Secret Allure Of South Africa

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Includes: EZA
by: Evans Osemwegie

Summary

South Africa is in chaos right now.

Beneath the surface, the economy is making progress.

The key is the manufacturing and industrial numbers.

Right now South Africa is a mess. The riots and looting have fueled civil and social unrest, the politicians are divided and there is significant international markets pressure for South Africa to make deep structural reforms in order to remain an investment grade borrower.

It is fair to say to say that South Africa has not been in such dark days since the period just after apartheid ended.

The question that still remains is what is next for South Africa and is there any glimmer of light in the midst of all this turbulence.

Without going in too much detail and hand wringing, the core of the problem in South Africa is social. Since the ANC came into power even under Nelson Mandela, they believed in gradual reforms and that inequalities between the various races present in South Africa will correct itself over time and that their job was to continue building the economy largely in the mold that they found it.

This has proven itself not to be the case and in the process, South Africa has lost a generation to poverty, illiteracy and crime.

What the ANC needed to do was to invest significantly in sectors like education, housing and healthcare that would have laid a foundation today for a wider base of economic participation by every racial group in South Africa.

In addition, there is also the persistent cloud of corruption that hangs over South Africa as with all other government around the world.

In moving forward, I was very disappointed with the 2016 budget plans because it did not really with the main issues plaguing the South African economy and furthermore, it lacked the urgency and decisiveness necessary to pull South Africa out of its current slump.

For example, there was very little details about how they intend to redress the imbalance in the public purse particularly reducing the headcount in the Civil Service.

In addition, there were no practical information about how they can increase government investments into the economy and encourage private investments into priority sectors.

The paucity of these types of details is what has continued to fuel the uncertainty concerning South Africa's growth prospects.

Despite all of this, I am still bullish over South Africa for a number of reasons.

It has very attractive demographics. Since 1994, South Africa's working-age population aged 15 to 64, has grown by 11 to 13 million, according to the World Bank. The age group comprises 65% of the country's total population of 54.9 million in 2015. More than half of the working-age population is under the age of 25, and the sector is expected to grow by another nine million in the next 50 years. The country is aiming to be the leader in the renewable energy space in Africa in order to improve its electric production capabilities in an environmentally sustainable manner and also to develop a new industry.

The Department of Energy has approved 79 REIPPPP projects with 5 243MW being added to a national grid desperately in need of power, at a capital cost of R168-billion. The project winners had to supply all their own capital.

The energy contribution should grow to approximately 7 000 gigawatt hours a year with the first 47 renewable energy independent power producers fully operational and producing at full capacity by mid-2016 according to government sources.

While these are not projects with immediate pay off, it will put the nation on a path to higher levels of economic growth over the medium term and can help it achieve a GDP growth of about 3.5% by 2020 beating the current forecast of 2.2%.

South Africa's exports is projected to decrease steadily over the short and medium term as the graph below shows.

Nevertheless, it is my expectation that the decrease in exports will be matched by an increase in local consumption and also increases in the service sector of the economy.

It is worth noting that South Africa's trade surplus increased to ZAR 8.22 billion in December of 2015 from a downwardly revised ZAR 0.68 billion surplus in the previous month and beating market expectations of ZAR 4.85 billion. It was the highest value since December of 2010, as exports dropped 5.1 percent while imports fell at a much faster 13.3 percent.

Furthermore, this shift will also include exports of more value added products than before.

6. The inflation rate is beginning to gradually slow down after significant increases over the course of 2015 and early 2016.

As we come into the summer months and harvest season, we will continue to see a continued drop in the price of food thus lowering rates even further.

This is good news for the administration who have been hiking interest rates higher in an attempt to slow down the growth of inflation but I do not see inflation falling below 6% in the foreseeable future.

This is because consumer spending is increasing, disposable income is increasing and also household debt to GDP is also increasing.

The best they can do is harness this positively by increasing government and private sector investments to achieve greater productivity gains which will feed into the GDP positively over a longer period of time

The area of manufacturing and industrial production is the area where the South African economy is currently most challenged. Manufacturing PMI, Industrial Production and Capacity utilization are all struggling which seems like an oxymoron in a nation where demand and disposable income is rising.

The reason for this is the social and political upheaval that the country is facing at the moment and as this changes, we should see a significant uptick in this area.

It is worth noting that they are already doing that with steel and electricity production.

In my opinion, the net beneficiaries of this will again be the local companies and investing in the South African equities markets right now will be a very shrewd move.

The JSE has remained surprising resilient and this is certainly a sign of the strength in depth of the companies listed here and with greater industrial utilization and productivity, it is my belief that this market can grow to up to 65000 points by the next 24 months.

Finally, the iShares MSCI South Africa ETF EZA is on a significant growth trajectory having grown by nearly 5000 points since the end of 2015.

Conclusion

In conclusion, beneath the social unrest and political instability, South Africa still retains that secret allure.

Nevertheless, as a word of warning, conditions may get worse before it gets better so start your investments small and as things begin to improve particularly the manufacturing and industrial numbers then you can start to add to positions in the equity markets only, the fixed income markets already looks significantly overvalued.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.