South Africa: A very stable forecast resting unstably

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By Cees Bruggemans, Chief Economist of FNB.

One of the more unsettling aspects of recent times is the sense of very stable forecasts resting on unstable foundations.

We are 32 months into economic recovery, with GDP cruising steadily at 3% or thereabouts.

Forecasts differ for this year, and through 2014, but not by much.

The more cautious allow for European weakness to eat away some of our income and output gains.

Realistically, most of us allow for higher inflation and wealth taxes and slower public sector wage growth and transfers (off high bases) to constrain household income growth, while as yet not hoping for much from public and private fixed investment gains.

That said, we may be pleasantly surprised by faster income growth from property (meaning the many variable sources of income) in an economy showing momentum in all sectors except the building trades.

The global picture looks severe in places, but mostly so where we have least exposure (EU peripherals), even as Europe generally doesn’t suggest much growth. But then how big a difference does zero make compared to +1%?

We are apparently not to expect too much from public sector fixed investment in the short-term, going by the budget this week, but could private fixed investment be giving us a bit more, given recent trends?

These are perhaps slim hopes, but then we seem to be mostly arguing the toss around 2.7%-3% GDP for 2012, statistically not a big spread to get precise about.

More interesting is the question why GDP growth should top 3.5% in 2013 and 4% in 2014 if the infrastructure push may only materialise later, if then.

The answer seems to be receding inflation (minimally) and stabilising tax burdens (but then who knows, given some of the sentiments in last week’s budget), together easing up on households, giving them more space to boost spending anew after 2012.

Then again, global growth is supposed to be tweaking higher from 2H2012 and beyond as crises recede, also benefiting our export performance.

And, yes, there might be slightly more push from fixed investment spending, private and public, but then don’t hold your breath.

Anyway, Year Three in any forecast is always easily revised, and we have been doing that now serially for three years. So a bit of disappointment for longer in the 3% growth range would not come as a huge surprise.

Inflation forecasts have steadily crept higher, but for the past year have assumed a relatively short sojourn outside the 3%-6% target before dipping back.

Peaking territory seems to be flexible around 6.3%-6.8%, after which a slide towards 5.5% is expected, mostly due to changing food and energy prospects with core inflation rising to top 5% and not easing much thereafter.

The Rand as always is a very volatile proposition, but few call 6:$ or 9:$ shortly. That amounts to relative stability saddling 7.50:$ with a 200 cent trading range.

Interest rates are unlikely to rise with such GDP growth underperformance, considerable resource slack (output gap) remaining and inflation mostly tame if high up in the target. Most forecasts see repo at 5.5% (prime 9%), also bearing in mind a faster budget deficit step down.

With Fed, BOE, BOJ or ECB unlikely to raise rates before 2014 (if then……) it isn’t obvious in the least why our SARB would want to start raising rates through 2013 UNLESS some of these numbers turn out to be less stable than here suggested.

But even then we seem to be mostly tweaking the verbiage.

It is a different matter altogether when considering the possibly very unstable foundations on which most of our forecasts tend to rest at present.

Not so much domestically, where politics of late appears to have acquired renewed focus, macro policy is traditionally stable and even some of the micro policies may gain in coherence, though dissonance remains a disturbing feature consistently confusing audiences.

It is globally where we seem to be traversing deeply troubling times, with every important part of the world grappling with uniquely existential questions, in some instances offering up the chance of genuine mayhem if missteps are made.

The focus used to be on the US, with many ready to switch to China, though the flavor of the moment remains Europe, with the Persian Gulf an exotic alternative.

If, as feared most by our policymakers, Europe were to encounter another twist in a contorted road, a much bigger disruption could still originate there than seen so far, in which case both our exports and Rand have weakening potential, undermining growth while boosting inflation, potentially in undreamed orders of magnitude.

While acknowledging such risks, markets seem to be pricing less of it while shifting their attention (again) to oil and Middle East. Early last year it was the Arab Spring (or Fourth Revolt as some call it) that especially in Libya caused oil export disruption.

Coming on top of the Japanese tsunami distorting energy demand/supply, it added heavily to the oil price premium.

Today, the world is getting succour from gas prospects (long-term fracking offering revolutionary prospects) but the focus is increasingly on potential conflict in the Persian Gulf. Even a short-term 50% spike to oil prices could be lethal, never mind a bigger one lasting longer (remembering the 1970s).

Anything significant here could move our cheese by a few percentage points, growth from +3% to -2% (?), inflation from a 6.5% peak to over 12% (?), the Rand potentially getting a 50%-60% haircut towards 12:$ (?), and only the SARB knowing what it would do to interest rates (with the weaker Rand stabilising the economy, interest rates traditionally boosted to tame the inflation surge?).

But then we can’t be sure about other effects, such as precious metal booms as seen in the 1970s, compensating much and yielding quite a different outcome.

These are fat tailed risks (huge outcomes but now with significant probabilities), given the unsettled state of the world today. We may therefore mostly stick with our stable ‘base’ case views, but these merely reflect an inability to firmly incorporate heightened event risk.

Thus many are waiting in dread for the butcher’s knife (and bill), though wondering whether there will be a respite before having to face the music once again.

Yet stock markets seem far less perturbed, everything gradually pushing higher again after the handwringing of late last year. But then an ocean of liquidity and record corporate margins dictate their own reality show.

Source: Cees Bruggemans, FNB, February 28, 2012.

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