South Africa Hits a Wall

It's a narrative that many emerging-market observers have become rather familiar with: a left-leaning leader runs for the top post of a country on the back of a very populist agenda involving redistribution of wealth and runaway social spending, a prospect that leaves investors extremely wary. But once elected to office, the new ruler adopts a more measured approach and does little to disturb the economic orthodoxy.

South African President Jacob Zuma's term so far appears to be playing to that script. At least from an economic standpoint, his first few months in office have been unremarkable. Despite all the posturing to the left, his attitude toward business remains largely benign. Newly appointed economic leaders, like the finance minister and the central-bank governor, favor moderate rather than radical change.

But much of the good news for South Africa's economy ends here. The country is unlikely to return to the high growth rates of nearly 5 percent that it enjoyed from 2003 to 2007. That growth spurt was the result, in large part, of a one-off credit-and-consumption boom triggered by the emergence of a black middle class, which grew off the back of newfound financial and political stability. But the middle class now seems tapped out as it carries a large debt burden, with the country's debt-to-disposable-income ratio close to 80 percent.

A more fundamental problem is that the people who could join the ranks of the middle class have now done so. Education levels remain low. Homegrown job opportunities are scarce as credit availability has slowed post–financial crisis. South Africa's unemployment rate is estimated to be almost 25 percent, and it is possibly the only major country where the number of people receiving social grants is greater than those with jobs. Life expectancy remains low, at just 49 years, and crime is high—more than 90 percent of homicide cases are never solved.

It is, of course, hard to reverse these trends, part of a long legacy of apartheid, in a short time. President Zuma is spending money on better infrastructure, like power plants and schools, yet these are long-term solutions. In the interim, the economy will have to settle for a muddle-through path, and Zuma will need to use all the people skills that brought him to power to ensure social stability. But while the South African economy could well be in for several years of lackluster growth, its stock-market prospects are brighter, thanks in large part to a better macroeconomic climate on the rest of the continent. South African companies have been expanding aggressively in countries like Nigeria, Tanzania, and even Angola. The momentum is likely to pick up the pace, as these countries are now following the same development path as South Africa. Many of these nations will likely enjoy 5 percent growth going forward as the middle class grows, a relatively wealthy diaspora returns, and frontier investors pour money into their economies.

For investors, a good way into these markets is through South African blue chips. South Africa has some of the best-managed companies in any emerging market: they have strong margins, high dividends, and good corporate governance. In past years, South African firms expanded into the U.K. and the rest of Europe, but recently they've sensed opportunity closer to home. South African banks, telecoms, and retailers are likely to be more successful in Africa, as they tap into a less-competitive and faster-growing market where they understand the terrain.

Of course, there are plenty of caveats to the Africa renaissance theme. The collapse in commodity prices last year exposed the continent's continued dependence on natural resources, with at least a half-dozen sub-Saharan African economies experiencing an economic contraction this year, as opposed to only one (in Zimbabwe) in 2008. The lack of proper roads, reliable power, and other basic public infrastructure also poses major challenges, and property rights remain a nightmare in otherwise promising markets such as Nigeria.

Still, the recent stabilization in commodity prices and continued discipline on the economic-policy front should help many African economies deliver relatively high returns in the coming years. The fact that well-run South African companies are allocating more resources to markets closer to home is proof of the longer-term potential of the world's second-largest continent.