Despite Economic Challenges, Investors See Profit Potential in South Africa

By Mike Caggeso
Associate Editor

The latest news out of South Africa is that its economy grew an "unexpected" 5.3% in the fourth quarter.

Perhaps what perplexed economists about the country's growth last quarter [and last year] is the wealth of negative economic news coming out of South Africa.

For instance, consider these challenges:

  • Consumer inflation excluding interest on mortgage bonds - the Reserve Bank's measure for its inflation target - rose to 8.8% in January, up slightly from the 8.6% from December. That makes it the tenth consecutive month the so-called CPIX has clocked in above the 6% maximum target.

Yet, the Reserve Bank's hands are tied on inflation, because lowering the country's 11% key interest rate could allow market prices to race even higher.

It's like the South Africa economy is a speeding car that rolled over as it crossed the finish line. The question becomes: Can it land on its wheels?

And the answer becomes more important as the country approaches 2010, the year the world converges on nine of South Africa's cities for the month-long FIFA World Cup.

The impact that event will have on South Africa's economy is much greater than the Summer Olympics will have on host China later this year. In South Africa, five new stadiums are currently being built for the event, and five more are being restored. Off the soccer field, the hosting cities have under way a variety of restoration projects totaling tens of millions of dollars.

That makes South Africa an interesting case study. Can the emerging economy and turnaround government prepare for the short-term festivities and cement the country's long-term economic prospects? 

GDP Growth is Shrinking

It's well known that South Africa is the world's largest producer of platinum and its second-largest producer of gold. And reduced mine production played a significant role in the recent price spikes of each commodity.

However, its mining industry only contributes 5.8% of the country's GDP. The real economic drivers are financial services, real estate and business services [19.6%]; manufacturing [16.3%]; and wholesale and retail trade/hotels and restaurants [14.1%].

And each of those industries underperformed in 2007.

A detailed report from Statistics South Africa shows that its financial, real estate and business services sector grew 8.5% in the fourth quarter, down from the 12.3% growth in the third. For the year, it grew 8.3%, compared to 8.6% in 2006.

Manufacturing surged 8.2% in the fourth quarter compared to a 2.5% decrease in the third. For the year, however, it grew only 3.9%, compared to 5.2% growth in 2006.

Wholesale and retail trade/hotels and restaurants grew only 2.1% in the fourth quarter, less than half of the 4.5% growth in the third. For the year, growth in the sector clocked in a 5%, drastically down from the 7% posted in 2006.

This is especially alarming because those core economic contributors are going down while the construction industry soared 18.1%, and when the smoke clears after the World Cup frenzy, there may be a lot of empty apartments, hotels, restaurants, businesses and airports.

Which is perhaps why economists were scratching their heads at the country's 5.3% fourth-quarter growth.

Foreign Investors are Confident

Make no mistake, South Africa is one of the continent's major economies and an emerging market over which many investors are salivating.

And though internal economic figures may be slipping, the country has its abundance of foreign investment to thank for its growth. For proof, look no further than the $5.4 billion that China's state-owned Industrial and Commercial Bank of China Ltd. doled out for a 20% stake in Africa's largest bank, Standard Bank Group Ltd., which is based in South Africa. 

Also, the country's high interest rate makes its currency - the rand - an attractive investment for currency traders. 

South Africa's 5.3% growth is "an exceptional number," Russell Lamberti, an economist at Econometrix Treasury Management Ltd., in Johannesburg, told Bloomberg News.  "This is evidence that investment spending is really a strong driver of growth."

Investors can tap this growth, too, and have a variety of options that cater to all levels of risk.

If you like the long-term prospects for South Africa, the iShares MSCI South Africa Index Fund (EZA) has been a solid performer.

AngloGold Ashanti Ltd. (AU) is an attractive play if you don't mind its excessive hedging and South African political risk. However, stay away from Harmony Gold Mining Co. (HMY), as it recently posted its third-straight quarterly loss and forecast lower production for the quarter ended March 31, 2008.

Instead of investing in mining companies, investors are probably better off buying gold and platinum, both of which are sitting near record highs.

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