South Africa’s growth prospect constrained

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By Cees Bruggemans, Chief Economist of FNB.

Our current economic upswing is about 21 months old.

This is still relatively young when compared to the average of the fifteen post-WW2 upswings (30 months) and very young compared to the 42 month expansion of the mid-1990s, the 44 month expansions of 1961-1965 and 1978-1981 and the 99 month expansion of 1999-2007.

We really have barely started.

There is still a lot of resource ‘slack’ (meaning employable labour, underutilized industrial capacity and vacant structures – offices, warehouses, shops).

In a modest growth environment this should ideally allow many years of expansion without offering serious supply constraints.

But then one also notes labour having become expensive, wage demands being multiples of inflation, politically there being few brakes on entitlement and all this inviting greater focus on technology to do things more smartly, inviting capital deepening and labour substitution, to keep wage bills manageable and businesses competitive.

This in a country with huge labour surpluses (if not always with the right skill sets).

So even employable labour runs the serious danger of becoming structurally unemployed (longer term).

Also, certain types of infrastructure (electricity, railways, municipal services) are constrained, offering growth bottlenecks. And certain industries (building trades, construction, mining) suffer their own blockages (credit, manpower, regulatory issues).

Office vacancy rates refuse to drop because take-up of office space remains very slow, according to Erwin Rode.

This reflects slow growth, but also the labour conditions already discussed. Formally employed labour has averaged about 9.2 million these past two years after their 9.5 million peak in 2008.

No sign of a real improvement yet. And with more people working from home, technology-assisted, there is no upsurge in the need for physical space yet.

If anything, the need for space may gradually dwindle (though vacancy rates seem to have bottomed, perhaps as structures completed are now also declining?).

One should be careful about saying there is a large output ‘gap’ that can still be closed if it wasn’t for a shortage of demand. There are important bottlenecks blocking a more natural uptake of available resources.

If the perceived output ‘gap’ isn’t perhaps what it seems, is this also true of the balance of payments?

The current account deficit has dwindled to a cyclical low of 2%-3% of GDP, surely indicative we can handle a lot more domestic demand and associated imports?

Well, yes, but be careful.

Our export earnings are very strong at present, but our actual volumes traded are not. Mining output is up by 3% but commodity earnings are up by 30%, courtesy of export commodity price surges (even in terms of a strongly overvalued Rand).

Such commodity windfalls don’t last indefinitely. Less favourable times doubtlessly will come again, when our dependence on favourable export price windfalls will be shown up for what it really is – a temporary assist.

The same applies to the huge capital inflows favouring us. These reflect the world condition more than our own. These things are known to change eventually. Better be realistic about it and manage things accordingly.

With our growth slow at 3.5%, our resource slack real but some of it apparently increasingly semi-permanent (not unlike a sickening body finding its blood flow partly blocked), and the balance of payments constraint perhaps only temporarily dissolved, what else is truly for real?

Inflation is steadily ratcheting higher this year, after a low of 3.2% last October now on its way to test the 6% upper boundary of the SARB inflation target.

Our 30-year low interest rates won’t survive this encounter. Markets are discounting higher interest rates from 2H2011, prime likely rising from 9% now to 11% or even slightly higher over the coming 18 months.

Beyond that the outlook is murky, very much dependent on whether the global condition continues to favour our export prices and capital inflows, or whether there is a change in fortune to be absorbed eventually.

Forewarned is forearmed.

Source: Cees Bruggemans, FNB, May 9, 2011.

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