The mixed message of slip sliding prospects

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By Cees Bruggemans, Chief Economist of FNB.

The South African economy disappoints, going by fiscal vibes seeping into the ether.

Growth and therefore tax revenue haven’t been as hot as hoped for earlier this year, while spending Ministers seem to be firmly doing what comes naturally.

With the global mood somber and fearing further growth slowing, South Africa isn’t escaping these strains. This is apparently inducing an inclination to take things easy with right-sizing our state finances after the Great Recession Hit.

With government debt aiming for 45% of GDP (double its 2008 low) and overall public sector debt aiming for 60% (after including parastatal debt), there remains a sense of comfort about our state finances.

Public debt is well below other countries, the budget deficit has shrunk from its 7% of GDP recession peak, there is time to rectify things, the economy can do with a little tonic, tax collections are disappointing while spending ambitions never tire.

Not a situation in which one wishes to be too starkly austere and press down on a modestly performing economy.

And yet overseas there are numerous instances of countries doing just that, with a severity which should give our easy-going ways some pause.

Are things so dire?

It could well be that our growth may struggle for longer than expected, tax shortfalls may rise even as spending pressure keeps rising.

With no clear national emergency hitting the panic button and the political clamour for greater budget allocations intensifying, putting upward pressure on the budget deficit above 5% of GDP, the Minister may find it difficult to resist all such stresses.

Thus our fiscal policy appears to be more accommodative than perhaps intended, postponing planned budget deficit correction and accepting some budget and debt slippage.

Does it matter?

It will if there is no change in the script soon, and the finance slippage becomes more pronounced, attracting the unfavourable attention from credit providers.

Also, fiscal slippage is starting to impinge on monetary policy freedom to act to support a weak economy. It isn’t only the inflation prospect, the insufficient demand hobbling output growth, and the EU crisis risks that is shaping our monetary response. A deteriorating fiscal overlay is also coming into focus.

If the budget deficit remains too high for too long, it would start precluding rate cuts.

That would be inconvenient, given the economy’s mixed messages of recent months.

Some things seem still to be performing reasonably strongly. Passenger car sales year to date are +16%, retail sales +5%, wholesale trade +5.4%, unsecured debt growth aggressively high. Latest monthly cement sales were +8% per trading day, real residential buildings plans were +4% and non-residential +3% y/y.

But mining output is up only 2.2% year to date, steel output declined by 5.5% in August and 10% in September, oil refining output remained under pressure, buildings completed kept declining steeply, business and consumer confidence has eased.

Though manufacturing output bounced back by 5% in August, but year to date has done only a poorly 2% while credit growth of 5% is only half what it should be (reflecting ongoing delivering).

Property generally remains a depressed area.

Following the disappointing 2Q2011 growth data spilling over into 3Q2011, private sector growth forecasts have generally been pulled back from nearly 4% to below 3%.

Public sector GDP forecasts have been moderated nearer 3% for this year, with a slightly higher bias for 2012.

This is in an economy not noticeably succeeding in closing its sizeable output gap of 2%-3% of GDP. Much underutilised capacity, employable labour and buildings remain. What are we doing about it?

Some of the growth restraint is due to supply side shortcomings that are either only being addressed in the medium term (electricity shortage, credit restraint, public sector technical manpower shortages, material shortages such as steel and bitumen), are long-term propositions (public transport) or don’t seem to be noticeably changed at all (education and labour markets).

But even with such glaring supply restraints keeping growth back, it doesn’t look like being only a supply issue. Demand, too, is insufficient as shown up in BER business opinion surveys and recently highlighted by the SARB Governor to parliament.

So there appears to be a prima facie case for doing more to encourage faster growth.

As things stand, we are probably not trying hard enough to prevent fiscal slippage and relieve supply caps.

This leaves the SARB. It already has substantially lowered real interest rates (to zero), and remains deeply cautious about what could still play out in overseas economies and markets soon.

Clearly, the Rand remains shock-absorber-of-last-resort in times of crisis to protect domestic incomes and output. But if we were to be hit by another shock, SARB could still cut interest rates, even aggressively.

Markets in any case expect more rate easing during the next six months, given that insufficient demand appears to be a concern.

Ideally, we succeed in lifting the growth rate and get those many idled resources eventually back on stream.

Source: Cees Bruggemans, FNB, October 24, 2011.

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