South Africa: a ray of hope

By Stéphane Monier Chief Investment Officer Lombard Odier Private Bank

Following weeks of contestation, Jacob Zuma resigned on 14 February 2018 after nine years in office, leaving a mixed legacy to South Africa's new president, Cyril Ramaphosa. Facing a tough road ahead, Ramaphosa promised to fight corruption, rebuild the economy and create jobs. While Zuma’s resignation opens the way for much-needed change in South Africa, we believe that the wave of optimism that has followed the end of the Zuma era must be balanced with a realistic understanding of the economic and social issues that the country has faced for a long time. While economic challenges could turn into investment opportunities in the medium term, we recommend continued caution when investing in South Africa as we await clarity on Ramaphosa’s reform agenda.

The end of Zuma

On 14 February, Jacob Zuma resigned under the weight of intense pressure, ending a scandal-plagued term as South Africa’s president. While he survived eight motions of no confidence in parliament during his presidency, Zuma decided to step down after the African National Congress (ANC), the country’s ruling party, called for his resignation in the wake of a string of scandals. Zuma leaves behind a country that must now recover from a painful decade of weak growth, very high unemployment and deficient public services.

Despite Zuma’s “National Development Plan 2030” – a long-term initiative to increase employment and reduce inequality – the legacy of apartheid is still apparent and inequalities remain visible. According to the World Bank, the Gini coefficient (a measure of income inequality) ranks South Africa as one of the most unequal societies in the world with more than a quarter of the population unemployed.

Hopes for change with Ramaphosa

After years of stagnation, the country has recently slipped into recession and President Ramaphosa’s first challenge will be to set the economy back on a growth path. But Ramaphosa is no stranger to challenge and investors may garner some optimism from the history of the man himself: Ramaphosa held the microphone to Nelson Mandela when he spoke to a crowd of 50,000 people on the balcony of the Cape Town City Hall after his release from incarceration in February 1990. In 1991, he became Secretary General of the ANC but lost the race to become Mandela's successor to Thabo Mbeki. Ramaphosa made a successful move into business and became one of South Africa’s richest men with an estimated fortune of $450 million, in 2015, according to Forbes.

After learning the value of foreign investment and the importance of good corporate governance, Ramaphosa returned to politics and was elected president of the ANC last December. After becoming president of the country this February, he offered assurances that his government would stay committed to constituency and policy certainty. Although he will undoubtedly try to put the country on the right track, Ramaphosa must tackle a long list of challenges to restore credibility before the next general election in 2019.

Dealing with structural challenges

The first issue to be tackled is slow economic growth. While emerging countries have grown at an average annual rate of close to 5% over the last decade, South Africa’s economic activity remains weak with an average growth rate of 1.5% since 2008. Gone are the glory days of the South African mining giants, and industrial and financial behemoths. The likes of Anglo American, Mondi, Richemont and Old Mutual have all re-domiciled offshore.

The economic recovery will depend on the ability of the new government to create jobs, enhance the inadequate education system and confront the issue of land reform. More than 20 years after the end of the apartheid regime, the country still faces huge poverty in spite of its vast resources. Cape Town, the country’s second city, is a prime example: following prolonged drought, the city faces water shortages exacerbated by mismanagement at government level.

In spite of this, we believe South Africa is on the right path with Ramaphosa as its leader. Indeed, he started his tenure with a new budget that was enthusiastically received by the market as currency and local rates continued to improve. The budget focused on the sovereign debt outlook and projected national government debt stabilising below 60% of GDP, over time. A value-added tax rise for the first time in 25 years, lower local debt issuance and budget cuts were combined with increased social spending and investment in higher education. These pockets of progress are especially crucial in advance of Moody’s review of the country’s sovereign rating in March 2018. While the downgrade risks have declined on the back of recent advances, we would recommend investors wait until the priced-in improvements materialise before increasing risk exposures in their portfolios.

Cautiously optimistic

In a nutshell, we are cautiously optimistic on South Africa given the removal of the Zuma administration. Although Ramaphosa’s presidency has raised hopes of improvements in business confidence with market-friendly policies expected, strong structural concerns for growth and stability have not gone away. While we see clear rays of hope for South Africa, investors should wait for more visibility from the new administration. Since markets already sent the rand to a three-year high against the US dollar in February, we recommend investors who are keen to take risks in emerging markets to be very cautious before exploring investment opportunities in South Africa in the short term.

Investment takeaways

• We are cautiously optimistic on South Africa given the removal of the Zuma administration.
• We recommend that investors who are keen to take risks in emerging markets to be very cautious before exploring investment opportunities in South Africa in the short term.
• However, economic challenges could turn into investment opportunities in the medium term.

Source: Bloomberg, unless otherwise stated