Land Reform Debate and Poor Fundamentals to Weigh on South Africa

The African National Congress (ANC) is moving ahead with controversial land reforms by withdrawing an existing land reform bill. President Trump’s recent tweet on the ongoing land reform debate is sure to keep this controversial issue in focus ahead of South African elections next year.

POLITICAL OUTLOOK

President Trump recently brought his attention to the controversial land reform being debated in South Africa. Let us be clear: there have been no seizures nor widespread killings of white farmers in that nation. Instead, let’s take a look at the facts as they stand.

At its December party conference, the ANC announced that it would pursue a land reform policy of expropriation without compensation. President Ramaphosa said it was urgently needed but stressed that any reforms must not harm the economy. Lawmakers have already started the process for making the necessary changes to the constitution. Public hearings on land reform are being held nationwide.

Why now? Senior ANC official Zweli Mkhize said that doing it too soon after the end of apartheid would have hurt investor confidence but warned that waiting too long now could stoke unrest as unemployment and income inequality remain high. Whites reportedly still own almost 75% of the nation’s agricultural land. Whilst down from 87% during apartheid, this share remains very high given that whites make up less than 10% of the total population.

Yesterday, it was announced that the government is withdrawing the land expropriation bill that was passed in 2016. This is a negative development, though expected. That 2016 bill was never signed into law, but it was meant to have the government pay for land at some sort of “fair value” determined by an adjudicator. By withdrawing this bill, the ANC is setting things up for the more controversial option of land seizure without compensation.

Pursuing land reform of any sort is a potentially risky move ahead of elections next year. There is no date in set yet, but they will be held in Q2 2019. Post-apartheid elections have been held in April (1994, 2004, and 2009), May (2014), and June (1999). Pushing ahead with land reforms would likely secure a greater share of the black vote, which has been drifting to the opposition in recent years. On the other hand, it will likely spook businesses and hurt investment.

The ruling African National Congress (ANC) has seen its share of the popular vote fall in every election since 2004. The ANC only got 54% of the vote in the 2016 municipal elections, a record low and down from 62% at the last national election in 2014. Since seats are awarded proportionally to the popular vote, a sub-50% showing next year would be a disaster for the ANC, to state the obvious.

Recent polls suggest the ANC’s popularity has rebounded after Ramaphosa replaced Zuma as its leader. The latest Ipsos poll suggests 60% would vote for the ANC. 13% would back the Democratic Alliance (DA) and 7% would back the Economic Freedom Fighters (EFF). Many believe the DA’s standing has suffered from infighting. Still, a lot can happen between now and next spring.

 

A BRIEF HISTORY LESSON

After the defeat of the Boers in the Second Boer War of 1899-1902, the Union of South Africa was created. It brought together the four separate British colonies (Cape, Natal, Transvaal, and Orange River) into a self-governing nation within the British Empire. From the start, the white South African government followed harsh segregationist policies, including the denial of voting rights for blacks.

The Native Lands Act of 1913 prohibited blacks from engaging in any farming outside of their designated reserves. At that point, whites made up 20% of the population but held 90% of the land. Many blacks were deprived of their farming livelihoods. Many were also forcibly relegated to these rural land reserves, segregated from the rest of the population.

While segregationist policies had been in practice for centuries, apartheid was only institutionalized after the National Party came to power in 1948. Many aspects of apartheid were quickly enshrined in law. The first to be introduced was the Prohibition of Mixed Marriages Act of 1949, which was followed by the Immorality Act of 1950. The Population Registration Act of 1950 then classified all South Africans into four racial groups: black, white, colored, and Indian. Forced segregation along racial lines quickly followed.

The reserves were relabeled as “homelands” or Bantustans by the Promotion of Bantu Self-Government Act of 1959. The ten Bantus were eventually organized along ethnic lines, and residents were later made legal citizens of their homelands, thereby stripping them of their South African citizenship. Between the 1960s and the 1980s, the government continued to forcibly move blacks from the white urban areas of the country to the rural Bantus.

The National Party remained in power throughout the apartheid era. Faced with growing global opposition to apartheid, the National Party saw the writing on the wall and began making a series of concessions in the 1980s. President de Klerk released Mandela from prison in 1990, and the two negotiated an end to white-only rule. Apartheid was ended in 1992, and this led to all minorities being able to vote in the historic 1994 election.

The ANC ran on promises of land reform. One state goal back in 1994 was that 30% of agricultural lands be eventually transferred from white to black ownership. Initially, the ANC committed to a “willing seller, willing buyer” policy. However, that was widely recognized as a failure. At the start of this year, only 8% of the land had been transferred, well short of that 30% goal. That failure coupled with the rise of the more radical EFF helps explain the ANC’s shift to a new, risky approach.

Last month, we wrote a piece on South Africa that contained a section on land reform in neighboring Zimbabwe (“Hawkish Hold From SARB Likely as Political Risks Rise”). That piece contained a short summary of what happened in Zimbabwe. The conclusion bears repeating: “Zimbabwe provides a stark example of why it is so important for South Africa to do it correctly. It would seem that South Africa feels that a voluntary, compensated solution did not work in Zimbabwe, and so is bypassing it for an expropriation-based model of reform. As Zimbabwe clearly illustrates, this strategy is fraught with dangers. “

 

ECONOMIC OUTLOOK

The South African economy remains sluggish. GDP growth is forecast by the IMF at 1.5% in 2018 and 1.7% in 2019 vs. 1.3% in 2017. GDP rose only 0.8% y/y in Q1, down from 1.5% peak in Q4 and the weakest since Q2 2016. In annualized terms, the outlook is even worse as GDP contracted -2.2% in Q1, the worst since Q1 2009 amidst the Great Financial Crisis. As such, we see downside risks to the growth forecasts. Note Q2 GDP data will be reported on Tuesday.

Price pressures are rising. CPI rose 5.1% y/y in July, the highest since June 2017 and nearing the top of the 3-6% target range. PPI rose 5.9% y/y in June, the highest since January 2017, with July data out tomorrow expected to show a slight acceleration to 6.0% y/y. Note that state workers won a three-year wage deal with raises of 6-7% for the current fiscal year. All the signs are pointing to higher inflation ahead.

The South African Reserve Bank (SARB) started an easing cycle last July with a 25 bp cut to 6.75%. Heightened political risk forced the bank to remain on hold until March, when it followed up with another 25 bp cut to the current 6.5%. Next policy meeting will be held September 20, and we expect a hawkish hold due to rising inflation risks as well as the still-vulnerable rand. We believe the easing cycle has ended, and that it’s only a matter of time before the tightening cycle begins. Bloomberg consensus sees mid-2019 but we think the first hike will likely be seen by year-end or Q1 2019.

The fiscal outlook bears watching. While returning Finance Minister Nene has prioritized fiscal tightening, slow economic growth has taken a toll on revenues. Surprisingly, expenditures have been kept largely under control despite the multiple changes at the Finance Ministry. However, with the elections looming ahead, we will be watching spending carefully. In the first budget under Ramaphosa, the deficit forecast for FY2018/19 was cut to -3.6% of GDP from -3.9% previously and -4.3% in FY2017/18.

The external accounts are worsening. The current account deficit was -2.9% of GDP in 2017, and the IMF expects the deficit to remain steady this year and widen modestly to -3.1% in 2019. However, export growth has been slowing noticeably this year, leading the trade surplus to narrow. The current account gap widened to -4.8% of GDP in Q1 while data in Q2 suggests some further deterioration. This points to upside risks to the deficit forecasts. Note Q2 current account data will be reported next Thursday.

Foreign reserves have risen to a record high, but vulnerabilities remain. At $50.5 bln in July (down from the all-time high of $51.2 bln in May), reserves cover over 5 months of imports but are only equal to around 90% of its the stock of short-term external debt. Thus, the country remains vulnerable to shifts in sentiment and so-called hot money. Indeed, FDI slumped to $1.3 bln in 2017, the lowest in eleven years.

Data from the National Treasury show foreigners held 40% of South African government debt at the end of Q2. While down from 43% at the end of Q1, this is still up sharply from only 10% ten years ago and illustrates the country’s heavy reliance on external financing. Moody’s rating is very important, as the loss of investment grade would lead to forced selling of South African bonds.

 

INVESTMENT OUTLOOK

The rand is underperforming after a stellar 2017. In 2017, ZAR rose 10% vs. USD and was behind only the best EM performers KRW (13%), MYR (11%), and THB (10%). So far in 2018, ZAR is -14% and is ahead of only the worst performers ARS (-41%), TRY (-41%), BRL (-20%), and RUB (-16%). Our EM FX model shows the rand to have WEAK fundamentals, and so we expect this underperformance to continue.

USD/ZAR was trading at its lowest levels since August 10 yesterday but has since moved higher. Using the August 13-28 drop in USD/ZAR, the major retracement objectives come in near 14.565 (38%), 14.7535 (50%), and 14.9420 (62%). As we remain negative on EM, we think the pair will eventually test the August high near 15.55. That was the highest level since June 2016, and a break above that would set up a test of the May 2016 high near 15.9825 and then the March 2016 high near 16.2445.

South African equities are outperforming after underperforming last year. In 2017, MSCI South Africa was up 19% vs. 34% for MSCI EM. So far this year, MSCI South Africa is -2% YTD and compares to -7% YTD for MSCI EM. Our EM Equity Allocation Model puts South Africa at VERY UNDERWEIGHT, and so we expect South African equities to go back to underperforming.

South African bonds have held up well. The yield on 10-year local currency government bonds is +37 bp YTD. This is behind only the best performers China (-28 bp), Poland (-12 bp), Taiwan (-11 bp), Korea (-10 bp), Malaysia (+9 bp), Mexico (+22 bp), and Peru (+26 bp). With inflation likely to move higher and the central bank taking a more hawkish stance as a result, we think South African bonds will start underperforming.

Moody’s recently noted that ongoing uncertainty regarding land expropriation without compensation is limiting investment near-term. Indeed, the agency warned that this could lead to a more pronounced long-term drop if the final terms are onerous for businesses. The IMF made a similar warning earlier this year after completing its annual Article IV consultation.

Our own sovereign ratings model shows South Africa’s implied rating steady at BB/Ba2/BB after rising a notch last quarter. We still believe Moody’s and Fitch’s ratings of Baa3 and BB+, respectively, are facing continued downgrade risk. S&P’s BB rating appears to be on target. Moody’s just affirmed its Baa3 rating in March but inexplicably moved the outlook from negative to stable.