FNB Fixed Investment Round Table: 3Q2010

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By Cees Bruggemans, Chief Economist of FNB.

This COMMENT is dedicated to the memory of Dr Charles Martin, Senior Economist at the BER, who tragically passed away last Thursday after this document had been completed. Charles was a good friend. We will miss him.

Participants in the FNB Fixed Investment Round Table for 3Q2010 included:

  • Cees Bruggemans, Chief Economist FNB
  • Charles Martin, Senior Economist BER
  • Christelle Grobler, Senior Economist BER
  • Johan Snyman, building economist, Director of Medium-Term Forecasting Associates (MFA)

Bruggemans: The world has been through two major crises in three years. I submit we are past the Anglo-Saxon banking crisis of 2008 but have not yet shaken off the blues it has created. And Europe is past its sovereign-debt-cum-banking-crisis, but hasn’t stopped arguing yet either (and won’t do so for some years as there remain many things still to be done).

Other than encountering an third fallout from this global crisis condition, say a Chinese property-cum-banking crisis, the world is essentially in a post-crisis aftermath and in an extended workout condition.

This is marked by heavy resource slack (high unemployment) in the West, while the East has changed gears and continues with rapid growth, with many commodity producers and other emerging countries benefiting from this condition.

Still, the initial post-crisis growth recovery in 2009 was driven by the inventory cycle and export volumes normalizing. Past that, and we encounter in 2010 a far more complex global recovery picture.

It turns out the recovery process so far has been more industrial than services driven, with many unsettled sectors and economic role players trying to refocus and getting themselves going again. Though generously assisted by accommodative governments and central banks, sustaining recovery has nonetheless been a challenge.

With the special inventory and export recoveries out of the way, and fiscal boosters being removed, we find underlying final demand in many regions not as robust as expected.

Grobler: The Purchasing Managers Indices (PMI) in many countries have downshifted in recent months. This isn’t so much signaling industrial weakness ahead as that the exceptional growth boosts to manufacturing are ending and now nearly everywhere reverting to more normal conditions as final demand catches up.

It reflects the fading of stimulatory measures, at least on the fiscal side (not the monetary side), with the inventory situation in many countries coming back to normal. After an exceptional production dip and recovery final demand is back in focus.

Bruggemans: South Africa seems to be mirroring this global picture, perhaps just not as strong in terms of initial output declines and recoveries, but certainly of final demand now taking over and this not yet being very robust. The very profile we see globally?

Grobler: Manufacturing this year is showing strong output gains year-on-year, with June up by 8.8%. But don’t be misled. Growth momentum is very slow in 1H2010.

Bruggemans: Yes, I put it at only 1.8% annualized in 1H2010 and precisely nil in 2Q2010.

Grobler: This slow manufacturing momentum is reflected in our BER business tendency surveys – the BER manufacturing survey and the Kagiso PMI survey. The sector is struggling to advance in its totality, though in some sub-sectors this is not the case.

Bruggemans: Can you give us a flavour?

Grobler: Household consumption goods such as textiles, clothing, furniture, appliances, radio, television all seem to be encountering active import substitution. While final demand in each instance isn’t THAT weak, some of this demand is siphoned off by increased imports.

Bruggemans: This is a consequence of the strong Rand?

Grobler: That is what we suspect.

Bruggemans: Other areas of manufacturing have been performing much stronger?

Grobler: Food and beverages output has been strong, particularly in 2Q2010, with imports not as important. These subsectors focus on the local market. With household incomes recovering, despite many job losses and higher unemployment, the real income gains of those surviving in employment is outranking the fallout from the job losses.

Also, inflation in non-durable product categories is now relatively low, implying in many cases an increase in household purchasing power. There is also the broad support from government social safety nets as yet more people receives grants and allowances.

Bruggemans: how are our leading industrial sectors doing?

Grobler: The motor industry is doing well locally and in terms of export orders. Iron and steel hasn’t really lost much momentum, with the 1Q2010 showing good foreign demand and local demand supportive in 2Q2010. And the petrochemical sector has also been doing well.

Bruggemans: how would you describe the outlook?

Grobler: For manufacturing overall it is a matter of continued-but-contained growth. Growth is expected around 5% this year, on the back of an almost 11% decline in 2009, while growth in 2011 will be more in the 3% range.

Domestic demand will be slow to translate orders into production. Import substitution due to a firm Rand should remain problematic. And the non-performing sectors are probably structurally not trade competitive.

Bruggemans: It sounds as if manufacturing will continue to expand, if with headwinds. Something similar is playing out elsewhere in the economy.

By early 2010 electricity output had recovered its 2007 peak, but has since moved sideways, reflecting capacity constraints (still only a limited reserve buffer) but also restrained demand by important energy end users.

Mining output had shown a very persistent recovery track since mid-2009, but this lost its footings during 2Q2010, falling back to early 2009 levels.

Although a few outperformers (diamonds, iron ore) were way ahead of last year, relapses occurred in platinum group metals, gold, coal and building materials. Some of these relapses may have been temporary, but not all of it can be reasoned away. Mining output today remains at decade low levels.

Bruggemans: That’s three major industrial sectors representing over 25% of GDP where we can question growth momentum. To this we still need to add the building and construction sectors. How are things going there?

Martin: Residential (housing) activity is still negative for 2010, but we are seeing a turning point in 3Q2010, with gains possible from 4Q2010. Townhouse activity will still have negative growth this year, but should grow by 5% in 2011.

In contrast, non-residential building activity is expected to resume growth only from 2012.

Bruggemans: why is the latter negative at present?

Martin: The speculative element is now absent in non-residential building activity, with existing clients investing for their own needs only.

Vacancy rates in certain regions have stabilized, but this is misleading because of so-called shadow vacancies, where landlords double up or sub-let. This results in empty space, which isn’t advertised/declared, but this space must be filled first when recovery comes before new demand starts to be noticed.

In office buildings this is a factor that could lengthen the down cycle.

Bruggemans: Johan, how would you describe the state of the building industry and its prospects?

Snyman: Total residential building activity declined by 9% in 2009, should decline a further 3% this year, and may recover by 3% in 2011.

In contrast, non-residential building activity always lags the residential cycle. Consequently, non-residential activity still grew by 2% in 2009, will likely fall by 8% this year and may decline another 7% in 2011, before showing a marginal gain of 4% in 2012.

Bruggemans: And construction prospects?

Snyman: Construction works increased by a robust 36% last year, may decline by 9% this year, and decline a further 23% in 2011 and still even decline another 7% in 2012.

Martin: True, but certain public corporations such as Transnet and Sanral may still make good contributions, lifting these numbers. Also TCTA (Trans Caledon Tunnel Authority) is spending strongly on water infrastructure.

A large part of infrastructure spending such as power station generators and transformers are classified as machinery and equipment, boosting those categories of fixed investment rather than construction works.

Same with Transnet’s annual order of 100 locomotives, which will start showing up in transport equipment.

Treasury continues to show positive fixed investment on infrastructure, with the budgets to show for it. This will not show up so much in construction works as in machinery and equipment fixed investment.

Bruggemans: How do you see fixed investment moving?

Martin: Public corporations are moving at a much slower rate. After still growing by 41% in 2009, the pace was down to 13% growth in 1Q2010.

The government sector saw fixed investment decline by 1.2% in 2009, and this decline accelerated to 7.8% in 1Q2010. Public housing was down by 33% in 2009, while non-residential was down by 25%.

Bruggemans: Safcec is on record as saying civil engineering turnover this year will be down by 40%, with especially municipal and provincial contracts running off and new tenders slow in being issued.

Martin: Public sector housing completed 166 000 houses in 2009. The target for 2010 is 220 000 houses, but this is not achievable, given the many problems at municipal level.

Bruggemans: How is private fixed investment doing overall?

Martin: The rate of decline in private fixed investment has been improving, from -9.9% in 3Q2009 to -6.9% in 1Q2010. Given the very large fixed investment decline seen in 2009, we have some confidence that fixed investment in recent months has arrived at a basic level, with no further decline taking place.

The strong Rand of recent months has favoured fixed investment and importing and should be supporting demand.

Bruggemans: When can we expect any acceleration in fixed investment spending again?

Grobler: Such increased demand is a function of final demand (spending) in the economy, import conditions, exports dependent on final demand in other countries and of course the level of the Rand.

Bruggemans: I understand civil engineers are seeing more tenders being issued by the private sector and this could suddenly translate into new contracts. Such confidence is perking up of late.

Martin: The important thing to appreciate about public corporations is that what their budgets currently proclaim regarding projected spending intentions is not quite the reality when it comes to actual spending patterns, the latter lagging the former.

At municipal and provincial levels, capex budgets in recent months have not been fully spend, as highlighted last week by Treasury estimates for 2Q2010.

Bruggemans: in conclusion, the economy is growing, but it has lost some of its forward momentum of late last year. This can be seen in most industrial sectors.

Residential, non-residential and construction works are still working off the recession, with residential building activity expected to return to minor growth next year, while non-residential building activity may only do so from 2012. Construction works may take yet longer, depending on the pace of tendering in the public sector over the next three years.

Especially private fixed investment awaits revival of final demand domestically, the take-up of underutilized capacity and export demand from overseas, with the Rand as always crucial in determining competitiveness.

Source: Cees Bruggemans, First National Bank, August 24,  2010.

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