructure bottlenecks, skill mismatches, and harmful insider-outsider dynamics-have kept unemployment and inequality unacceptably high. Also, a confluence of external and domestic shocks, combined with heightened governance concerns and policy uncertainty, have weighed on confidence and growth. Though private balance sheets are still strong, vulnerabilities are elevated.

The South African authorities thank staff for the constructive engagement during the 2016 Article IV Consultation, and welcome the detailed assessment of the economy and analysis of relevant policy issues. Staff’s analysis is broadly in line with the authorities’ view of economic challenges, vulnerabilities and risks. The authorities are also concerned that the protracted period of low growth has resulted in declining per capita incomes. They agree with staff that structural reforms are imperative to raise potential growth and that they should implement tangible measures to boost confidence and enhance resilience.

Much progress has been made since 1994 to reverse the legacy of the past, yet the challenges remain. During this period of low growth and rising public debt, and as articulated in the National Development Plan (NDP), the authorities are placing emphasis on rebalancing the economy through structural reforms. Rebalancing will require difficult trade-offs and stronger cooperation with social partners. Reducing imbalances, including narrowing the budget deficit and consolidating the debt ratio, will provide a sound and predictable basis for achieving structural reforms. In this context, the authorities are focused on three key areas: restoring confidence and boosting investment, including minimizing regulatory obstacles to doing business; removing obstacles to faster employment creation; and strengthening state-owned entities (SOEs).

Recent Economic Developments and Outlook

GDP growth has decelerated from 1.6 percent in 2014 to 1.3 percent in 2015 due to external and domestic factors. In addition to lower commodity prices, electricity supply constraints were more binding in 2015, with adverse effects on mining and manufacturing production. A severe drought has also resulted in lower crop yields, while business and consumer confidence remained weak.

Official growth projections are reviewed bi-annually by the authorities. The current growth projection of 0.9 percent, tabled in February 2016, will be updated in October 2016. The authorities are aware that their current projections are higher than staff’s projection of 0.1 percent, and that for these growth projections to materialize, GDP would have to grow at around 3 percent for the remaining quarters of the year. The authorities’ new growth projections will, like staff, take into account the 1.2 percent GDP contraction in the first quarter of 2016 and second quarter data. Although downside risks prevail over the medium term, some upside risks are evident, including the resolution of electricity supply constraints, marginally lower inflation, some recovery in business confidence, and the likely finalization of mining legislation. The authorities estimate that resolution of energy constraints could add between 0.8 and 1 percentage points to the country’s growth. For this reason, the authorities expect growth to recover from 2017.

The South African Rand depreciated sharply against major currencies during 2015. The weighted exchange rate of the rand depreciated by 19.7 percent in 2015, and the real effective exchange rate (REER) fell to its lowest level since 2001. While the current exchange value of the rand is supportive of domestic-export growth, higher input costs and slower economic growth in South Africa’s main export trading-partner countries may erode potential gains from the depreciation, in addition to other inflationary and negative balance sheet effects. Gross gold and other foreign reserves provided import cover of 5.6 months during the first quarter of 2016. The authorities are committed to take every opportunity to build more reserves in order to bolster resilience against future shocks.

Inflation remained firmly within the target range of 3-6 percent during the course of 2015, with headline inflation averaging 4.6 percent for the year. However, due to rising food prices, which are expected to peak at 12 percent in the final quarter of 2016, and the recent upward revisions in the international oil price, headline inflation has breached the upper band of the inflation target range. While core inflation has remained relatively stable at 5.5 percent, recent data on firm profitability, proxied by gross operating surplus, also indicates a build-up of inflationary pressures. The South African Reserve Bank (SARB) expects core inflation to peak in the fourth quarter of 2016 and moderate in late 2017.

Fiscal Policy and Public Debt Management

Given the overall outlook for growth and heightened fiscal risks, the authorities are committed to pursuing a prudent and sustainable fiscal policy trajectory. In October 2015, the authorities strengthened the fiscal framework by reaffirming their commitment to a fiscal guideline that sets the expenditure ceiling in the outer years of every fiscal framework. Over the long term, the guideline is meant to maintain spending as a stable share of national income. This is complemented by a capital budgeting framework, which includes new appraisal tools for capital projects, strengthening of procurement regulations and more transparency on the full life cycle costs of large capital projects. The authorities also utilize an on-going process of expenditure reviews, which reconciles budget allocations with intended program outcomes, to inform decisions on expenditure reprioritization and improving program efficiency.

The 2016 Budget sets a course for more rapid fiscal consolidation and stabilizing the growth of public debt while carefully weighing the impact of the consolidation on domestic output. The authorities have proposed gross tax revenue increases of 1.5 percent of GDP and expenditure reductions amounting to 0.5 percent of GDP. The budget deficit is thus projected to close from an estimated 3.2 percent of GDP in 2016/17 to 2.4 percent in 2017/18, with net debt projected to stabilize at 46.2 percent of GDP in 2018/19. A primary surplus will be achieved in 2016/17. The Tax Review Committee, which was set up in 2014, continues its work on assessing the optimal tax composition to support growth and the authorities’ developmental objectives. Almost all of the expenditure reductions are being targeted at the public wage bill, and extracting more value for money in the other recurrent spending items.

The authorities are cognizant of the main risks to their borrowing program and actively manage these risks. In this regard, the authorities continue to reconcile the outlook with the debt sustainability targets, and clarified in the budget documents that they would take additional measures to achieve the above fiscal targets if conditions warrant. The medium term borrowing program is underpinned by strategic benchmarks for refinancing, interest, inflation and currency risks. The debt portfolio remains well within prudent limits. In addition to benchmarking, the borrowing strategy includes measures to manage refinancing risk by adjusting the composition and maturity of the debt portfolio.

SOEs and other public sector institutions are an important element of the authorities’ strategy for development and inclusive growth. In this context, the authorities are continuously monitoring the financial position of SOEs through a formal fiscal risk mechanism, and contingent liabilities are reported in the annual Budget. The 2016 Budget outlines four areas of reform that are intended to strengthen the ability of SOEs to support the NDP; namely, financial and operational stabilization, coordination and collaboration among different entities, rationalization and consolidation, and the enactment of a new governance framework.

Monetary Policy

Monetary policy in South Africa continues to confront the risks of rising inflation. In addition to rising food prices, currency weakness and volatility pose a risk to inflation. The substantial rand depreciation could generate higher inflation over the forecast period, if it persists. While the pass-through from the exchange rate to inflation has been low in recent years, there are indications that this may be increasing. The SARB estimates the pass-through to currently be half its long term average of about 20 percent. However, the authorities note that with substantial depreciation and falling corporate profits, even low levels of pass-through still generate meaningful amounts of inflation and there remains a risk that pass through may return to more normal levels.

Although the Monetary Policy Committee (MPC) has increased the policy rate by a total of 200 basis points since January 2014 and most recently by 25 basis points at the March 2016, the policy rate was kept on hold in the May 2016. The authorities indicated that monetary policy remains focused on its price stability mandate while sensitive to the state of the economy, within a flexible inflation targeting framework. Future monetary policy actions will be subject to data outcomes.

The authorities indicate that despite recent interest rate increases, monetary policy remains accommodative as the policy rate is low from a historical perspective and is near or below policy rates in peer countries. Therefore, with growth continuing to undershoot potential, monetary policy is still providing stimulus to help absorb surplus capacity. The pace of tightening has also been gradual relative to previous hiking cycles. The authorities are of the view that modest tightening of policy should keep inflation expectations in check.

Financial Sector Policy

The South African financial sector is well regulated and continues to attract global investment flows. The SARB actively monitors the compliance of the banking sector with the country’s regulatory framework and also monitors the fundamental capacity of financial institutions to deal with economic headwinds and regulatory changes. The banking system remains resilient, with the authorities’ stress tests indicating that even under severe adverse scenarios, capital adequacy for the participating banks remains above the regulatory requirements. Total banking assets exceeded 120 percent of GDP in 2015, with a combined total capital adequacy ratio of 14.19 percent. The level of NPLs is low, at around 3 percent of gross loans and advances at the end of 2015, and level of impaired advances to total loans and advances was 3.12 percent at the end of 2015. Therefore, the authorities view the risk management frameworks of the banks as being robust.

Since the completion of the 2014 FSAP, the authorities have initiated significant financial regulatory architectural reforms. The Financial Sector Regulation Bill, the enabling legislation for shifting to a Twin Peaks model of financial sector regulation, is expected to be enacted towards the end of 2016. Under the Twin Peaks model, two regulators will be established, a Prudential Authority within the SARB and a Financial Sector Conduct Authority. The Prudential Authority will focus on institutional soundness (including prudence and solvency), while the Financial Sector Conduct Authority will focus on business conduct or consumer protection. A “shadow” Prudential Authority structure was established in the SARB at the end of May 2016. The Bill will also address two areas of concern raised in the FSAP, namely conglomerate supervision and strengthening oversight of over-the-counter derivatives.

Progress is being made on a comprehensive resolution framework for banks based on lessons learnt from the successful resolution of African Bank. The ultimate objective of these reforms is to significantly reduce the state’s contingent liability relating to the financial sector. In August 2015 the authorities published a Resolution Framework Policy Paper. This policy paper outlines an approach that is closely aligned to the FSB’s Key Attributes for Effective Resolution Regimes for Financial Institutions. Its main features are the introduction of a depositor guarantee scheme, a bail-in framework, and a creditor hierarchy in line with the key attributes. Legislation to give effect to this policy is expected to be introduced to parliament during the fourth quarter on 2016.

Macro-Financial Linkages

The authorities welcome the assessment of macro-financial linkages in staff documents. They reiterate that South Africa’s reliance on foreign flows must be viewed within the context of the depth and liquidity of domestic financial markets, and the flexible exchange rate. In line with trends in other emerging markets, net out-flows from equities continued during the first few months of 2016, with year-to-date net sales by non-residents amounting to R48.5 billion. However, there have been net purchases of domestic bonds by offshore investors amounting to R13.4 billion as of May 31, 2016.

The authorities’ welcome staff’s detailed assessment of global and regional spillovers, in particular the growing importance of China’s growth for South Africa through the commodity trade channels. The authorities are also carefully monitoring spillovers. Overall, the SARB assesses financial stress as emanating from five sources; namely: a possible sovereign rating downgrade to non-investment grade (especially local currency), spillovers from excessive volatility and risk aversion in global financial markets, protracted period of slow economic growth in the Euro region and lengthy rebalancing of growth, low domestic economic growth and fragility of global banks.

The authorities agree that a combination of commodity-price driven macro-fiscal shocks and declining growth rates in Sub-Saharan economies will negatively affect firms’ profitability and South Africa’s economy. They are also cognizant that while the largest outward spillover of lower growth to the rest of Africa maybe limited, for countries in the Southern African Customs Union the slowdown in the South Africa economy has a significant impact.

Structural Reforms

Economic inclusion remains a key challenge for South Africa. The authorities are committed to raising growth and creating jobs over the medium and long term. In this regard, they recognize the urgent need to build partnerships between the state, the private sector, the labor movement and civil society in order to realize the goals of the NDP. The Cabinet has approved a Nine-Point Plan, which is an implementation program for the NDP to prioritize sectors with high potential to boost employment and growth. The authorities have proposed measures to support small businesses, manufacturing, tourism and revitalization of the agricultural value chain.

The authorities believe that government and private sector initiatives aimed at expanding infrastructure, transforming cities, supporting SME development and regional integration will boost growth and employment. The authorities are working with business to identify measures that will restore confidence, boost private sector investment, remove obstacles to employment creation in key sectors and identify regulatory hurdles to doing business. In partnership with the private sector, the authorities have established a Small-Business Innovation Fund, with over R1 billion already committed, to support the development of small enterprises. Work is also ongoing to put in place measures to minimize protracted strikes and review the employment effects of compensation agreements and the introduction of a national minimum wage.

Interventions already in the 2016 Budget include the implementation of a public infrastructure investment program for which R865.4 billion has been allocated; as well as greater support for the country’s eight metropolitan areas to transform the urban landscape and incentives to the automotive industry. The Presidential Infrastructure Coordination Commission continues to coordinate public infrastructure project plans across spheres of government and identify skills gaps and mechanisms to speed up project delivery.

The Renewable Energy Independent Power Producer program is a major initiative by the authorities to increase the country’s energy supply capacity, but also significantly boosting private investment in the sector, while also facilitating further upstream investments. To date, 92 projects amounting to over $13 billion have been approved. The authorities intend to use the program to boost electricity capacity by 17 000 MW by 2022 and will expand it to include other technologies.


The authorities recognize that South Africa faces exceptionally difficult global and domestic economic conditions over the near and medium term and difficult choices and tradeoff are necessary. As recognized in the staff report, appropriate policy choices have been made in managing fiscal, monetary and financial sector policy.

The authorities do, however, realize that monetary and fiscal policy are not sufficient to respond to the negative outlook for growth, and the need to raise potential output and aggregate demand in the near to medium-term. The authorities are focusing on building on the strengths of some positive fundamentals that characterize the South African economy and are placing urgency on effective implementation of existing plans.

Finally, the authorities look forward to the Executive Board’s conclusion of the 2016 Article IV Consultation and appreciate the engagements with the Fund on the critical goal of achieving inclusive growth for the South African economy.