South African interest rate outlook

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By Cees Bruggemans, Chief Economist of FNB.

The year 2011 offered much scope to test to destruction two propositions: that higher inflation would trigger early SARB rate increases (the fear of 1H2011) and the possibility that modest growth and large lingering output gap would trigger more SARB rate cuts (2h2011).

In the event, neither outcome played, with SARB keeping rates unchanged, while noting inflation rising as expected (though core much better anchored than headline) and also noting the modest GDP growth performance and lingering output gap (disappointingly so).

Much more pronounced was SARB’s unease about global tensions, in particular the EU sovereign debt and banking crises and what this still might mean for other parts of the world, South Africa in particular, with growth downside uneasily flagged.

There followed repeated promises that in the event of a major shock, SARB could be depended upon to take ‘appropriate’ action.

Meanwhile, the policy powder was being kept dry.

Is there any reason why this picture will change much in 2012, triggering a policy shift at the SARB?

The simple answer appears to be “no”, though there is a fiendish complex of risks potentially playing havoc with any tranquil policy stance, for which reason SARB keeps signaling it comes prepared for all eventualities.

Besides being in permanent ‘crisis mode’ two other important aspects deserve highlighting.

Firstly, South Africa’s macro policy stance isn’t tight or neutral but generously accommodating, supportive and stimulatory.

Secondly, using a simple Taylor Rule, the expected inflation and output gaps over the next year or so would warrant slightly higher interest rates than currently prevailing, with prime 11% when using headline CPI and prime 9.5% when using core CPI as opposed to the prevailing prime 9%.

In other words, at prime 9% SARB could be said to be straining at the policy leash at its most accommodative end, signaling some comfort that inflation won’t go out of control, unease about slow growth and output gap, and a risk bias that favours support over tightness.

When considering South Africa’s overall macro stance, the fiscal deficit has been allowed to widen towards 5.5% of GDP at a time when global manhood is being measured by the extent to which fiscal austerity undo such deficits.

During 2011 SARB has maintained the lowest nominal interest rates in 35 years, which in real terms made the 5.5% repo rate slightly negative as inflation rose above 6% (not a minor feature).

The Rand was eventually in 4Q2011 shocked beyond 8:$ by overseas financial events, shedding its overvalued condition in favour of a more neutral level.

Taken together, these three macro stances offer important support for the economy in present circumstances and are indicative of anti-cyclical policy.

That the economy doesn’t grow much faster than 3% under these circumstances has much more to do with our many own supply-side shortcomings (electricity and railway constraints, new credit culture, public sector manpower issues, regulatory inhibitions).

Also, it reflects our business defensiveness regarding domestic political risk, societal under-performance and global crisis conditions.

And also, beyond these restraints, that European recession this year may constrain some of our exports.

Thus there is much over which our macro policies have little control. Indeed, one is reminded of Europe (and far less of the US), where the ECB is unwilling to become the soft tool of politicians sidestepping hard decisions to clean up financial messes and improve growth dynamic.

Similarly, our macro stance is as accommodative as it judiciously can be. Beyond this, in order to improve our GDP growth performance, the world condition needs to improve (please), but especially more reform needs to be undertaken domestically to improve the supply-side performance of the economy and make private agents more willing to take risk and support faster expansion.

If in the absence of such needed structural improvements the macro policy stance were to be made too supportive, we might end up pushing inflation higher while weakening the currency rather than improving the growth dynamics longer-term.

This still leaves the main risks facing the country, namely a sudden oil price shock (if higher, pushing inflation higher) and a further EU crisis shock (implying more SA export downside and capital outflow risk, weakening the Rand and pushing inflation higher).

At present, SARB seemingly is prepared to look past a headline CPI inflation peak of 6%-7% in 2012 to renewed subsidence into 2013, and also accepting only modest GDP growth near 3% with lingering output gaps in mining, manufacturing, building, construction and especially the formal labour force.

But if mainly outside events were to push inflation and growth unacceptably beyond these levels, SARB may need to take ‘appropriate’ action.

The nature of such action would depend entirely on the circumstances. So depending on the mix of scenarios one could end with a firming or weakening Rand, and higher or lower interest rates, or no change if things cancel out.

Until we know more about 2012 (surprise, surprise), the most likely outcome will be no change in interest rates, with likely Fed, BOE and ECB policy stances remaining highly accommodative.

Tellingly, visiting IMF Managing Director Christine Lagarde encouraged the SARB this weekend to maintain an accommodative monetary policy 2012, given likely global developments, especially in Europe.

And so we await events.

Source: Cees Bruggemans, FNB, January 10, 2012.

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South Africa’s prospects for 2012

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By Cees Bruggemans, Chief Economist of FNB.

Evita Bezuidenhout probably put it most clearly. Freely translated, she had this to say about the year ahead:

“We won’t have much of a government this year because they are fighting so much among themselves they haven’t got time for much else. It is going to be a healthy year for South Africa, but we will all have to work hard at it to make it happen. It won’t be given to us on a platter……” (Die Burger 3 January 2012)

This is a remarkable insightful view. We have to struggle with what we have, however imperfect, especially infrastructure. Most of us will be giving it our best, hoping we won’t get a global wave hitting us sideways and overturning our little sloop.

In so many respects, though, we could be getting lucky.

Our politicians may not be interfering too much in the economy, as Evita remarked so clear-eyed, because they will be preoccupied with other things.

And the world financial system and economy won’t collapse. That at least is the view of German Finance Minister Schaeuble, who opinioned in the closing days of 2011 that there won’t be a market collapse in 2012, things remaining ‘controllable’ (in Europe).

The same sensation doesn’t quite prevail regarding the US, where politicians extended the payroll tax cut for just two months past Xmas, so that the issue pops up again right in the middle of electioneering season.

If last year was written off fiscally in the US, this year will be an even bigger existential battleground as opposing philosophies pontificate while the economy struggles on.

Former Fed chairman Greenspan suggested in the Financial Times last week that the US is experiencing declining education standards implying a future productivity downshift while facing unfunded entitlement promises and bifurcating politics cementing gridlock. Not a promising future.

Still, she is a big ship, capable of sailing onwards under her own stewardship for the time being. Mainly a matter of private enterprise and true grit.

Though US households are still deleveraging, their savings rate has peaked, housing is bottoming, corporates have strong balance sheets and are achieving record earnings, innovation is as richly experimental and productive as ever, and the imaginative monetary policies of Ben Bernanke are succeeding in keeping rates low, investment portfolios repositioning and cash flowing.

An even bigger existential challenge is playing out in Europe where fiscal austerity and bank repositioning (keeping credit tight) keeps uncertainty high and spending defensive, likely causing core Europe led by Germany to barely expand this year and some peripherals to keep experiencing deep recession.

Still, global growth will stay supportive, structural reforms are in the works nearly everywhere aiming to resuscitate growth dynamics, and the ECB and EU politicians will likely keep the overall show afloat as implied by Schaeuble.

China has slowed, but policy is expected to be loosened this year, keeping growth near 8-9% rather than the usual 9%-10%. China’s existential challenges are very real, too, but may play out over a longer timeframe.

The Middle East may see regime changes favouring more conservative politics, and nuclear-bound Iran could cause consternation, potentially impacting on oil prices.

Modest US growth, and still high Asian growth, could keep oil demand lively, and when coupled with supply-side concerns, push Brent oil towards $120-$130/b.

That, along with mildly falling EU demand, would be a corrosive for global growth, keeping things slow in 1H2012 but hopefully reviving anew from 2H2012.

All of this could be good for gold, with lingering anxiety and uncertainty keeping people on edge and looking for safety, except EU bank liquidity issues may squeeze gold as it appeared to do in 2H2011.

As to currencies, the Euro could be under pressure from sovereign debt concerns and ECB liquidity support, while the Dollar should be under pressure from Fed liquidity support (but countered by safe haven inclinations?).

Commodity producers may be getting past their 2011 adjustment, with Asian growth pulling and rich country liquidity actions boosting prices anew.

Along with supportive domestic actions, this global picture suggests reasonable EM growth, good commodity prices and strongly performing currencies against the majors outside of crisis moments.

With our politicians and the global context neutral to supportive, South African households may continue to grow nominal income at 8%-10%. With inflation averaging near 6% this year, it leaves enough real disposable income to continue the consumption-driven expansion.

Also, public and private fixed investment may continue to give just enough lift to maintain GDP growth near 3%.

Macro policy will be an important support, with the fiscal deficit this year marginally lifting to 5.5% of GDP, real interest rates negative (considering a repo of 5.5%) and the Rand at least 15% weaker near 8:$ instead of 7:$ (as long as this prevails).

Such modest growth can still generate at least 200 000 jobs annually, half in the public sector, thus keeping our long-term structural transformation alive.

Source: Cees Bruggemans, First National Bank, January 9, 2012.

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Crisis high jump or business as usual

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By Cees Bruggemans, Chief Economist of FNB.

Is South African stability about to become disturbed by another major overseas crisis on a par with 2008 or 1998?

Or will we be able to keep cruising within existing Rand, inflation, prime interest rate, JSE share prices and GDP growth parameters as seen so far this year?

Do we keep the Rand 6.70-8.70:$ bound, CPI inflation peaks in 6.3%-6.7% territory after which subsiding anew to within target, prime stays unchanged at 9% (low-for-long though not forever), and the JSE All Share index remains 30–33000 bound even with corporate earnings gaining another 15%-20%?

If so, this would likely keep us on a 3% GDP trajectory through 2012.

Or do we repeat crisis stations like in those earlier crisis years?

If so, do we see the Rand shock-like lose 50% to 10-15:$, CPI inflation peak nearer 12%, prime interest rate lifted by 2%-3% to 10%-12%, and the JSE nose-diving to 20 000?

With export volumes falling off steeply, and households and business defensiveness causing spending to hiccup, GDP might even go negative for a few quarters?

It has happened before and could happen again.

In the past 18 years such rude shock interruptions have been linked only to foreign crises. Our economy is performing below potential with manufacturing capacity utilisation only 80%, office vacancies over 10% and formal labour not fully deployed. No chance of a domestic overheating triggering policy restraint and recession.

So it has to come from the outside, if it were to happen. Here we encounter the usual suspects.

There’s deep suspicion about US political gridlock in a Presidential election year forcing severe fiscal consolidation even with its building and construction industries still out for the count.

This could outweigh the natural recuperation powers of US households and businesses, keeping US growth low, making it vulnerable to global shocks tipping into recession.

Here, Europe, China and Middle East oil come into focus, in their own right capable of havoc and as tipping point for other weak regions, with Americans anxious about banking channels (and European havoc), and the Middle East particularly unstable.

Our policymakers appear deeply perturbed about Europe.

Europe has accumulated too much public debt. It is in deep disagreement about the way forward. Its banks are short of capital and have difficulties funding. It has lost most of its internal growth dynamic. And bond investors have lost trust, draining away in droves and causing a liquidity crisis, with the ECB wishing to stick to its purity and Germany sticking to its guns.

Even the greatest optimists are holding their breath as long-term skeptics merely hold their noses, given the rottenness they observe daily.

So it isn’t too difficult to see a final EU crisis moment approaching, in which markets cause asset prices to collapse and there isn’t sufficient public support to keep things afloat, never mind reform and regain market trust. And that moment, by all omens, may be neigh.

So 2012 could for us be another 2008 or 1998, as an EU disruption would also sideswipe us.

Then again, nothing ever happens in Europe without a little pressure in the right places. Given the creative institutional innovations required and the political resistance to be overcome, this isn’t just your average walk in the park.

It isn’t a given that Europe can’t find the historic compromise needed to make political changes and put their common show back on the road. But it is for them to show this is possible, and so far all we have are deepening sovereign and bank funding problems, governments being replaced, growth a lost dynamic, and despair a general currency (except in Germany, which may well be what matters most).

So, yes, there could be a severe European crisis moment, but it may also prove able to overcome its troubles, in which case there need not be a deepening crisis.

We could still see a severe Chinese slowing (in which case oil prices could halve), but there could also still be a Middle Eastern political disruption (in which case oil prices could double).

Then again, the Chinese slowdown has been minimal and on cue they are starting to reboot, easing monetary policy.

Iran is still some years off nuclear, while the Islamic Arab Spring aftermath may take time evolving, possibly creating more imponderables than greater certainties.

The only certainty appears to be US political gridlock in 2012 because its political elite seem to think this worthwhile, a rather fascinating calculation.

But a little slower growth in the US (say 1.5% instead of 2.5%) or a mild EU recession (say -1.5% instead of +1.5%) isn’t going to torpedo the world or us.

Still, Europe is the real crisis key for 2012, yet it might well surprise with its calculated machinations.

This gives the 2012 prospect a sense of comfort, like an old shoe, something you have known for years and of which you have the full measure.

That gives a Rand of 7-9:$, CPI inflation above 6% and then dropping back, prime at 9% (or thereabouts), the JSE in the early 30s and GDP growth near 3%.

But no year goes by without major surprises. The Big Ones for 2012 still need to show and their consequences fully estimated. Until then, comfort prevails.

Source: Cees Bruggemans, FNB, November 28. 2011.

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Rich world lessons for South Africa

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By Cees Bruggemans, Chief Economist of FNB.

All three major rich regions (Japan, America, Europe) have fundamentally stumbled in recent decades.

Has South Africa something to learn from their experiences or can we afford to ignore them?

Japan stumbled first.

Since WW2 Japan’s favoured economic model was government-led, export dependent and manufacturing focused.

By the 1990s, this Japanese model fell out of touch with the changing global economy as other Asian economies started catching up, challenging Japanese dominance in core industries.

Others had lower domestic cost bases, weaker currencies, larger economics of scale while getting access to the same technologies and marketing distribution channels.

Yet Japanese policymakers keep clinging to this old model. Such inflexibility has resulted in decades of relative stagnation (minimal growth).

In Europe, many countries over a number of decades build elaborate welfare states, along the way accumulating high national debts.

It took the recent sovereign and banking crises following a series of earlier financial shocks (Eastern Europe, Anglo-Saxon subprime securitisation) and a great recession for these countries to discover that fiscal space shouldn’t be taken for granted ever.

If a country wants a welfare system, it should pay its way from taxes and social security levies. The fiscal space (low national indebtedness) should be preserved as an emergency buffer, in case the Keynesian advice at a time of crisis needs to be followed (with government taking the lead as private agents withdraw and deleverage).

That’s not what happened in Europe. By the time recession hit, national debts in many countries were (excessively) high already and started to accelerate.

When the need for fiscal austerity became obvious in order to arrest the debt spirals, it came at the wrong moment as crisis-induced weakness required more (not less) fiscal stimulus.

But with the debt-reduction priority prevailing, it was found that democracies do not easily scale back acquired social ‘rights’.

Europeans today are attached to their national welfare systems even though it is burying them in debt. Being inflexible about it threatens Japanese-type debt burdens and the stagnation that follows in its wake.

In the US, the country is so devoted to its version of the free market that it won’t get political backing for needed infrastructure because of public aversion to state intervention in the economy.

Inflexibility on this score will undermine US growth in the long run, too.

In all three rich regions things should be done differently.

In Japan there is need to address excessive regulation keeping back competition and entrepreneurship. Producers should be encouraged rather than discouraged in their attempts of changing the economy.

Also, Japanese households should be encouraged to save less and consume more, allowing the country to acquire a better domestic balance while creating more domestic demand for producers.

In the US there should be a clever restructuring of mortgages to repair the housing market.

In Europe, more reform could be undertaken to reduce national trade barriers, within professions and among countries, with a better performing European-wide common market spurring faster growth.

How does South Africa shape against this background?

Recent South African government policy initiatives champion a government-led, export-promoting and manufacturing focus.

While Japan benefited from this approach in its early economic recovery years post-WW2, the world has moved on.

Japan has become more costly while many countries now try to use incentives, low cost labour and weak currency to boost their manufactured exports.

It is late in the global catch-up game, and a busy space for South Africa to try to gain some advantage.

Similarly, we are ambitious to build bigger social safety nets, whose extensions (pensions, health, education) increasingly look like a European welfare state.

Providing social services while paying for them through taxes and levies is one thing. Allowing borrowing and national debt to carry part of the initial burden would be folly as can now be daily observed in Europe.

The US suffers at present from excessive zeal regarding free markets at the expense of doing something about infrastructure and cleaning up its housing mess.

South Africa cannot be said to show excess zeal in favour of free markets. Instead, it shows a relative lack of zeal in strengthening its economy’s supply side, meaning more infrastructure, better education, better performing labour markets, but also more affordable housing.

But also like all three rich regions, South Africa exhibits a love for regulations whose overall effect may be more costly in growth foregone than perhaps fully appreciated.

Japan, Europe and America became rich by doing certain things well. They have stumbled and have started to stagnate by doing certain things wrong.

South Africa would do well to study these experiences closely, and not to repeat the mistakes. As things stand, we seem to be repeating the mistakes of all three of them, even if we have only barely begun doing so.

Source: Cees Bruggemans, FNB, November 9, 2011.

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Three challenges facing South Africa

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By Cees Bruggemans, Chief Economist of FNB.

Last week saw three major challenges facing South Africa reach the news headlines simultaneously.

The SARB Governor in her monetary policy committee statement referred to the European crisis as lacking meaningful progress towards resolution, with major implications for the region and those exposed to it.

A day earlier, Moodys had put South African government debt on watch for a rating downgrade, a shot across the bow that shouldn’t be denied (as some immediately were prepared to do) or swept under the carpet and ignored.

And ANC Youth leader Julius Malema was suspended for five years for bringing the ANC into disrepute, but which ruling could not wish away fundamental issues (disquiet over historic iniquities and inequalities living on in new embodiments today and into the future).

Each of these three dimensions are major and reach into the very core of our national being, mostly as major risks, but also by offering opportunity.

The SARB Governor held boldly that since the last MPC there had been no meaningful progress of resolving the sovereign EU debt crisis, with the primary focus now on Italy and Greece.

In particular, this protracted crisis has now spread beyond the peripheral countries despite recent attempts to devise a credible and workable approach to contain the problem, heavily weighing on growth prospects in the region and beyond.

Yet over the past two years the euro-zone lifeboat has been steadily enlarged. Greece, Ireland and Portugal have been given assistance. Private debt holders of Greek debt have agreed to 50% ‘voluntary’ haircuts. EU banks have been told to raise their capital buffers by €106bn by mid-2012, raising bank capital ratios to 9%. Greece last week gained a technocratic caretaker government under Lucas Papademos and as early as this week Italy may gain something similar under Mario Monti. Throughout, the ECB has provided liquidity to EU banks and has kept sovereign debt markets functional.

Much of this may not feel like ‘progress’, but that doesn’t mean Europe isn’t steadily, if slowly in typical European step-by-step fashion, moving to resolution.

Continue reading Three challenges facing South Africa

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South Africa could also do with interest rate cuts

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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.

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