South Africa: Selected Issues

International Monetary Fund. African Dept.

doi:10.5089/9781475568615.002.A001

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South Africa: Selected Issues

Author: International Monetary Fund. African Dept.

Publication Date:: 07 Jul 2016

eISBN:: 9781475568615

Language:: English

Keywords:: ISCR; CR; China; debt; Mining sector; Exports; Commodity price shocks; Export prices; Africa; Global

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South Africa: Selected Issues

Abstract

South Africa: Selected Issues

THE IMPACT OF CHINA’S GROWTH SLOWDOWN AND LOWER COMMODITY PRICES ON SOUTH AFRICA¹

This paper estimates the impact of China’s growth slowdown and the recent large decline in commodity prices on South Africa. It seeks to identify the key channels through which a shock to China’s economy is transmitted to South Africa, as well as the propagation of this shock within the economy. Our findings suggest that China’s growth slowdown is likely to have a significant impact on South Africa’s economy, with commodity prices and global financial conditions the main transmission channels. Sectoral interlinkages are found to play an important amplifying effect, notably through employment, corporate profitability, and wealth effects.

A. Linkages between South Africa and China

1. Increasing trade linkages have made China the most important single-country destination for South African exports. China now absorbs 10 percent of South African exports compared to around 2½ percent in the mid-2000s. This trend reflects not only rapid growth in China and the associated rise in China’s demand for commodities, but also weak demand from the Euro Area whose share of South Africa’s exports has declined to 15 percent from more than 20 percent over the same period. Sub-Sarahan Africa (SSA) remains the most important regional destination for South African exports.

2. China’s impact on the South African economy is magnified by China’s role in the global economy and commodity markets.

China accounts for around 17 percent of global output in PPP terms compared to 16 percent for the US. In terms of imports, China accounted for approximately 16 percent of the world total compared to 14 percent for the U.S.
More than 60 percent of the world’s traded iron ore—South Africa’s main mineral export—is absorbed by China. China also plays a large role in other commodities that South Africa exports including coal, gold, and platinum. As a result, China plays a key role in determining global demand and prices of South Africa’s main commodity exports, which now account for 34 percent of total goods exports (51 percent when manufactured commodities are included). China is also one of the world’s largest oil importers, and therefore plays an important role in setting the price of South Africa’s oil imports (though supply factors have been key for prices), which account for around 16 percent of total goods imports.

3. Capital flows into South Africa from China are modest, but financial spillovers are increasing.

Both direct investment and portfolio flows from China are increasing, but remain modest relative to capital flows from the UK and the US. However, as noted in the April 2016 Global Financial Stability Report, financial conditions in China are now increasingly affecting global financial conditions, mainly through equity and FX markets.

The Johannesburg Stock Exchange (JSE) equity index beta with China’s HSCEI index (after controlling for movements in the VIX and S&P500) has increased to 0.2 from less than 0.1 in 2005, likely reflecting South African corporates increasing reliance on exports to China. Also, the share of mining companies in the JSE has declined to 13 percent in April 2016 from 42 percent at end-2011. Though this partly reflects the increasing valuation of non-mining companies, the decline in importance of the mining sector in the JSE points to sizeable wealth effects from the decline in commodity prices.
The FX beta with the Chinese renminbi (after controlling for a U.S. dollar index and the VIX) has increased to 1.3 since August 2015 from 0.9 in a longer sample starting in January 2013, and is one of the highest among EM peers. The increasing correlation with the Chinese renminbi suggests that it may be acting as a proxy for market confidence in Chinese policymakers’ ability to manage the rebalancing and slowdown of the Chinese economy, and thus the impact on EM commodity exporters.

B. Assessing the Impact of Lower Growth in China on South Africa

4. A VAR analysis suggests a slowdown in China has a significant impact on South Africa, and exceeds that from other countries. A simple VAR estimated on quarterly real GDP growth in the U.S., the European Union, China, and South Africa from 2000 onwards suggests that a one percentage point decline in China’s real GDP growth would lower South Africa’s growth by 0.3 percentage points after one quarter.² This is smaller than the impact of a similar shock to the U.S. or E.U. growth and broadly consistent with estimates in other studies including the World Bank’s June 2015 Global Economic Perspectives. However, the impact of a shock to China’s growth rises to 1 percentage point when the sample is restricted to the past five years (2010-15), significantly exceeding that of the U.S. and E.U. This result is consistent with our earlier finding that both trade and financial linkages with China have increased significantly in recent years. The period 2010-2015 also coincided with an increase in the importance of structural bottlenecks in South Africa (e.g. electricity shortages, protracted strikes, etc): to the extent that these structural factors disproportionalty affected exports to China (e.g. strikes in the mining sectors), the VAR may overstate the impact of a slowdown in China. On the other hand, the use of overall GDP—rather than GDP in the secondary sector which is more closely related to the demand for South African export commodities and where the slowdown in sharper, especially in nominal terms—could underestimate the impact of a growth shock in China.³

Spillovers from the US, EU, and China to South Africa

^{^1/}Impact of a 1 percentage point negative growth shock on South Africa’s growth after 1 quarter.

^{^2/}Annual frequancy.

Source: Staff estimates

Spillovers from the US, EU, and China to South Africa

US		EU	China
	Latest sample (2010-15) ^2/
Growth impact ^1/	−0.3	−0.2	−1.0
	Full sample (2000-15) ^2/
Growth impact ^1/	−0.4	−0.7	−0.3

^{^1/}Impact of a 1 percentage point negative growth shock on South Africa’s growth after 1 quarter.

^{^2/}Annual frequancy.

Source: Staff estimates

Spillovers from the US, EU, and China to South Africa

US		EU	China
	Latest sample (2010-15) ^2/
Growth impact ^1/	−0.3	−0.2	−1.0
	Full sample (2000-15) ^2/
Growth impact ^1/	−0.4	−0.7	−0.3

^{^1/}Impact of a 1 percentage point negative growth shock on South Africa’s growth after 1 quarter.

^{^2/}Annual frequancy.

Source: Staff estimates

5. Commodity prices and tighter global financial conditions are the main transmission channels. In order to identify the relative importance of different transmission channels we follow the approach in Bayoumi and Swiston (2008) and augment the baseline specification described above with additional explanatory variables to capture potential transmission channels: trade, export and import commodity prices. Financial spillovers (proxied by U.S. financial conditions) are also included to capture global confidence effects that could also be important. To capture the importance of each transmission channel we compare our baseline VAR with four auxiliary VARs where variables that capture the different transmission channels are included as exogenous variables one at a time.⁴ In particular let r_t be the impulse responses from the baseline VAR and $r_{t}^{t r a d e}$ the impulse response functions from the auxiliary VAR where the trade channel is included as an exogenous variable. The importance of the trade channel in transmitting shocks to growth in China can then be captured as the difference between the impulse response functions from the two VARs:

B_{t} = r_{t} - r_{t}^{t r a d e}

The results suggest that the decline in South Africa’s export commodity prices resulting from a shock to China’s growth has a large and persistent impact on output growth in South Africa. The importance of this channel (which will be explored in more detail later) is consistent with our earlier discussion which suggests that China plays a major role in determining global demand for South

Africa’s main commodity exports. Financial spillovers that may capture global confidence effects are also important, pointing to the increasing impact of Chinese economic developments on global confidence and financial markets. Spillovers to trade volumes are small and positive, suggesting the positive impact of exchange rate depreciation on total South African exports outweighs the impact of a decline in trading partner growth on the demand for South African exports. Declining import commodity prices (mainly oil) provide a partial offset.

C. Domestic Propagation of Commodity Price Shocks

6. Sectoral interlinkages between the commodity sector and the rest of the economy are significant. We use an input-output (IO) table to identify the industries that are directly or indirectly linked to the mining sector in South Africa.⁵ The industry with the most important upstream linkages (sectors that are used as intermediate inputs by the mining sector) with the mining sector is transportation. Important downstream linkages (sectors that use output from the mining sector as inputs) include: metal production; petroleum, chemical, and mineral production; and other manufacturing. The mining multiplier calculated from the IO table suggests a R1 million increase in mining output raises output in the overall economy by R1.8 million (i.e. the indirect effect is R0.8 million). This is slightly higher than the mining and quarrying sector multiplier estimated by the South African National Treasury and the Chamber of Mines.⁶

7. A structural VAR analysis confirms that the impact of commodity price shocks is amplified by sectoral interlinkages.

We estimate a sectoral structural VAR identified using multipliers from the input-output table in order to investigate the importance of sectoral interlinkages in amplifying the impact of commodity export price shocks. In particular we estimate the following structural VAR:

A Y_{t} = c + B (L) Y_{t} + C (L) x_{t} + u_{t}

where Y_t is a vector of endogenous variables which includes a South Africa-specific commodity export price index $(P_{t}^{e x})$ and the growth contributions of real value-added in the mining $(V A_{t}^{mining})$ and non-mining $(V A_{t}^{n o n - mining})$ sectors. x_t is a vector of exogenous variables which includes a South Africa-specific commodity import price index, growth in South Africa’s main trading partners, and a measure of global financial conditions.⁷ The structural VAR is identified using parameter restrictions derived from the IO table:

A = [\begin{matrix} 1 & 0 & 0 \\ b_{1} & a_{11} & a_{12} \\ b_{2} & a_{21} & a_{22} \end{matrix}], Y_{t} = [\begin{matrix} P_{t}^{e x} \\ V A_{t}^{\min i n g} \\ V A_{t}^{n o n - \min i n g} \end{matrix}]

where a_ij is a coefficient measuring the magnitude of transactions between the mining and non-mining sectors taken from the IO table and b_i are parameters to be estimated.
The results suggests that a 10 percent fall in the growth rate of export commodity prices would reduce real GDP growth by nearly 0.2 percentage points after two years.⁸ The direct impact coming through the mining sector is relatively small and dies out relatively quickly. However, the indirect impact on upstream and downstream industries is more prolonged and larger than implied by the IO analysis, suggesting that a decline in commodity export prices has a negative impact beyond that captured in the IO table. A caveat is the fact our VAR does not account for the increasing importance of structural bottlenecks in the economy (e.g. electricity), which coincided with a period of declining commodity prices. This could affect our estimate of the overall impact of a decline in commodity prices and—to the extent these bottlenecks affect the mining and non-mining sectors differently—the relative importance of the direct and indirect effects.⁹

8. Commodity price shocks are transmitted to the economy mainly through changes in corporate profitability and employment. We use the approach in Bayoumi and Swiston (2008) described above to quantify the relative importance of four potential channels that transmit the impact of a shock to export commodity prices on the economy: the real effective exchange rate (REER), employment, and the growth rates of net wealth and the gross operating surplus in the economy. Our results suggest that the main channels whereby lower export commodity prices spillover to non-mining sector growth include lower economy-wide income resulting from the decline in employment and lower corporate profitability. A decline in net wealth in the household and corporate sectors also plays a role. The REER does not play a substantial role, which is consistent with the slow responsiveness of export volumes to the REER depreciation observed in recent years.

D. Conclusion

9. China’s growth has been found to have large spillover effects on South Africa, transmitted mainly through commodity prices and global financial conditions, and amplified by sectoral interlinkages. The analysis in this paper suggests that rising trade and financial linkages with China, as well as China’s large role in the global economy and commodity markets, has increased the impact of a growth slowdown in China, which now exceeds that of a growth slowdown in the U.S. and the E.U. Commodity prices and tighter global financial conditions are the main international transmission channels. Domestically, the impact of a fall in commodity export prices is amplified by linkages between the mining and non-mining sectors, and is transmitted to the economy through large falls in mining sector employment, corporate profitability, and wealth effects.

References

Bayoumi, Tamin, and Andrew Swiston (2008), “Spillovers Across NAFTA”, IMF Working Paper WP/08/3.
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Gruss, Bertrand (2014), “After the Boom: Commodity Prices and Economic Growth in Latin America and the Caribbean,” IMF Working Paper WP/14/154.
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- Export Citation
IMF (2014), “The Unconventional Energy Boom in North America: Macroeconomic Implications and Challenges for Canada”, IMF Country Report No. 14/28.
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IMF (2014b), “South Africa’s Exports Performance: Any Role for Structural Factors?”, IMF Country Report No. 14/339.
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Pesaran, Hashem, and Yongcheol Shin (1998), “Generalized Impulse Response Analysis in Linear Multivariate Models”, Economic Letters Vol. 58, Issue 1.
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Prepared by Manabu Nose, Magnus Saxegaard, and Jose Torres.

The VAR is estimated on seasonally adjusted annualized quarterly real GDP growth and one lag of the endogenous variables as suggested by different information criteria using data from 2000Q1-2015Q3. The results are derived using generalized impulse response functions (GIRF) proposed by Pesaran and Shin (1998) which are unaffected by the ordering of the variables in the VAR.

Estimation using real GDP in China’s secondary sector is hampered by data limitations and would also complicate a cross-country comparison.

The trade channel is captured by quarterly annualized growth in the volume of goods exports. The export and commodity price channel is captured by the growth rate of a weighted average of the world price of South Africa’s most important export commodities (aluminum, diamonds, coal, platinum, and iron ore). To aid identification the import price channel is identified as the difference between the commodity terms of trade and export commodity prices. The financial channel is captured by the Chicago FED financial conditions index, which captures a broad range of U.S. financial indicators including credit spreads, the VIX, and liquidity measures. A specification which instead uses the VIX index to capture the financial channel yields broadly similar results.

We use the Eora Multi-Region input-output (MRIO) table (25 sectors) together with Statistics South Africa’s IO table (50 sectors) for 2012. A similar IO analysis was used by IMF (2014) to estimate the spillover from an energy boom in Canada to other industries and its broader macroeconomic impact.

National Budget Review 2016, Chapter 2: Economic Overview.

The commodity export and import price indices are computed as the growth rate of a weighted average of the prices of 47 commodities (in U.S. dollars) including precious metals. The values of exports and imports in the previous period are used as the weight in constructing the index following Gruss (2014). Growth in South Africa’s main trading partners is captured by trade-weighted real GDP growth in China, the United States, and the European Union. Global financial conditions are proxied by the Chicago Fed’s financial conditions index. The VAR is estimated using one lag of the endogenous variables as suggested by different information criteria on data from 2000Q1-2015Q2.

The overall GDP impact is derived using a simplified VAR where the growth contributions of real mining and non-mining value added are replaced by overall real GDP growth.

Accurately measuring these bottlenecks is not easy, but could be a promising area of future research.

References

Chow, Julian T.S., 2015, “Stress Testing Corporate Balance Sheets in Emerging Economies,” IMF Working Paper 15/216.
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International Monetary Fund, 2014, South Africa Financial System Stability Assessment.
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International Monetary Fund, 2016, “Strengthening the International Monetary System—A Stocktaking.”
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JP Morgan, November 2015, “Initiation Coverage of South African Banks.”
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Moody’s, May 2016, “South Africa Banks: Subdued economic prospects drive negative outlook”
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South African Reserve Bank, Financial Stability Review, various issues.
Standard and Poor’s, Apr 2016, “South African Banks’ Credit Risks Are Rising As The Economy Slows.”
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Prepared by Hui Miao, Pablo Morra, and Yi Wu.

The gross external financial requirement is the sum of the projected current account deficit for the following year (4.1 percent of GDP for 2016) and the external debt coming due within one year (14½ percent of GDP as of September 2015, comprising mainly corporate and bank debt).

See international investment position data reported by the South African Reserve Bank.

See Anand, Rahul, Roberto Perrelli, and Boyang Zhang (2016), “South Africa’s Exports Performance: Any Role for Structural Factors?”, IMF Working Paper No. 16/24; and Hlatshwayo, Sandile, and Magnus Saxegaard (2016), “The Consequences of Policy Uncertainty: Disconnects and Dilutions in the South African Real Effective Exchange Rate-Export Relationship”, IMF Working Paper No.16/113.

The gap averaged 0.3 percentage points since 1998. The current gap is large by historical standards notwithstanding the expect policy rate hikes.

Currently standing at 84 percent.

The SARB drains liquidity from the banking system overnight to maintain the overnight rate. This creates a ‘money market shortage’.

See, e.g., JP Morgan (2015), Moody’s (2016), and S&P (2016).

The financial cycle is estimated based on credit, and home and equity prices, using the Christiano-Fitzgerald band-pass filter.

The table, which is based on a cross-country dataset, suggests that at credit growth of 7 percent, 10 percent of the countries had GDP growth below 0.5 percent, 10 percent of the countries had GDP growth above 7.5 percent, and 80 percent of countries had growth between 0.5 and 7.5 percent.

The study also showed that nonresident holders of South Africa’s LC bonds are primarily institutional investors. These investors typically take longer to return after a downgrade to sub-IG level. See IMF, (2014), Global Financial Stability Report, April “How Do Changes in the Investor base and financial-deepening affect emerging market economies?”

It is very rare that any South Africa company can be rated above the sovereign rating of South Africa. To the best of our knowledge, only one company currently has a rating above the sovereign.

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