South African recovery spreads and deepens

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By Cees Bruggemans, Chief Economist of FNB.

The first stage of a cyclical upturn is often very difficult to discern, for it tends to start narrowly, with few people benefiting and denial still universal.

Our recovery is now 14 months old, heralded six months in advance by SARB leading indicators vigorously turning up. The initial upturn was, as always, dominated by inventories, something few people see or experience.

That’s what happened in 4Q2009 and 1Q2010.

Once inventory effects peter out, we look to recovering disposable income (net of saving) and final demand (consumption, fixed investment) to sustain output expansion.

There was initially disappointing growth in 2Q2010 and 3Q2010. But it wasn’t only a demand weakness. Especially 3Q2010 was marked by public and private strikes, causing output to disappoint.

Meanwhile income and spending gains were spreading and deepening. Growth will probably have re-accelerated quite considerably in 4Q2010 if only because of strikes falling away and producers having to catch up (especially cars).

It is income gains and the spreading household spending recovery that sets the pace as we enter 2011. This is also confirmed by the SARB leading indicator, of late resuming its (vigorous) advance.

Good wage and salary gains for those in employment are sustaining disposable income growth of 10% nominal, with inflation barely 3.5%-4%. Flexible bonus payouts are recovering, and 2011 will see the first big dividend payout gains of this new upswing. Along with a near halving in interest rates these past two years, many households are experiencing easing cash flows.

This is also reflected by the number of credit-active consumers in good standing increasing again from 3Q2010 for the first time in three years.

Psychologically, this is an important turning point. Retailers are redoubling their efforts to convince consumers of the attractiveness of their offerings, including credit availability.

With equity prices substantially recovered, eyeing new record highs in 2011, and house prices slowly rising in nominal turns, the ratio of net household wealth to disposable income has recovered to peak levels.

This and easier household cash flows are inviting ‘wealth effects’ (households spending some wealth gains).

The proof is 18 months old in the motor trade where April 2009 was the statistical bottom, with 3Q2009 seeing the genuine lift out of recession, and take-off proper dating from 2Q2010, with steep gains thereafter.

This has spread to furniture and household appliance retailers reporting good gains. Similar evidence is reported from retail merchants of building materials, confirming increased maintenance, additions and alterations activity. The retail trade generally has been showing good gains this year.

With good gains in agriculture, mining output recovering, and the industrial goods pipeline advancing, road freight transport was 4% up in 3Q2010 on a year ago.

The Kagiso Purchasing Managers Index recovering to 52.9 is a strong signal manufacturing is resuming its advance as it recovers from strike activity.

Financial and property services may only show gradual gains in the coming year, even with household credit growth back above 6%, given existing high debt loads.

The public sector, however, is unlikely to hold back and resume faster job growth, given medium-term budget intentions of 3% real spending gains.

After the first-stage inventory rebound in late 2009 and catching our breath in mid-2010 (with time out for widespread labour unrest following the admirable restraint during the world cup), the economy is showing evidence of good income gains and spreading spending recovery touching more sectors of the economy.

The recovery proper is with us, probably from about October 2010. Adjusted for ended labour strikes, GDP growth is now probably motoring at 3%-3.5%.

But instead of this being the jump off point for even faster growth acceleration, important drag anchors are holding us back.

Household income growth and spending intentions is the main growth engine, supported by low interest rates and early wealth effects.

Also supportive are strong export price gains relative to import prices, with such net gains percolating through to households via high wage gains and other cost increases in key export sectors.

Unlike previous mining booms, this one isn’t so much boosting mining profits and investment spending as benefiting primary and secondary labour forces and their consumption spending.

Missing in action is a more decisive lift in export volumes (mostly stagnating in Dollar terms these past two years) and lackluster fixed investment.

Public infrastructure activity is still slowing. Private investment has stabilized at low levels and will take time improving. Capacity utilization is low and business unsure about prospects, keeping back new expansion.

The recovery therefore remains household consumption led, with especially the motor trade vigorous due to its heavily distorted replacement cycle now normalizing. Export volumes and fixed investment are still dragging their feet and unlikely to improve much in 2011.

For now, growth will only be gradual at 3%-3.5% until investment kicks in more decidedly sometime in 2012-2014.

Exports may remain missing in action until we get our act together as a country (mining rights, infrastructure, labour costs).

Source: Cees Bruggemans, FNB, December 6, 2010.

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