Fixed investment faces uncertain crossroads

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By Cees Bruggemans

The SARB’s quarterly bulletin for 4Q2007 still showed a remarkable robust fixed investment growth picture, led by construction activity, dominated by the tremendous infrastructure effort underway in many areas (Gautrain, power stations, port expansion, with road building next).

This general impression of construction robustness was carried through into the 1Q2008, as borne out by the FNB Construction Confidence Index, as compiled by the BER.

This index declined only slightly from a reading of 83 in 4Q2007 to 79 in 1Q2008. Construction has generally remained at a high level of confidence even as other sectors in the economy have of late suffered large falls in business confidence.

According to the SARB quarterly bulletin, the annualised pace in fixed investment in 4Q2007 was 14%. For 2007 as a whole, fixed investment gained 15%.

These fixed investment gains are four times the growth in household consumption in 4Q2007, indicative that fixed investment has decidedly taken over growth leadership in the economy, relegating households to second position.

Even so, there were already some indications of impending weakness, some of these most surprising, seriously clouding the overall fixed investment outlook.

To this we must now add what we already know from other data, especially in the building industry, and following Eskom revelations in 1Q2008, changing rather dramatically the fixed investment growth outlook for 2008 from what it was just a quarter ago.

Real fixed investment growth is now also expected to halve, to nearer 8% in 2008 from 15% in 2007.

This would maintain growth leadership of fixed investment in the economy, as household consumption may only do 3%. Also, the fixed-investment-to-GDP-ratio will continue to rise, from 21% reached in 4Q2007, but the pace of ascent will be slower, aiming for 23% of GDP by 2010.

Growth analysis

The main growth strength in fixed investment in 4Q2007 remained in the electricity sector, its fixed investment gaining 47%. Work continues apace on the Medupi power station and on the recall of mothballed power stations.

This was also reflected in the 27% gain in the fixed investment of public corporations. By type of fixed investment asset, “construction works” grew by a solid 29% in 4Q2007.

If construction remained the fixed investment star performer, some other sectors did not need to stand back unduly. Transport, storage and communication grew its fixed investment by 19% in 4Q2007, mining gained 17% and manufacturing increased by 15%.

These high to very high growth sectors represented just over half of fixed investment in 4Q2007.

This strength was also reflected when analyzing by type of fixed investment asset. Besides construction works gaining 29%, transport equipment did 17% and non-residential building activity did 13%, also benefiting from the sport stadia and airport expansions.

These remained the fixed investment boom areas in 4Q2007.

Meanwhile, a few worms were making their appearance in the 4Q2007 fixed investment data, with their nature not particularly well explained. And then there are the wheels coming off in 1Q2008 yet to be reflected upon.

By sector, it was the non-descript “community, social and personal services”, which was shown to have experienced a 4% decline in annualized fixed investment in 4Q2007. Usually this sector is taken as shorthand for general government, with a smattering of private service activities. Yet general government showed still an annualized gain of 3% in its fixed investment, itself very weak, especially after the pullback of the 1H2007. Year-on-year, fixed investment by general government was 5% down in 4Q2007.

The SARB mentions ‘sluggish capital spending especially by smaller local authorities’. But there was no further explanation or highlighting, yet clearly this could be a major drag on fixed investment if it were to continue.

The financial and business services sector still showed fixed investment growth of 8.5%, but this also underperforms the booming sectors and the overall fixed investment picture. The explanation resides in residential building activity, which grew by only 4%, also reflecting the falloff in mortgage demand.

Finally, it materialized that machinery and equipment, which is by far the biggest area of total fixed investment spending, with a share of over 40%, grew by only 9%, which was slower than understood in the course of last year.

Thus, the overall fixed investment picture in late 2007 continued to show areas of exceptional strength (such as infrastructure construction), with very good growth still taking place in other areas (transport, mining, manufacturing and non-residential building).

But if this represented the shrinking acreage of the fixed investment boom, there was already considerable weakness elsewhere to be found in 4Q2007.

Inexplicable was the 4% decline in the community and personal services sector (why?), and within it the underperforming general government sector with its anemic 3% growth gain, apparently largely traceable to municipalities. Could it be that political jockeying, as much in 2007 as ahead of 2009, is interfering with capex funding allocations? From a social delivery point of view, that would be such a pity, a lost opportunity hardly warranted by the trust of the electorate shown in its appointed civil servants.

But worse is to come.

Fixed investment outlook for 2008

When considering the fixed investment outlook for much of 2008-2010, there remains the unqualified strength to be expected from infrastructure maintenance, upgrading and expansion, in power stations, railways, ports, roads and buildings where it concerns the 2010 soccer effort.

But general government has already during 2007 shown disappointing weakness in fixed investment relating to social delivery, mostly unexplained except for vague references to municipalities. It may well be that such opaque sluggishness will linger.

The contrast today between the government’s very strong fixed investment in infrastructure and its apparent underperformance in delivery-linked fixed investment is surprisingly stark.

During 2008 these sharp public sector distinctions are likely to be further augmented by deepening fissures suddenly appearing in private fixed investment and entirely due to macroeconomic policy, microeconomic municipal and especially Eskom interferences.

Residential fixed investment has been slowing throughout 2007 as affordability problems due to higher interest rates and building costs impacted. These corrosive influences are hardly yet at an end, with higher energy costs, commodity prices, weak Rand and the unfolding pass-through from last year’s interest rate increases.

To this one needs to add apparently increasing problems at municipal level in providing bulk services to newly proposed building developments, and the Eskom moratorium on new electricity connections, especially for non-residential building activity.

The SARB quarterly bulletin sketched a stark picture for the outlook for building activity in this country when highlighting indicators of real economic activity.

Building plans passed started declining abruptly from September 2007, and were by December 2007 already 19% down on a year ago in real terms.

Buildings completed also started to show worrying evidence of decline in real terms from November 2007.

Projecting these early slides into 2008, superimposed on the Eskom troubles, suggests strong declines in both residential and non-residential building activity in 2008, possibly in excess of 10% in real terms.

These two areas represent 20% of fixed investment. General government (excluding building activity) represents another 8%. Thus, nearly a third of fixed investment spending could be a major drag this year.

And that is before we need to allow for any erosion in fixed investment in the so far strongly-performing areas, especially mining, manufacturing and transport, and also machinery and equipment.

There will be some positives as businesses try to address the electricity shortages with defensive investments of their own. But in other respects we may see more pullbacks as growth and expectations suffer.

Source: Cees Bruggemans, Chief Economist, FNB, March 31, 2008.

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