There has been a glimmer of light in the high-frequency data1 we saw in the past few weeks with positive figures from both retail and manufacturing.
However, it remains to be seen how sustainable these figures are and how much they will contribute to GDP growth for the third quarter (Q3) of this year.
Unlikely to repeat first-quarter growth
All indications are that despite these increases, Q3 growth will still be weak compared to the robust growth we saw in Q1 2011. In his medium-term budget address in October, Finance Minister Gordhan revised South Africa’s growth forecasts downwards to 2.8% for this year compared to 3.3% last year. The economy is likely to deliver stronger economic growth only in 2013 when the growth rate is forecast to increase to 4.4%.
Manufacturing faces headwinds
Most of the growth in manufacturing was due to base effects, in other words the growth was coming off a low base. In the same period last year, output fell due to protracted strikes (particularly in the car industry) so this year would look better by comparison. There are few factors that do not bode well for manufacturing in the short run:
- Foreign demand, which is vital for the export-facing side of this sector, will continue to struggle until we see decisive action in solving the euro area problem which threatens to derail the already fragile global growth.
- Business and consumer confidence here at home do not point to strong demand for manufactured goods as South Africans remain cautious about spending.
An overview of the medium term budget
In October finance minister Pravin Gordhan presented the medium term budget policy statement where he provided an update of the state of government finances in the midst of the current global economic uncertainty.
As expected, the weak economic growth had a negative impact on government finances and tax revenue declined by R13 billion from what was originally budgeted for. It is clear though that government still has to play a role to stimulate the economy by spending on crucial infrastructure expenditure which is investment in future economic growth as well as service delivery.
Increased debt levels
The result of the increased spending when revenue is low is increased borrowing and an increased budget deficit. South Africa, unlike most European countries, has run a tight ship when it comes to fiscal policy, in other words our debt levels are relatively low. This means we can still borrow at reasonable rates and service our debt comfortably. The budget deficit has increased to 5.5% but is projected to slow down to 3.3% in the 2014/15 fiscal year.
Job creation through investment
It is important to note that job creation is still very much central to government policy. A fund of R25 billion has been set aside over the next few years to fund industrial development zones, assist green economy initiatives and boost job creation. The minister also raised concerns about the burgeoning public service wage bill. He believes the country needs to move to a point where government is not looked at to create jobs but to provide an enabling environment for small and medium enterprises to thrive so that they in turn can create jobs.
Employment needed to support retail figures
Retail figures published by Stats SA have increased for two consecutive months which indicates an improvement in consumer demand. However, as we have not seen a corresponding increase in employment and overall economic recovery, this cannot be sustained.
For disposable income to increase so that it can finance spending, more people have to be employed. The reality is that not enough new jobs are being created for those already retrenched as well the new entrants into the labour market.
Credit extension numbers from the Reserve Bank show that consumers are exercising prudence in borrowing, preferring to work down existing debt levels while the cost of servicing debt is still low. Debt has fallen from a peak of 82% of disposable income to 75.9%.
If neither disposable income nor credit go up, it will be difficult for consumer spending to increase convincingly in the future.
Interest rate outlook
The second week of November will be the final MPC2 meeting of the year. Weak growth data combined with higher inflation figures will pose a challenge for the Reserve Bank.
CPI inflation increased to 5.7% in September, a bit higher than consensus forecast. There’s no doubt that we’re heading towards a breach of the upper band of the inflation target (6%) during the last month of the year, suggesting pressure to hike interest rates.
However, this comes at a time of great uncertainty for global growth prospects which will not leave South Africa unscathed. If European authorities do not come up with a decisive way to deal with Europe’s sovereign debt in a way that convinces the markets, the uncertainty will continue to erode confidence and hamper the chances of an economic recovery. The bank has to consider how higher inflation and these external developments will affect domestic economic growth.
Inflation outlook
The details of the inflation numbers paint a different picture. If you exclude items with volatile prices like food and fuel, inflation is actually well within the target band at 4.3%. In the medium-term budget, National Treasury forecasts inflation to breach the 6% upper band briefly but to fall back within target within the first half of next year. They are forecasting an average inflation rate of 5.4% this year and 5.2% next year.
Unfortunately, in real life you do face the higher food and fuel prices, two items that form a substantial part of inflation for low-income earners. The biggest chunk of their income goes towards transport and food. Added to this, administered price inflation (inflation on things like education, municipal rates and taxes, water and electricity) continues to be much higher than the overall CPI number. This is partly why inflation feels much higher than the official CPI figure for many people.
Growth vs inflation
The MPC faces a dilemma in setting a monetary policy that will not result in people feeling that inflation-targeting is no longer the primary mandate of the bank and that the bank is now focusing on growth at the cost of inflation risk.
Our preference and forecast for the coming meeting is that the Reserve Bank should leave rates unchanged while monitoring developments in the international economy. In doing so, they will be sending out a message that inflation is still a concern but that that they will pursue their mandate in a way that supports domestic economic growth. Leaving rates unchanged would support growth because it would keep the cost of borrowing cheaper for businesses and support consumers’ efforts to reduce debt.
Waiting on Europe
Looking forward to 2012, any improvement in the economy will be closely linked to what happens in Europe. We are looking at what will come from the latest euro-zone summit. Any policy change by the SARB should come around the same time. Deterioration in growth will result in a cut in interest rates by the bank to stimulate growth.