Recent Economic Developments and Outlook

Economic performance remained sluggish in 2019, with growth estimated at 0.5 percent. GDP growth was weighed down by declines in activity in the mining, manufacturing and transport sectors which outweighed positive growth registered in the trade, government services and finance sectors. Going forward, the authorities expect growth to improve to 1.2 per cent in 2020, 1.6 per cent in 2021 and 1.7 per cent in 2022, due to a gradual recovery in confidence and investment. Meanwhile, the unemployment rate increased to 29.1 percent in the third quarter of 2019.

Headline CPI inflation averaged 4.7 percent in 2018 and inflation outcomes continued to moderate alongside inflation expectations during 2019. Subsequent to the IMF mission team’s visit, inflation outcomes declined below forecasts, with headline CPI averaging 3.6 percent in November 2019. Food price inflation continued to surprise on the downside, and the currency has strengthened, contributing to the SARB revising down its January 2020 inflation forecasts. Headline CPI is expected to average 4.7 percent in 2020, 4.6 percent in 2021 and 4.5 percent in 2022.

The current account deficit narrowed from 3.5 percent of GDP in 2018 to 3.3 percent in 2019 on account of low imports. Foreign exchange reserves increased from $51.6 billion in 2018 to $55.1 billion at the end of December 2019, representing 5 months of import cover. Over the medium term, the current account is expected to widen somewhat as investor confidence recovers.

Fiscal Policy

The authorities broadly agree with staff’s assessment of the fiscal position. They remain committed to prudent fiscal policy and fiscal sustainability while creating the required space for large infrastructural projects. Consequently, they place strong emphasis on achieving a low primary balance, excluding Eskom provisions, by 2022/23. While the fiscal deficit is projected to increase to an average of 6.2 percent over the next three years from 4.3 percent in 2018, the authorities are committed to the continuation of fiscal consolidation and containing debt accumulation. To this end, the authorities plan to stabilize and improve the fiscal position through several measures, including reducing the public sector wage bill and additional revenue measures.

Slower than expected growth in revenues, along with slow nominal GDP growth, are placing pressure on the fiscal framework. Thus, the authorities attach great importance to strengthening revenue mobilization and prudent expenditure execution, while protecting priority pro-poor spending. Government has made significant strides in improving the capacity of the South African Revenue Services, including through the re-establishment of the Large Business Centre to improve tax compliance by the largest tax payers.

Further, the authorities recognize that improving the efficiency of expenditures also contributes to increasing fiscal space and arresting the accumulation of debt and protecting the poor. Complementary reforms are underway to enhance the governance and efficiency of public spending. In this regard, the authorities have already reviewed the procurement regulatory framework and developed a Public Procurement Bill for submission to Parliament in 2020.

Debt Management and SOE reforms

The authorities have put forward recommendations to achieve both fiscal consolidation and reprioritization of expenditure in order to ensure stabilization of debt by 2025/26. However, implementation of the proposed wage bill measures and economic reforms require politically difficult decisions. Without these decisions, debt is likely to continue rising over the medium term and beyond. According to the authorities, total gross loan debt is expected to remain slightly above 70 percent of GDP at 71.3 percent in the medium term. They remain cognizant of the fiscal risks that SOEs, particularly the electricity utility – Eskom, present to the fiscal framework. Mindful of the current burden, the authorities will provide financial support to Eskom over the medium-term to secure energy supply and mitigate risks to the economy and the fiscus.

To mitigate risks from SOEs, the authorities have instituted a series of measures to strengthen SOE governance and finances. They have stepped up efforts to restructure the electricity sector, as outlined in the reformed Electricity Supply Industry paper (Eskom Roadmap). Once implemented, these measures would reduce the need for government to continue to support Eskom. Furthermore, the Eskom Roadmap also sets out a plan for expanding renewable energy output and cutting fuel costs. In this regard, the authorities have promulgated the new Integrated Resources Plan (IPP) which will guide the expansion and diversification of electricity supply over time.

In the transport sector, the authorities remain committed to resolving the challenges facing South African Airways (SAA). They have since placed the airline under voluntary business rescue to improve its financial position. This was preceded by extensive consultations between government and the creditors on the financing modalities.

Monetary Policy

Consistent with the IMF’s analysis, the SARB has made progress in shifting inflation closer to the middle of the 3–6% target range. The disinflation effort is not complete, however, as inflation expectations – while lower – remain in the upper half of the target range.

At its recent meeting, the Monetary Policy Committee (MPC) of the SARB revised down its inflation forecasts. Both surveyed and market-based expectations have continued to moderate gradually. The MPC reduced rates by 25 basis points as of 16 January 2020. The authorities concur that interest rates are not the right tool for fixing South Africa’s growth challenges, which are primarily structural in nature. Domestic macroeconomic fundamentals are also a significant source of vulnerability, posing a significant upside risk to the inflation outlook. Nonetheless, in the context of lower inflation and an improved risk profile, monetary policy can provide a degree of support to borrowers, without jeopardizing the central objective of delivering inflation well within the target range.

Financial Sector Policy

The South African financial sector has remained resilient in the face of challenging macroeconomic conditions. This has been underpinned by sizable capital and liquidity buffers as well as a robust regulatory and financial infrastructure. South Africa’s deep and sophisticated capital markets complement traditional bank credit and have contributed to the relatively low reliance on foreign currency funding in the economy.

The promulgation of the Financial Sector Regulation Act in 2018 introduced a “twin peaks” model of financial regulation, which provides a delineation of responsibility between market conduct regulation (under the Financial Sector Conduct Authority (FSCA)) and prudential regulation (under the Prudential Authority (PA)) for the sector at large. Furthermore, this legislation assigns an explicit responsibility to the SARB to enhance and monitor financial stability. As part of these powers the SARB recently designated six financial institutions as systemically important, providing the ability to impose macroprudential requirements on these institutions, should the need arise.

The Financial Sector Laws Amendment Bill (FSLAB) was published for comment in September 2018 and is expected to be introduced during the calendar year 2020. The FSLAB will introduce a resolution framework for designated financial institutions, thereby strengthening the ability of the SARB to wind down or resolve failing institutions with the least possible disruption to the economy. The Bill will also establish an explicit deposit insurance scheme.

The establishment of three new banks, with a specific focus on digital channels, is expected to support competition and expand financial inclusion. Significant growth in the number of fintech firms (especially in the payments space) has further contributed to the dynamism of the financial sector. In this regard, the Intergovernmental Fintech Working Group (IFWG) has been established to develop a common understanding, among regulators, of fintech developments and their policy implications.

The authorities have announced their intention to reform the framework for cross-border flows by making it simpler and more transparent. This is expected to improve the ease of doing business and support the attractiveness of South Africa as an investment destination. Additional measures to combat illicit financial flows are also being developed.

The authorities continue to make steady progress in the reform of key interest rate benchmarks, that play a fundamental role in the domestic financial system. This reform will align South Africa with international best practice, while also enhancing the transparency and efficiency of domestic money markets. It is also expected to improve both the implementation of monetary policy and the monitoring of risk in the domestic financial system.

Structural and Governance Reforms

The authorities remain committed to implementing structural reforms to boost overall growth. Amongst others, they have made progress on the easing of the visa regime to support tourism, demarcation of new special economic zones, and releasing a policy directive for licensing the auctioning of high demand broadband spectrum. Further, the authorities are planning to implement reforms in transport, water, telecommunications, industrial, trade and competition policy to address microeconomic binding constraints, as outlined in the “Economic Transformation, Inclusive Growth, and Competitiveness: Towards an Economic Strategy for South Africa” discussion paper that was published in October 2019.

To address governance and corruption challenges, the authorities have strengthened the capacity of the National Prosecuting Authority. The judicial commission of inquiry into the state-run asset manager of the Public Investment Corporation has been completed and the final report was submitted to the President and the judicial commission of inquiry into allegations of state capture is proceeding.

Conclusion

The authorities recognize the mounting pressures and remain steadfast in addressing the macroeconomic challenges and ensuring fiscal sustainability in order to set the economy on a firm and accelerated growth trajectory. To this end, they remain committed to fiscal consolidation and expediting the much-needed structural reforms to support fiscal adjustments and achieve inclusive growth that will create jobs, reduce poverty, and inequality. They look forward to continued engagement with the Fund, including through technical support.