Nadias Property Shop

SA Prospects 2012-2016

 

By Cees Bruggemans, Chief Economist FNB                                                  

This e-mail address is being protected from spambots. You need JavaScript enabled to view it

31 January 2012

 

When lifting our vision from the quarterly grindstone to a five-year perspective for the South African economy, an unusual spectacle greets us.

 

Mostly flat earth!

 

This is unusual in a small economy very much exposed to oceanic global forces shaping our playing field, lively domestic politics and micro-policy making often of the disruptive kind conspiring to undermine confidence and encourage a sense of insecurity in boardrooms where major investment decisions are made, not infrequently keeping our business cycle expansions nasty, brutish and short in the way Hobbes meant it.

 

To suggest that somehow the expansion will continue, not too hot and not too cold, if mostly subpar, for years and years, is a very stable forecast resting on very unstable foundations.

 

But it could conceivable happen, with the forces of cyclical destruction either spend, or conveniently neutralised, at least for a considerable distance, while acceleration potential keeps being hobbled by supply constraints (caps) and pervasive uncertainty restraining risk taking in favour of defensive cash flow and balance sheet management.

 

We started this latest recovery in mid-2009 and have so far completed 30 months, very much still only a down-payment where ‘average’ expansions are concerned rather than a mature age at which demise is near.

 

What is making for longevity in the first instance is the rather mediocre start so far to this expansion, hardly averaging 3% GDP growth annually.

 

This is subpar, compared to normally more vigorous inventory and export recoveries which this time seemingly have remain very subdued along with fixed investment and job growth.

 

The saving grace has been the household and government sectors acting fairly normally in keeping consumption growth going near 3.5%-4.5%, but mostly with only limited credit access for households as the new credit culture took hold.

 

Disappointing has been the absence so far of a much more vigorous public infrastructure revival, given the enormous backlogs and private capacity able and willing to put shoulder to the wheel.

 

And the deep defensiveness observable among private businesses, preferring to strengthen balance sheets and sitting on cash mountains while lowering credit exposure.

 

Both these fixed investment engines have lacked aggression, perhaps understandably so in the private sector, given the global backdrop and ‘confusing’ domestic signals, but less so in the public sector.

 

As a consequence, though, nearly three years into cyclical recovery, we are still stuck with manufacturing capacity utilisation near 80% (rather than 90%), offices and other structure vacancies over 10% (and still widening), a formal labour force employing 9.3 million (rather than the 10.5 million comfortably possible) and an informal labour force of barely 4 million (rather than the 5-6 million of a high growth era), and all that on a labour force of over 20 million, giving us still over 7 million unemployed-and-discouraged rather than 5 million.

 

In other words, though we tend to emphasize the supply side shortcomings in our economy hampering growth performance (and for very good reasons), we also seem to suffer from ‘inadequate demand’, meaning we probably could do more demand-wise without running into overheating, inflation-and-import-boosting shortages (EXCEPT in the case of infrastructure).

 

Still, those supply restraints are well known in electricity, railways, credit culture, public sector manpower, regulatory interference.

 

Electricity supply maintenance backlog has apparently become ‘unsustainable’, requiring a (large) cut in electricity use soon. The start-up of the first Medupi unit has apparently been delayed to late 2013 though sterling effort is being made. The electricity system looks being severely constrained for the next five years.  

 

Also, there are private sector capacity issues in the oil refining and steel sectors regularly inviting shutdowns (but probably not limited thereto, as for instance the increasingly chronic safety-linked shutdowns in platinum mining attest, with important loss of output), while some of that extra deployable labour may not be as productive as perhaps imagined due to low educational levels and skills and limited experience.  

 

These shortcomings are such that much of our subpar growth performance may now be structural, baked-into-the-cake, meaning extra demand would not generate much more resource uptake and output but would simply trigger higher imports.

 

But we would only know that for sure by running at greater speeds, and we may be surprised how much non-inflationary growth could still be squeezed from our rather sick patient.

 

Unfortunately, policy means to provide more support is limited (indeed, at the limit of its capability?).

 

Fiscal support is at maximum with a budget deficit in excess of 5% of GDP and national debt climbing towards 40% of GDP (carefully watched by global markets).

 

Monetary policy has a constrained transmission channel, with credit growth limited to 5%-6%, barely half nominal GDP growth of 9%-11%, limiting the effectiveness of more rate cuts.

 

The Rand is floating freely and mostly determined by global market forces.  

 

Cyclically, key sectors such as the building trades and construction remain at suppressed output levels. They don’t have much more downside potential, with their demand still largely impaired and output fully compressed by traditional standards.

 

The real potential here is up, provided more demand can materialise.

 

Similarly, inventory levels don’t appear excessive, while mining and agriculture can hardly be said to be performing beyond capacity (ready for a fall).

 

Our main cyclical compressors, with less than a one-quarter weight in demand/output, are therefore still at extremely low performance readings with minimal downside potential (short of climatic or global disaster), yet by implication with considerable cyclical upside if only their dynamics could improve.

 

The bulk of the economy beyond these sensitive cyclical performers tends to have a more stable growth path.

 

As long as global windfalls continue, especially high commodity export prices but also capital inflows keeping the balance of payments well funded and the Rand in a reasonably stable (if wide) trading range, the disruptive power of external events may remain manageable.

 

The bulk of privately managed activity will continue to innovate and gain productivity while hiring some labour, while government has even more reason to be a smoothing device for social support systems and public sector jobs.

 

With our macro-policy levers reasonably supportive, by way of fiscal budget deficits over 5% of GDP, the repo interest rate at 5.5% effectively negative in real terms relative to 6% inflation (rather than being maintained at +3% in real terms as in more normal times) and the Rand less overvalued and more producer-friendly at 7-9:$, the less-cyclically sensitive sectors are being encouraged to maintain a 3% growth rate.

 

This economic engine, so positioned, could keep running like this for quite a while, within the limits of its structural constraints, provided world events were to remain supportive and domestic events were not to turn too disruptive.

 

With the cherry on top that if we could get better output performances going in the building trades, construction and mining, with less leanness in inventories, the cyclical lift this decade beyond the 3% growth level remains achievable, in turn reinforcing some more private risk-taking and faster growth in fixed investment.

 

Given the extent of cyclical compressors, the resource slack in evidence, the modest growth suggesting only a slow uptake of such resource slack, and the likely accommodative macro policy stance provided inflation and imports don’t overheat, the economy could run at this pace for many years in this decade.

 

In our case, the intrusive outside world eventually tends to interrupt the growth party, ending the cyclical expansion, or alternatively we grow too fast and take up resource slack to the point of overheating, requiring policy to end the expansion temporarily.

 

Despite the very complex and lively events playing abroad, our balance of payments constraint may not get activated shortly or even this decade (short of a crisis interruption not now foreseen).

 

Oil could prove a special case, as on occasion in the past, thinking MidEast events.

 

If we have lost some of our insulation against such oil crises (by having a lesser precious metal exposure), and oil (food and the Rand) were to conspire to give us an inflation shock ending our supportive macro policy stance as interest rates were raised, our cyclical expansion could come to a grinding halt.

 

This (and local drought) remains the biggest risk for ending our cyclical expansion prematurely, rather than events in Europe, the US or China, though globally views differ on this (radically so).

 

As to our ability to create domestic shocks triggering recession, our speciality seems to reside more in keeping structural shortcomings active rather than creating short-term demand shocks, despite much noise to the contrary in recent years.

 

Adding all this up, the economy could expand at a pace of up to 3.5% (its long-term average) through 2016, with some of our infrastructure constraints easing somewhat in the latter part of this period (electricity, railways, municipal infrastructure, but also credit).

 

However, one should not presume too much on this score. Even so, private risk-taking may perhaps perk up a notch (or two) the longer the cyclical expansion continues.

 

Such a growth performance would be driven by 3%-4% consumption gains, and 3%-5% fixed investment boosts, though with net trade remaining a drag.

 

The net employment gain through 2016 may push formal employed labour to a new high of 10.5 million and informal employment to 4.5 million, for a combined 15 million, reducing the ranks of the unemployed-and-discouraged to 6 million (plus) on a labour force by then topping 21 million.

 

Provided that oil is not shocked by major warlike MidEast events (a massive uncertainty), global demand and supply could remain sufficiently in balance to offer us a $100-$120 oil price range.

 

With the above-average electricity tariff boosts needing to come to an end post-2013 (we heard you, SARB Governor Marcus) and global food production achieving a better balance this year (though the price risks remain to the upside), the absence of nationwide droughts would allow our food price inflation to moderate somewhat as well.

 

Provided the global forces as described keep the Rand in 7-9:$ territory most of the time, our CPI inflation should fluctuate in a 4%-7% range, with core inflation nearer 5%-6%.

 

Given the growth underperformance and lingering resource slack domestically, and the richer countries remaining in repair mode for most of the decade and keeping monetary policies supportive, such an environment could also keep our nominal prime interest rate stable in 9-10% territory and real repo neutral, with repo in 5.5%-6.5% territory.

 

Such a comfortably stable outlook for an outrageously long period of five years or more just begs for severe punishment from unexpected disruptive intrusions from a very lively unstable global environment.

 

But except for 2008/2009, most of our time since 1999 has been in such cocoon-like growth stability (indeed inviting over-exuberance during 2004-2007).

 

It is not inconceivable that we sidestep another bullet like 2008-2009, and extend the greater experience of 2000-2011, if without the euphoria as we have much that will keep us subdued and thoughtful, fighting the waves of despair, desperation, skepticism and despondency (not unlike observable in many other countries today).

 

It still suggests a more modest pace rather than eventually an exuberant one as the ageing cyclical success boosts our collective confidences.

 

The big positive to look for is the absence of disruptive external shocks, and that for five years plus. It is asking much, but then consider the state of the world.       

 

Cees Bruggemans

Chief Economist FNB