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By Cees Bruggemans, Chief Economist of FNB. The SARB this year has been most decisive about inflation (rising, but so far not giving rise to second-round effects and likely relapsing back into target next year), most outspoken about the economy (a lingering subpar growth performance and sizeable output gap) and most concerned about Europe and its many crises (the worst could easily happen, and if so sideswiping us, too). Throughout this year this has been a formula for keeping interest rates unchanged at 35-year lows. This has been a rather unusual policy stance in terms of rising inflation towards 5.5% and projected to stay there on a three-year view (arguing in favour of higher real rates), but also unusual when considering insufficient demand keeping the economy subpar and the output gap large (arguing for even lower real rates, bearing in mind a supportive fiscal policy, even overly so). So what kept them? Mainly it has been the intimidating risks offered by a Europe on fire, and any possible contagion engulfing us, too, in case of a country and/or banking collapse. This risk presumably made it advisable to keep the policy powder dry, in case market volatility were to also destabilise our conditions, in which case ‘appropriate’ policy action could follow alongside any Rand moves (the Rand remaining preferred shock-absorber-of-last-resort). As the year progressed, our inflation rose ever higher (CPI 5.7% though core CPI excluding food/energy remaining anchored for now at a comfortable 3.8%), the economy’s growth undershoot gradually showed its full dimensions (some sectors still performing reasonably, especially on the consumption side, but many doing poorly), while the European crisis at times bordered on farce as it moved ever deeper into fearful territory. So why resume cutting rates now rather than wait? For one thing, inflation prospects have changed little, with summertime peaking in 6%-6.5% territory after which a renewed slide towards 5%-6% is expected in 2012 and lasting thereafter for a good while in 2013 (even 2014). The SARB fully appreciates the key relative price changes underway at home, with the economy having to adjust to higher electricity and other user charges (transport, municipalities) and to higher oil, gas and coal costs. Still, when excluding such wrenching changes, and even when allowing for politicised labour demands in key areas, underlying cost pressures apparently remain remarkably subdued, undoubtedly affected by low global inflation, intense trade competition and the disciplining of an overvalued Rand. Regarding the economy, it remains consumer-led with especially new car sales holding up well (year to date +16.5% on a year ago), but retail sales have slowed modestly year to date. In contrast, fixed investment is growing sluggishly, both public and private. Going by sectors, mining and manufacturing output are barely 2% higher year to date, building and construction remain at low levels of activity, property generally is subdued with recession-like vacancies lingering in office, retail and industrial space. Employment has seen some gains, especially in the public sector, but some of these gains appear overstated. Household indebtedness at 76% of disposable income is only gradually easing while credit growth at 5% is barely half nominal GDP growth of 10% two years into recovery. Such credit weakness indicates the extent to which the credit act of 2007 and the Basel 111 bank capital requirements have tightened credit standards and the cost of credit. Such structural changes may be a long-term benefit, but in the short-term it may keep growth back. There is little evidence of consumer binging, reckless business expansion or speculative excesses in the economy. Instead, both business and consumer confidence came off in the course of the year, signaling the economy’s performance to be modest, also confirmed by the stagnating SARB leading indicator. Although any interest rate cuts may not excite much extra demand in the economy, it would assist with the repair of household balance sheets (reducing indebtedness) while bolstering business cash flows, in both instances probably boosting confidence. There has been progress on the political front in Greece and EU bank recapitalisation is underway. The short-term focus has now shifted to Italy, with its playout a cause of concern for many. Meanwhile, severe fiscal austerity and evidence of a credit crunch as banks shrink balance sheets, along with falling confidence, appears to be steering the EU economy into a ‘mild’ recession. This has made the ECB under President Draghi willing to ease its policy stance, cutting rates by 0.25% last week, with more cutting expected, thereby offering a lead to EM central banks to follow where this is deemed useful. In contrast, US growth has improved compared to 1H2011, with no evidence of an imminent double-dip, while China also is maintaining growth momentum. It is a global picture which is proving less threatening than it looked for a while during 3Q2011, with good reason to expect more progress in 2012, especially if Italy could also successfully addressing its problems. Whether this will prove enough for the SARB to become less insistent on ‘keeping its powder dry’ and be guided more by domestic needs and cut interest rates another notch (as Aussie also did last week) we will discover later this week. Source: Cees Bruggemans, FNB, November 7, 2011. More on this topic (What's this?) The High Cost of Low Interest Rates (REIT Wrecks, 10/4/11) Sorry Inflationistas, But This Chart Proves You Were Wrong (Wall Street Daily, 10/21/11) The Secret to Gold Prices: Real Interest Rates (Wealth Daily, 1/20/12) 
By Cees Bruggemans, Chief Economist of FNB. Participating in the FNB Fixed Investment Round Table for 4Q2011 were:
Cees Bruggemans: An interesting week lies behind us, with 3Q GDP growth in the US coming in at 2.5%, China still offering promising growth data and Europe coming through with an insurance-leveraged €1 trillion lifeboat, a ‘voluntary’ 50% haircut for private holders of Greek debt, €106bn of extra capital demanded from EU banks to reach 9% tier 1 capital by mid-2012, and Italy requested to undertake more serious reforms shortly. Also, reported corporate earnings continue performing well globally. This news has been well received by global markets. Even though the EU actions are unlikely to offer the final solution to all our ills, this news flow is another serious down payment on restoring lost confidence to global markets. Though growth in the US next year will experience strong headwinds from fiscal austerity and weak housing market, a double-dip is not expected. Europe may experience a mild recession in coming quarters, austerity and credit-led, but its GDP should be lifting by 2H2012. Global growth should continue moderately. Hugo Pienaar: Given slow global growth and our export exposure to the US (8% share), Japan (8%), China (12%), Africa (15%) and Europe (23%), and domestic adjustments underway (considering the lower levels of business and consumer confidence as reported by BER opinion surveys), we expect only modest South African GDP growth this year and next averaging about 3%. Fixed investment shows a nice correlation with business confidence. We expect a mild fixed investment recovery of just over 2% this year and just over 3% next year, with business reportedly sitting on a huge cash pile of some R470bn. If only more of that money could be put to work! Cees Bruggemans: What drives this fixed investment picture from the demand side, thinking public infrastructure and private capacity needs? Pierre Blaauw: In the public sector we have seen serious attempts at public-private-partnerships (PPP) and user charging, with the latter having encountered resistance. Eskom is being allowed to improve its cash flow through high tariff increases in order to fund its infrastructure maintenance and expansion, but large electricity users keep objecting. The recent experience of Sanral with toll roads is significant for its impact on private sector views as to how to unlock investment in the country. In 2004/2005 there was an instance of a toll road PPP idea that was at first sold to the government, only to be undone. Today there are new attempts at toll roads which seem to be failing, with question-marks about this funding mechanism. It is causing construction industry doubts about sufficient government commitment to make this work. There appear to be doubts about using the mechanism of PPPs, which is creating doubt about the next phase of highway expansion. We appear to be at a fork in the road as to what to do next, in building roads, but it really goes wider than that. South Africa is consuming its existing infrastructure on a daily basis through wear and tear, and it massively expensive to maintain, replace and expand. If government doesn’t have the funds, and private funding is cut off, it isn’t obvious that we will be expanding our infrastructure at a pace adequate to support our expected growth. Compromises will be needed. Elsie Snyman: In fact the government last week cancelled the much-delayed PPP arrangements for four new prisons, which were initiated in 2003 and never consummated, intended to add 3000 bed spaces to Paarl, East London, Nigel and Klerksdorp correctional centres. Apparently, the cabinet has decided on a review of all PPP models across government. Erwin Rode: Know the joke about Nigeria? They have the cheapest electricity in the world, except for the fact that they actually don’t have any electricity! We may have to swallow our objections and pay up. If we don’t pay, we may not have much infrastructure left before long. Continue reading South African fixed investment slow for now, faster later
By Cees Bruggemans, Chief Economist of FNB. South Africa has completed two years of economic upswing, averaging 3.1% growth (less than our 3.5% long-term average). Saddled still with much unutilised industrial capacity, labour and buildings following the 2008-2009 recession (at least 5%-10% of those in use remain idled), though parts of its infrastructure straining at breaking point, the economy is far from overheating. So how long could this business upswing become, how much growth is it likely to generate, and what will end it? The slow growth so far has its reasons in demand and supply conditions. Some of these will be with us for long, but others may fade, transforming growth speed and resource slack. On the demand side, the first two years of expansion have seen good real income growth and consumer spending, but high uncertainty and slow-coach investing, with export volumes worryingly underperforming EM peers. How will this picture change, if at all? Nominal household income growth should keep running strongly at near 10%. Wage and salary gains will be fed by high global commodity prices, rich government patronage for some, strong union wage demands favouring others, many benefiting from skill premiums as well as informal work gains and job growth of 1%-2%. With inflation 5.5%-6%, real income gains have tapered off to 3%-4%, driving real consumption. Fixed investment growth to 2013 is likely to remain modest, held back by supply constraints, public financing and manpower challenges and deep private caution. Electricity and railway capacity shortfalls keep hampering mining and heavy industry expansion, oversupply and credit access curtails residential building activity, and infrastructure expansion remains ‘challenged’. This may not add further to household income and spending momentum, keeping GDP growth near 3%-3.5%, with idled resources and output gap still large. Post-2013 some of these restraints may ease gradually. Europe will be growing again and less cause of anxiety, US growth should do better while Asia may also grow faster again. This should favour our commodity earnings (robustly) and export growth (modestly). There should be much less crisis-fear weighing down on SA willingness to take risk, for households to incur commitments and businesses to expand. Though electricity and rail capacity constraints will be with us, the physical limitation on expansion may become less acute as we adapt. Meanwhile, credit and building industries should experience more lift. Current debt burden on household incomes should be proportionately lighter, the country will have adjusted to the national credit act, and credit growth should by mid-decade have normalised nearer nominal GDP growth (10%pa). By then, housing oversupply should have been digested, ongoing urbanisation and formal employment gains at 2%-3% annually should boost housing demand across all categories and building activity will play catch-up, normalising from present depressed levels (currently still only building at half their normal long-term pace). By mid-decade three boosters should drive fixed investment considerably faster than presently the case. Residential building will become a catch-up booster; non-residential building will be in normal recovery as vacancy rates fall off; infrastructure construction may run a little faster as public finance and manpower issues may be a notch easier; and cash-rich companies, less crisis-morose and more confident, led by improving sales and pinched production capacities, should be more willing to commit to faster investment spending. When will the boardroom greyhairs capitulate? It will only occur in stages, with one eye on Europe (relax), another beady eye on China (will it pop?), a third on the US (are they crazy?), a fourth on our domestic scene (certified lunar most of the time), and a fifth on our political calendar (2012, 2014), its many beauty contests and ideological voodoo fringes. But bulging balance sheets, steady sales gains, pinching output capacities have their own logic and will grudgingly overcome all sobriety, conservatism and prudency so expensively acquired during 2008-2012. With fixed investment growth picking up, from 2% now to 6%-10% in the second half of the decade, the GDP growth performance can also accelerate towards 4% plus. So it is only post-2013 that we seriously start to eat into the resource slack so evidently present since 2008. If lucky (!), we may then be granted some years of above average growth. With potential probably still near its 3.5% century-long average, we could be doing 3.5%-4.5% during 2014-2020 without building up too much of an inflation sweat from domestic sources while our budget inches back towards balance and national debt subsides anew nearer 30%-35% of GDP. During this decade our interest rates may well be very low for long, certainly in the first half and cyclically rising possibly only in the second half, as much guided by global as local conditions. Until it is time for another interruption, abruptly imposed from the outside (anytime this side of 2020), some severe natural calamity (contagion, drought!) or simply attained eventually through overheating old age. Bottom line: it could well be a 100-120 month expansion, the longest on record since the Boer War. Source: Cees Bruggemans, FNB, October 31, 2011.
This post is a guest contribution by Michael Kafe and Andrea Masia of Morgan Stanley. If you were driving along the interstate, and had a flat tyre, you would generally be faced with two options: Reel out the spare wheel or preserve the spare for ‘later’ and risk being stranded. It is no different with fiscal accounting: If one made provision for unforeseen contingencies (e.g., unanticipated spending requirements, revenue shortfalls, a dry up in funding, etc.) and one or more of these contingencies unfolded over the course of the fiscal year, it would not be out of place to draw down on such reserves to plug the hole. In this case, the National Treasury of South Africa chose to make use of its contingency provisioning for this fiscal year, thereby allowing it to report a slightly smaller-than-expected deficit. The Macro Backdrop The Treasury’s macro assumptions have been downgraded across most categories, driven in the main by a weakening external environment, deteriorating levels of confidence, and volatility in global asset markets. GDP growth is now seen at 3.1% in 2011 and 3.4% in 2012, compared to earlier estimates of 3.4% and 4.1%, respectively (Morgan Stanley forecasts 3% GDP growth for both years). Household consumption has been revised lower, while fixed investment has been downgraded by close to a percentage point in each year across the forecast horizon. A weaker demand environment has done little to rein in the Treasury’s inflation forecasts, however. Indeed, domestic inflation, expected to be driven almost exclusively by cost-push factors, is now forecast at 5.4% in 2012 and 5.6% in 2013, from 5.2% and 5.5%, respectively. Finally, the current account deficit is expected to shrink in line with the more somber growth backdrop. Contingency Reserves to Fund Spending Increase Details of the October 2011 Medium-Term Budget Policy Statement (MTBPS) show an increase in recurrent expenditures from R588 billion in February to R592 billion – exactly as we had expected. Transfers and subsidy allocations of R313 billion were in line with our R315 billion estimate, while capital assets and other expenditures also came out in line with the R75 billion print that we had expected. Interestingly, however, the headline expenditure reading remained unchanged at R979 billion – much lower than our forecast of R987 billion, thanks largely to a drawdown on the contingency line (R4 billion) as well as a modest undershoot in the wage bill (R4 billion). We must point out that, although basic wage negotiations in the public service were concluded in 3Q11, outstanding issues surrounding housing allowances are yet to be resolved. On our estimates, this could lead to a further R2-3 billion increase in the wage bill once settlement is reached. We are therefore happy to stick with our wage bill estimate of R347 billion for fiscal 2011/12, which is slightly higher than the Treasury’s R343 billion estimate. Over the medium term (2012-14), the government hopes to spend some R802 billion on infrastructure – slightly lower than the R808.6 billion that it planned to spend over 2011-13 as per the February 2011 Budget. Of this, the estimated outlays on economic services infrastructure such as water & sanitation, transport & logistics and energy have been raised from R664 billion to R676 billion, while supportive infrastructure on social services such as health and community facilities has been scaled back while spending capacity is being built in these latter sectors. Looking forward, although the Treasury’s wage bill for the upcoming two fiscal years is likely to push the recurrent/capital ratio in the ‘wrong’ direction, it is important to note that this is already priced into our forecast. Increases in transfers, subsidies, capital assets and other expenditures are also as we had expected. The headline expenditure reading, however, is slightly lower than we expected – again simply because the Treasury has decided to halve its contingency provisioning for the outer years to help plug the burgeoning revenue gap. Revenue Undershoot in Line with Expectations With regards to fiscal revenues, Treasury estimates of R814 billion are in line with our R815 billion estimate, although details on the various tax handles as well as between tax and non-tax revenue do show some variation. The greatest variation is expected in VAT receipts, which the Treasury expects to come in at a rather conservative R187 billion (our estimate R195 billion), thanks to higher-than-anticipated VAT refunds. Revisions to corporate and personal tax estimates were in line with ours. Fiscal Deficit Lower than Expected As expected, the fiscal deficit was also revised upwards, thanks to higher spending and lower revenues. The Treasury’s estimate of 5.5% of GDP for this year is however marginally lower than our 5.8% estimate, thanks mostly to the drawdown in contingency reserves. Excess Cash Holdings to Fund Borrowing Requirement With regards to funding, the MTBPS presents an unchanged debt position, as it hopes to fund the higher deficit from two key sources: i) a drawdown on its cash holdings in the National Revenue Fund; and ii) embarking on a switching program that will allow it to swap maturing debt for longer paper, allowing for better cash flow management. With regard to the drawdown in cash, it appears that most of this will be a part-liquidation of its effectively dormant foreign exchange deposits at the SARB – again, another prudent decision to fall back on idle reserves in difficult times. This not only allows the Treasury to minimize net interest payments, but also ensures that its debt ratios are kept in check – an important metric that rating agencies have focused on lately. And while there may be some liquidity and/or FX implications as the cash holdings are withdrawn, we believe that such an impact will be virtually negligible. On the whole, the Budget is reflective of a rather innovative Treasury team that has been able to adeptly maintain its expenditure targets in the face of a shrinking resource envelope without compromising the country’s debt ratios. Faced with lower revenues and a slightly higher baseline expenditure bill, the Treasury appears to have made good use of the cash buffer that it has built over the years. From a macro perspective, we believe that this was the prudent thing to do in such difficult times. Source: Michael Kafe and Andrea Masia, Morgan Stanley, October 28, 2011.
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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By Prieur du Plessis, on November 9th, 2011 posted in: 
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