A sense of risk

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By Cees Bruggemans, Chief Economist of FNB.

The economy is now on a 3%-3.5% growth trajectory powered mainly by household and government consumption spending.

Public fixed investment remains disappointing due to slow contract flow (apparently a function of state capacity).

Private fixed investment has cut back defensively in recent years and remains subdued, reflecting business reticence, low capacity utilization (manufacturing, services), issues (mining), electricity constraint and vacancies (structures).

Increased unemployment is another measure of our large output gap (the difference between what is and could be).

Some 400 000 formal jobs were lost since late 2008 even as 1.1 million new graduates and matriculants have come on stream since then, with at least 800 000 of these entering the labour market longer term.

Retiree replacement has absorbed only some 0.2 million, leaving over one million formal employable labour looking for work when new jobs are very scarce currently.

These realities make for huge slack on a 9 million formal labour force, though demographic mortality needs to be taken into account.

This aside of the huge pool of unskilled labour numbering in the millions, to which mentally should be added the African hinterland ability to indefinitely augment this, giving rise to visions of Asian labour potential.

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With income growth advancing steadily now mainly due to wage gains on the back of productivity improvement and activity expansion, and business earnings cyclically reviving, the economy looks good for some years of at least 3%-3.5% GDP growth without soon running into new domestic constraints (except electricity).

There are political risks to this prospect. A greater apparent preference for intervention, by eroding property rights, making the labour market less flexible and burdening the economy with yet more layers of costly social endeavours, could weaken risk-taking incentive and increase the brain drain.

Scope and probability of such changes remains uncertain and mostly wrapped in rhetorical political fog (or as Raymond Parsons put it, if talk were counted part of GDP, South Africa would have one of the best performing economies in the world).

Less foggy are immediate global risks, where the focus is on commodity price inflation (mainly oil and food) and financial crises (Europe).

Positive risk is offered by both the US and Chinese (Asian) economic expansions, which continue to look well-vested and are not questioned (even if the US is progressing less fast than wanted, and China is tempering its advance, but probably not drastically).

Asian growth and rich country policy stances continue to underwrite our financial situation, with high commodity export prices, high global liquidity and appetite for our bonds, equities and corporate assets underwriting rising bond and equity prices and firm Rand of 6-8:$ and 8-10:€.

As these tendencies probably have some years to run (!), the Rand could still firm anew from present levels UNLESS our policymakers intervene more decisively on the basis of a China, Brazil or Chile (or global conditions were to become more adverse).

Such increased intervention (more forex accumulation, exchange control relaxation, public pension fund overseas diversification, deposit requirements or taxes on incoming capital flows) have been talked about, could still be acted on more pervasively, but have so far been unable to prevent Rand firming.

Meanwhile global demand growth and supply constraints (export bans?) could boost energy and food inflation, potentially radically. Although our own good harvests continue to provide price buffers, we may not ultimately escape a new infusion of global commodity inflation.

If this were to lift the inflation trajectory yet further (SARB already expecting inflation to rise to 5.4% in 2012), it could mean an early need to raise interest rates, though a relatively underperforming economy and outperforming Rand would argue against this (THE dilemma in many EM countries).

In recent weeks, attention globally has once again shifted to faster inflation trends, partly commodity driven and in many EM countries due to closing output gaps or even positive output gaps as growth proceeds. Such inflation preoccupation leads markets to price in higher interest rate expectations.

European sovereign debt and banking stress (as private refinancing has become more problematic due to solvency issues and political slowness in cutting Gordian Knots) could still cause bouts of risk-aversion through 2013 (even if these strains seem to have been lessening again in recent weeks as political breakthroughs are expected and a perhaps more realistic risk spread differentiation is becoming reflected in bond prices).

Such strains, should these deepen anew, could still rebound on us, penalizing the Rand (temporarily) though potentially boosting precious metal prices, with SARB continuing to express deep concern on this front.

All this makes for a VERY cautious SARB, which as seen at the January MPC may remain inclined to do nothing for some while, provided no significant risks intrude.

Inflation is expected to remain within the target (4.5% this year, 5%-5.5% next year), growth well vested in the 3%-3.5% range and interest rates at over 30 year lows for some time (but for how long?).

Credit growth is expected to remain single-digit, given 8%-9% nominal GDP growth, the restrained credit culture and minimal house price gains.

Source: Cees Bruggemans, FNB, January 26, 2011.

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