Opinion: How South Africa, Nigeria Can Reform Financial Policies

Opinion: How South Africa, Nigeria Can Reform Financial Policies

From Barrons. Story by Manuela Badawy.

Africa’s two biggest economies, South Africa and Nigeria, face different challenges in 2016, but both need to reform financial policies. The goal: reignite economic growth.

South Africa is facing widening fiscal problems amid sluggish growth and neglect of reforms, just as investors grow wary of risk, and commodity prices fall. The country’s bonds and currency plunged last month, after President Jacob Zuma unexpectedly fired Finance Minister Nhlanhla Nene, who investors had viewed as an advocate for fiscal discipline. He was replaced by a relative unknown, David van Rooyen. This stirred concern that the ruling party had little interest in dealing with the country’s weak fiscal position.

The yield on South Africa’s 10-year government bonds rose by more than 100 basis points (each equal to 0.01 percent), exceeding 10 percent for the first time since 2008, while the rand fell to 16 per dollar, its weakest level on record. Four days later, the currency bounced as much as 5 percent after Zuma did an about-face and named a respected previous finance minister, Pravin Gordhan, to the job. Still, many analysts contend, the damage is done.

“The dire fiscal position, coupled with high inflation, and a fragile balance of payments (position), point to a further depreciation of the rand against the dollar in 2016-17,” says David Rees, an economist at research firm Capital Economics, adding that a weak risk appetite among investors is likely to ensure that bonds continue to perform poorly. The rand closed at 15.55 per dollar on Dec. 30.

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South Africa’s current account deficit widened to 4.1 percent of gross domestic product in the third quarter from 3.1 percent a quarter earlier, and Fitch Ratings estimates that it equaled 4.3 percent of GDP in all of 2015. “Lower commodity prices, a lack of capacity to produce goods currently imported, and the tendency for gain in competitiveness to be absorbed by higher wage growth will limit the structural improvement,” Fitch said in a note.

Fitch and Standard & Poor’s rate South Africa credit at BBB-minus, the lowest investment-grade level. Moody’s Investors Service rates the debt two notches above junk. The cost of insuring South Africa’s dollar debt against default for five years has almost doubled in the past year, to 3.36 percent of the amount covered.

South Africa could lose its coveted investment-grade rating because of low growth and limited progress toward structural reforms. Nonresidents hold more than a third of all outstanding government bonds. Gordhan, analysts maintain, will focus on fiscal discipline and stabilization of the nation’s debt profile. He’s an even stronger candidate for the finance minister’s job than Nene, who apparently was sacked for opposing the creation of a nuclear power program and South African Airways’ procurement plans.

Nigeria, on the other hand, must boost growth in its non-oil sector and make a dent in high unemployment. The key to an economic rebound will be the government’s decision on what to do with its dollar-pegged currency. Foreign-currency shortages have contributed to the slowdown and undermined confidence and investment, while foreign-exchange reserves slowly decline. To offset the slump, the Central Bank of Nigeria cut interest rates from 13 percent to 11 percent late last year, but investors say that the easing of monetary policy will have little effect on the real economy.

In any case, Nigeria must devalue the naira from its current level just under 200 per dollar to battle above-target inflation, deal with a current-account deficit, and boost security and foreign policy.

Read more at Barrons.