The unfolding state of the South African economy

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By Cees Bruggemans, Chief Economist FNB

The most recent data releases reflect the economy’s performance in the closing moments of 2009. Although recovery took hold around mid-2009, the overall performance so far remains an anemic one, setting the tone for the opening batsman in 2010.

Such a hesitant start is not entirely understandable, given the quite vigorous revival overseas, even if fragmented between high and low performers. One would expect us to ride on their back, while also benefiting from vigorous policy support domestically.

Yet so far this hasn’t been quite the case.

Most meteoric has been the rise in the SARB leading indicator, hinting at a vigorous return to growth within six to twelve months of its turning. As that moment has come and gone, however, one looks in vain for such vigour. What’s cooking?

Part explanation is the strength of financial market revival, especially the stock market, an important leading indicator in its own right as predictor for real sector action to come. Yet our equity revival seems mostly driven by global forces and global considerations. Though this is traditionally so, this time the crucial link with local real revival seems weaker than usual.

Going by sector evidence, manufacturing has shown the most convincing upturn in activity levels to date.

After an abrupt deep decline between September 2008 and April 2009, largely due to an export collapse and the remainder due to large changes in local ordering patterns (inventories) and falloff in private fixed investment, there has been a clear recovery these past six months.

Indeed the new growth trend reminds of 2004-2007, with annualized growth of 5% plus in manufacturing output. Doing the driving mainly is export recovery on the back of global industrial revival, and presumably a lessening inventory destocking and renewed ordering starting to filter through, going by BER business opinion surveys.

In contrast, domestic passenger car sales probably bottomed statistically in June 2009, but the revival thereafter has remained relatively muted, though real. The main drawbacks appear to be high consumer debt levels, poor real income trends and resistance to high new car price increases. Prospects for 2010 are upbeat, if modest, with 6.5% growth expected off a low base (half the previous peak level).

Electricity output also fell deeply in late 2008 on the back of our export falloff, and did show a firm comeback from early 2009 as our electricity intensive heavy industry gradually started to switch on their furnaces again. But for the past six months electricity output has essentially moved sideways, no longer making headway.

Mining output is a worse performer, having fallen off deeply in 4Q2008 and early 2009, thereafter stabilizing in typically volatile fashion but not really starting a new recovery yet.

As to retail conditions, aside of company-specific success stories (Shoprite Checkers, Mr Price come to mind), retail sales volumes moved sideways last year at low levels, reflecting the loss of real household income only partially compensated by still growing transfer payments (government allowances) and falloff in income and VAT tax collections.

In addition, residential building activity probably reached rock bottom in mid-2009, but has so far not yet shown much of a recovery, while non-residential building activity kept easing off. GDP data showed still strong construction activity gains, yet industry sources report some temporary falloffs.

These sectors together reflect nearly 50% of economic activity and are its most volatile output components.

So aside of manufacturing riding on export recovery and the inventory cycle, much of the rest seems to have stabilized, with some hints of improvement, but as yet nothing impressive to show.

It can be argued this is normal following a cyclical bottom, especially a deep and painful one. Recovery will take time. But the main takeaway should be that revival, though slow, will gain cumulatively in strength as economic agents gradually see new opportunities, regain their confidence and start to get growth back on track.

The outlook for 2010 should production-wise see a steady recovery in manufacturing activity, probably increasing at a pace of 5% plus. Domestic motor vehicle sales are projected to grow by 7%, with subsidiary parts of the motor trade (used cars, parts and accessories) showing even firmer recovery.

Car exports should gain 30% and total vehicle production should grow by 17% in 2010, importantly supporting manufacturing output gains.

Mining, retail sales, building activity and electricity are more difficult to call.

Given global recovery trends, mining volumes should rise strongly unless held back by sector-specific reasons. Electricity output should follow in its wake. But it is not obvious how strong these tendencies may prove to be.

Residential building activity should show some gains off very low base levels, even as non-residential activity for now keeps tailing off. Construction should benefit from large turnkey projects (power stations, road building) but one wonders about political tensions at local government level further disrupting activity levels as the political cycle moves from one set of elections to the next.

Along with steady gains in government employment levels, and a more modest revival in private service activity generally, household incomes should be rising this year. This should underwrite an upturn in retail sales volumes, even if mostly jobless growth for now may remain a drag on non-durable consumption recovery.

Overall, one is pressed to assume growth modesty, if only because there is so much to be modest about.

A more vigorous recovery profile would require a quicker uptake in business risk-taking, a greater appetite among banks to grant credit and for consumers to increase their debt uptake, and a faster revival in job growth, with fewer sector-specific (mining, construction) drags.

Yet such renewed vigour is to be shown rather than assumed, even if the typical cyclical turn from recession to recovery is with us. And thus we do well to allow for a slow GDP growth coach in the 1.5%-2.5% range, until ‘surprised’ by greater vigour. Hopefully it won’t keep us waiting too long. But then again who can say?

It perhaps does create scope for some more policy support, provided some growth sacrifice isn’t deliberate policy in order to keep the private debt bulge, import bill and inflation bias contained longer term within more acceptable ranges than encountered during 2004-2007.

Then again the economy looks far from entering another outperformance binge shortly, and at least the debt bulge and import bills should remain naturally contained for the time being while the ‘new’ credit and consumption disciplines and fixed investment hesitancy prevail.

Source: Cees Bruggemans, FNB Economics, January 21, 2010.

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