Azar Jammine: KPMG, McKinsey furore is already hitting SA’s economy

Azar Jammine
Dr Azar Jammine is a leading South African economist.

LONDON — The industrial scale plundering of South African national resources by the Gupta family has become a global story, with the facilitating multinationals being brought to account in the court of public opinion. As independent economist Azar Jammine puts it, the furore is unprecedented – even though it all happened far away from the world’s economic hubs. The corruption by KPMG, McKinsey and SAP has implications which extend far beyond the South African criminal justice system. The firms attract clients on the basis of a reputation. So the current contamination of their brand has massive business implications. But what of South Africa itself? Jammine looks at likely consequences of the fallout, concluding that the damage is already being seen in SA’s currency which is reflecting a further decline in investor perceptions, And there is worse to come with a likely interest cut postponed and a significant drop in global rankings in prospect. – Alec Hogg

By Azar Jammine*

South Africans will have become accustomed to the ebb and flow of news covering a very volatile political environment in the run-up to the December presidential elections. The past week has been no different, this time with the furore surrounding leading auditing firm KPMG’s involvement in state capture reaching a crescendo.

The manner in which the country’s anger against both the firm and SARS’ current leadership has mounted, has been unprecedented. It illustrates the manner in which so many persons recognise the economic and financial costs of state capture in recent years.

The furore has developed out of a growing recognition of the depth of state capture and the tentacles of the penetration of this process into all manner of the economy. Estimates of the cost of state capture vary enormously.

“South Africa is captured.” More magic available at jerm.co.za.

A year ago, then Finance Minister Pravin Gordhan commented on the fact that if only a quarter of state capture was eliminated, this could help to fund free education across-the-board at a cost of R40bn. The implication was that the cost of state capture was around R160bn, or approximately 10% of overall government spending.

Other more alarming estimates suggest that R700bn has been lost to the economy in recent years through the diversion of funds to certain individuals closely aligned to President Zuma.

Either way, the perception has grown that the rise of state capture and associated corruption has cost the economy enormously. Such funds could have been used far more effectively in social development and infrastructure to benefit the masses of underprivileged people rather than going into the pockets of a handful of privileged persons.

The irony is that the rationale often given for state capture is that it represents a deliberate attempt at altering the ownership structure of the economy away from a relatively small group of white-owned businesses so that the benefits of economic power can be dispersed more widely across the whole of society.

The fact remains that economic growth might have been substantially stronger in recent years in the absence of this damaging diversion of wealth to less than worthy causes. In turn, lower economic growth has resulted in reduced living standards, a relative dearth of service delivery and amenities for the majority and has also contributed indirectly towards a loss of employment for many.

Huge damage to auditing profession, SARS and potentially investment as well

The outcome of the furore is that most significant businesses in South Africa who have been employing KPMG as auditors, are questioning the merits of continuing with that relationship.

Already one has learnt of a few leading organisations, starting with asset management company Sygnia and most recently with investment bank Sasfin, withdrawing from use of KPMG’s services. This is likely to prove just the start of what could be a snowballing cancellation of contracts with the auditing firm.

As much as there are perceptions of him being implicated in the whole issue of state capture, SARS Commissioner Tom Moyane has now entered the fray and recommended to government to stop working across the board with KPMG.

As much as the viability of KPMG as an auditing firm in South Africa stands to be decimated, the fact is that the reputation of the auditing profession as a whole has been dealt an enormous blow. So too has the reputation of SARS as an institution of integrity.

This is a serious because until a year ago, the perceived excellence of South Africa’s auditors and the capability of SARS as an important financial institution, had stood as significant pillars around which international investors viewed the South African economy and its business environment.

The noble reputation of South Africa’s auditing profession was reflected in the fact that according to the Global World Competitiveness Index compiled by the World Economic Forum, South Africa’s ranking in financial management and governance was regarded as close to first in the world.

Recent developments are likely to see South Africa’s ranking in the World Competitiveness Index declining sharply. To the extent that rankings in this index are used as a vehicle for encouraging international investors to commit to a country, recent developments could lead to a further diminution in the alacrity with which international investors would like to invest in South Africa.

It may be no coincidence that the annual RMB investment survey of investment attractiveness rankings amongst African countries was released yesterday, showing South Africa losing top spot for the first time ever, to Egypt. One fears that this will prove to be a precursor to further loss of confidence.

Replacement of finance minister has inflicted much economic damage

There can be no doubt that the KPMG report on involvement of SARS in allegedly spying on individuals’ business dealings was directed at the removal of key personnel within SARS who were determined to fight corrupt practices and tax evasion.

The suspicion is that this was deliberately aimed at paving the way for implicated persons closely aligned to President Zuma and his patrons to avoid being convicted of unsavoury tax practices.

Further, it seemed over the past year or so to be directed at removing Finance Minister Pravin Gordhan and his Deputy Mcebisi Jonas from leading the National Treasury and replacing them with persons who would be more pliable to redirect procurement practices of public entities in the direction of benefiting financially those closely aligned to the President.

Former finance minister Pravin Gordhan speaks to Mcebisi Jonas during a news conference in Pretoria on March 31, 2017. Photographer: Waldo Swiegers/Bloomberg

It is common ground now to argue that the credit ratings downgrades that followed the subsequent Cabinet reshuffle undertaken at the end of March were the result of the rising perceptions of state capture of the National Treasury in the manner suggested above which were seen potentially to jeopardise the ability of the country to stem the rising trend of its public debt.

Apologists will argue that economic growth accelerated in the 2nd qtr despite the Cabinet reshuffle and credit ratings downgrades. After all, q-o-q seasonally-adjusted and annualised growth accelerated from -0.6% in the 1st qtr, to 2.5% in the 2nd qtr.

However, as we have frequently explained, this represents a statistical distortion linked to the fact that the Easter long weekend fell into March in 2016, but into April in 2017. The fact is that fixed capital formation contracted by – 2.6% in the 2nd qtr and more specifically fixed capital formation in the private sector fell by -6.9% in that quarter, following the credit ratings downgrades.

The longer-term effects of this decline in fixed investment is likely to be to stem economic growth still further.

Rand suffers and possibility of interest rate cuts jeopardised by recent events

It is interesting to note how the Rand has been affected negatively by the recent furore surrounding KPMG’s involvement in state capture. The incident drew front-page coverage in the globally read Financial Times. Clearly, it is also seen as reflecting on the auditing profession globally.

Be that as it may, it is noticeable that the Rand’s performance this quarter has been the second worst amongst leading exchange rates. Ironically, this has occurred at a time when sentiment towards emerging markets has been rather positive.

It suggests that the Rand would have appreciated significantly had it not been for recent political turmoil. Especially over the past few days, the currency has lost around 2% of its value on a trade-weighted basis. This has implications for the interest rate decision to be taken at the MPC meeting currently underway.

This most recent currency weakness could just play into the hands of a decision not to reduce interest rates contrary to overwhelming expectations most recently that the repo rate will be reduced.

In turn, from a shorter-term point of view, the absence of an interest rate cut will prevent economic growth from receiving some reprieve from a monetary policy perspective, even if this is not seen as the panacea for lifting economic activity.

From a technical perspective, the Rand/Dollar exchange rate has now depreciated to a level close to the R13.40 market which the Dollar’s downward trendline against the Rand currently sits. In recent weeks, we have been commenting on the wedge formation of the Rand/Dollar exchange rate and on the potential for a break of this trendline to lead to the Rand depreciating quite rapidly to a level of around R14.75.

One cannot be certain of such a break in the exchange rate, but it is interesting to note an investment report on emerging markets by none other than the wealth management company UBS yesterday which cited the attractions of 21 emerging markets with one single exception, viz. South African assets and currency.

Will outrage ultimately see state capture and corruption being dealt with?

On a more positive note, one senses that the scale of outrage against state capture and corruption is reaching unprecedented proportions, not only for South Africa but for most countries implicated in such processes.

Given the coverage in the media of the transparent nature in which such practices are being conducted, one can only hope that this outrage leads to a change in leadership which ultimately sees harsh action being taken against perpetrators of such practices.

Is it possible that in the longer term, the events of recent weeks and months will come to be seen as a turning point that was necessary to pave the way for an elimination of such practices? Such an outcome stands to create the space for substantial funding of developmental projects without breaking the bank and increasing public debt to unsustainable levels and in so doing helps to reverse the declining trend of economic growth seen over the last six years.

  • Dr Azar Jammine is the chief economist at Econometrix. 
Visited 52 times, 1 visit(s) today