South Africa’s economy is suffering from economic structural risks and natural capital degradation, pushing sectors of its economy – from agriculture to banking to energy to transport – into decline and companies into restructuring. South Africa’s government now faces a choice – continue along its old path of economic stasis or pursue a nationwide green recovery agenda.
South Africa’s Q4 2019 economy shrank 1.4% after a Q3 2019 drop of 0.8%, the economy’s second recession in the last two years. Now, exacerbated by COVID-19 and structural risks, South Africa has entered into its worst economic downturn since World War II, with about one third of its labour force unemployed, coupled with slumping business confidence.
While South Africa maintains a flexible exchange rate and a Central Bank that has room to cut rates with inflation relatively under control, Moody’s 25 April ratings update forecast South Africa’s growth rate for 2020 to be negative 6.5%, while the IMF is forecasting the country’s growth rate over the same period to be negative 5.8%.
On 30 April 2020, S&P further downgraded South Africa’s long-term foreign-currency and local-currency rating to ‘BB-‘ and ‘BB’ respectively, while maintaining the country’s outlook as stable for both ratings.
Now, with South Africa no longer rated investment grade by Moody’s, its sovereign debt is excluded from the FTSE World Government Bond Index as of 30 April 2020, significantly decreasing demand for its debt coupled with sizable net outflows of non-resident portfolio debt.
Compounding these cash outflows, the shock to South Africa’s economy from COVID-19 is further weakening its prospects. South Africa has limited fiscal room to support the higher social spending required to fund healthcare and economic shocks caused by COVID-19. In response, South African Finance Minister Tito Mboweni has stated that the country’s budget deficit could increase to greater than 10% of GDP because of the COVID-19 crisis.
Despite generally well-capitalized private banks and an active Johannesburg Stock Exchange, many state-owned financial institutions are at times also struggling as their non-performing assets are increasing.
For example, on 12 May, in the light of the April downgrade, the South African Reserve Bank suspended the qualification of South Africa’s state-owned Land Bank’s short-term debt, previously considered “High Quality Liquid Assets”, as collateral to obtain funding for liquidity from its repo auctions. This prevents local banks, which have 30 days to comply with the order, from using Land Bank’s debt for their Liquidity Coverage Ratio calculations.[i]
These structural risks are exacerbated by three years of persistent drought in many parts of the country, interrupted at times by extreme rainfall and flash flooding. Natural capital risks are now financially material to an economy already suffering from inconsistent energy supplies, inefficient public services and chronically aging public assets.
South Africa’s agriculture sector contracted 4.8% in 2018 and 8.2% in January-September 2019.
As natural capital risks heat up, Land Bank, a leading lender to emerging and commercial agriculture interests in South Africa with a market share of 29% of the country’s agricultural debt, has now defaulted on two of its domestic medium term notes valued at $2.63 billion (ZAR 50 billion) because of a “liquidity shortfall”. As a result, despite Land Bank’s cross-default clauses, Moody’s downgraded the bank deeper into junk status to B1, further complicating the bank’s ability to pay off its debt, 50% of which matures in the next year.[ii]
As shown by the default in its agriculture loan book and stated by the bank in 2019 “climate risk effects are impacting the quality of [the] loan book and some farmers are struggling to repay loans”.[iii]
The bank further states:
“Climate risk poses a major challenge to the Bank and our clients. Our long-term sustainability depends on a climate and socially resilient agricultural sector, stakeholder understanding of our management approach and oversight of this risk category.” [iv]
Furthermore, non-performing loans, in its Commercial Development and Business Banking division which provides lending solutions to the commercial and smallholder farmer segments, have increased over the last fiscal year from 15.6% in FY2018 to 18.6% in FY2019 “due to a combination of climate stress and difficult economic conditions for farmers”. As a result, these non-performing agriculture loans contributed to the overall bank’s non-performing loan ratio increasing to 8.8% FY2019 from 6.7% in FY2018, driving down the bank’s overall capital adequacy ratio from 17.3% in FY2018 to 16.4% in FY2019 and decreasing its net stable funding ratio to 102.0% in FY2019 from 108.6% in FY2018.[v]
Even more worrying is what is on the horizon, as “under-performing loans” were 8.8% of Land Bank’s over loan book in FY2019, a ZAR 643.5 million increase from 6.7% in FY2018.Land Bank’s investor roadshow in September 2019 also highlighted “unexpected challenges” such as uncharacteristic hail in usually hail-free areas and drier weather conditions in certain regions.
It also reported that drought conditions over several seasons had reduced agricultural activity and that less interest income had been earned as the delayed planting season had affected drawdowns on loans.
Now the Government of South Africa may have to rescue Land Bank during the COVID-19 crisis by guaranteeing debt and adjusting bank capitalization funding. Yet South Africa’s government needs to determine where to start and who to support first given limited funds – electricity by bailing out Eskom again, or food and agriculture by supporting Land Bank.
Eskom, the country’s public electricity utility provider, the largest in Africa and one of the seven largest global electricity producers, needs another state bailout of ZAR 26 billion and ZAR 33 billion in FY 2019/20 and FY 2020/21 respectively after already receiving in July 2019 ZAR 59 billion in emergency government, tax payer generated, funding.
Now, with a nationwide Covid-19 lock-down in place, Eskom has enacted a force majeure clause with its coal supplier contracts, such as with Exxaro Resources, as demand for the carbon polluting fuel has plummeted.
Eskom, which produces 90% of South Africa’s electricity, is also responsible for 42% of the country’s carbon emissions from its 15 coal power plants, many of which frequently significantly breach air quality indices, resulting in respiratory health implications and in some instances mortalities.[vi] South Africa’s greenhouse gas (GhG) emissions are the 14th largest globally, increasing by 20% between 2000 and 2015, largely due to its coal energy footprint.[vii]
In total, the government of South Africa has budgeted ZAR 128 billion in bailouts to Eskom by 2023.[viii] Meanwhile, Fitch Ratings downgraded Eskom’s credit rating on 14 April 2020 to B+ from ‘BB-‘ with a Negative Outlook.[ix]
In 2012, the think-tank Carbon Tracker Initiative found that coal reserves earmarked for the South African market, equivalent to 19.2GtCO2e, exceeded the South African Government’s ‘required by science’ carbon budget (in line with 2°C global warming) of 16.4GtCO2e for all sectors from 2010 to 2050.[x] In December 2019, this negative outlook had not changed. Following the publication of the Department of Energy’s long awaited Integrated Resource Plan (IRC), Climate Action Tracker rated South Africa’s commitments to reducing its climate footprint as ‘highly insufficient’, aligning with a 3°C to 4°C scenario.[xi] Actions within the IRC include the completion of nearly 6 GW of coal capacity currently under construction and commissioning of a further 1.5 GW of new coal capacity by 2030, together with extending the operational lifetime of South Africa’s sole nuclear power plant by 20 years, up to 2044.
Time will tell if Eskom’s muted alignment to a renewable energy transition and the Paris Agreement will cost the country in terms of foreign direct investment, trade competitiveness and sovereign bond purchasing.
Water risk is a real-economy concern in South Africa, with many communities and enterprises lacking consistent access to clean potable water. South Africa is a water-stressed country with agriculture areas in and around the Western Cape already impacted. Water risk was rated ‘extremely high’ by the World Resource Institute Aqueduct Tool within the Olifants and Breede basins of the Western Cape in April 2020.
Day Zero is a risk that many in South Africa remain concerned about, following the Cape Town water crisis which began in 2015 and peaked in 2017–2018. Day Zero is when Cape Town’s water reservoirs would fall below 13.5 percent of capacity, with municipal water supplies largely being switched off and residents having to queue for their daily water ration. At this point, Cape Town would have to turn off water taps to maintain its water infrastructure.
The problem is that, as water risks increase, they threaten and then weaken industrial competitiveness. With rising water scarcity and increasing perennial drought risks, water availability for industry, agriculture or residential use is becoming a “winner takes all” strategy, with communities often the losers.
Dwindling freshwater supplies, increasing pollution of groundwater and aging infrastructure are taking a toll on South Africa’s economy. Many South African provinces suffered from potable water shortages in 2019, including Gauteng (province of Johannesburg and Pretoria), the Eastern Cape and the Western Cape. Continued lack of access to consistent water in agricultural zones remains an immediate short-term risk.
With the International Air Transport Association forecasting that the industry globally will lose $314 billion in ticket sales in 2020 due to travel shutdowns from COVID-19, state-financed South African Airways has announced it is laying off all 4,700 of its staff. The national airline was last profitable a decade ago in 2011 and since has relied upon a series of government bailouts and state guaranteed debt agreements.
On top of this, with the 30 April 2020 S&P downgrade of South Africa’s long-term foreign-currency and local-currency ratings to BB- and BB due to the country’s growing current account deficit, decreasing capital flows and steep declines in international tourism receipts, South African Airways faces insurmountable hurdles.
South Africa’s international tourism receipts in 2018, at $9,789 million,[xii] contributed 2.7% of the country’s GDP, much of which was nature-based tourism businesses that are now in steep decline as COVID-19 related international travel restrictions have taken hold. As short-term prospects for nature-based tourism are very poor, South Africa can support these businesses by seeking ways to replace their lost income with other natural capital enhancing economic activities.
Will South Africa Choose a Green Recovery?
South Africa, its businesses and government, must strengthen its economy by enhancing its natural capital risk mitigation. The government can do this pursuing a rigorous green recovery plan based on sustainable long-term natural capital principles, reduction of climate eroding energy systems, and support for an equitable and “just transition” for all participants in the economy. Its energy, water, transport, banking and agriculture sectors need to coalesce around a green economy vision, where natural capital risk mitigation conserves economic capital in support of regional sustainable development.
[i] Reuters (12 May 2020). South Africa strips Land Bank debt of high quality asset status.
[ii] Toyana, Reuters (9 May 2020). South Africa suspends use of Land Bank debt as collateral after default.
[iii] Land Bank (2019). Integrated Annual Report FY 2019. P. 71.
[iv] Land Bank (2019). Integrated Annual Report FY 2019. P. 39.
[v] Land Bank (2019). Integrated Annual Report FY 2019. P. 71.
[vi] Sguazzin and Ramalepe, Bloomberg (26 June 2019). People Are Dying From Eskom’s Pollution in South Africa.
[vii] Department of Environmental Affairs, Republic of South Africa (March 2019). South Africa’s 3rd Biennial Update Report to the United Nations Framework Convention on Climate Change.
[viii] Fitch Solutions (April 2020). South Country Risk Report Q2 2020.
[ix] Long-term local-currency issuer default rating.
[x] Carbon Tracker (2012). Unburnable carbon: Budgeting carbon in South Africa.
[xi] Climate Action Tracker (2 December 2019).
[xii] World Bank (2020). “International tourism, receipts” (current US$, indicator code ST.INT.RCPT.CD) include expenditures by international inbound visitors, including payments to national carriers for international transport. These receipts include any other prepayment made for goods or services received in the destination country. They also may include receipts from same-day visitors, except when these are important enough to justify separate classification. For some countries they do not include receipts for passenger transport items. Data are in current U.S. dollars.