SA’s power crisis underpins stagnant construction outlook
While we forecast growth in South Africa’s construction sector to remain positive, averaging 3.9% in real terms annually over the coming decade – it will be stagnant and risks being weighted to the downside. Investor sentiment is being hit by an ongoing electricity crisis and its political fallout, which is also constraining government’s ability to invest in new infrastructure. This environment will also weigh on non-residential building in particular.
Our expectations for South Africa’s business environment – currently dogged by power shortages and labour strikes – is that it will negatively influence the construction industry’s growth over the coming years. Both the continuing electricity crisis, a product of issues at state-owned Eskom, which has led to rolling blackouts, and strikes by a number of labour unions will drag on private sector sentiment. This will inhibit investment in new capacity and constrain the government’s ability to expedite its infrastructure development plans. For 2015, we are forecasting real growth in the construction sector of 3.4% - downgraded last quarter from 3.9%. With 2014 real growth coming in slightly below our estimate of 3.1%, and the South African economy under pressure from weak exports and a depreciating Rand, we are highlighting downside risks to our long-term construction forecasts. South Africa’s potential for growth is significant; however, long-standing issues when advancing significant infrastructure and housing plans under President Jacob Zuma’s National Development Plan (NDP) will remain. Our forecasts indicate growth will improve over the medium term as various measures under the Infrastructure Bill take effect, but it will not have a huge impact owing to subdued private investment.
Infrastructure Transport winning over Energy
Immediate concerns for the infrastructure sector are focussed around a constrained government budget. The South African government has already increased income tax for top earners and the fuel levy, but the country will continue to face mounting fiscal pressures, especially given ongoing wage negotiations with public sector unions which see wage increases above what have been budgeted. Elsewhere, in the face of growing strength of opposition parties, the government will do all it can to achieve priorities ahead of next year’s ballot. Coupled with this, the financial burden of dealing with the electricity crisis will divert funding away from investment; Eskom has estimated a funding gap at USD 18.4bn, and the government has suggested it will inject cash into Eskom to help. In this context, we expect growth in the transport infrastructure to outpace that of energy and utilities sector. The government’s inability to deal decisively with financial and operational problems at Eskom mean that the domestic power sector will remain in crisis mode.
Tariff hikes and government cash injections will be the short-term measures employed to stave off collapse of the electricity system. Privatisation could be forced on the government in the long run – although we do not think this will occur in 2015/2016 as it would be too contentious politically. Divestment would occur through the sale of power stations or an initial public offering, either of which could raise much needed capital, although an IPO could also bring on board a strategic partner. Until that time, the financial burden of Eskom will drag on investment in new power infrastructure - with transmissions grid investment plans being significantly altered for the coming decade. One area in which we continue to see positive momentum is in South Africa’s renewables sector. However, although not directly under the control of Eskom, which increases the likelihood of project realisation, the momentum in this sector could be hit by questions about Eskom’s ability to pay for both power purchase agreements in the traditional power generation segment and the Renewable Energy Independent Power Producer Programme.
While Eskom continues to face challenges which pose a downside risk to our energy and utilities infrastructure forecasts, we note that our already positive outlook towards South Africa’s transport-specifically rail - forecasts have been boosted by the announcement that state-owned freight logistics company, Transnet, is partnering with the Development Bank of Southern Africa(DBSA) in a drive to accelerate private sector participation in its multibillion rand infrastructure investment programme. We have long-noted that Transnet Group’s ZAR300bn plan to modernise and expand its rail, ports and pipelines businesses would be financially challenging, given the constrained public sector support available. As such, garnering private investment - a group of South African banks financed new rolling stock for Transnet. Making Transnet’s infrastructure as attractive as possible through working with the DBSA will be crucial.
Residential and non-residential building
We have long held that the South African residential sector will see buoyant activity on account of the government’s pledge to provide formal housing at the affordable end of the scale, and accommodative interest rates buoying private developer’s activity. This remains in play, although we note that the Reserve Bank has adopted more hawkish language of late, in light of increased inflationary pressures, and our Country Risk team have accordingly altered their interest rate expectations, which could see a slight drop in private activity. While we expected the repo rate to be kept on hold at 5.75% throughout 2015, we now expect a 25 basis point(bps) increase in the second half of the year.
South Africa’s poor business environment and economic outlook is most evident when looking at the disparity between the impressive growth in the value of permits for the residential sector and the underperformance of the non-residential sector. In the face of uncertainty surrounding power supply, labour strikes and 2016 legislative, investment will turn around markedly. Foreign perceptions of the investment environment in South Africa are likely to remain fairly downbeat, especially amongst portfolio investors. South Africa is widely viewed, along with Turkey and Brazil among others, as being particularly exposed to a dollar strength and weak global growth.