SA is in dire need of growth and a restoration of business confidence.
After President Cyril Ramaphosa’s recent positive state of the nation address we may be forgiven for hoping — or believing — that we are on the threshold of a new dawn: a period of active real investment, asset formation and higher economic growth rates. But we need to be realistic about the pitfalls too.
The president outlined a number of initiatives aimed at restoring business confidence and kickstarting the economy. However cynical and weary we may be of repeated statements of plans to mend what is broken, it does seem that the country’s leadership is determined to attract investment into the economy and wake it from its decade-long, low-growth slumber.
Since the great financial crisis not only have foreigners held back on long-term real investment in the SA economy, but local businesses have either been dissuaded from investing locally or persuaded to seek opportunities offshore — too often with disastrous consequences.
As a rule, SA’s corporate sector did not enter the last 10 years of low growth with excess levels of debt. Those companies that did paid a heavy price. Prolonged tough trading environments often result in higher levels of “operational leverage”, namely higher fixed costs that threaten the bottom line and longer term sustainability. Firms trying to navigate these cyclical downturns tend to steer clear of “financial leverage”, or higher debt levels.
This occurred in corporate SA, where firms are now facing the new dawn (real or imagined) with relatively low levels of debt. Compared with its developed market counterparts, SA’s corporate sector has always shied away from high financial leverage. But in contrast to its developing market peers, corporate SA tends to tolerate more and longer-term debt.
Having spare capacity on the balance sheet puts the SA corporate sector in a comparatively strong position to make the most of the emerging opportunities. Apart from helping stretch each available rand, debt is cheaper than equity, not only because lenders require lower returns than shareholders, but also because the fiscus covers part of the costs of borrowing. Compared with prior expansionary cycles, the cost of borrowing has decreased steadily in the last 10 years. In SA a R1m corporate loan taken out in 2007 would have cost the borrower on average R108,000 a year in interest after tax, compared with R72,000 today.
Of course, since the events of 2008, the cost of capital has reduced globally, and some may argue to unsustainably low levels. However, unlike the rest of the world, events in SA halted investment activities across broad swathes of the economy, including personal investment in hard asset classes such as residential property. SA consumers are today 10% less indebted than they were 10 years ago. If our leaders are able to address these constraints to investment and regain investor confidence, the lower costs of available capital could lead to a prolonged period of asset value growth as we catch up on what we lost — over an entire decade.
Alas, the picture wouldn’t be complete without a dose of sober realism. Recent history has taught us that firms and individuals either incorrectly predict the timing or nature of the recovery, or falter and splurge available capital on unproductive assets. No matter how cheap or abundantly available it might be, all capital (and especially debt capital) requires a return to be delivered to investors.
If the long-suffering SA private sector is rewarded with politicians who deliver what they promise, the discipline and caution of the last 10 years may just allow corporations to reap extraordinary rewards. Of course this will only materialise if they can be persuaded to invest.
• Marnewick is head of Stanlib Credit Alternatives.
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