The shape of the pending recovery

Transcription

1 Sizwe Nxedlana Research Economics Economist (011) The shape of the pending recovery Domestic expenditure deteriorated in the second quarter Real expenditure on durables hardest hit Private sector capital expenditure weighs down fixed investment The decline in imports exceeded that of exports Why did the contraction in the internal dynamic accelerate in Q2 2009? Downward trend in inflation expected to continue The shape of the pending recovery Domestic expenditure deteriorated in the second quarter The rate of real contraction in South African economic activity is reported to have slowed to an annualised 3.0%qq in Q from a decline of -6.4%qq in the Q While this slowing in the rate of contraction in economic activity may at face value be regarded as a positive outcome, a closer inspection of the data reveals that the economy in fact weakened further in Q Real Gross Domestic Expenditure (GDE) the sum of total consumption expenditure by households and government and total expenditure on investment and inventories, a measure of the state of domestic demand, fell at an annualised rate of 14.5%qq in Q This was due to the fourth consecutive decline in Household Consumption Expenditure (HCE) which fell at a rate of 5.8% annualised in the three months to June down from an annualised decline of 4.8%qq in Q Both Government Consumption Expenditure (GCE) and Gross Fixed Capital Formation (GFCF) moderated in the second quarter. The rate of contraction in inventories also accelerated as private business adjusted stock levels downward in response to prevailing demand conditions. The reason why the rate of contraction in Gross Domestic Product (GDP) moderated in Q was due to the fact that imports fell at a faster rate than exports which led to an improvement in our trade balance. Therefore, imports were less of a drag on the South African economy in the second quarter then in the first. However, the steep decline in imports merely reiterates the deterioration in South African economic activity in the three months to June. The South African Reserve Bank (SARB) attributed declining imports to the cancellation of numerous private sector capital expenditure projects which tend to be intensive in imported machinery (see Table 1). Page 1 of 13

2 Table 1: Slower contraction in second quarter GDP a false signal %qq saa 2008** 2008-Q Q Q Q Q Q2 Household consumption expenditure Government consumption expenditure Gross fixed capital formation Change in inventories (R billions)* Gross domestic expenditure Exports Imports Gross domestic product Source: StatsSA **The 2008 figures are year-on-year growth rates. The quarterly figures are quarter-on-quarter seasonally adjusted and annualised rates. The more durable the good the worse the contraction in expenditure It seems the more durable the good the steeper is the rate of decline in spending. The rate of decline in total real HCE (67.4% of GDP) 1 accelerated to 5.8%qq in Q from 4.8%qq in Q Real spending on durable goods (9.4% of total HCE) such as furniture, appliances and personal transport equipment was particularly hard hit, falling by 18.8%qq annualised from a 15.2%qq decline in Q Expenditure on semi-durable goods (16.5% of total HCE) also contracted at an annualised rate of 9.7%qq in Q from -7.9%qq in the previous quarter. Real expenditure on the services (40% of total HCE) and non-durables (34% of total HCE) components of household spending contracted at slower rates. Real household expenditure on services fell by 2.7%qq in the three months to June after increasing by 6.5%qq in Q The decline in real expenditure on non-durable goods like food and beverages moderated to an annualised rate of 3.4%qq (see Table 2). Table 2: Real household expenditure on durable goods hardest hit %qq saa 2008* 2008-Q Q Q Q Q Q2 Durable goods Semi-durable goods Non-durable goods Services Total Source: SARB 1 Based on seasonally adjusted and annualised Q data. Page 2 of 13

3 The poor expenditure outcome is roughly in line with the most recent performance witnessed in the different sectors of the South African economy which have shown the persistence of recessionary conditions although there are some signs of bottoming out that are beginning to emerge particularly in mining and manufacturing production. However, the internal trade sectors remained very weak as we moved into Q going by the latest retail sales, wholesale sales, motor vehicle sales, construction (outside of the public sector infrastructure drive) and manufacturing production. However, when digging deeper into the monthly sector data, at the sub-sector level one finds evidence of pockets strength within the overall weakness with the relative strength concentrated mostly in food, beverages and tobacco and in pharmaceuticals and cosmetics while the hardest hit sub-sectors are the directly or indirectly interest rate sensitive such as furniture and appliances, motor vehicles, parts and accessories and hardware paint and glass. These trends are generally consistent across the supply chain from the retail and wholesale, to the manufacturing level. This is clearly in line with the expenditure data that shows that the more durable the good the greater is its rate of decline in expenditure. Private sector capital expenditure weighs down fixed investment Turning to fixed investment, there was an alarming moderation in the rate of growth in real GFCF (24.1% of GDP) 2, fixed investment for short, in the three months to June Real expenditure on fixed investment grew at the feeble rate of 0.1%qq annualised in Q down from 12.7%qq in Q Real expenditure on GFCF can be disaggregated by type of organisation, in other words by who is doing the fixed investment, or by type of asset in other words by what is being invested in. Total GFCF is clearly being buffeted by fixed investment of private business enterprises (62.9% of total GFCF) which contracted at an annualised rate of 3.0%qq in Q following a contraction of 2.8%qq in Q The decline in private sector fixed investment may be a business response to the very poor trading conditions witnessed during the first half of This is further substantiated by the accelerating decline in inventory investment witnessed in the Q In contrast to private sector fixed investment, growth in public sector capital expenditure continued in the second quarter with fixed investment by public corporations such as Eskom, Transnet and ACSA remaining relatively strong. However, fixed investment by general government and by the public corporations combined make up less than 40% of total GFCF (see Table 3). Real fixed investment on construction works (26.7% of total) is strongest from an asset perspective growing at an annualised rate of 54.3%qq in Q This once again is due to the ongoing public sector fixed investment drive. Real fixed investment in residential buildings (7.9% of total), real fixed investment on transport equipment (14.3% of total) and real fixed investment on machinery and equipment (41.8% of total) all contracted in Q This is likely to be the result of adjustments by private enterprises to the very weak state of both the domestic and global economies and due to falling business confidence (see Table 3). 2 Based on seasonally adjusted and annualised Q data Page 3 of 13

4 Table 3: Fixed investment by type of organization and by type of asset %qq saa 2008-Q Q Q Q Q Q2 Fixed investment by type of organisation Private business Public corporations General government Fixed investment by type of asset Residential buildings Non-residential buildings Construction works Transport equipment Machinery and other equipment Total Source: SARB The decline in imports exceeded that of exports Due to subdued global demand conditions and the strengthening of the exchange rate of the rand in the three months to June there was a large decline in both merchandise and net gold exports in the Q Seasonally adjusted and annualized South African merchandise exports fell to R484.2 billion in Q down from R538.4 billion in the previous quarter. Net gold exports fell to R47.5 billion in Q from R51.0 billion in Q South African merchandise imports fell by approximately R138.0 billion annualizes, to R505.1 billion in Q This outcome reflects the weakness of the domestic economy with the SARB ascribing the sharp decline in imports to the cancellation of numerous private sector capital expenditure projects which tend to be import intensive and to a the lower cost of importing crude oil. This is in line with the deepening contraction in private sector fixed investment that occurred in the second quarter and is in turn due to the weak state of South African economic activity that prevailed during the period. However, the fact that imports fell faster than exports led to a marked improvement in the deficit on the current account of the balance of payments. The current account deficit halved to-3.2% of GDP in Q from -7.0% in Q Finally, while lower than in Q1 2009, capital inflows into South Africa continued in Q and provided adequate funding for the deficit on the current account (see Table 4). Page 4 of 13

5 Table 4: Imports fell faster than exports R billions (seasonally adjusted and annualised) 2008 Q Q Q Q Q Q Merchandise exports Net gold exports Merchandise imports Trade balance Net service, income and current transfer payments Balance on current account As % of GDP Source: SARB Why did the contraction in the internal dynamic accelerate in Q2 2009? Despite lower inflation and an aggressive reduction in interest rates real gross domestic expenditure deteriorated in the second quarter. The acceleration in the rate of contraction in domestic expenditure and economic activity in Q in our view is due to the persistent decline in real household disposable income, which according to the SARB is due to large scale jobs losses and reduced overtime and bonus payments. Also levels of household indebtedness remain near record highs, while it seems domestic savings levels are rising and credit extension is moderating sharply. This is all consistent with declining gross domestic expenditure and weak economic growth. Real household disposable income fell for the fourth consecutive quarter in Q with the rate of decline accelerating to 5.7%qq from 4.5%qq in Q and 1.9%qq in Q (see Figure 1). Page 5 of 13

6 Figure 1: Real household disposable income falls for the fourth consecutive quarter %qq saa Grow th in household real disposable income %qq saa Source: SARB Almost half a million jobs were lost in the first half of According to Statistics South Africa s Quarterly Labour Force Survey (QLFS) 208,000 jobs were lost in Q followed by 267,000 job losses in Q There is also anecdotal evidence of fewer hours worked and lower overtime and bonus payments all contributing to the decline in real household disposable income (see Table 5). Page 6 of 13

7 Table 5: Almost half a million jobs were lost in the first half of 2009 Industry Job losses Q (000) Q (000) Q (000) Q (000) Agriculture Mining Manufacturing Utilities Construction Trade Transport Finance Community and social services Private households Other Total Source: StatsSA Household indebtedness remains near record highs. However, an attempt at reducing the large debt level may also be underway going by the loss of momentum in credit extension. The impact of stricter bank lending criteria may also be behind the great moderation in domestic credit extension. Private Sector Credit Extension (PSCE) slowed to 3.4%yy in July. To place things in perspective, the growth in July last year was 19.6%yy. It is likely that we will soon see negative growth rates in private sector credit extension signaling a decline in the total outstanding stock of debt. There is also evidence that national savings levels are increasing. At 16.5% of GDP gross national savings are noticeably higher than the levels witnessed between 2004 and the early parts of While increasing savings rates and falling levels of indebtedness signal an improvement the financial health of households in particular following several years of over indulgence, a simultaneous increase in savings is not ideal for national expenditure and therefore for economic activity (see Figure 2). Page 7 of 13

8 Figure 2: The paradox of thrift 20.0 %qq saa per cent Gross domestic expenditure Gross savings ratio Source: SARB A reduction in household wealth due to the collapse is asset prices last year, in the case of equities, and seemingly ongoing although possibly stabilising in the case of residential property may also explain the worsening declines in real household consumption expenditure. Downward trend in inflation expected to continue Headline consumer inflation (CPI), which is now the targeted measure of inflation used by the SARB for the purposes of setting interest rates has followed a steady downward trend in the first half of From an annual growth rate of 8.6%yy in February and March, domestic consumer price inflation slowed to 6.7%yy in July. There are several reasons why we expect this trend to continue. The Producer Price Index (PPI) is in negative territory indicating deflation or falling prices at the South African factory and farm gate. Producer prices declined for the third consecutive month in July, falling by 3.8%yy after a decline of 4.1%yy in June. The decline in the PPI for imported commodities has been particularly steep in recent months implying that we are importing deflation. This is in line with the trends is the economies of our major trading partners who are witnessing deflation even at the consumer level or very low inflation. The PPI for food at the farm gate is also falling while that for food at the factory gate slowed to only 0.8%yy in July. This implies further moderation in food and overall consumer inflation in coming months. Prevailing trends in commodity prices will also support the downward trend in consumer inflation. In July, the spot prices for white and yellow maize and wheat were all more that 30% lower than during the same period last year. At current levels the spot price of crude oil is also approximately Page 8 of 13

9 30% lower than the prices which prevailed during the same period last year, while the rand price of crude oil is approximately 35% lower over the same period. Continuing recessionary conditions in South Africa, characterized by declines in domestic household spending and falling output and sales levels will also limit the pricing power of private enterprises. This was already evident in the responses of retailers and wholesalers to the Q Bureau for Economic Research (BER) sector surveys, who reported declining realized purchase and selling prices. Domestic inflation expectations, a key determinant of future inflation are also seemingly moderating. The BER s survey of inflation expectations for Q indicates that inflation is expected to moderate from 8.7% in 2009 to 8.1% in 2010 and to average 7.9% in This relatively benign outlook for inflation is not without risks. The risks emanate from the growth rate of wages and from future trends in electricity tariffs and other administered prices related to municipalities and public corporations. Awarding the electricity utility Eskom, a tariff markedly higher than what is expected poses an upward risk to the trajectory of consumer inflation. The persistence of wage settlements above the upper end of the inflation target also pose an upside risk to the outlook for inflation. However, in South Africa, wage settlements tend to be backward looking. With inflation on a downward trend and a moderation in inflation expectations we anticipate that wages should be less of a problem over the next eighteen months. The risks to the outlook for inflation notwithstanding, we expect growth in consumer prices to re-enter the target band during the first half of 2010 and to end the year close to 5.5%. Our expectation for 2009 is for headline CPI to average slightly more than 7% while our expectation for 2010 is an average consumer inflation rate of 5.6%. (Please see appendix 1 for our latest inflation forecast?) We are at or near the end of the interest rate cutting cycle. We expect interest rates to remain at current levels for an extended period. Furthermore, the downward trend in inflation which can be reasonably expected to continue coupled with the weakness in gross domestic expenditure and the negative impact that this is having on the internal trade sectors, a theme highlighted throughout this report, suggests that we cannot rule out further easing of monetary policy. At the moment it seems the 500 basis point reduction in interest rates has not gained traction and that households are repairing their balance sheets through debt reduction and increased savings and private enterprises have responded by reducing costs through lower investment spending, lowering stock levels (which can t carry on forever) and lowering employment. However, monetary policy easing is known to impact real economic activity with a lag and the SARB has already cut aggressively and speedily and may want to keep rates steady to assess whether the medicine administered so far is having an impact, keeping in mind that there will be Monetary Policy Committee meetings in October, November and December. The shape of the pending recovery Despite the sharp decline in Q domestic expenditure, signaling further weakening in the South African economy, there have been several positive developments that have come to pass. The worst of the banking and credit crisis induced global recession is behind us so are the extreme levels of risk aversion that went with it. There has been continued appreciation in emerging market currencies showing a decline in risk aversion. Interbank credit spreads have continued to fall signaling an unfreezing in credit markets. Equity markets and commodity prices Page 9 of 13

10 have continued to improve from the lows seen earlier this year. All of this correctly signaled growing confidence and a recovery in real economic activity which has in fact come to pass going by the fact that some countries exited recession in Q for e.g. France and Germany with others likely to follow in Q for e.g. the US. However, recovering from and exiting the worst global recession since the 1930s does not imply a return to the strong growth rates that were witnessed in the years leading up to the crisis for several reasons. The recovery is on fiscal and monetary crutches. It has been supported/caused by record low interest rates and quantitative easing by central banks and by massive government spending which is a leading to a rapid deterioration in government balance sheets in countries such as the US, UK and Japan. This government support will eventually have to be repaid, through higher taxes, lower government spending or a combination of the two. The easy credit conditions which led to asset price bubbles and strong albeit unsustainable economic growth in the years leading up to the crisis are unlikely to be repeated. Regulators of the financial services sector globally are likely to become stricter and ensure that risk is priced for correctly. All of this implies that the global economy, while recovering is unlikely to grow in a manner similar to the years leading up to the crisis. In short the world economy is headed for a new normal. For South Africa, this means that in the short term the global economy will be less of a drag on the domestic economy, on our exports and the related sectors relative to what was the case in Q and Q when the global recession decimated domestic mining and manufacturing production. In fact we have already witnessed four consecutive months of monthly growth in mining output while manufacturing output has been rising for three consecutive months. This will be positive for South African GDP growth in the second half of Secondly, despite the deterioration in domestic expenditure in Q and the impact that this has had on the internal trade sectors such as retail, wholesale and motor trade, lower inflation and lower interest rates will provide support to household incomes and to domestic expenditure. However, while both these trends are consistent with a recovery in the South African economy, the recovery is likely to be slow and protracted. Over and above the global speed bumps to a quick domestic recovery, understood as a quick domestic return to growth rates seen before the crisis, there are also internal speed bumps. Job losses, high levels of household indebtedness, the need to reduce that debt and the impact of lower wealth from the decline in asset prices all imply that the recovery, particularly in consumer sending will be slow and protracted. By extension so should the recovery in the internal trade sectors. We expect the economy to contract by roughly 2.0%yy this year and to recover to between 2.0% and 2.5% in (Please see appendix 1 for our latest GDP forecast) Page 10 of 13

11 Appendix 1 FNB Commercial Macroeconomic Forecast Annual Forecast Summary (forecasts in bold italics) GDP growth f 2010f 2011f GDP %yy Household Consumption %yy Govt Consumption %yy GFCF %yy Current Account (%)of GDP Inflation Headline CPI %yy PPI %yy Interest rates Repo Rate %p.a. (period end) Prime Rate %p.a. (period end) Exchange rate Rand / $ end of period Source: StatsSA, SARB, Reuters Ecowin and FNB Commercial Figure 1: GDP forecast 6.0 %yy f 2010f 2011f GDP Source: SARB and FNB Commercial Page 11 of 13

12 Inflation forecast Consumer Price Index (forecast in bold italics) f 2010f January February March April May June July August September October November December Source: StatsSA and FNB Commercial Interest rates Prime rate forecast %p.a. (forecast in bold italics) f 2010f January February March April May June July August September October November December Source: SARB and FNB Commercial Page 12 of 13

13 The information in this publication is derived from sources which are regarded as accurate and reliable, is of a general nature only, does not constitute advice and may not be applicable to all circumstances. Detailed advice should be obtained in individual cases. No responsibility for any error, omission or loss sustained by any person acting or refraining from acting as a result of this publication is accepted by Firstrand Group Limited and / or the authors of the material. First National Bank a division of FirstRand Bank Limited. An Authorised Financial Services provider. Reg No. 1929/001225/06 Page 13 of 13