South Africa’s weak economy | KPMG | ZA

South Africa’s weak economy and its impact on the insurance industry

South Africa’s weak economy

South Africa’s economy is characterised by slowing growth, stubborn inflation and macroeconomic imbalances,” commented the South African Reserve Bank (SARB) in its Monetary Policy Review (MPR), released during April 2016. The central bank attributed the situation to three relatively persistent problems, namely: High levels of household debt; Electricity supply constraints; and An unfavourable global economic environment. Added to these issues are several short- lived shocks, e.g. strikes and the current drought.

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The moribund economy will grow by less than 1 percent this year, the worst performance since the 2009 recession. South Africa was until recently known as the continent's second- largest economy, but data released by the International Monetary Fund (IMF) in mid-April suggests that it is now placed third behind Egypt when considering the international standard of gross domestic product (GDP) in US Dollar terms. Fortunately, fourth-placed Algeria and fifth-placed Morocco are still far behind.

Economists prefer to look at an economy from the perspective of five factors: household spending, investment, government expenditure, exports and imports - GDP data is calculated by quantifying these factors. When considering low consumer confidence, weak business confidence, a tightening of the fiscal purse and a heated political environment, low international commodity prices, and the adverse effect of a weak Rand on the import bill, it is not surprising that the South African economy is stuck in a rut.

Household spending

The First National Bank (FNB)/Bureau for Economic Research (BER) Consumer Confidence Index recorded a fifth consecutive quarter of negative consumer sentiment during Q1 2016. It was also the 13th out of the last 16 quarters that the index was below a reading of zero, pointing to more consumers being negative than positive about their financial and economic positions over the past four years. This negative sentiment is also reflected in quarterly business confidence data and actual household spending data.

Declining foreign direct investment (FDI)

The United Nations’ Conference on Trade and Development (UNCTAD) recorded a near 69 percent drop in South Africa’s net foreign direct investment (FDI) during 2015 compared to a decline of around 30 percent for the continent as a whole.

One of the factors behind this slump is a number of new or proposed legislative changes that, analysts say, areweighing on foreign investors’ confidence in the safety of their investments. These include the Promotion and Protection of Investment Bill that necessitated the cancellation of several bilateral investment treaties to be signed into law early in 2016.

Business investment - both local and abroad - has since late 2015 been hit by a myriad of other challenges.These include an unexpected double change in the Finance Minister post, deteriorating sovereign credit ratings, stuttering economic growth, a slump in the Rand to its weakest level on record, as well as political issues diverting government focus from policymaking and implementation (a lack of electricity load shedding was a rare positive point).

Government expenditure under pressure

The Medium-Term Budget Policy Statement (MTBPS) and Budget Speech delivered in October 2015 and February 2016 respectively, jolted government expenditure into a more austere direction.

State finances have already been under pressure sincethe global financial crisis, with fiscal deficits - and an accompanied accumulation in public debt - used to help stimulate the local economy. Combined with political issues and a weak economy, this has contributed towards the South African sovereign credit rating nearing a downgrade to non-investment grade.

Finance Minister Pravin Gordhan indicated that the 2016/17 budget is “focused on fiscal consolidation.” He warned that the government “cannot spend money we do not have,” and “cannot borrow beyond our ability to repay.

Export revenue under pressure

South Africa’s export revenues are under pressure from weakness in global commodity prices. The Economist’s commodity price index reflects a more than 15 percent decline in US dollar metal prices in the year ended April 2016. The Rand depreciated by a similar margin over the same period, resulting in no real boost to exporters’ earnings from the weaker currency.

Weather-induced economic weakness

A weak economy could result from a phenomenon that in itself could put pressure on the insurance industry. In the case of South Africa during 2016, the country’s worst drought in decades is playing a role in the overall economic malaise. However, it is also a point of great concern for insurers due to the failure of crops and some farms in their entirety. Other adverse natural phenomena – e.g. hurricanes, tornados and earthquakes – would shake an economy as a whole and its insurance sector in particular.

Social unrest

Strain on fiscal finances as a result of the weak economy could translate into increased unrest in low-income areas where residents are highly dependent on the delivery of public services (e.g. schools and hospitals) for their existence. This, in turn, could translate into protest action, which in the case of South Africa is too often accompanied by damage to private and public property. Escalation into open conflict between citizens and security forces would deepen this damage and associated insurance claims to repair after the fact.

Exchange rate shocks

Currency volatility associated with low economic growth could affect some insurers depending on where their risk exposure and capital base is situated.

For instance, if risk exposure is domestic and (revenue generating) capital is located largely offshore, shocks to the exchange rate could have a real and significant impact on investment revenues. Also from an offshore perspective, weak confidence in a country’s economy could divert foreign financiers’ attention away from local companies, including insurers who might be in need of cash or alternate financing.

Reduced demand for imports

The country’s demand for imports has ebbed alongside a slowdown in economic growth and weakness in the Rand inflating purchasing prices from abroad. The latter has undone the potential benefit to local consumers ofweaker global commodity prices.

The real value of imports is expected to expand by 3 percent this year, thereby eroding all of the potential benefit that real exports could have generated in terms of GDP. Were it not for the large amount of grains that will have to be imported this year as a result of drought conditions, import growth could have been smaller.

Taking into account the outlook for household spending, investment, government expenditure, exports and imports during 2016, it is unlikely that South Africa will see any significant employment growth this year. Realdisposable income will grow marginally at best and at a rate significantly below an average of 2.7 percent per annum seen during 2010-15. This is setting off alarm bells for the local insurance industry.

Expected ratings downgrade

A further challenge posed by South Africa’s current situation is the expectation that at least one of the three major rating agencies will downgrade the country to non-investment grade (generally known as ‘junk status’) over the coming 12 months. Downward pressure on a sovereign rating also places downward pressure on corporate credit ratings. Insurers (and financial companies in general) are vulnerable to weaker corporate and sovereign ratings when they look to international markets for funding. Borrowing costs – ranging from interest rates charged by merchant banks to debt servicing costs on bonds – are influenced by these ratings.

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