Despite a volatile currency, the South African government kept its cool. Public finances are now in good shape, and investor-friendly investment and indutrial policies are beginning to turn heads, says James Eedes.

Foreign investment, particularly into emerging markets, has never been for the faint-hearted. Even then, the dramatic fall in the value of the South African currency, the rand, followed by an equally dramatic rise would have tested the steel of the bravest.

The rand began 2001 trading at R7.56 to the US dollar; on December 20 that year it hit a low of R13.77. The spectacular 82% collapse sent South Africans into a state of panic and prompted the setting up of a commission to investigate allegations that traders and less-than-ethical companies had manipulated the currency. But the eventual findings found scant evidence to support the allegations.

Then the rand staged a robust comeback, climbing steadily against the greenback to a recent high of R7.20. And South Africans – as is their wont – started to panic again, worrying that too strong a rand would hurt exports.

Rollercoaster rand

Although no-one has been so brave (or foolish) to venture a definitive reasoning for the rand’s rollercoaster performance, a number of factors have affected it to varying degrees. The interest rate differential between South Africa and developed markets is as wide as 10 percentage points, for instance, which is attractive considering global returns are lacklustre. Whereas the Zimbabwean crisis previously weighed heavily on sentiment for South Africa, there is now a less alarmist view. There are also a number of more technical explanations, including South Africa’s oversold position in the forward currency market being uncovered by reserves – this structural problem has now been addressed.

While commentators have ruminated on the relative pros and cons of the rand’s fall and rise, there is little doubt that it has cost corporate treasuries dearly. Not even the most masterful act of clairvoyance could have anticipated the extent and pace of the currency’s movement, meaning actual numbers took a sharp deviation from budgeted numbers as hedging tactics were left wanting and rand revenues took a beating. A string of South African companies have blamed the rand’s strong performance for shrinking profits.

It was not an easy environment to press ahead with investment plans because projected returns went out the window.

No panic

Such volatility is a high octane fuel for panic. However – and this is the silver lining in this saga – the South African government and monetary authorities did not panic. Admittedly, rising inflation, fuelled in part by the falling rand, had to be curbed with stiflingly high interest rates. South Africa’s central bank, mindful of its self-imposed 3%-6% inflation target, drove the commercial banks’ prime lending rate to 17%. Economic growth has suffered. First quarter figures, to be released soon after publication of this article, were anticipated to come in at 1.5%-1.9% on an annualised basis, marking a conspicuous slowdown from the 3% growth rate achieved last year. Economists have, on average, cut growth forecasts for the full year from 3% to 2.5% in part, ironically, because of the strength of the rand, which has put exports under pressure.

The brakes are now firmly on inflation and economists expect aggressive interest rate cuts in the second half of this year and first quarter of next. To its credit, the central bank acted predictably and cautiously, deliberately not intervening in the currency market to prop up the rand or reverse its strength more recently. The rand is not far off “fair value”, the vague level at which it should be trading relative to the country’s trading partners’ currencies, inflation and interest rate differentials.

Hallmark of stability

Acting in a predictable and consistent fashion is becoming a hallmark of the African National Congress (ANC) government. It was an approach mastered by the Finance Ministry and National Treasury, which implemented vastly improved transparency, consistency and continuity in government revenue and expenditure.

Public finances are now in excellent shape and the country is being rewarded for it. Ratings firm Moody’s raised its rating on South Africa to Baa2, one notch above investment grade, late last year and has the country’s sovereign rating on positive outlook, indicating it is likely to upgrade again in coming months. Rival ratings firms Fitch and Standard & Poor’s followed suit recently, raising South Africa from investment grade triple B minus to one above at triple B. On the S&P scale, this puts South Africa in line with China, Slovakia and Tunisia, and ahead of countries such as Mexico and Thailand.

Making a plan and sticking to it is paying dividends elsewhere. The Motor Industry Development Plan (MIDP) was put together in consultation with the automotive industry. It is gradually lowering tariffs and exposing the local auto sector to increased competition. It is also providing allowances on new investment that would improve global competitiveness.

Above all, the plan provided long-term policy certainty, meaning that companies could invest with peace of mind. Huge investment followed from the likes of BMW and Daimler Chrysler. The former manufactures all left-hand drive 3-series vehicles in South Africa.

Policy hopes

South Africa’s ministry of trade and industry hopes to expand this into a national industrial policy which, paradoxically, will focus on micro economic interventions tailored for specific regions and industries. The Integrated Manufacturing Strategy places high importance on international competitiveness against the backdrop of globalisation. The emphasis is on technology – and not just in high-tech industries – to enhance overall productivity levels.

Specific sectors are being targeted, including clothing and textiles; agro-processing; metals and minerals; tourism; automotive and transport; crafts; chemical and biotechnology and knowledge intensive services.

The view is not radical. According to the Department of Trade and Industry, the share of exports in manufacturing output has more than doubled in seven years to 28%. The trend towards greater production for export markets has been consistent, even when domestic demand has been strong, which suggests a structural shift towards export-orientation. Manufacturing’s share of total exports has risen from 35% in 1994 to more than 50% now.

Not perfect

This does not suggest that the government’s report card is without blemish. The world has watched aghast as President Thabo Mbeki has repeatedly refused to acknowledge conventional scientific wisdom that HIV causes Aids, in turn preventing the roll-out of anti-retroviral treatment. With one of the highest infection rates in the world – 22% of all adults by one estimate – South Africa is a ticking Aids time bomb. It costs 10 to 20 times more to treat a patient that has developed full-blown Aids than to control the disease in the early stages of HIV infection, amounting to a potentially massive drain on government spending before factoring the economic costs of the loss of labour and disruption to workplaces.

Is this anything other than a disaster? There are tentative signs of a government climb-down. Finance minister Trevor Manuel said in his budget speech in February that the government would make a fiscal allocation to fund the roll-out of anti-retrovirals – treatment that campaign groups believe can add up to 10 years to an infected person’s life. This about-turn is credited to the tireless work of campaigners, like the Treatment Action Campaign, which have aggressively lobbied government and mobilised public support for their work.

If there is a silver lining to this blight on the face of South Africa, it is the fact that civil society is growing in strength and proving an effective counter balance to the African National Congress (ANC) government. The importance of such esoteric concerns may not be so obvious to outsiders but, considering South Africa’s democracy is less than 10 years old, the growing influence of civil advocacy groups bodes well for the entrenchment of democratic values and the pursuit of good governance.

Zimbabwe effect

Similarly, when the Zimbabwean information minister Jonathan Moyo asked the South African government to curb the South African media’s hostile stance towards President Robert Mugabe’s government, the approach was rebuked on the grounds that South Africa’s press is free. Positive as this was, it was cold comfort to many who feel that the South African government failed miserably in preventing Mr Mugabe from sending his country into social and economic collapse. It fostered unfounded speculation that, faced with the same threat to its political hegemony, the ANC might similarly cling to power at whatever cost.

In this instance, it is difficult to see anything positive in Mr Mbeki’s “quiet diplomacy” approach and, despite Zimbabwe’s suspension from the Commonwealth being upheld, there is little hope of a quick resolution to the problem. In mitigation, given populist sensibilities in the ranks of the ANC, who sympathise with the idea of taking land from rich whites to give to poor blacks, it is understandable that Mr Mbeki is wary of losing support within his own party. It is clear that he would like Mr Mugabe to disappear.

Costs of crisis

The costs of the Zimbabwean crisis to South Africa have been heavy. As a direct consequence of the crisis, trade with Zimbabwe has plummeted. But it has been the indirect impact – the so-called contagion effect – that has hit hardest: it has weakened the currency, fuelled inflation and, in turn, pushed up interest rates. A report commissioned by the Zimbabwe Research Initiative estimates that the crisis could have shaved 1.3% off South Africa’s GDP. However, the recent strength of the rand, despite no sign of change in Zimbabwe, suggests that the impact is less severe. And the crisis has had almost no impact on the practical aspects of doing business in South Africa, so investors can largely insulate themselves from any negative impact.

Indeed, as a better-informed, more accurate picture emerges, South Africa’s sound, investor-friendly investment and industrial policies that are credible and consistent are starting to turn heads. The South African newspaper Business Day reported that, on return from the US recently, trade and industry minister Alec Erwin said there had been a fundamental change in attitude towards the country. Describing the trip to the US as “by far and away” the most successful investment promotion road show, Mr Erwin indicated that companies such as Boeing and General Motors were showing interest in the call centre and business processes outsourcing areas.

This sustains momentum that is clearly evident. According to the Industrial Development Corporation, projects amounting to R314bn ($40bn) were unveiled by foreign and local investors last year, up from R64bn in 2001. The number of projects was up 17% to 251. Despite disagreement on what should and should not be included in this data, there was consensus that the trend is overwhelmingly positive.

Paying off

Hard work is paying off. The long-planned industrial development zones, for instance, where customs concessions and investment incentives can be enjoyed, are at last turning soil. At Coega in the eastern Cape, where construction on the multi-billion rand deepwater port is now under way, final negotiations with French aluminium producer Pechiney are being concluded to build a R16bn smelter.

In East London, foreign automotive firms are considering locating to its industrial development zone. In Cape Town, a three-and-a-half year old partnership to revitalise the city centre is paying off. In Gauteng, particularly around Johannesburg, targeted projects are being rolled out. All around the country, various investment promotion agencies are courting investors.

Challenges do lie ahead. Balancing black economic empowerment with investor interests will be difficult. But the government has been showing a sensitivity to investors. Addressing other concerns of investors, such as crime and corruption, is ongoing.

As the most sophisticated and well-developed economy in the region, South Africa is the obvious staging ground for entry into the 14-member Southern African Development Community, a 180-million customer common market that remains under-exploited. Similarly, perched at the confluence of the Atlantic and Indian oceans, the country is an important trans-shipment hub for ships plying the lanes between South and Central America and the Middle and Far East.

Good infrastructure

Underpinning this strategic location is good infrastructure – certainly the best in Africa and in many respects world class. Rapid increases in trade volumes have led to bottlenecks and problems at certain points but this is being addressed by investment in new facilities and privatisation.

South Africa’s ports, where problems are most acutely felt, are benefiting from multi-billion rand upgrades but are likely to benefit the most when the government awards concessions to private sector operators. Spoornet, the state-owned railways operator, is spending R15bn on new rolling stock while South African Airways, the state-owned flag carrier, last year concluded a R35.8bn deal with Airbus to supply 41 new aircraft – the largest aircraft order ever placed by a southern hemisphere country.

South Africa’s communications are first rate. The country’s mobile network operators are world leaders in technology while fixed line services and internet are smooth running. Critics contend that the government needs to overhaul telecommunications policy to allow greater competition. Regulators accept this begrudgingly. But this should not obfuscate the fact that the country’s telecoms infrastructure is the best on the continent and as good as any middle income country.

As for South Africa’s banking and financial system, it is almost without rival among emerging markets.

The case for South Africa is getting stronger.