South African growth cycle approaching cruise control

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By Cees Bruggemans, Chief Economist of FNB.

As the economy completes two years of recovery shortly the time appears ripe to transfer to cruise control.

This may take another 12 to 18 months to be completed.

Thereafter, with our cyclical upswing already a ripe 40 months old by late 2012, there could await a longish growth cruise at modest speeds, at all times subject to abrupt unexpected disruption coming out of global space.

Compare it with a human life projected to a ripe old age, ultimately ended by infirmity, but where at any time in the interim life can be cut short by some unexpected external event (accident) or internal illness.

The liftoff so far has been a story of post-crisis export revival, inventory normalization and household income-led consumption spending.

It has been facilitated by generous government spending and hiring and the lowest interest rates in 35 years.

This was accomplished despite the credit engine being partially disabled by the National Credit Act (for household property mortgages) and by Basel 111 bank capital requirements (for all borrowers in terms of higher risk premiums charged).

The real stimulus for the economy overall seemed to come from outside.

Not higher export volumes, but windfalls nonetheless.

Higher commodity prices boosted mining earnings, allowing high income growth in mining-exposed sectors.

High capital inflows further assisted in keeping the Rand overvalued and inflation suppressed, allowing prime to fall to 9%, easing indebted household strains.

The great drags on recovery were curtailed credit growth and electricity output, technical skill shortages in the public sector and an overvalued Rand, holding back property investment, infrastructure construction, faster mining expansion and import-competing activities.

With GDP growth reaching 3.5% (consumption-led with limited investment support) and inflation reviving back to 5%-6%, SARB needs to take back its emergency generosity (some 2% off interest rates). This will likely be achieved over the next 15 months, prime reaching 11%.

Whatever the February Budget claimed, fiscal policy is collecting more taxes, with the budget deficit not stagnating (which looks more than ever mostly a ruse to keep the spendthrifts at bay) but improving towards 4.5%-4.8% of GDP after all.

More crucial is the question whether our export prices can outperform indefinitely.

A global inflation surge isn’t on the cards, with US, EU and Japan burdened with slack resource. There is some EM inflation revival, and commodity demand remains lively, but it need not push up global inflation inordinately.

What’s left is crisis potential, in EU sovereign debts and banking (and ultimately the Euro itself – watch the ECB challenge to European politicians not to reschedule peripheral debt), in Arab oil supply, in the US budgetary stalemate, with future India-Pakistan conflicts the wildcard (following Henry Kissinger’s musings, see FT interview this weekend).

It may be US growth still disappoints shortly, keeping Bernanke accommodative longer, depressing the Dollar and keeping many anxieties alive, feeding precious metal prospects.

But it may not last indefinitely, after which we really become crisis-dependent again, not a surefire support for sustainable high precious prices.

But even if global income support for us stabilizes, it could remain rich enough to sustain us for the time being, with domestic growth further supported by slow private investment revival (mainly non-property).

If simultaneously the Rand’s overvaluation doesn’t worsen (targeting for now 6.75-7.50 territory), oil surprises with $100 modesty as global political premiums fade some more and agricultural spot prices settle off their recent highs as demand/supply balances improve, our inflation rate stands a chance of falling back into the 3%-6% target zone despite high real wage increases (accompanied by poor private job growth).

That suggests 3.5%-4% GDP growth post-2012 as the world absorbs debt cleansing in Europe, US budgetary adjustment (with or without market friction), sees out the maturing of the Arab Spring (with New/Old regimes in Egypt, Libya, Yemen and Syria taking hold), and Asia readying to reopen the throttles once commodity inflation (food), core  and property (!) inflation subside.

It is a world that remains growth-led (Asia), commodity friendly (Asia), sufficiently unstable to be precious metal supportive (crisis-mode), and still facilitating enough to remain low-yield and EM-yield hungry, sending its capital outwards.

With our balance of payments not severely constrained either through insufficient capital funding or excessive importing (an excessive savings gap really), with the Rand capped, inflation peaking and modestly subsiding, income-growth well established, some private investment activity gradually reviving and macro-policy on cruise control, there could post-2012 follow some mature growth years before this cyclical expansion finally stumbles.

Domestically, we probably will remain preoccupied with continuous politicking through 2014, after which awaits the second Presidential term.

Though macro policy appears stable, paralysis seems to be the defining reality in micro space in the public sector and between the various ideological policy strands.

Monies will be spend, laws changed, regulations promulgated, personnel switched, but the real cyclical force (as always for us) remains the global economy, for good and ill.

Hopefully most of this decade will remain for us on balance rewarding. Mainly a reflection of our times.

Source: Cees Bruggemans, FNB, May 23, 2011.

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