Insufficient demand a huge concern

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By Cees Bruggemans, Chief Economist of FNB.

SARB Governor Marcus has not been reticent about her concerns regarding EU banking and sovereign debt crises, slowing global growth, South Africa’s exposure via exports and capital flows, and the situation at home whose insufficient demand she typifies as a huge concern.

To this can be added the many supply constraints hobbling the economy, such as capped electricity supply, limited export rail capacity, technical manpower shortages in the public sector holding back infrastructure construction, a new credit culture constraining property and the building trades, and poor education results and poorly functioning labour markets not supportive of the growth process.

Our economic recovery these past two years since 3Q2009 has been a strange affair.

Unlike many of our EM peers, our manufactured export volumes have barely recovered from the vicious 2008/2009 falls. Instead, our recovery has been strongly led by consumption revival (itself a surprise in the absence of more vigorous credit support) while suffering from weak, if any, public and private fixed investment revival.

Throughout we were subjected to some of the strongest labour action in South Africa’s history, not in protest at severe hardship (as in peripheral Europe or increasingly at grass root level in the US), but in support of amazingly high real wage increases (in many instances twice to thrice the inflation rate).

So there has been good personal income growth, as much driven by high global commodity prices, strong government patronage, focused union action and widespread skill shortage premiums.

But inflation has also revived due to commodity price surges (including infrastructure tariffs), this year eroding real income gains and household purchasing power.

After a strong 1Q2011 start, these many realities have led to a number of disappointing supply side performances in manufacturing, mining, tourism, retail, wholesale, motor trade, construction and the building trades.

Car sales have kept growing, but at about half the pace of last year. Not particularly worrying in its own right as initial growth spurts following recession has much replacement catch-up to it. Still, the car slowdown has come earlier than expected, and may indicate middle class pent-up demand is more limited than perhaps hoped.

Retail and wholesale trades have also seen their growth dwindle as real purchasing power faded this year.

Manufacturing was badly hit by strike action (a transient feature), but the steel, petrochemical, paper and textile complexes also saw production units out of action, exports reduced and/or trade competitiveness suffering.

Mining output stagnated, partly reflecting high precious metal prices (favouring more marginal ore bodies, prolonging mining life) and constrained export and electricity infrastructure.

Construction activity rose mildly, but growth remained modest due to uncertain overseas conditions, public sector manpower shortages and financing constraints.

Residential building activity remains mired well below normal levels due to constrained credit access, high debt loads, oversupply, falling real property values and reduced household appetite for new commitments.

Non-residential building activity still suffers from substantial office and retail space vacancies.

Following 2.8% GDP growth last year, growth through 2015 may average only 3%-3.5%, below long-run growth potential and maintaining a substantial output gap by way of idled physical capacity and employable labour.

SARB Governor Marcus is well known for expressing concern that the aftermath of the global financial and economic crises of recent years will likely be with us still for many years.

This should keep growth in the rich developed countries disappointingly low and also weigh on even the better EM growth performances.

These global conditions are seen as offering many headwinds to the South African economy.

To this we can add the many self-inflicted domestic shortcomings already enumerated also keeping growth back and that may be with us still for a considerable time.

Thus South Africa, as elsewhere the case, also presents a picture of relative growth underperformance and lingering resource slack, potentially for many years still.

This situation is being addressed via many policy channels simultaneously.

Macro-economically, SARB has lowered interest rates to 35-year lows (with repo at 5.5% and prime at 9%), with the real repo-rate effectively zero and very supportive.

Treasury has allowed a sizeable budget deficit near 5% of GDP to linger and its reduction will only be slowly achieved, even as government debt is expected to be stabilized near 45% of GDP (and all public sector debt near 60% of GDP).

Micro-economically, government favours various industrial interventions aimed at boosting industrial activity and job creation.

Even so, as the SARB Governor’s comments bear out, none of this seems to be succeeding in getting effective demand to rise faster and output growth to be more satisfactory in more fully reabsorbing slack resources.

More policy action may still follow. If undue currency weakness doesn’t materialise (indeed, if the Rand stages a comeback nearer 7:$) and inflation remains mostly target bound (below 6%), more interest rate cutting may still follow (as soon as early November), with markets now not expecting any interest rate increases before 3Q2013 (mirroring US conditions).

More policy easing could still follow in 2012, if warranted.

Source: Cees Bruggemans, FNB, October 17, 2011.

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