The EU crisis and the outlook for SA

by Mark Botha, editor

The European Union is the developing world’s largest trading partner and one of the key investors in the global economy. It is a major source of remittances and an important donor to developing countries – poorer "third-world" countries depend on Europe for roughly half their international aid. Will this, the second European financial crisis, lead to the predicted (and dreaded) "paradox of thrift" and impact our industry negatively as markets around the world reduce demand?

Research by Isabella Massa, Jodie Keane and Jane Kennan of the London-based Overseas Development Institute (ODI) highlights a number of factors that would make poor countries vulnerable to the Euro crisis. These include a dependence on remittances (money sent home by migrant workers), foreign direct investment (FDI) and aid, as well as large-scale trade with countries affected by the crisis.

While, at face value, South Africa seems generally unaffected in terms of the ODI’s criteria, it is the latter – trade – which exposes our flank. In the financial year following the 2008 financial crisis in Europe, exports from South Africa, the EU’s principal African trading partner, dropped by 35% from R165-billion in 2008 to R105-billion the following year. The European Union, lest we forget, also provides 70% of all external aid to this country.

The South African economy came away from the 2008 crisis with a decline in demand for export products, a fall in commodity prices and a wariness among portfolio investors of emerging markets such as ours. In his 2012 state of the nation address, President Zuma announced that almost 1-million jobs had been lost to the EU crisis in the previous year. But these are minor injuries compared to what may come.

On the EU’s current crisis, finance minister Pravin Gordhan warns that the outlook this time round is not bright. Speaking in the debate on the main budget in the National Assembly, he said that the crisis in Europe, combined with low global growth patterns, heralds tough economic times for our economy.

A statement by the South African Institute of Chartered Accountants (SAICA) also paints a bleak picture. The impact of the current crisis on business in South Africa, it says, will place "continued pressure" on local companies as credit becomes less available. Companies will become caught between slow debt recovery and "payment pressure" from suppliers. Acquisitions may dwindle, pension fund deficits may become "more common" and entrepreneurs will have to focus on finding growth opportunities and grasping them when loans and working capital are scarce.

Massa, Keane and Kennan explain that the EU crisis affects developing economies through channels of impact. The first of these are "Financial contagion effects" result from shifts in investor market sentiment and changes in investors’ perception of risks.

"Fiscal consolidation effects" result from the austerity measures imposed in some European economies. These have led to a rise in unemployment and have weakened the growth of economies still not fully recovered from the 2008/9 crisis. This may affect demand for exports from developing countries and even affect FDI and flows of remittance and aid from European countries.

According to the International Monetary Fund (IMF), the "overarching risk" to developing economies is "an intensified global ‘paradox of thrift’" as households, firms, and governments around the world reduce demand. This risk is exacerbated by fragile financial systems, high public deficits and debt, and by low interest rates in the developed world.