Potential for surprise!
By Cees Bruggemans, Chief Economist FNB
These are dynamic times in which few things remain the same for long. What surprises could await us these next six to twelve months?
Externally, there has been plenty of warning of a long period of near zero interest rates at the global centre (America, Europe, Japan) while growth and yield remains most attractive in the periphery (Asia, Latin America, other Middle Eastern and African commodity producers).
These past six months this condition has pushed global equity and bond prices higher, while favouring a steady liquidity leakage from the global centre to the periphery, giving many emerging asset markets a double leg-up while also firming their currencies.
The main likelihood for the next twelve months (or longer, bearing in mind the evolving nature of the shaping global expansion) is that these processes will continue. By implication expect more asset price gains, especially in the global periphery, even when interspersed by periodic pullbacks. Also, there should be more emerging market currency appreciation unless actively countered through policy action (for instance observable in China).
Since March this year, these global forces have boosted JSE equities by 40% and the Rand by 30%. There could be further gains in the year ahead, even if their progress will likely be volatile.
Internally, however, we may be building up towards a set of circumstances that will see even bigger changes, potentially hugely surprising ones.
In micro space one may want to monitor the Patel/Manuel interface and the Eskom electricity resolution, while in macro space it is fiscal and monetary policy, with all these areas affected by the Rand’s behaviour (the external influence).
Whereas the Patel/Manuel trade-off could be centered on providing a few billion Rand in subsidies here and there for select troubled companies or sectors, add a zero for the impact of Eskom’s electricity tariff doubling. Potentially add two zeroes for the impact of any macro surprises in a R2.5 trillion economy.
Whereas the availability of state aid will undoubtedly be important to specific companies or sectors in trouble (that is if the various policymakers can reach agreement about what needs to be done and actually doing it), by far the greater impact will come through in the energy sector and then especially at macro policy level.
Key sectors of the economy are affected by inadequate demand, higher electricity charges, wage cost pressures and a firmer Rand, in some instances cripplingly so.
As things stand, capacity utilization in manufacturing remains low near 80%; labour market slack has increased substantially due to job losses, new entrants and returning migrants; company earnings and household incomes have suffered (often grievously); and this is reflected in R70bn less tax revenue than budgeted.
With the economy stabilizing from mid-2009, a new cyclical expansion is probably by now underway, but many pointers suggest it will be a slow, mostly jobless take-off through 2010.
Though the ending of inventory destocking, the unwinding of the export collapse and the 500 point of interest rate cuts will provide lift to GDP activity levels there nonetheless remain serious headwinds.
With government, bankers, households and businesses badly shaken by recent events, one notices a general risk averseness and inclination towards deleveraging.
Thus government imposed the new national credit act as of mid-2007, banks have become more conservative about extending credit and the cost thereof (probably more so than can be explained cyclically), while households have reduced appetite for debt (probably also more than just cyclically, at least in the short-term).
Though the budget has functioned as major shock absorber by running up a deficit approaching 8% of GDP, one would expect fiscal policy already from next year to be looking for a gradual narrowing of this deficit.
The recessionary condition, the uncertain outlook and the greater credit conservatism is weighing on private sector investment decisions.
Besides these domestic headwinds holding down income growth and private and business spending growth, there is the impact of higher electricity charges and a firming Rand. Here one is really most concerned about what is still coming these next twelve months.
There is downside to just about every angle here. Most costly for the economy would be if the Minister has to narrow his budget deficit through tax increases, and export capacity is lost in mining and heavy industry through the combination of a doubling in electricity charges and a further stiff firming of the Rand.
The one thing that probably cannot be sidestepped is a doubling of electricity charges (however phased). Though one can argue in favour of state subsidies for key affected sectors to ease the necessary adjustments, this would merely shift the burden to an already overburdened fiscal policy.
The one thing we probably can all agree on is that the Rand should not firm further towards 5.50-6.50:$ territory. Preferably it should be nearer 8.50-9.50:$, bearing in mind what is realistically going to happen to our electricity charges and trade competitiveness.
There remains one more lever, namely interest rates. Here we face the debilitating influences of unrestrained public sector tariff charging in many areas, while unionized labour forces bargain for inflation-plus and recession-proof wage increases and strong business franchises try to protect their margins by passing on cost increases where they can.
Though inflation passed through its 13% peak a year ago and has since halved, there remain many concerns as to build-in rigidities keeping inflation and labour demands elevated and interest rates of necessity also high and less accommodating to the economy than what otherwise would still be possible.
However, all is not lost. Oil and agricultural commodity prices are currently reasonably behaved and may stay the course through next year. Crucially, the Rand may not weaken next year towards 8.50:$ as hoped for, but actually firm further, suppressing inflation yet more. And the next wage round will start off a 5%-6% base, with increased labour slack, and company earnings heavily reduced, even as productivity should be gaining, suggesting slower unit labour cost growth. Also, imported costs could still fall as global trade prices contract, aside of the firming Rand.
Thus domestic inflation should enter the SARB’s 3%-6% target range next year. Though there will be unpleasant public sector pricing surprises we should not underrate the potential for favourable private sector surprises.
Provided inflation succeeds in decisively re-entering the SARB target range, the economy’s general condition may become a strategic issue, also for monetary policy.
Key policy issues will presumably include having to increase electricity charges, yet preferring not to lose important export capacity. Wanting tax revenues to recover, but preferably not by increasing tax rates (even though tax burdens will inevitably rise) and not having to grant outsized industry subsidies (not least because trade partners wouldn’t be amused). And instead of giving in to outsized labour demands, it would be nice if the promise of employment gains could be traded off with promises of wage restraint, buying a measure of labour peace as has happened on occasion elsewhere.
All this points to two first prizes, getting the economy to grow faster than the 2%-2.5% currently envisaged for 2010 and to head off further Rand firming (never mind succeeding in getting a more trade competitive Rand).
Provided inflation actually does gradually move back towards acceptable territory, it will be interesting to see what interest rate policy could still deliver these next six months, despite being late in the global cycle.
Only if the data were largely unchanging and we remained in a Manuel/Mboweni/Mbeki policy mindset would one not really expect surprises.
But neither condition any longer applies. The data is changing, indeed more than what we may like, and we now face a Zuma/Gordhan/Marcus policy reality.
Only time will tell what this could mean exactly.
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