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Monday, January 17, 2011

South African Blues

Many ordinary South African citizens trying to figure out what is happening to their economy, and what is behind all those ups and downs which seems to characterise it, must have been scratching their heads in wonder on Saturday when they read in their morning papers that the country's currency, the rand, dropped sharply in value - by something like 2.3% against the dollar - last Friday as a result the decision by the Chinese central bank to raise reserve requirements for banks. What the hell, they must have thought, is the connection between these two phenomenon.

In fact the fall turned the South African currency into the worst performer globally among Emerging Market Currencies so far this year, and all because of something happening in China!

For the more discerning economic eye the reasons for the move in the currency are not that hard to identify, since the South African economy (and with it the rand) is generally seen as being more exposed to any eventual economic slowdown in China than it is to potential contractions in either the U.S. or European Union. Thus has the world changed during the last decade and a half!

The reason for this is the reliance of South Africa’s export reliance export sector on Chinese demand. Asia has replaced Europe as South Africa’s biggest export market, and China now accounts for almost 30 percent of the country’s exports to the continent.

And in another of example of how in the modern globalised world virtually everything is connected with everything else global coal prices hit a 28 month high during the week, largely driven by news of the Gauteng flooding tragedy, which following closely on the heels of the far more publicised problems in Australia, has started to catch investors eyses. The common thread which links the two events in the investors mind is unfortunately not the loss of human life involved (in fact at least 32 people are reported dead between Gauteng and Kwa-Zulu Natal provinces) but rather the coal shortages that could be produced in their wake. Both Xstrata, South Africa's biggest thermal coal exporter, and BHP Billiton reported delays to deliveries to the Richards Bay Coal Terminal as rain halted the goods trains. All of this of course, has Hedge Fund commodity traders all across the globe busily examining maps of road and rail networks, and photos of damage to mine installations (in the Australian case) in a bid to estimate how long it will take for output to get back to normal, and thus what the likely short run consquences for coal futures are likely to be. Such are the smoothly-oiled and tightly meshed set of gears which drive the inner complexity of the modern global economic system.

A further example of how global sentiment is influencing trends in the South African economy can be seen in the fact that government bond yields have been falling in value due to an expectation that the central bank won’t lower its main interest rate when it meets next week. The bank is worried about the additional growth slowdown that any monetary tightening might produce. South Africa's economy has emerged from the crisis, and is expected to have expanded by around 3 percent in 2010 after contracting by 1.75 percent in 2009. But these levels are a far cry from the growth rates many Emerging Market economies are currently experiencing.

Thus while South Africa's inflation remains relatively benign (prices rose by an annual 3.6% in November), the central bank is likely to keep loosening monetary policy. But there is another reason for this loose monetary policy, apart from the obvious growth-stimulus one, and that is the biggest problem facing South African manufacturing industry isn't the recent fall in the rand (which is probably welcome), but rather the sharp rise the currency has experienced vis-a-vis the dollar over the last two years (it has risen by roughly 35% since the start of 2009).

Inflows Present A Major Challenge To The Global Recovery

The key driver of the upward surge in the rand are capital inflows, these flows have been behind the vigour of the recovery in many emerging economies, although they are now increasingly starting to pose risks to a sustainable global recovery as they can trigger abrupt currency fluctuations that may do “lasting damage” to some vountries, according to the World Bank's Global Economic Prospects 2011 report, published last week.

In the words of Hans Timmer, the World Bank’s director of development prospects, “The pickup in international capital flows reinforced the recovery in most developing countries. However, heavy inflows to certain middle-income economies may carry risks and threaten medium-term recovery, especially if currency values rise suddenly or if asset bubbles emerge.”

And this of course is what has been happening in the South African case, since the currency value is sharply up, while stocks have risen much more sharply than would be justified by the rate of growth in the real economy, and while the rand was busy weakening, last Friday Johannesburg's blue-chip Top-40 put in its highest close since June 2008, finishing at 9,226.96

Countries across the globe, from Indonesia to Turkey, and from India to Brazil, are struggling to limit their currency volatility as near-zero borrowing costs in advanced economies fuel demand for higher-yielding assets in emerging markets. Net private capital flows to developing countries were up by 44% in 2010 to about $753 billion, according to the World Bank report. And the countries that attracted the main part of the fund flows were the middle-income ones “with well developed debt and equity markets". In these cases large inflows “either have caused their currencies to appreciate by more than warranted by their fundamentals, or have forced them to take extraordinary measures to prevent a disruptive appreciation.”

The nine countries that attracted the bulk of capital flows were Brazil, China, India, Indonesia, Malaysia, Mexico, South Africa, Thailand and Turkey. Brazil, for example, has seen the its currency (the real) appreciate by 39 percent against the dollar since the start of 2009, making it the third biggest increase among the 16 most traded currencies as tracked by Bloomberg, behind only the Australian dollar and the South African rand.

In an effort to try and stem the rise, the South African Reserve Bank has now lowered its benchmark repurchase rate nine times since December 2008 to its current level of 5.5 percent, the lowest level since the interest rate was first introduced in 1999.

South African domestic demand is still struggling to find growth after the years of rapid credit expansion between 2005 and 2008. Cement sales fell for a third consecutive year in 2010 as growth in the construction industry slowed and the housing market remained weak. Sales were down 7.8 percent compared with 2009, when they declined 13 percent. The recovery in housing and construction demand in Africa’s biggest economy has been slow, with house prices expected to increase by 5 percent in 2011, following an estimated 7 percent rise in 2010. Construction growth slowed to an annualized 0.8 percent in the third quarter compared with 1 percent in the previous three months, according to statistics office data.

And retail sales are also not strong for an emerging market, growing by only an annual 6.2% in November. This is a long, long way from China type growth levels.

Competitivness Pressures Crimp Manufacturing Industry Growth

South African manufacturing production, which accounts for around 15 percent of the total economy, increased an annual 4.6 percent in November following a 2.3 percent increase in October. The recovery in manufacturing output has been slow as growth eased in Europe, which buys about a third of South African manufactured exports. The rand’s 11 percent surge against the dollar in the past six months has also crimped shipments. As a result South African manufacturing still has a long way to go to recover from the 2009 slump.

There is another tool available to the South African administration in their effort to take some of the wind from the sales of the rising rand, and that is good old straightforward currency intervention. In October the Finance Minister announced that the government intended to transfer part of the last year's tax revenue windfall to the Reserve Bank to help it buy dollars. As a result the National Treasury increased its foreign currency deposits with the central bank by $614 million in December and the country's reserves rose 1.1 percent over the month, increasing them to a total of $43.8 billion.

For its part the bank said it bought $404 million of foreign currency through swap transactions during December, in order to “drain liquidity from the domestic money market.” However the banks ability to influence the value of the currency should not be overestimated, since South African reserves are still comparatively small compared to those of other emerging markets. Turkey, for example, has reserves of $80.7 billion, while Brazil has around $289 billion.

Job Creation The Key

At the emd of the day, the most pressing problem facing the country is not the rising currency, it is the continuing high level of unemployment. The country faces a quite favourable demographic outlook, and the key to growth and improved living stardards lies in finding productive work for the hundreds of thousands of young people who are desperately in search of it.

The recession worsened the country’s unemployment picture considerably, with close to one million jobs being lost in 2009 and 2010, and the unemployment rate stood at some 25.3% in the third quarter. This excessively high unemployment meant rate is - as the IMF note - an important contributor to the high level of income inequality which exists in the country. Raising potential economic growth. Current trend growth rates ( estimated by the IMF to be between 4% and 4.5% over the medium term) are unlikely to be enough to quickly reverse even the recent sharp cyclical increase in unemployment, and even less make inroads into reducing the high level of structural unemployment. The Fund suggest that really tackling this problem would require growth rates in the 6% range.

South Africa’s growth potential cannot be unleashed without tapping into the large reservoir of unemployed. The severity of the unemployment problem calls for bolder action to enhance the efficiency of both the labour and the product markets, and a very strong case can be made for undertaking these reforms now during the business cycle upswing, at a time when profitability is improving and more jobs can be created.

Towards An Unorthodox Orthodoxy?

At the same time, South Africa cannot build a sustainable economy without attracting far more inward investment to build up its manufacturing base. At the present time the country's current account deficit (which definitely needs reducing) is being financed by short term fund inflows into the debt and equity markets (and not the much desired longer term FDI). This again makes funding the deficit vulnerable to shifts in global risk sentiment, and even to that dreaded European Sovereign Debt Crisis (yet another example of global linkages).

At the end of the day the two parts of the problem go hand in hand, and in order to get sustainable employment growth solutions must be found in South Africa, as in many Emerging Markets, to the problem of unsustainable currency increases resulting from the excess liquidity being exported from the heavily endebted developed economies. In this battle, new and previously unthinkable policy measures will be deployed (see the Turkish case here). Indeed, only last week Caroline Atkinson, Director of the External Relations Department at the IMF, indicated that the Fund didn't even exclude capital controls from the armoury of possible macro-prudential measures. Ten years ago such views would have been the next best thing to heresy.

What I’m trying to suggest is that the range of measures that countries may take, some of which are particularly focused on the way that capital comes into the countries, on whether it should be taxed if it comes in on a short-term basis, and some are particularly focused on well, if a bank gets capital, an inflow of foreign exchange, should it have higher reserve requirements so that it’s in a better position to pay that capital back if it needs to go. So these are all a part of the toolbox of measures, and some people always said capital controls, macro-prudential controls, there’s kind of a fine line between them. I don’t think that really matters. I think the point is to see what the purposes of the measures are. Are they going to strengthen the economies? Are they going to lead to good use of the capital and stronger and sustainable growth going forward? That’s more important than the nomenclature.
Monetary policy in a globalised world is no longer a single country matter, and a more creative and demanding toolkit is needed to swim in the ocean of global liquidity which surrounds us all today. As Caroline Atkinson says, the question we should be asking ourselves is not whether such measures are "unorthodox" or not. The question we need to ask is rather, are they going to strengthen the economy concerned, are they going to lead to sustainable employment creation, are they going to minimise the level of structual distortion an Emerging Economy suffers as a result of near zero interest rate policies in the developed world, and above all, are they going to work?

Sunday, August 23, 2009

South Africa's Recession Continues Even As The Rand Surges

"The banking sector in South Africa has insubstantial leverage and did not enter in to excessively risky lending practices that were the hallmarks of the credit-boom days. However, South Africa’s Current Account Deficit remains wide and its ability to service its short-term debt is on the wrong side of comfortable. These factors, along with the size of the banking sector in relation to that of other emerging markets, would bring unwelcome attention to the economy in the event of a deterioration of global risk sentiment (perhaps precipitated by a sovereign debt crisis elsewhere in the world)."
Simon White - Variant Perception


As was expected by most analysts, South Africa's GDP shrank in the second quarter of this year at an annualised rate (q/q saar) of 3% over the first quarter (which represents an actual seasonally adjusted shrinkage of 0.75%) as comparted to the 6.4% rate (1.6% actual) seen in the first three months of the year. The improvement in GDP was largely due to better performance in mining, manufacturing and the energy sector. Activity declined 2.8% year on year from the 1.3% drop recorded in Q1 2009. Agriculture was a serious disappointment, with a 17% (q/q saar) from a 2%(q/q saar) drop in Q1. Evidently the pace of decline is easing, manily due to expansionary fiscal measures and an increasingly accommodative monetary policy and in part to the impact of what have become colloquially known as global green shoots (that is demand stimulus from other countries). The figure is unlikely to significantly influence interest rate decisions next going foward as it was broadly in line with consensus expectations, and was effectively factored in at the last RBSA monetary policy meeting. Going forward, downside surprises on inflation and continued weakness on real economy could potentially lead the Reserve Bank to further reduce interest rates.

The Analyst View

Cees Bruggemans, First National Bank: "Q3 2009 will be a transition quarter, between the recession proper (4Q2008 and 1H2009) and the recovery proper in GDP growth (Q4 2009).Interest rate-sensitive sectors should benefit from the cumulative 500 point interest rate easing since December 2008." (18 August, 2009)

Danelee van Dyke, Standard Bank: "The prospects for rejuvenation in depleted inventory levels, a catalyst for a rebound in production should bolster the economy’s growth potential in the second half of the year." (18 August 2009)


South Africa's economic performance has steadily been strengthening recent years, with real GDP growing at an annual average rate of 4.6 percent in the years between 2005 and 2008. Inflation had declined to mid-single digits and employment had been growing steadily. Growth in recent years has been driven by strong domestic demand, with private consumption and investment spending supported by robust consumer and business sentiment. Household consumption was also boosted by growing disposable income, rising employment, and wealth effects from rising asset prices until late 2007.

However, 2008 saw a slowdown in activity reflecting the cumulative impact of electricity power shortages, the global slowdown, and a policy of monetary tightening. Real GDP growth slowed to 3 percent as the country entered recession.The deceleration in the pace of growth is clearly seen in the in the evolution of the Reserve Banks preferred measure of money supply (M3, see chart below which comes from the RBSA) with increases slowing sunstantially after Q4 2007, but with the slowdown clearly deepening in early 2009. Twelve-month growth in M3 decelerated from 14.8 per cent in December 2008 to 10.6 per cent in March 2009 and further to 8,5 per cent in April. On a quarter-to-quarter3 basis, M3 growth amounted to 4,1 per cent in the first quarter of 2009; down from 15,1 per cent in the fourth quarter of 2008.

Comparing this year's first half with that of last year, the economy is down only 2%. It is expected to stabilise next quarter, and move back into growth by the fourth quarter, making it unlikely that the full-year decline will be as bad as the 2% plus that more pessimistic economists had predicted. Excluding the volatile agriculture and mining sectors the economy actually improved by as much as four percentage points to minus 2.4% in the second quarter from minus 6.2% in the first quarter.

Construction, government and personal services (such as healthcare) carried what growth there was, and export-oriented sectors of mining and manufacturing did better than in the previous quarter. But the big disappointment was the retail and wholesale trade sector, which did far worse than expected and the decline accelerated to 4.5% in the second quarter from 2,5% in the first. The manufacturing sector continued to contract in the second quarter, but the 10.9% drop should be seen against the first quarter's steep slump of 22%. The financial sector also contracted again, by about 2.5%.

Mining expanded 5,5% after the first quarter's 32% fall as it started to benefit from better commodity prices.

Unemployment Continues to Be A Major Problem

South Africa's unemployment rate increased very slightly - to 23.6% in the second quarter from 23.5% in the first quarter of 2009 - what is perhaps surprising is that this was despite the fact that 267 000 lost their jobs during the quarter. Part of the explanation for this is that the number of discouraged work seekers rose by 302 000. Had that number been added to the unemployment total, the result would have been an unemployment rate of more like 29.7% (compared to an equivalent calculation of 28.4% in Q1 2009).

Most importantly, the latest rise takes the total number of discouraged workers to 1.5 million from 1.1 million in Q2 2008. As a result the number of people who are not economically active in the working age range increased to 13.58 million, from 12.86 million in Q2 2008 with the consequence that the economically inactive population, of which discouraged workers form 11.2%, is currently larger the employed workforce and almost one and-a-half times the size of those in formal employment.

Retail Sales Continue To Fall

Price adjusted retail sales decreased in June by an annual 6.7% following a 4.4% drop in May. For the three months to June, sales contracted by 6% relative to the corresponding period a year earlier . Anxiety about job security, comparatively high levels of household debt, still high inflation which is still relatively high and a low level of consumer confidence are the likely reasons for the negative growth in real retail sales and this may well continuer for most of 2009. Ultimately declining interest rates, lower inflation and improved household balance sheets should see a recovery in retail sales in early 2010.

The household debt-to-disposable income ratio continued to rise in the first three months of the year - if only marginally to 76.7% from 76.3% in the last quarter of 2008 - implying that financial strain on households remained significant. Debt consolidation should gain traction during the second half of the year, when the debt service cost-to-income ratio falls to around 8% from its current level of 10.9%, at the same time as lower inflation frees up some additional cash in the household sector.

While Manufacturing Struggles

Although the final result was not as bad as many expected, manufacturing production still fell by an annual 17.1% in June, little changed from the downwardly revised 17.2% contraction in May. South African industry still appears to be in the throes of an inventory stockpiles rundown. Iron and steel were down 24.3%, the automotive sector 32.8%, and petroleum and chemicals were down 14.7% . Output did increase by a miniscule 0.1% seasonally adjusted setween May and June, but more to the point the rate of contraction in production did slow down significantly in the second quarter, showing minus 3% q/q s.a. as compared wuth minus 6.9% q/q s.a. in Q1.

Encouragingly, electricity consumption, often a useful indicator of economic activity, rose in June by 1% over may (s.a.) and by 2.9% (s.a.) in Q2 over Q1, which would seem to confirm that the recession eased markedly in Q2. The latest manufacturing purchasing managers index reading, however, did not give as much grounds for optimism as might have been hoped for, since the PMI weakened in July to 37.3 from 37.9 in June following two consecutive monthly gains, suggesting the rate of contraction in manufacturing activity accelerated again, even if only slightly.

The weakening was pretty broadbased, with business activity, new sales orders, suppliers performances and input prices falling in the month.

In fact South Africa’s manufacturing PMI seems to be lagging the PMIs of the country's major exporting partners (US, Germany, Japan and UK) by two-to-six months. While these economies reached the troughs in their PMIs between November 2008 and February 2009, their PMIs have rebounded nearly seven times as much as the South Africa one, since hitting their respective troughs. This suggests that by October the decline in production could be over and out of the system, provided that is that the slow but steady recovery in the three above mentioned economies continues, which is far from guaranteed.

Inflation Still A Problem

The inflation measure targeted by the South African Reserve Bank until the end of 2008 was the consumer price index excluding mortgage interest costs for metropolitan and other urban areas (CPIX). The year-on-year inflation rate as measured by CPIX peaked at 13.6 per cent in August 2008 and then declined continuously to 10.3 per cent in December. According to the central bank the main drivers of inflation during the last quarter of 2008 were food prices, fuel and power (electricity prices), and transport (petrol prices). Average CPIX inflation for the calendar year 2008 was 11.3 per cent.

Since the release of the January 2009 CPI data, the targeted inflation measure has been the headline CPI (CPI for all urban areas). This new CPI includes a number of changes of methodology when compared to the previous CPI. The year-on-year CPI inflation rate was 8. 1 per cent in January 2009. It then rose to 8.6 per cent in February before declining marginally to 8.5 per cent in March (Figure 1). Inflation in the first quarter of the year was driven mainly by increases in food prices, alcoholic beverages, household maintenance and repair, electricity, and in financial services.

Since that time the inflation rate has fallen back slightly - from 8.0 per cent in May 2009 to 6.9 per cent in June - but given the extended recession and the low levels of capacity utilisation this rate is still noteworthy for its size. One of the underlying problems is evidently still the rate of administered price inflation, which (excluding petrol prices) was running at 9.1 per cent in June, with electricity prices increasing by 28.6 per cent.

Producer prices, on the other hand, do show the impavt of the fall in energy prices and the economic slowdown, since they declined at a year-on-year rate of 4.1 per cent in June, compared with a decline of 3.0 per cent in May. Prices of mining and chemical products were the main contributors to this trend, but there was also further moderation in food price inflation.

Interest Rates In A Bind

Basically, having headline CPI inflation still running at 6.9 percent is something of a headache for the central bank, since given the recession they would evidently like to ease more (which would also help take some of the upward momentum out of the Rand), but the bank will be wary of going too far, given the extent to which its credibility will be under test. South Africa’s central bank unexpectedly cut its benchmark interest rate by half a percentage point, the sixth reduction since December, to curtail the economy’s first recession in 17 years. The repurchase rate was lowered to 7 percent. Governor Tito Mboweni said in a televised statement after the monetary policy meeting that the decision to reduce rates had been a “very closely debated one”, and it seems unlikely that further rate cuts will follow rapidly.

Carry Trade Monetary Policy Dilema

The problem is that the central bank is on the horns of a real and very important dilema here, as it struggles to apply text book inflation targeting monetary policy in times which are most definitely not of the text book variety. One of the issues is that interest rates which are set high to contain inflation can often have the perverse effect of attracting fund flows which are drawn by the yield differential, and the expectation of further currency appreciation (among other things South Africa's is a commodity producing economy) - and the swift reversal of the fund outflows witnessed last winter (see chart below) gives some hint that this kind of counter intuitive effect may now be at work in South Africa. Thus South Africa’s rand, despite the current severe recession, has in fact been the second best-performing currency, after Brazil, across the globe this year. But is this impressive performance of the ZAR supported by the underlying macro fundamentals? Negative growth, depressed confidence and steadily rising unemployment certainly do not make it look like it is.

The rand appreciated the most in a month against the dollar last week - maintaining its first weekly advance since July 24 - on the back of consensus feeling the global economy is moving out of recession, increasing appetite for high-yielding assets. On Friday (August 21) the currency strengthened by as much as 1.9 percent to 7.7474 per dollar, its biggest intraday jump since July 20 and best level since Aug. 4. It was up 1.1 percent at 7.8139 per dollar as of 5:06 p.m. in Johannesburg, for an increase of 3.4 percent over the week.

The rand has now climbed 21 percent against the dollar this year as benchmark interest rates fell to near zero in the U.S. and Europe compared with 7 percent in South Africa, making the South African currency a favorite for the so called carry-trades where investors borrow money in countries with low interest rates to invest in markets with higher returns. The rand offered the third-best carry-trade return of the 16 major currencies monitored by Bloomberg last week.

Much of the ZAR move has been closely correlated with the return of investor risk appetite. One of the main catalysts for this has been the upside surprise from US economic data (as Varinat Perception's Simpon White put it the second derivative of the data turned positive while the second derivative of the consensus estimates remained in negative territory).

Unsurprisingly, as Simon points out, there is a very good fit between ZAR and the Citigroup US Economic Surprise Index (this measures the degree of "surprise" in the data releases). This close relationship simply serves to emphasise the seductive power of emerging markets to investors – now wallowing in liquidity. In fact the ZAR has moved more closely with unexpectedly good US economic data than either the S&P or US 10y Treasury yields. This liquidity-driven geared-play on emerging markets is now a central part of the global recovery. A softening attitude to the prognosis for the South African economy is also reflected in risk spreads. Sovereign CDS continues to fall, approaching levels seen last summer, and the spread between South African and US 10y Treasury yields has returned to its average over the period late 2007 to the present.

The stock market has also bounced back, and is so far up 36% from the trough. With the rally in equity markets that began on the 6th of March this year and on the 13th of July continued with renewed vigour, money inflows to South Africa began to recover after a sharp rout in the fourth quarter of 2008.

In fact there was huge net outflow of portfolio flows in Q4 2008 which quickly reverted to a net inflow in Q1 2009. The current account deficit as a whole – perennially wide in South Africa - narrowed from a low of -8.8% of GDP last March to -5.8% in the last quarter of 2008, driven in part by falling import prices (primarily oil). More recently the deficit has widened again due to mining and manufacturing exports falling faster then imports. Further widening in the current account deficit from this source will likely be limited as the trade balance has recently improved somewhat (but due to falling demand for imports rather than an increase in export trade). On the positive side, the composition of South Africa’s relatively large current account deficit looks healthier than in previous years as net foreign direct investment has improved dramatically: it was over 100bn ZAR in 2008 compared to an average of close to zero in the preceding 3 years.

The Liquidity-Driven Gearing-Play Is Certainly Bad For SA Exports

With almost half of South Africa's goods exports destined for the US, Europe and Japan, the recession in the developed economies has naturally severely affected South Africa's trade performance. But with the real effective exchange rate of the rand also increasing - according to central bank data it was up by 4.9 percent between March 2008 and March 2009 - then evidently South Africa's exporters are facing a price competitiveness problem.

So it is no surprise to find that the volume of goods exports was down at a 21 percent annualised rate in the first three months of 2009, and this on the back of a decrease of 6.3 per cent in the fourth quarter of 2008. Relative to real gross domestic product, the value of goods exports dropped from 20.8 per cent to 16.7 per cent during the first quarter. Although declines were noted in all major export categories, the decrease in the volume of manufactured exports was strongly related to the sharp contraction in manufacturing activity among SA's most important trading partner countries. In addition, the deceleration in the Chinese demand for raw materials used in production processes had a negative impact on South African mining products.

As a result, it is understandable that the country's goods trade deficit was widening - from R19,6 billion in the fourth quarter of 2008 to R53,4 billion in the first quarter of 2009. A trade deficit of similar magnitude was last recorded in the first quarter of 2008 as a result of the fact that the country experienced severe power outages. South Africa’s government is no so concerned about the situation that Economic Development Minister Ebrahim Patel warned last week that the current recession might irreparably erode the country’s manufacturing capacity.

“We are deeply concerned about a permanent decline in productive capacity as factories close rather than simply reduce output,” Patel said to the South African Parliament, "Manufacturing output has been declining since mid-last year. It has now reached levels last seen some five years ago.”

All of which naturally enough feeds directly through to the pretty substantial current acount deficit.

Credit Pinch?

Credit growth in the private sector has slowed subtantially, and while it still remains positive, it has now dropped from a 20.3 percent in the year ending in June 2008, to more like a 5% annual rate of increase in June 2009. Household debt rose slightly to a record level of 78.25 percent of disposable income by the first quarter of 2009. Pushed mainly by rising interest rates, household debt service has risen to about 11.25 percent of disposable income, but remains below historic highs. Total loans and advances extended to the private sector continued to decelerate in the first quarter of 2009. The deceleration was partly a consequence of the decline in income and deteriorating outlook for economic activity, restrictive credit conditions and the cumulative effect of the tighter monetary policy stance introduced since 2006.

Growth over twelve months in total loans and advances extended to the private sector decelerated from 14.0 per cent in December 2008 to 7.3 per cent in March 2009, and further to 6.3 per cent in April. The annualised quarterly growth fell from 6.2 per cent in the final quarter of 2008 to a mere 0.1 per cent in the first quarter of 2009 – the lowest rate since the first quarter of 1966, when this rate was negative.

Adjusted for inflation, loans and advances fave contracted significantly in recent quarters. With the exception of mortgage advances, all the other main credit categories contracted in the first quarter of 2009. Mortgage advances, which comprise about 52 per cent of total loans and advances, continued to rise, but their twelve-month growth rate decelerated from 13,2 per cent in December 2008 to 11,3 per cent in March 2009 and further to 10,6 per cent in April as stricter lending criteria and higher deposit requirements by the banking sector continued to dampen mortgage business, especially residential mortgages.

Not surprisingly, given the economic and credit environment, South African house prices have been falling, and were down 4.2 percent in July from a year earlier, according to Absa Group Ltd., the country’s biggest mortgage lender. The average nominal house price dropped to 925,100 rand ($115,548). Prices fell 0.2 percent in the month, after declining 0.4 percent in June. After gaining 3.7 percent in 2008, house prices will probably fall between 3 percent and 3.5 percent this year, according to the Absa Group forecast.

Twelve-month growth in instalment sale and leasing finance has also slowed noticeably and showed negative growth of 0.2 per cent in April 2009, largely reflecting the slump in sales of motor vehicles and other durable goods. Other loans and advances contracted for the second consecutive quarter in Q2. Twelve-month growth in other loans and advances decelerated from 17.9 per cent in December 2008 to 3.9 per cent in March 2009 and further to 2.8 per cent in April.

Demographic Processes Favourable, But Massive Strain On The Labour Market

Demographic processes are now very favourable to South Africa, as fertility declines, and the mdeian age of the population steadily rises, and more and more of the population are to be found in the working age ranges. This creates the favourable situation where the country can reap the benefits of what is known as the "demographic dividend", as the percentage of dependent population steadily falls.

However, this process puts enormous pressure on the labour market, as more and more young people enter looking for work. As can be seen in the chart below, South Africa's working age population is increasing at a rate of 375,000 a year, or nearly 100,000 a quarter. That is a lot of jobs to find.

But, as we can see in the next chart, due to the recession employment actually fell between Q4 2008 and Q1 2009, while over the course of Q2 2009 it more or less moved sideways. Little wonder there is such a large problem of "discouraged workers".

The Immediate Future

The current protracted recession is putting substantial pressure on the South African administration and is increasingly calling into question president Jacob Zuma's pledge in May to create half a million job opportunities by the end of 2009 through public-work programs. At the same time the deterioration in South Africa's labor market has both weighed on consumption and deteriorated the level of credit quality

Economic growth is expected to return slowly - especially given the creit squeeze, which is of course reflected in the weak performance of retail sales. The economy is expected to contract by 0.3% this year by the IMF, but many expect the contraction to be nearer 1.5%. Standard Bank anticipates formal job losses totalling more than 400 000 in the current cycle and then -depending on the duration of the economic slump - further job losses which will evidently hamper economic growth. Such labour market trennds will also have negative knock-on effects on household spending and income growth. Soft labour market conditions could aggravate the current contraction in real disposable income growth, also affected by a sharp decline in bonus payments, operating hours, and lower property income, and this trend is likely to endure for at least another six months

At the same time there will be growing pressure on the fiscal side. South Africa’s borrowing needs are likely to be double the government’s projection according to estimates from JPMorgan Chase & Co. They suggest government borrowing may surge to 183 billion rand ($22.4 billion) in the 2009-10 fiscal year to cover spending, compared with the forecast of 90.37 billion rand outlined in its February budget. If confirmed this would increase the budget deficit to 7.4 percent of gross domestic product, compared with a government forecast of 3.8 percent, she wrote.

“The increased borrowing will be driven predominantly by a revenue shortfall rather than over-expenditure. The economic recession is taking a bigger toll on the fiscal position of South Africa than previously thought.”
Sonja Keller, Johannesburg-based economist for JPMorgan
The national government fiscal balance moved into surplus (0.9 percent of GDP) in the financial year 2007/08, bringing the total government debt level down to around 28 percent of GDP. The surplus, the second in a row, reflected a large increase in tax revenue, owing to strong economic activity over most of the period and continued collection efforts. Total public debt, including obligations of public enterprises and local governments, dropped to about 35 percent of GDP.

Sonja Keller estimates that South Africa is likely to miss its 643 billion rand revenue-collection target by between 75 billion rand and 80 billion rand in the current fiscal year (forecasting the economy to shrink by 2 percent). Some confirmation of her view can be found in a recent statement of Finance Minister Pravin Gordhan, who admitted the government may miss its target by as much as 60 billion rand this year.

Pressure on public finances may come from higher wage settlements in the public sector, since civil servants look set to push government expenditure above the budgeted 738.6 billion rand by about 10 to 15 billion rand. South Africa’s government granted a 13 percent wage increase to about 125,000 striking municipal workers on July 31 to end a wage dispute.

In conclusion I see four main downside risks in the South African Economy at the present tim:

1) The current account deficit.
2) The fiscal deficit
3) The overleveraging of South African households in the context of a weak labour market
4) The serious structural distortion which can be produced in South Africa's industrial and economic development by the kind of strong geering-related liquidity play to which the country is currently being subjected by the financial markets, since this is producing substantial distortions in relative pricing and in the country's real effective exchange rate, a factor which is critical for those contemplating long term serious greenfield site invement projects.

Tuesday, September 23, 2008

South African Inflation Rises Again In August

South African inflation hit a record annual level for the third consecutive month in August, reaching 13.6 percent, as electricity and food costs continued to rise. The CPIX inflation rate, which excludes mortgage costs, increased from 13 percent in July according to today's data from the Pretoria-based Statistics South Africa. Prices were up by 0.9 percent month on month.

The central bank has increased its repurchase rate by 3 percentage points since June last year to the present level of 12 percent as inflation soared above its 3 percent to 6 percent target range.

The bank now expects inflation to drop within the target by the second quarter of 2010. Higher interest rates have also hurt consumer spending, and retail sales are falling, dropping by a record annual 4.6 percent in July, according to separate data from the statistics office. This is the fifth consecutive month in which retail sales have fallen. Consumer spending growth slowed to an annualized 1.2 percent in the second quarter, the lowest in more than five years, and South African vehicle sales plunged an annual 30 percent in August, the biggest drop in 14 years. Manufacturing output growth was also down to a year on year 3.3% in July.

The weakening in the economy, and the probability that inflation may now be about to slow make further rates increases unlikely in the short term.

Friday, September 12, 2008

South African Manufacturing Output Slows In July, Rand Decline Continues

South African manufacturing growth slowed to an annual 3.3 percent in July as higher interest rates continued to damp consumer spending. Growth in manufacturing output - which accounts for 16 percent of the South African economy - fell back from a revised 5.7 percent in June, according to data from Statistics South Africa earlier this week. Output fell a seasonally adjusted 0.4 percent in the month. Manufacturing output of food and beverages were down by an annual 3.3 percent in July, textile and clothing production dropped an annual 5.2 percent in July, while vehicle output declined 5.1 percent.

Sales of manufactured products have fallen considerably since the central bank began increasing the benchmark interest rate in June 2007. It has now been raised six times to the current 12 percent rate. The slowdown in manufacturing suggests that growth in Africa's largest economy, which rebounded to an annualized 4.9 percent in the second quarter from 2.1 percent in Q1, may now be slowing again.

The Reserve Bank left interest rates unchanged on Aug. 14 as consumer spending eased and it forecast inflation, which reached 13 percent in July, will slow significantly in the last quarter of the year. The bank will very likely begin lowering interest rates late in the first half of 2009.

There have been clear signs recently that domestic consumer demand has been weakening. Vehicle sales fell by an annual 30 percent in August, the biggest decline in 14 years. Retail sales fell for a fourth consecutive month in June, dropping by an annual 2.6 percent.

Falling Rand

South Africa's rand slipped back to its lowest level since May 2003 against the dollar following publication of the manufacturing report. This was the third day the rand has fallen as platinum, South Africa's most important export, slumped to a 20-month low and gold also declined. The rand droppedat one point by  as much as 1.5 percent to 8.3322 per dollar, touching the weakestlevel  since May 2003, although it was back at 8.3258 by 4 p.m. in Johannesburg. 

South Africa produces about 10 percent of the world's gold and almost 80 percent of its platinum, and the rand often  moves in tandem with these commodity prices. The movement in the value of the rand has been almost constant since late July now, as the dollar has risen steadily, reflecting in part declining global risk sentiment.

South Africa's business confidence index fell 11 points to 34, marking its eighth quarterly decline, according to the survey published by Rand Merchant Bank yesterday. The index is now at its lowest level since the first quarter of 2001.

Thursday, September 4, 2008

South Africa's Current Account Deficit Slightly Lower In Q2 2008

South Africa's current account deficit narrowed to 7.3 percent of gross domestic product in the second quarter as power outages eased, boosting gold and platinum exports. The deficit shrank from a revised 8.9 percent of GDP in Q1, according to data from the Pretoria-based Reserve Bank.

Electricity supply stabilized in the second quarter after power outages forced mines to shut for five days in January, enabling a rebound in exports. Imports also gained as the government stepped up spending on stadiums, roads and power plants, keeping the deficit above 7 percent for a fourth consecutive quarter.

The deficit narrowed to an annualized 164.4 billion rand ($20.9 billion) in the second quarter from 194.6 billion rand in the previous three months.

South Africa relies mainly on foreign investment in stocks and bonds to fund its import needs, inflows that began to dry up in the fourth quarter as investors sold riskier, emerging market assets. The rand has fallen 13 percent against the dollar this year on concern South Africa will struggle to finance the deficit.

The country recorded an inflow of portfolio investment of 27.3 billion rand in the second quarter, compared with an outflow of 19.1 billion rand in the previous three months, the central bank said. The deficit has widened in the past two years as the government boosted spending on road, rail and power infrastructure in preparation for hosting the 2010 FIFA World Cup. About 40 percent of the equipment needed for the 568 billion rand infrastructure program will need to be imported, according to government estimates. The government expects the deficit to reach 7.9 percent of GDP in 2009 and 8 percent in 2010, compared with an estimated 7.3 percent this year.

Export volumes rose an annualized 12.2 percent in the second quarter after dropping 7.2 percent in the first three months of the year, the central bank said. Higher gold and platinum prices helped to boost the value of exports by 20 percent to an annualized 682.1 billion rand in the second quarter. Imports rose 12 percent to an annualized 760.9 billion rand in the same period, the central bank said.

South African Mortgage Growth Slows In August

According to the Absa Group, which is South Africa's biggest mortgage lender, South African house-price growth slowed to an annual 1.7 percent in August, the slowest pace since January 1993, as rising interest rates curbed demand. Growth in house prices fell back from a revised 2.6 percent in July. The average price of a house was 962,500 rand ($122,294) last month. Adjusted for inflation, prices in the middle-segment of the market dropped by an annual 9.6 percent in July, the sixth monthly decline in real terms, and the biggest drop in real terms since November 1992.

Friday, August 29, 2008

South Africa Trade Gap Widens In July

South Africa's trade deficit widened to 14.3 billion rand ($1.9 billion) in July, close to a record, as oil prices surged, boosting import costs. The deficit increased from 200 million rand in June, according to data out today from the South African Revenue Service. The shortfall was close to a high of 14.7 billion rand reached in October 2007.

Crude oil climbed to a record $145.29 a barrel in New York on July 3, while the rand's 12 percent drop against the dollar in the first half of the year boosted import costs. The rand has weakened this year on concern South Africa will struggle to attract the foreign investment needed to finance its import needs as the current account deficit widened to a 26-year high of 9 percent of gross domestic product in the first quarter.

Against the dollar, the rand dropped as low as 7.728 from 7.674 before the data was released, and was trading at 7.70 as of 2:34 p.m. in Johannesburg.

The South African government is spending 568 billion rand over the next three years on power plants, roads and stadiums as it prepares to host the 2010 FIFA World Cup. About 40 percent of the equipment needed for the infrastructure investment will be imported, according to government estimates.

Imports jumped 25 percent to 75.6 billion rand, mainly due to a 53 percent surge in oil, the revenue services said. Exports increased 1.8 percent to 61.3 billion rand as a drop in gold and platinum prices offset an increase in coal exports. The price of platinum, South Africa's biggest export, plunged 15 percent last month, while gold dropped 2.7 percent.