*This content is sponsored by The Loyalty Specialists. Their Rewards, Your Growth, Our Speciality.
by Lauren Haworth*
1. Mining Industry Chaos
Mining has been the backbone of our economy for around 150 years. It has been central in the contribution of employment, investment, the trade account and foreign exchange earnings. In 2013, according to KPMG, the mining sector was contributing 18% of GDP and over 50% in foreign exchange earnings. The sector was contributing 20% of all investment in the country.
It was also the largest contributor by value to the Black Economic Empowerment (BEE). Mining provides jobs for unskilled and semi-skilled people.
From 2012 – 2015, the mining sector cut 47,000 jobs and it was mentioned that an additional 32,000 were under threat. In 2016, its estimated that 100,000 jobs could be lost due to retrenchments in the restructuring of the mining sector.
Michael Haworth, an Investment Strategist for Applied Capital Insights detailed in one of his monthly reports that, “South Africa used to be a world leader in deep level mining, but this is no longer the case”. Haworth added that, “we are also the world’s largest producer of platinum and manganese and the largest gold exporter on the continent. The mining industry contributes 8.1% of current price GDP directly and around 10% indirectly. The mining industry produced 55% of South Africa’s exports in 2015.
The mining industry is struggling and has been since 2013 due to a fall in commodity prices, though the considerable depreciation of the ZAR has significantly diluted the negative impact on ZAR commodity prices. Major government policy changes together with high wage demands and considerable production disruption have brought the industry to its knees, resulting in production and employment shrinkage.”
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Government revenues are under pressure because of the slowdown in business in general, and particularly in the mining industry. Revenues are falling and expenditure is rising. The shortfall will be made up of taxes or capital expenditure.
This means that individuals in the higher income groups (R550k per annum) can expect to be taxed more.
The draft mining charter stipulates that all the suppliers going forward are going to be exclusively BEE companies. Procurement bias is towards BEE under the banner of ‘transformation’. Any business not within this ‘segment’ will be negatively affected.
2. Restructuring Imperative:
Haworth continues to explain that, “The South African Reserve Bank and National Treasury have forecast South African real GDP growth at 1.5% and 0.6% for 2016, respectively. Confidence, both business and consumer, has fallen to 2009 (Great Recession) levels. Within the economy, there are growing imbalances in the economic, employment, tax revenue, trade and savings-investment mixes. Infrastructural shortages are accumulating as more people migrate toward urban areas in search of a better life. Formal job growth, according to the latest Quarterly Employment Survey, recorded 6,000 new jobs in South Africa in 2015, of which an estimated 50 jobs were in the private sector. In 2015, the population in South Africa is estimated to have grown by 912,000.”
“The growing imbalance and prolonged exceptionally low economic growth in South Africa does not allow the reduction of unemployment and poverty, two key social issues. External demand looks unlikely to recover significantly in the short term. This means economic recovery, in the short term, will have to come from within.”
To achieve this, policy makers need to undertake major restructuring of the economy to remove blockages, improve efficiencies and effectiveness in public spending and more productive private sector asset allocation. This process needs to start with co-operation between government, trade unions, and the private sector.
As we move into the middle of Q2:2016, the rift between government and the private sector seems to be even further apart. Recent political events and outcomes have created greater distrust in the political systems and its intentions. The need to heal the rift is becoming more urgent.
He adds that, “Restructuring is taking place in South Africa, it’s called ‘transformation’. It is about racial transformation to “right the wrongs of the past” and is focused on racial proportional representation of wealth, ownership and income. This process is focused on what is, not on what could be. A recent spate of legislation which includes the Promotion and Protection of Investment Bill, the Expropriation Bill, the Equity Employment Bill and the draft new Mining Charter focus on the transformation of the existing economic base, not on building an expanded base for the future. Recent and current empowerment legislation looks likely to further ‘straight jacket’ the existing economic base.”
Frans Cronje, CEO of The Institute of Race Relations (IRR) adds, “Essentially the problem is that the economic model that worked so well from 1994 to 2007 of rising growth and declining debt levels is no longer in evidence. The global crisis, commodities pullback, and incredibly investment-unfriendly policy making have conspired to reduce forecast growth levels to below 1% of GDP while debt levels have doubled since 2007. The resultant fiscal crisis means that the government no longer has the revenue it needs to implement its social develop policies while job growth has slowed. The consequence is growing social anger and protest. But rather than introduce policy reforms that would free the private sector and return the country to a more positive growth trajectory an increasingly dogmatic and rapacious government has instead sought to undermine property rights and introduce all manner of counter-productive regulations. The effect is that businesses find themselves in a slowing economy and increasingly hostile policy climate.”
This could potentially get much worse after August 2016.
3. Government’s lack of support for entrepreneurship
Mike Stopforth, CEO of Cerebra. “The major challenges facing (smaller) business owners is government’s lack of support (convoluted administration, bureaucracy, tax policy and zero funding) for entrepreneurship. I believe SA’s future will be built on small business success, but I’m not sure our government shares that sentiment. If I look at the tax breaks, convenience, opportunities, learning and support provided for entrepreneurs in developed nations, I get really sad that the same is not provided in a country which really needs it.”
4. Investor confidence:
Haworth mentions that, “South Africa has been running a current account deficit since Q2:2003 and high twin deficits since 2009.”
South Africa is dependent on foreign savings (mostly foreign portfolio inflows) to plug the investment-savings shortfall leaving it highly vulnerable to movement of foreign savings.
He continues that, “growing risk aversion to Emerging Markets by international investors has significantly altered foreign inflows, affecting South Africa too. The result is the ZAR has devalued just over 50% against the USD since May 2013. South Africa needs foreign portfolio inflows of between R140bn and R170bn in 2016 to hold the ZAR relatively stable.”
Foreign investor confidence in South Africa’s policies is therefore critical in this regard. If we are to experience any kind of radical changes like we saw in December 2015 to key cabinet roles, at this time – our position, which was already revised down to the bottom of the investment grade rating band (with two of the three credit rating agencies), looks to tip limited confidence over the edge and plummet.
5. Potential junk status rating and investor confidence:
The International Credit Rating Agencies (ICRA) were initially concerned about three main issues prior to the budget presentation to parliament:
- The political discipline to adhere to the fiscal consolidation plan
- The contingent liabilities in the budget associated with the broad-based underperformance of State-Owned Enterprises (SOEs)
- The policy actions needed to improve the growth trajectory of the economy
The Medium Term Expenditure Framework (MTEF) presented late February, addressed the first concern, showing improvements in budget deficits and headline expenditure. Consolidated tax revenue is expected to rise 8.3% in fiscal 2017 mainly due to additional tax revenues over the next three years coming from higher PIT among higher income groups, higher capital gains tax, higher excise duties and higher environmental levies.
The ICRA’s second concern was not allayed because even though government indicated it was going to conduct a broad program of reforms to stabilize underperforming SOEs – no detail was provided at all.
The third criteria was also not addressed sufficiently because government indicated nothing new in its endeavors to ‘prioritize raising investment, improve labour relations and create certainty around policy’ again, no details were given, so we sit with no direct, overt policy changes which will credibly alter growth trajectory of the economy over the next three years.
This leaves SA vulnerable to a downgrade at some point.
Haworth’s May macroeconomic theme analysis reports that, “South Africa’s policy direction, commitment to the rule of law and integrity of its key institutions has become a growing concern in the private sector. The frequency of political scandals and high level of exposed corruption, nepotism and government interference together with frequent high level cabinet changes have generated policy uncertainty and a growing sense of manipulation and distrust around political institutions.”
He continues that in late 2014, “increasing pressure from the International Credit Rating agencies forced National Treasury to enter a phase of fiscal consolidation. Public sector wage demands and protests at universities during 2015 have placed more expenditure pressure on the fiscus at a time when its social protection demand continues to grow.”
“In early Dec-15, “out-of-the-blue” President Jacob Zuma replaced Finance Minister Nene with David van Rooyen, an unknown ANC parliamentary backbencher. This critical cabinet position was changed with total disregard to the sensitivity around the South Africa’s credit rating process which was under review by the International Credit Rating Agencies. The domestic markets erupted, equities fell, the ZAR collapsed and the sovereign yield curve rose by over 100 basis points. President Zuma gave no explanation for the firing of Minister Nene so there was speculation that it was because of his resistance to a significant SAA deal and the nuclear deal.
South Africa is now in real danger of having its investment grade credit rating downgraded to “junk” with serious implications for the cost of and access to international capital.”
What does this mean for businesses?
It means that it will cost us more, as a country, to borrow money. By regulation, many of the foreign portfolio inflows will not be allowed to invest in sub-investment grade assets. All our imported goods will shoot up in price, raising the prices of basic necessities across the board. It will also push up the interest rates and ultimately weigh heavily on cash-flow.
6. Local elections on 3rd of August
Understanding how critical international confidence is to our country’s stabilization of the rand, we can then begin to absorb the gravity of how many small elements factor into such a confidence, once such being the municipal elections in August.
Municipalities are governments vehicles. They deliver the services and make the towns livable. If the ANC stays in power, we can expect more of the same. If they lose it however, or the ANC does not win some of the key areas, there is a real concern that whichever coalition does win – the ANC is going to give them a very tough time. Changing a party creates enormous uncertainty and is potentially hazardous and violent.
Currently municipal boundaries are being redefined without consultation which is causing a problem. The only way the people can get them to listen is to protest violently. This leads to a break-down of law and order. It’s a safety hazard for all.
7. Economy expected to grow by less than 1% of GDP this year
Since GDP is one of the main indicators used to measure the performance of a country’s economy, it’s only natural for external firms to be more confident in their investments when the country’s economic growth is strong.
However, when economic growth is low, it does quite the opposite – employees face retrenchment or lower wages and firms are reluctant to invest.
“South Africa’s GDP has been declining year-on-year for the past 28 months and its back at a level seen in November 2009. Major global financial institutions seem to agree that this country’s economic growth will slow to 0.6% in 2016. Consumer inflation rose to 7% in February and is expected to rise further driven by drought and currency factors rather than by demand, according to Michael Haworth.
“The FNB/BER Consumer Confidence index is at a 14-year low and has been negative for 13 of the past 17 quarters. Similarly, the RMB/BER Consumer Confidence index is also low as well as the FNB/BER Construction confidence index.
SA’s cyclical recovery looks to be constrained by the worsening structural imbalances in the domestic economy (growing dependence on PIT for revenue; job mix is shifting to lower income jobs and age group of unemployment is largely occupied by the youth). “The SA economy is in serious trouble despite the ample mineral and human resources.”
What does this mean for businesses?
Demand for your products and services is reduced. More competition means you can’t push your prices up. High inflation and low demand. So the costs are going up but there is very little demand growth. Turnover is a function of your growth in volumes and growth in prices. In a slow economy, your volume growth is very low so you become hugely dependent on your price growth for turnover but where there is high inflation, you have high cost increases – however, the high level of competition won’t allow you to push up your prices. You will have low volume growth, and low price growth which ultimately means low turnover growth – this puts your cash-flow under pressure.
Unemployment at highest level
26.9% as of Q1-2016 with gradual incline but the labour participation rate is low and the employment population ratio is also low by global standards, according to Statssa and SARS.
This would explain the high requirement for increased social protection in SA and creates social unrest.
Utility shortages and high tariff increases:
The delays and cost overruns of major infrastructural expansion projects have resulted in utility shortages and high tariff increases. The current level of electricity production in South Africa is at levels last seen in 2005 and 2009, but the cost of electricity has more than doubled since 2008. This has caused the delay and cancellation of many private sector investment projects. Tender corruption and mismanagement have been key factors behind delays and cost overruns. Private sector companies which won tenders to supply goods to these projects suffered severe losses due to the delayed construction and commissioning of these major utilities.
Load-shedding has abated since September 2015, but electricity demand remains weak. This reflects low business confidence which is resulting in especially weak business demand, low employment growth and therefore weak consumer demand.
Having said that though, people are migrating into the cities and more and more people will need electricity. Higher demand (to be expected in the winter months) needs to be matched by higher supply but we do not have the capacity to meet it.
Eskom’s two Open Cycle Gas Turbines are meant to run during emergencies or peak hours (three hours in the morning and three in the evening). However, these OCGT’s have been known to be running for at least 16 hours per day to keep up with demand, albeit at great cost. In addition, since Diesel burns much hotter than natural gas, we can assume that the turbine’s life-span is very short.
These turbines consume roughly 32, 400L of diesel per hour, each. Diesel is expected to cost R11.21 per litre in June 2016 which equates to a cost of R363,204 to run one OCGT per hour (provided everything remains the same).
Our electricity supply levels have not really increased since 2003 (obviously its seasonal), but the population has increased and urbanized since then. Increasing demand, inadequate supply resulting in the usage of excessively expensive OCGT on a consistent basis puts Eskom in a clinch. They were bailed out with our contingency reserves before, but our reserves are depleted now. Where will the money to fund this come from?
Government revenue sources
SARS collects revenue from multiple sources including Personal Income Tax, CIT, VAT and Import VAT and Customs Duties. In the 2015 tax year, tax revenue grew by R86.3 billion to a total of R986.3 billion in this last tax year. The total was comprised of:
however, the 2015 budget highlights states that a revised estimate of R1 trillion was collected and a consolidated R1.35 trillion was spent.
Our contingency reserves were also completely depleted, which means, should anything go wrong in this country this year, we cannot bail ourselves out financially.
Michael Haworth adds that, “Our fiscal position of the country is increasingly dependent on personal income tax growth (as seen in the 2016/2017 tax revenue forecast showing further increases in PIT), where the base of high income earners is narrowing and the income mix is deteriorating creating a situation where 1 million tax payers contribute 77% of the personal income tax revenue.
Company tax revenue growth has been exceptionally low over the past few years and a decreasing share of the national tax revenue.
Current government expenditure consumes the entire national tax revenue resulting in all capital spending being deficit and debt funded. South Africa’s persistent high budget deficits since the ‘Great Recession’ have resulted in a rapid accumulation of public sector debt relative to GDP growth pushing up the public debt to GDP ratio, to levels which have triggered concern among the International Credit Rating Agencies.”
PAYE burden on individuals
There are currently just over 55 million people in the South African population. That is divided, for the purpose of this article, into those who are outside of the labour force of either <15 years old and over 65+ (18.9 million people) and those who are within the labour force age of 15 – 65 years old (36.4 million people):
Of the people within employable age (between 15 – 65): 15, 054, 000 are not in the labour force and 21, 377, 000 are in the labour force. The 15mil that are not eligible to be employed rely on some kind of financial support, and the majority of this group comprises of the youth:
Of those that are in the labour force (within employable age): 5, 714, 000 are unemployed and 15, 663, 000 are employed according to the quarterly labour force survey:
Finally, of those that are employed, 10, 963, 000 are formally employed (70%) and 4, 700, 000 (30%) are informally employed.
Regarding taxation, only those within the labour force who are employed and earn a certain amount per annum are eligible to be taxed, but some do earn under the threshold where doesn’t PIT apply.
Most informal jobs pay less than the threshold, so those recipients do not pay PIT (high tax registration but low payers). In addition, there are a large group of people who are formally employed but do not earn enough to qualify for PIT. The latest stats show that roughly 6.6 million people pay PIT.
In other words, 12% of our entire population pays for the rest. That’s almost a 1:8 ratio.
Government is increasingly relying on increasing PIT taxation for the majority of its revenue. Individuals can logically assume PIT to increase.
This is pertinent because this affects your employees and their lifestyles, which indirectly affects companies. Companies may need to reconsider their staff incentive schemes, HR functions and other services aimed at aiding staff through some tough stages ahead.
8. Agriculture
Haworth weighs in on our state of agriculture, “South Africa is going through one of the worst droughts in 20 years which has severely decreased grain, fruit, and vegetable supplies which has subsequently increased the cost-push effect in the agricultural to food retail inflation pipeline massively.
Domestic maize growers are predicted to produce 7.16 million metric tons in the 2016/2017 season which is 3.58 million metric tons less than in 2013.
Grain SA predicts that we will produce 1.422 million tonnes of wheat but we will need to import 2 million tonnes. (imports have been increasing over time due to increased consumption and decreased production).
Agricultural prices increased by 23% in March, with cereal and other crop prices increase by 50% YoY. Manufactured food product price inflation accelerated to 10.5% with the category of food, beverages and tobacco products contributing 3.1% to the March outcome.”
9. The 2016 Budget
The 2016 budget will see the rise of revenue collection from R1 trillion in 2015 to R1.2 trillion in 2016.
Expenditure will again exceed revenue standing at R1.3 trillion. Less than R10 billion increases in expenditure can be seen across the board except for Basic Education which increases by R24 billion, Economic Affairs and Agriculture increases by R32.8 billion and Social Protection (grants and social infrastructure) increases by R10.5 billion.
Personal Income tax, fuel levies, environmental taxes and excise duties will all increase for the 2016/2017 tax year.
Summary
Government are misallocating essential resources, overspending on the budget yet under-delivering across the board and alienating our foreign investors with almost every speech. Our country’s revenue is dwindling, mounted by social unrest, high unemployment levels and rising prices. South Africans are exporting most of our best items including wine and tuna which most of us don’t even know about. We are importing huge amounts of food types because our agricultural sector is critical. Our prices are shooting through the roof, limiting household income and thus consumption. Debts are rising and stress is killing our creativity.
If you keep doing what you’ve always done, you’ll keep getting what you’ve always got. That is not something any business wants. Businesses need to change to grow in different circumstances. Change is not terrible, it’s an opportunity to engage your staff differently – motivate them innovatively. Keep the staff excited by showing them the light at the end of the tunnel.
How can you, as a business, mitigate the severe depressive circumstances in which your staff find themselves in this country? The answer to this will determine your survival and growth in a slow economy.
- Lauren Haworth is Executive Head of The Loyalty Specialists.
Thanks to the contributors:
- Michael Haworth, Investment Strategist and MD at Applied Capital Insights
- Frans Cronje, CEO of Institute of Race Relations
- Mike Stopforth, CEO of Cerebra, a Wunderman company
References:
- SARS, 2015. 2015 Tax Statistics – highlights. Accessed online from http://www.sars.gov.za/AllDocs/Documents/Tax%20Stats/Tax%20stats%202015/Tax%20Stats%202015%20Highlights.pdf
- National Treasury, 2015. Budget 2015 Highlights. Accessed online from http://www.treasury.gov.za/documents/national%20budget/2015/guides/2015%20Budget%20Highlights%20Card.pdf
- National Treasury, 2016. Budget 2016 Highlights. Accessed online from http://www.treasury.gov.za/documents/national%20budget/2016/guides/2016%20Budget%20Highlights%20Card.pdf
- Statssa.gov.za
- Sars.gov.za
