Dark clouds gather for important South African industry

South African companies are extremely hesitant to invest in the country’s manufacturing sector, with investment being insufficient to even maintain existing equipment and machinery. 

In other words, the capital stock of the sector is going backwards after years of decline amid load-shedding crises, logistical ineffciencies and a stagnant economy. 

This is worrying for South Africa’s economy as the manufacturing sector is a crucial employer, able to absorb a significant share of the country’s low-skilled workers. 

Stanlib chief economist Kevin Lings outlined the lacklustre investment in the sector and where companies are investing instead in the asset manager’s recent Corporate Conversations podcast. 

Lings explained that corporates in South Africa are sitting on nearly R1.5 trillion in cash that is held in call accounts or money market funds.

This is a record-high and is equivalent to around 20% of the country’s GDP, with companies being unwilling to invest in the local economy. 

The main driver behind their caution is the country’s poor economic growth, ongoing political uncertainty, and elevated interest rates, which boost the returns of money market funds and call accounts. 

Some areas where companies are investing include renewable energy, backup water supply, warehousing, and services. 

South Africa’s historical sources of employment, manufacturing and mining, have seen investment plummet in recent years. 

“There is substantial underinvestment in the productive sector, as economists call it. In manufacturing, investment levels are terrible,” Lings said. 

“The capital stock is going backwards. In other words, in the manufacturing sector, corporates are not investing enough to maintain the machinery and equipment they already have in place.” 

This points to an industry that is in significant decline, where companies are barely investing enough to keep their doors open in the short-term. 

Data from the Reserve Bank indicates that only 77% of the country’s manufacturing capacity is used, indicating weak demand in the local economy. 

The graph below, courtesy of Lings, shows the declining output of South Africa’s mining and manufacturing sectors over the past two decades. 

More problems on the way 

South Africa’s manufacturing sector is not showing signs of recovery, with tariffs from the United States likely to hit the sector hard. 

In particular, South Africa’s automotive manufacturing sector, the cornerstone of local industry, is expected to be hard hit as the United States is a crucial export market. 

Old Mutual Investment Group’s head of equity research, Meryl Pick, explained that tariffs are unlikely to have a significant impact on the local economy, but will hit specific sectors hard. 

The elevated tariffs on South African goods effectively nullify the benefits of the African Growth and Opportunity Act (AGOA) for the country. 

The loss of AGOA would be significant but perhaps would not have as much impact as many fear, given its limited scope and South Africa’s diversified export markets. 

“The policy had actually become far less relevant in the last decade than it was when it began,” Pick explained. 

When AGOA was first launched, the US was South Africa’s largest trading partner. China has since replaced it, consuming over 20% of the country’s exports. 

Pick also said that the vast majority of South African exports to the United States are minerals, which are exempt from the tariffs. 

Despite the limited effect, specific sectors employing hundreds of thousands of South Africans could be severely impacted. 

“In a specific South African context, the motor industry is clearly the biggest beneficiary of the program,” Pick said. Another major sector impacted would be citrus exports. 

“So, very big impact in specific industries, for example, in the motor industry and citrus exports, but at a broader GDP level, the effect should be minimal.”

Another looming headwind for the manufacturing sector is the imposition of cross-border carbon taxes by some of South Africa’s largest trading partners, particularly those within the European Union (EU). 

About 422,000 South African jobs are supported by exports to countries with active or incoming carbon border adjustment mechanisms. 

Carbon border adjustment mechanisms, or CBAMs, are designed to reduce emissions by ensuring imports are subject to the same surcharges as domestically produced goods that use carbon-intensive methods.

The European Union, South Africa’s second-biggest trade partner after China, will start levying charges through its CBAM next year.

The UK plans to follow suit, and countries including Australia and Japan are also considering introducing measures.