Global growth debate impacts South Africa

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By Cees Bruggemans, Chief Economist of FNB.

After the global growth collapse of 4Q2008, also badly hitting South African exports and domestic order decisions, the 2009 growth rebound was V-shaped.

Not only did the whole world act fiscally supportive, some (US, UK) doing so with war-like emergency budget deficits in excess of 11% of GDP.

Central banks similarly went to action stations, with all cutting rates (some near zero) while many major ones engaged in bond buying.

It was massive, impressive and convincing, resulting in many private agents canceling their panics.

Even so, the world was not overnight placed back into the position where it was prior to the panic.

The US consumer finally declared no longer to be consumer of last global resort (at least according to her policymaker spokespersons Geithner & Summers), preferring to deleverage some more, especially in property where a large supply overhang has to be worked off first.

Such shakiness wasn’t limited to US consumers. Around the world there were large pockets, especially also in Europe, where consumers cautiously reconsidered life’s excesses, opting for late rather than early replacement of durable consumer goods.

Business fixed investment did roar back, but then the falloff had been steep. Here, too, ultimately, there lingered residual questions about future demand strength. Risk-taking would for a while not be the same.

None of this implied wholesale backsliding in Western demand. Merely that its domestic growth beyond 2009 could be slow for a while, stronger in the US (where policy and corporate cost cutting had been the most aggressive) and less strong in Europe (where they do everything slower and less drastic).

Happily, dynamic Asia remained on a roll, bankrolling commodity producers, other emerging regions and even some Asian OECD members.

Thus global growth has on balance been vigorous coming back from the 2008 crisis. Importantly, though, any cyclical rebound always has strong inventory unwinding effects, and this time export repair elements.

As the full benefit of these effects became absorbed, the world has increasingly to fall back on domestic final demand (consumption, investment).

As already indicated, this is still somewhat less vigorous, partly because of shaken confidence and lingering uncertainty about what still looms, partly because the multipliers (employment growth) aren’t yet back to full strength.

Still, there is growth out there and the world economy keeps advancing.

It was at this crucial juncture that Europe’s fundamental structural flaws became highlighted earlier this year, triggering recoil in the world’s many slumbering bond vigilantes.

In the process, the debt distress of a Greece was quickly transmitted to fellow Club Med members such as Portugal and Spain, but it didn’t stop there. Ere long, Italy, UK, France and even Germany realized that business as usual wouldn’t work. Bond vigilantes could ultimately also call for their heads.

Thus bond market pressure assisted the decision to accelerate fiscal exits in Europe, even though one should not overstate this phenomenon.

Aside of the distressed periphery (Greece, Portugal, Spain) overnight trying to slash their budget deficits, the other Europeans are basically setting themselves four year time horizons (2013) to get budget deficits below 3% of GDP and debt burdens (as share of GDP) ‘stabilised’.

In practice this means still a minor fiscal assist in 2010 overall, with the fiscal reversal really only kicking in from next year.

Still, this has triggered pandemonium in some quarters, where less fiscal support is seen as less growth, less chance of debt stabilization, more currency upheaval, possibly reigniting market panics, all the way back to the common hell we only escaped so very recently.

It apparently makes no impression that studies have shown any fiscal cutbacks relying for two-thirds on spending reduction and only one-third on tax increase (the approach in all the big players) tends to support growth prospects rather than undermine it.

Or that central banks are doing the really heavy lifting, in key instances sticking with near zero interest rates. Also that the weakest regions (Europe) are getting market assistance through currency depreciation (Euro) and that the strongest safe havens (US, Germany, UK) get the benefit of capital inflow and low-low long-term interest rates, all of which growth-supportive.

Very noticeable, front and center on the global stage as G20 met, are a few very unfriendly neighbourly tiffs. For any heavy lifting a neighbour can be made to undertake leaves less need to do so oneself, so the hunt is on for good neighbourly deeds.

Thus we see Americans trying to convince Germans to be more Anglo-Saxon by not cutting fiscal deficits too soon and indeed delay their fiscal exits, while admonishing the Chinese to accept a firmer exchange rate, improving the purchasing power of their consumers (and lessening the deadly trade competitiveness of their producers), in both instances improving global demand for US exports.

To put it another way, Germans (and Europeans generally) should not improve their fiscal and trade positions (maintaining growth) at American expense. Gaining such advantages on US tailcoats is not appreciated.

But as you probably know, in an egocentric world neighbours have a way of going their own way.

The Chinese are loath of giving up winning formulas, though seeing potential of buying off world criticism by making a (very) slow currency exit.

In contrast, the Germans are feisty, willing to tell the US they remain fiscally supportive for now and will only be slowly exiting their fiscal deficits.

As their large budget deficits are actually inhibiting their consumers from spending more in the short term from fear of future tax burdens, Germany feels its consumers are likely to do far more consumption lifting if the German state were to be seen to be more responsible in cutting back the large fiscal deficits and debt increases.

The reverse psychology also applies.

There are apparently many Americans who are uneasy about their own politicians’ free-and-easy spending approach to budget deficits and debt. They would love a more Germanic approach to be adopted. Having the German example of early fiscal exits, this could put pressure on the US political leadership to do more to rein in US budget deficits and public debt, which doesn’t currently suit.

Ironically, the US fiscal exit, when it comes, may be faster than anywhere else among the majors, partly because its stimulus programs will fall away, but also because the Bush tax cuts will run out and not be fully extended. Together with a faster growth rate, it will probably allow the US to outperform the European and Japanese fiscal exits.

Yet US policymakers aren’t ready yet to do so. The US economy still has an awful lot of resource slack, with unemployed and under-employed labour amounting to close to 18% of its labour force (where 5%-6% would be far more acceptable).

With GDP growth up and running, but rather slow once past the inventory adjustment, there is a long way to go to get the US economy back to full employment. With its populist democratic politics not accepting prolonged heavy unemployment, there is a deep US sense of urgency to keep plugging away, supporting its economy wherever possible, domestically where feasible and limiting global attempts of free-riding at US expense where necessary.

In short, it turns out the Germans aren’t going to become a major drag on global growth soon, but certainly are gearing up to get their long-term finances correctly positioned while having undone the Euro recent excessive overvaluation, with Europe getting some global payback via increased exports.

Americans sound aggressive, but they are merely ensuring that global attempts to coattail them remain contained, offering as much policy support to their economy as remains feasible, but will be ready for fiscal exits once politically sane (and financially advisable) to do so.

The Chinese have yet again bought more political time by allowing their currency to drift slightly higher while continuing to remain trade competitive.

From a South African point of view, Asian growth will continue robust, pulling in natural resources at a rapid pace, favouring African mining exports.

The Western world, especially Europe, will be growing slowly for some while at weaker exchange rates. Whereas the US can expect 2.5% GDP growth, Europe is barely good for 1%. Both are improving their net exports.

For South African manufactured and agricultural exports, this could mean an uphill struggle these next few years.

Overall, this implies a limited export growth potential for us, with over-reliance on capital inflows to keep the balance of payments fully funded as our domestic growth and import needs proceed cyclically to outstrip our export performance. Nothing new there.

Only a European country debt default, in turn triggering European banking problems, if not contained could lead to financial dislocations that remind of 2008, thereby also threatening South Africa’s economic outlook more deeply.

Such a new financial shock (were it to happen) would probably dampen global growth while lowering risk appetite anew, to the point of reversing our capital flows. We might under such circumstances again expect export falloff AND inflation surging as the Rand weakens.

Though a weaker Rand would assist the economy, the SARB would want to stabilize things, potentially in the case of too much persistent Rand weakness and inflation impulse raising interest rates to do so.

Such deep seated concerns clearly keep preying on our policymakers’ minds, going by their public utterances. It probably makes for a cautious policy stance.

It is a stance that will not want to knock the economy too much with a fiscal exit, but where the glide path to lower budget deficits and eventual debt stabilization remains clear.

Also one where the SARB may not want to disturb things too much through changes in its monetary policy, bearing in mind our external challenges, as much the European headwinds to our exports, our dependence on foreign capital funding and the effects of a firm Rand.

Presumably greater clarity on all these fronts is to be welcomed. Once this has been obtained, a fresh policy look may well be feasible. Until then, sit tight.

Source:  Cees Bruggemans, First National Bank, June 28, 2010.

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