Surprises

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By Cees Bruggemans, Chief Economist of FNB.

Over the next two years (2010-2011), the South African economy can be expected to achieve

• Average GDP growth of 2.5%-3.5% (not 5.5% or 0%)
• Average CPI inflation of 4%-5.5% (not above 6% or nearer 3%)
• Nominal GDP growth of 7%-9% (not more or less)Remuneration growth of 5%-7% without job losses (allowing for productivity gains, scarcity premiums and labour union strength), but wage gains of over 7% are quite possible, accompanied by matching job losses, except in the public sector, where different rules apparently apply.
• The Rand 6.50-8.50:$ (not annually averaging below 6:$ or above 9:
• Prime interest rate of 9.5%-11.5% (not below 9% or above 1
• Asset prices rising (equities by high double digit, house prices by high single to low double digit).

Having established the broad range of likeliest outcomes, it remains to argue about the exact location of the decimal point, historically not particularly profitable.

Instead, it may be more useful to focus on possible surprises, if any.

In the US they are now celebrating their economy reaching escape velocity (self-sustainable momentum), a full 18 months after the financial shock’s ground zero, and nine months after GDP turned positive. Only now is their employment turning positive again, no longer destroying jobs but creating them, ere long at 200 000 monthly.

Some 8.4 million Americans lost their jobs in this crisis and a further 7 million became temporary part-timers or become discouraged enough to drop out.

It will take many years for all these to be fully reabsorbed, as well as allowing for the additional one million annual newcomers to the US labour market (another 10 million in their own right through 2018). Yet self-sustaining recovery has to start somewhere. And it has now (1Q2010).

Theirs is now an export-driven, consumer-supported and business-led expansion that potentially has another 100 moons or more to run, probably at least until the mid-term elections of 2018 and potentially to the presidential elections of 2020 (Hillary’s second term?).

Sounds farfetched, but only by then are they likely to be overheating once again, sufficiently so for the Fed to temporarily snuff out the expansion anew.

For a considerable part of that long journey, with US inflation near zero and interest rates very low, while Asia continues to outperform despite periodic fears about overheating, South Africa and Africa generally will probably benefit from rising commodity export prices and supportive capital inflows (though never straightline).

Thus our balance of payments should not be a major constraint for most of this period, potentially sustaining fairly large external deficits of 6%-10% of GDP as savings ratios of 15% of GDP get outstripped by fixed investment ratios of 20%-25% of GDP.

That sounds remarkably like business as usual for us. Not for us higher saving rates and an export-driven effort. Far too Germanic, Asiatic (dare one say American?).

For it to be different would be the real surprise of the decade. It is possible but unlikely, unless remarkable abstinence, discipline, forbearance and hard slog were to be imposed. One fondly thinks of such anciently archaic terminology and thinks of other planets (eh, continents).

So what surprises CAN we potentially look towards? Real candidates here are consumers, public infrastructure and grey haired business managers and especially boardrooms.

It is counterintuitive to the extreme, following the worst recession in 25 years, formal job losses of 4%, very high bad debts everywhere in business, many house foreclosures and car repossessions, and two years of severe asset market underperformance.

But a large majority of urban households never had it bad (going by average monthly wage increases for survivors), never lost their confidence (going by FNB/BER consumer surveys), though for a long while turning very cautious, given all the frightening noises and events, and rationally so.

But if record numbers of households this early in an economic upturn are indicating they are highly confident about their own financial prospects AND the economy’s outlook, a new consumer boom won’t take long to ignite.

Granted, White, English-speaking and Afrikaans-speaking majorities (each in their own right) are still showing large cautious majorities about now being appropriate to buy new consumer durables. But they, too, are warming up at a terrific rate, the car isn’t getting any younger, new deliciously long-legged models are hitting the market daily, and interest rates are at mouthwatering levels.

The rest usually comes naturally.

Even so, a body cannot be too cautious, and with so much nonsense loose in the world, never mind on our political stage, it is extremely rational not to be taking the stairs two steps at a time yet (unless it is to emigrate, which is a different story altogether).

So where does that leave us?

Give these households some income and they will spend it. Give them access to credit and they will take it.

The real brakes on the system are income restoration and credit access. Both are recovering now, with GDP growing (mainly so far an inventory recovery and export repair story) and income following in its wake via various channels (wages and business income mainly so far).

This is a very traditional story, except that so few analysts seem to believe consumers are in a very positive frame of mind. As the deleveraging ends and durable good replacement takes off, the good credit risks will regain access to credit. As the economy gathers momentum, so employment and other informal income opportunities will start up again and further bolster income and the credit uptake it can support.

So far, so good.

Pity about steeply higher public sector tariffs draining away disposable income, holding the whole show back, but that can’t be helped. See our low-low interest rates as partial compensation for such unnecessary headwinds (policy under-steering if you wish).

But if public sector overcharging is a problem, driven by funding problems, there may still be a bigger public infrastructure problem focusing on ‘capacity’ (good old-fashioned skills).

There may be enough skill in the country to build new infrastructure, amply illustrated these past five years, but there simply may not be enough such skill in the public sector to absorb such large sophisticated capital good additions. It may be a simple matter of engineers. Their headcount is apparently far too low. That reduces the capacity to award contracts and commissioning projects to completion on the scale required.

After the magnificent take-off in new infrastructure projects during 2005-2008, we have seen too many cancellations, decelerations, postponements, rescopings since then in terms of large projects while at local authority level the awarding of contracts just doesn’t want to flow fast enough. Yet our needs are as large and urgent as ever on both scores.

It doesn’t mean our infrastructure effort is grinding to a complete halt post-world cup, but it does seem to mean construction activity isn’t maintaining critical mass. This will deduct from GDP growth in 2010 and possibly beyond instead of being the locomotive long foreseen by our urgent infrastructure needs.

This entire picture, as much its attractive global context, accommodating macro-policies, eager consumers and disappointing infrastructure slowdowns, is ending up on the doorstep of our business sector grey hairs, begging for their decisions regarding own expansion.

There remain questions about global risks (after such a terribly frightening crisis experience), about local politics (given the quality of the daily slapstick), about public sector drainage of consumer incomes, and regarding the apparently faltering infrastructure effort in a wider sense.

And it doesn’t help that business bonuses, profits and dividends were decimated in the recession, much capacity is idled requiring rationalization and finance hesitant.

So what are they supposed to do? Charge ahead as if nothing untoward happened? Some will, but many will probably remain cautious, at least for some while.

Even so, it is their job to recognize a good thing when they see it. The real question of the moment: when will most of them see it, and charge anew?

It will come. After 1998/99 it took (only) four full years of rising temperatures. This time it could go faster, provided:

• the Rand doesn’t go stratospheric (withering all)

• interest rates remain low

• banks keep unfreezing slowly

• equity prices keep on recovering

• house prices keep on gaining

• the economic expansion remains on track

• capacity utilization keeps rising

• politics doesn’t interfere

In there somewhere lurks a new cyclical private fixed investment take-off, hopefully sooner rather than later.

As the WW1 recruitment poster featuring Kitchener cries out so fittingly: Your Country Needs You!

Source: Cees Bruggemans, First National Bank, April 21, 2010.

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