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PolicyJuly 6 2009

Leaning against the wind

Major facelift: the Soccer City stadium near Soweto in Johannesburg will be the venue for the final of the 2010 FIFA World CupSouth Africa's banking sector has so far proved resilient to the country's worst recession in 17 years, but faced with soaring unemployment and high levels of consumer debt, the biggest challenges lie ahead. Writer Charlie Corbett in Johannesburg and Cape Town
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Leaning against the wind

One year from now, the eyes of the world will be on South Africa. On Sunday July 11, 2010 the final of the FIFA World Cup will be played out at Soccer City stadium in Johannesburg. It will mark the end of a journey that began in 2004, when South Africa narrowly beat Morocco to win the honour of being the first African nation to host the world's biggest sporting contest outside the Olympics. Hosting the competition will thrust South Africa to the forefront of the world's attention, and put its institutions and infrastructure under the microscope like never before.

Travelling through the country it is impossible to ignore the near-frenetic activity that is taking place to ready the nation for an influx of visitors from across the globe. It is a land of cranes and building sites. Airports, roads, railways and stadia are being built or upgraded. There is an air of optimism, but also one of desire - desire to get the job done before the June 2010 deadline.

At the World Economic Forum in Cape Town last month, South Africa's new president, Jacob Zuma, hosted a party outside the partially completed new Green Point stadium. He raised a glass to celebrate the fact that it was exactly one year until the kick-off of the tournament, and praised the construction industry's efforts to meet the deadline.

"Hosting the World Cup has led to the creation of more than 400,000 job opportunities. The construction industry has been invigorated and the hospitality industry is booming," he told an audience of leading financiers and politicians.

Economic headwinds

Beneath this veneer of optimism, however, there lurks a stark truth: South Africa is in its first full recession for 17 years. The resource-rich country has been hit hard by the twin impact of collapsing commodity prices and the global economic downturn. Gross domestic product (GDP) growth for the first quarter of 2009 fell at an annualised rate of 6.4%, its biggest drop for 25 years. Jean-François Mercier, chief economist at Citi in Johannesburg, says he was taken by surprise by the severity of the fall. "Mining and manufacturing were hit particularly hard," he says. "The picture is not very pretty at present and there are few signs that the worst has yet been reached." He estimates that the economy will shrink by 1% to 1.5% in 2009.

South Africa is facing severe economic headwinds. As The Banker went to press, the South African Reserve Bank (SARB) released figures that indicated an alarming, and unexpected, jump in the nation's current account deficit. It has reached 7% of GDP, up from 5.8% of GDP in the last quarter of 2008. Manufacturing output, which makes up 15% of the economy, collapsed by 22% in the first quarter, and the official unemployment rate climbed to 23.5% (the unofficial rate is estimated at more than 40%). In May production fell 18.6% and vehicle sales plunged 35% compared with the previous year. Inflation remains consistently high at about 8.4% and the SARB has been forced to slash rates by 450 basis points to 7.5% since December in a desperate bid to revive the economy.

Volatility ahead

To add to the pain, the rand has spent the past year seesawing against the dollar, giving exporters and importers alike severe headaches. Such is the concern over volatility in the currency that the SARB governor, Tito Mboweni, a life-long advocate of inflation targeting, was quoted as saying that he had "somewhat changed his mind", that there should be no intervention in the currency markets. "Leaning against the wind is actually not a bad policy approach," he said. As if to emphasise the point, Mr Mboweni's comments cued a 2.2% collapse in the value of the rand against the dollar.

Ratings agencies have not been kind to South Africa. Both Standard & Poor's and Fitch have downgraded the country's outlook to negative on the back of continued concerns about the economic downturn and South Africa's financing of its current account deficit.

Not everybody, however, shares such negative sentiments. It is true that South Africa is suffering as a result of the downturn, but it is not a uniquely South African problem and things could be a lot worse. "I don't think the South African economy has been hit at all, relative to what you see globally," says Nicky Newton-King, deputy chief executive of the Johannesburg Stock Exchange. "Certainly there are impacts, but the type of decimation that you see internationally is not what you've seen here. Our banks have come out very robustly. We did not have a single default. That speaks to the sophistication of our banking system."

Resilient banks

South Africa's bank sector has indeed weathered the storm. No South African banks were exposed to the complex derivative instruments that brought the Western banks to their knees. Added to that, the sector is not reliant on foreign inflows for its funding needs. Herman Bosman, chief executive of Deutsche Bank in Johannesburg, explains: "We have a closed banking market here with only 6% to 7% of our funding coming from offshore. We have a strong liquidity base in this country." On top of this, banks in South Africa were not highly exposed to those sectors hit the hardest by the recession. "The most exposed sectors in the downturn are not big in banks' loan portfolios. Manufacturing is about 4% [of total loan portfolios] and mining is just over 2%. They are not heavily bank-financed," says Citi's Mr Mercier.

Where banks will struggle, however, is on the consumer side. The past decade of prosperity in South Africa was built on the back of a debt-fuelled consumer boom. The emergence of a free-spending, post-apartheid, black professional middle class has driven house and retail sales, but the consumer binge has come on the back of large-scale borrowing. With house prices down nearly 5% year on year, and further falls likely, not only will consumer confidence be hit, but the threat of mortgage default looms higher and higher. South Africa's debt-to-income ratio has hit 74%, up from just 55% two years ago, and well above the SARB's preferred 68% safety threshold. Justin Bothner, a member of Rand Merchant Bank's equity capital markets team, says: "In the past five years we've seen a consumer binge fuelled by debt. People were living way, way beyond their means and that is not sustainable."

Profits hit

Anthony Walker, senior director and sub-Saharan banks analyst at Fitch Ratings, also has concerns. "Bank profits have been declining as impairments increase and volumes of deals decline," he says. "The main challenge will be impairment charges. If you look back over the past three years, we've seen impairment charges rising from 10% of pre-impairment profit to 50% at this point." He estimates that bank profits could be down 20% across the sector this year.

Aside from concerns on the consumer side, overall, South Africa's banks have come through the crisis with their honour intact. According to Deutsche Bank's Mr Bosman, it is a balancing act. "On the one hand, we suffered some of the confidence and activity demise that goes with a crisis of confidence. On the other hand, we were not the beneficiaries of the ECM [equity capital markets] and DCM [debt capital markets] activity prior to the crisis," he says. "On a macro-economic level we're probably worse off, but on a micro-economic level we have had the benefit of being in a sound, strong and stable financial system. So I would rather take exactly where we are, rather than what we saw offshore."

New president, old unions

Looking ahead, South Africans watch with a mixture of excitement and some trepidation as Mr Zuma assembles his cabinet and establishes his power base. So far, so good, according to most people that The Banker spoke to in Johannesburg and Cape Town. Fears about Mr Zuma's populist leanings were somewhat dissipated by the appointment of what most regard as a politically moderate and skilled cabinet. The removal of the experienced and well-respected Trevor Manuel from the finance ministry caused some murmurings of disquiet among the financial community, but his replacement by Pravin Gordham in the post of finance minster settled some of those doubts. Mr Gordham is highly respected for the job that he did in the tax office and most feel that the country's finances are in safe hands. Mr Manuel has subsequently been appointed to the planning commission.

The role of South Africa's powerful union movement in any future government is also a cause for concern. The Congress of South African Trade Unions (Cosatu), the country's biggest union, declared recently that the country's policies are determined not by the government alone but by a tripartite alliance comprising of the unions, the African National Congress and the Communist party. If this is not worrying enough, in May Cosatu nearly succeeded in sabotaging the R22.5bn ($2.8bn) sale of 15% of mobile operator Vodacom to UK-based Vodafone. Cosatu has also said that it will aim to block the reappointment of Mr Mboweni as SARB governor when he comes up for re-election next month. The unions have blamed the SARB's inflation targeting for the recession and job cuts.

Few, however, are taking this posturing too seriously. Mr Zuma has declared publicly that he will not be beholden to the unions and does not "owe anything to anybody". It is perhaps too early to tell whether this statement has any weight behind it, or how Mr Zuma will equip himself in running Africa's most developed economy. The most obvious barometer for success will be how the country handles its hosting of next year's FIFA World Cup. That, more than anything, will showcase to the world how far South Africa has come.

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