Evolving South African prospects

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By Cees Bruggemans, Chief Economist of FNB.

Just like in the larger world, our prospects are also gradually evolving, and not necessarily for the worse.

The focal point of global crises has shifted from Anglo-Saxon housing and banking (2007-2009) to European sovereign debt and banking (2010-2011) to Middle Eastern political and oil risks in 2012 (with China as risk factor remaining an unanswered question mark for many).

Europe remains for many a source of crisis and potential disruption. But the ECB’s two aggressive LTROs, in a matter of three months offering 800 EU banks €1 trill worth of 3-year money at 1% has, according to German Chancellor Merkel, bought the region 2-3 years time for EU banks to recapitalise, Eurozone countries to cut their fiscal deficits and arrest their debt spirals while refocusing on structural reform to get their flagging growth going again.

All these actions should underpin the continuation of a more viable European monetary union.

Within the US we had sharp recovery in 2009 and 2010, but hesitancy in 2011, and now we see renewed evidence of growth vesting and employment slowly coming back. Europe is likely to undergo something similar from later this year (if nothing big intervenes).

South Africa also initially recovered smartly from the 2008/2009 recession, but its effort was unbalanced in that it was mainly household consumption led.

Fixed investment was slow in coming back, held back by capacity problems in government and spare capacity and uncertainty in the private sector, while constrained infrastructure and the new, more disciplined credit culture were also limiting factors.

Last year still saw strong household income growth, especially in the public sector even as rising inflation eroded some of these gains. Thus we found retail, wholesale and motor trades and also many services performing adequately.

This, though, is not a static picture.

Inflation has risen further in the opening months of 2012, CPI reaching 6.3% and has yet to peak, with especially rising electricity, petrol and food prices eroding away real purchasing power.

In his February budget the Minister of Finance made further inroads here, projecting his personal income tax collections to rise by over 14% this year (well ahead of 6% inflation and 2% job growth). He further imposed greater wealth taxes through a 15% dividend withholding tax, upping capital gains taxes by a third and robustly boosting fuel and electricity levies, besides the usual sin tax increases. He also made changes to medical deductions, switching to a credit system that will impose a greater burden on middle class taxpayers.

The Minister is taking this extra pound of flesh in order to reduce his budget deficit faster, something demanded by global market conditions and simply precaution, just in case, as we are in no condition to face another major global crisis any time soon.

But the combination of higher taxes, more modest public spending and higher inflation should erode household real incomes enough to cause some slowing in consumption growth this year. The Minister appears stoically prepared to accept such growth sacrifice in the short term.

It makes the willingness of the SARB to keep interest rates unchanged this year at low nominal levels (prime 9%) and negative in real terms (repo rate of 5.5% against CPI inflation of 6.3% and rising) more understandable (provided inflation doesn’t shock too much on the upside, core inflation remains target-bound near 5% as now projected and headline inflation starts receding from later this year).

There is some hope our exports won’t do as poorly as some expect (provided mining labour unrest doesn’t escalate and indeed ends soon, especially in the platinum sector).

Also, fixed investment might do slightly better than projected, especially in the private sector as more machinery and equipment is being acquired than expected earlier, as reflected upon in a February FNB Round Table discussion.

Together these tendencies still suggest only about 3% GDP growth this year, with household consumption doing 3.5% after nearly 5% last year.

The big promise of much bigger infrastructure efforts, as highlighted by President Zuma in his State of the Nation speech and by the Minister of Finance in his budget appear to be things that may translate into much bigger fixed investment loads after 2014 at the earliest.

It will take time to gear up.

Meanwhile, SARB is expected to remain on hold with 9% prime, as neither 6% inflation nor 3% GDP growth warrant action at this stage.

The Rand as always will be volatile, likely in a wide 200 cent band straddling 7.50:$, supported by global growth pull out of Asia, less crisis concerns out of Europe (hopefully sustainable) and gradually better news out of America. The one big unknown for 2012 is the Middle East and oil, something to watch carefully, for it could have hugely disruptive potential, as seen on various occasions in recent decades.

Source: Cees Bruggemans, FNB, March 7, 2012.

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