Economic Overview

This week saw another SARB Monetary Policy Meeting, and its report back turned out to be memorial in the manner it was prepared to explain our predicament as a country, warts and all.

I cannot remember the equivalent these past 40 years, and that says something.

The analysis started off fairly mundane and not particularly alarming. But half way through the liturgy something changed, after which a few things were bared in the plainest possible language.

The country is experiencing severe, debilitating problems fundamentally undermining its performance and carrying the risk of far worse to come. Instead of meekly accepting this, the country should pull up its sokkies and address these problems, preferably head on, for time looks like being of the essence.

In short, no more fluffing, please, even if we are South Africans.

The MPC statement started off with an overall impression which sounded like an understatement, considering the eventual concluding remarks which sharpened the context and meaning considerably.

OVERALL IMPRESSION

South Africa faces domestic challenges and headwinds from a fragile and uneven global recovery. These create important constraints to growth.

Uncertain, increasingly difficult labour relations contribute to declining domestic and foreign investor confidence.

Our growing vulnerability to changes in sentiment is reflected in a falling, volatile Rand, also under pressure from the widening balance of payments deficit.

All this has added upside risks to inflation even as real growth prospects worsen.

INFLATION

Although CPI inflation has been unchanged at 5.9% for three months, the drivers have changed somewhat.

Food price inflation has increased to 6.3%. Administered prices increased 8.9% (and 7.8% when excluding petrol).

Core inflation increased to 5.2% (5.1%). Producer Price Inflation (PPI of final manufactured goods) increased to 5.7% (5.4%).

SARB inflation forecast remained relatively unchanged at 5.8% (2013), 5.2% (2014), 5% (2015). Temporary breach of upper target range is expected in 3Q2013 but only to 6.1% (6.3%), after which inflation is expected to moderate to 4.9% in 4Q2015.

This somewhat more benign inflation outlook is due to lower assumptions about commodity prices (oil) and global inflation.

However, core inflation in 2013 is now expected to average 5.3% (4.8%), a substantial upward revision reflecting sharp increases in medical insurance costs and administered prices (water, municipal rates, taxes).

Core inflation is to peak at 5.4% in 2H2013, averaging 5% (2014) and 4.6% (2015). No significant demand pressures are noted.

Inflation expectations remain relatively stable as per Reuter survey of analysts and BER survey of analysts, labour unions and business managers.

Overall, this inflation outlook is far from alarming. However, the risks to the outlook are very alarming, about which more anon.

INTERNATIONAL CONDITIONS

Global conditions remain challenging, with multiple growth speeds.

AMERICA is showing positive signs of recovery, growing 2.5% in 1Q2013. Consumer confidence is at a 6yr high, labour market is more favourable and there are strong wealth effects from the rising equity market and recovering housing market. Headwinds remain from fiscal contraction, deducting from US growth.

EUROZONE remains in recession (-0.9% GDP in 1Q2013). Germany is still growing (barely) but others are contracting, constrained by continued deleveraging by households, banks and governments. Although fiscal headwinds should moderate, recession or at best very low growth will persist for some time.

JAPAN has come out of recession (growing 3.5% in 1Q2013). The Yen has fallen 30% against the Dollar (to over 100Y:$) and this will contribute positively to growth.

EMERGING MARKETS are the main global source of growth but moderating in key countries (China, India, Brazil). Slowing Chinese fixed investment has contributed to global commodity price declines.

Slow global growth and weaker commodity prices have moderated global inflation, especially energy prices in advanced economies. Lower inflation and recession has prompted more ECB monetary easing. Japan has embarked on a major QE policy. This will persist for some time.

Though there is much concern about possible risks to financial markets and global capital flows by an early reversal of US monetary policy, the Fed is likely to proceed extremely cautiously and only to begin once a sustained US recovery is well-entrenched.

Still, there are growing concerns about buoyant financial conditions indicative of bubbles caused by excessive global liquidity rather than just reflecting underlying growth.

SO FAR NO MAN OVERBOARD. BUT THE TENOR OF THE ANALYSIS IS ABOUT TO CHANGE, STARTING SLOWLY AT FIRST.  

THE RAND continues to be impacted by global developments but these are compounded since mid-2012 by domestic factors undermining investor sentiment.

Increasingly fraught labour relations and high wage demands (mining) will impact badly on mining export volumes, even as global commodity prices are falling (a double whammy for the country it can ill afford).

There are understandably deep concerns about the widening current account deficit on the balance of payments.

All this may affect SA credit ratings and increase the cost of much-needed finance.

(In short, we cannot afford any of this nonsense in already for us very trying global circumstances).

The Rand has continued to decline due to several causes. Even so, non-residents remain net buyers of SA bonds and equities, so far buying R12.7bn net equities and R22.5bn net bonds (an annualised pace of about R100bn).

DANGER

These positive inflows, however, can reverse very quickly due to changing risk perceptions. Any exposure hedging can put more pressure on the Rand even if non-residents hold on to the underlying assets (they may not be selling but their hedging against a falling Rand makes a weakening Rand worse).

At present the RAND remains highly vulnerable to changes in sentiment with a tendency to overshoot in either direction, sometimes for extended but uncertain periods, making it difficult to forecast the IMPACT ON INFLATION.

If the Rand current value (9.60:$) is sustained, it poses significant upside risk to the inflation outlook.

(Now is therefore not a good time to burn the National House down as it upsets the locals and frightens the foreigners who between them are capable of taking the most unwanted actions).

DOMESTIC GROWTH PROSPECTS

Domestic growth prospects remain fragile amid low consumer confidence, mining output disruptions, electricity supply constraints and a weak global economy.

SARB revised down its GDP growth forecast for 2013 to 2.4% (2.7%), for 2014 to 3.5% (3.7%) and for 2015 to 3.8% (by the looks of it still mostly moving targets all).

This outlook reflects the flat SARB leading indicator these past 3yrs. Downside risk to growth remains due to difficult labour relations and global growth risks, implying the possibility of increased job losses.

The MINING outlook remains bleak with threats of shaft closures and retrenchments, falling commodity prices, high wage demands and protracted periods of industrial action and further supply disruptions.

MANUFACTURING has an uncertain outlook. The weaker Rand should improve trade competitiveness, provided gains are not eroded by rising wages and prices.

The weaker Rand should narrow somewhat the trade deficit. Subdued global demand and robust imports (infrastructure related) means net exports remain negative, constraining GDP growth.

HOUSHOLD CONSUMPTION spending has been our main growth driver but has weakened. Consumer confidence (FNB/BER surveys) is sharply lower, retail sales are growing only modestly now and new car sales growth has moderated.

Lower real income growth is a constraint on households, as are high increases in electricity and petrol prices and high debt levels.

Greater moderation in CREDIT extension has also been a factor. Total credit growth has moderated again, from 10% to 8%. Excluding (very tepid) mortgage growth, loans and advances growth slowed from 18.5% to 14.5%.

Unsecured lending to households remains high but has been steadily declining since 3Q2012 to 28% this March. This moderating trend is expected to continue, also because of rising impaired advances at some banks.

Even so, total impaired advances at banks keep declining.

THE REAL RUB

With various industries entering wage-bargaining rounds, SARB is increasingly concerned about any settlements well above inflation and productivity growth, and the risk of protracted and disruptive strike action, negatively impacting exports, growth and employment, job creation and causing higher inflation.

Risk of a wage-price spiral remains high, negating wage increases, undermining competitive gains of weaker Rand.

Andrew Levy Associates reports wage settlements rising to 7.9% (7.6%). Should this upward momentum continue, it increases upside risk to inflation.

With high and rising unemployment and slowing growth, there needs to be a commitment by all to wage and salary restraint.

Internationally, the Brent oil price has receded from $118 to nearer $100, but recent Rand weakening may cause further petrol price increases, putting upward pressure on inflation.

Food prices have of late reversed their earlier declining trend. The weak Rand again poses upside risk to food inflation as our food price benchmarks are international.

IN CONCLUSION

SARB is increasingly concerned about the deteriorating SA outlook.

Critical domestic issues contribute to our vulnerability. This needs addressing, especially balance of payments deficit financing, fractious labour relations, risks of protracted stoppages, output losses and excessive wage increases, electricity supply constraints, upside risk to inflation, downside risk to growth and job creation while unemployment is already so very severe, and declining domestic and foreign investor confidence potentially impacting badly on needed foreign capital inflows.

All this is reflected in a volatile and weak Rand. There is urgent need for government, labour, civic society and business to interact and address these issues and these many vulnerabilities.

SARB is prepared to play its part, but many of these challenges are beyond the role, scope and effectiveness of its monetary policy.

A weaker Rand helps the country to adjust its balance of payments imbalances, but the competition advantage of a weak Rand can only be realised through price and wage restraint.

(We did not succeed in doing this as a country after 1996 when, following a big real Rand weakening, the GEAR strategy was launched. Will we do any better today?).

In the absence of wage and price restraint, the outcome of a weakening Rand is simply higher inflation, with the risk of worse to follow (a Rand-inflation spiral?).

Thus, given all this unsettledness, SARB assesses risks to inflation to be on the upside, while the same factors also contribute to downside risk for growth.

POLICY STANCE

SARB considers its present policy to be accommodative. Given the risks, scope for further easing is limited at this stage.

TOMORROW IS ANOTHER DAY

Interest rates were left unchanged, for now, but SARB is ready to act in ANY direction in the event of material changes in the outlook.    

It is the best we can do at present under very trying circumstances.

Cees Bruggemans Consulting Economist                   

Cees@fnb.co.za
Twitter sound bites  @  ceesbruggemans