South Africa’s economic outlook: 2008 – 2009

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By Cees Bruggemans

After a still strong 2007 in which non-agricultural GDP averaged 5.5% growth, CPIX inflation was a subdued 6%, and the rand averaged 7.05:$, economic prospects for 2008-2009 have undergone an abrupt deterioration.

The main negatives have been electricity disruptions, a further steep climb in CPIX inflation mainly on account of commodity price shocks reducing real purchasing power of households, and further interest rate increases with prime rising to 15% in April 2008.

There has been a steady further increase in oil prices, topping $125/b in early May. Furthermore, large Eskom tariff increases loom this year and next year. As a consequence, the SARB has been making warning noises probably implying further interest rate increases.

The economy has gradually adjusted to these changing conditions and will probably adjust more in coming months.

Key consumer sectors such as passenger cars, household appliances and furniture, and residential building activity as well as the secondary property market, are already in deep recession or otherwise are steadily deteriorating.

Household consumption growth still averaged 7% in real terms last year, though the annualized growth had already dropped below 4% by 4Q2007. With weakening trends reported in a growing number of sectors, household consumption growth in 2008-2009 may barely average 2%.

Fixed investment still grew by 15% in 2007, though weakness was already evident in house building. Since then building activity has turned down even deeper, with growth now also easing in non-residential building activity, as electricity and higher interest rates bit.

In the coming year only infrastructure-related fixed investment is likely to keep its strong growth momentum. Private fixed investment, however, may sag and total fixed investment growth could slow to less than 10%.

The good news remains that agriculture is experiencing windfall conditions. It may well keep overall GDP growth at 3.5% this year, though the cumulating weakness and no repeat of crop windfalls next year may mean as little as 2.5% GDP growth in 2009.

This change is likely to mean a slowdown in formal sector employment growth, if not a slight actual decline in job levels in 2008-2009.

CPIX inflation has already risen to 10%. With further oil prices increases likely, and Eskom tariff increases still to be absorbed, CPIX may well peak nearer 12% later in 2008. The good news is that the favourable harvest conditions have capped crop prices these past few months. But if globally these prices were to rise further, they could well ultimately pull local agricultural prices up with them through export parity pricing.

In order to prevent inflationary expectations from rising overly much on the back of rising inflation, the SARB has been willing to increase interest rates, prime rising to 15%, and may still increase them once or twice more in 2008, prime possibly peaking at 16%.

Such tough-minded monetary policy is willingly incurring growth sacrifice to prevent inflation expectations from losing their firm anchoring of recent years. Recent BER opinion surveys have already shown a jump in inflation expectations towards 7.5% and the SARB is determined to keep this phenomenon constrained.

Although wage and salary increases have been rising this past year, and are expected to rise some more in response to rising inflation, the gains are expected to remain constrained in the face of higher interest rates, slower GDP growth and possible job losses looming ahead.

The rand has gained in recent weeks as global risk aversion has eased, coming back towards 7.50-7.70:$ territory. Though this will assist in stabilizing inflation, it won’t be enough of a firming to suppress inflation much.

The great uncertainty for the next twelve months is the extent to which global commodity prices, especially oil and food, will keep rising and thereby increase our inflation still more. At some point this global fever can be expected to break, and with it our inflation momentum, after which CPIX inflation can be expected to return fairly rapidly to the SARB’s 3%-6% target range.

Interest rate cuts can be expected by then as a matter of course, though the SARB is unlikely to cut interest rates by as much as it raised them during 2006-2008, given the perilous state of the balance of payments and lingering inflation concerns.

But for now such peaking and subsequent descent in inflation and interest rates lie in the future.

For now we first need to know how much commodity prices will still shock us, how far the SARB is prepared to go in matching such inflation shocks with interest rate increases, and the manner in which growth wil recede and jobs will be sacrificed.

The outlook is one of difficult adjustment from fast growth and rising prosperity to one of much slower growth and belt tightening for many.

This also applies to the company environment where good profit growth will be limited to the favoured few (such as mining and agriculture), but where most companies will be facing harder times, reduced growth, and limited profit growth, if not outright declines. It suggests a period of cost cutting and constrained employment in which the wage bill will be tightly managed.

Source: Cees Bruggemans, FNB, May 13, 2008.


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