Growth outlook clouded by significant challenges
As highlighted by President Thabo Mbeki in the State of the Nation Address, at the start of 2008 the South African economy is faced with a number of challenges. When the official statistics are released at the end of February, the BER expects it to show that the economy grew in the region of 5% for the fourth consecutive year during 2007. However, towards the end of 2007 a moderation in growth was expected for 2008 on the back of a weaker global economy, driven by the threat of a US recession, as well as the lagged impact of higher domestic interest rates.
The list of negative growth factors have increased significantly of late following the unprecedented mining shutdowns on 25 January after Eskom informed some of SA’s biggest mining companies that it could no longer guarantee uninterrupted electricity supply. The mine closures, as well as the increased severity of economy-wide load shedding, forced the BER (along with other analysts) to rethink the growth outlook for 2008. It has to immediately be emphasised that the uncertainty regarding the electricity supply crisis makes it very difficult to model the potential growth impact.
Until such time as more information becomes available, the BER decided to mainly focus on the potential negative impact that the power woes will have on the mining sector by working with two scenarios. The baseline scenario takes the view that the mining closures will result in total mining real value added declining by 20% quarter-on-quarter (seasonally adjusted and annualised) in the first quarter of 2008, but to then almost fully recover in the subsequent quarters as power is restored and operations continue as per normal. This scenario sees mining output falling by 1.6% in 2008 with GDP growth projected to slow to 3.9%.
The alternative scenario takes a more negative view that after falling by 20% during the first quarter, mining output does not recover in the following quarters i.e. shows no growth in the second through the fourth quarters. As a result, mining production declines by a more significant 4.8% during 2008. As this scenario assumes more sustained electricity problems, growth in the other major sectors of the economy is also weaker. The result is that overall GDP growth for 2008 is only 3.4%. In both scenarios GDP growth is forecasted to recover to 4.8% in 2009.
There have been fairly widespread opinions expressed about the potential economic impact of the power crisis. “While the BER acknowledges that even the alternative growth scenario may prove to be too optimistic, the lack of information means that at this stage we are cautious not to take an overly pessimistic view. We regard the probability of a recession as being low,” said BER economist Hugo Pienaar.
Inflation outlook deteriorates further, interest rate expected to remain on hold
The SA Reserve Bank’s (SARB) targeted inflation measure (CPIX) increased by an average of 6.5% during 2007, some way above the upper 6% band of the inflation target. A worrisome trend is that analysts, including the BER, have tended to underestimate inflation in recent months with the actual data coming in higher than forecast. The BER now sees CPIX peaking around 9% in February, before gradually easing towards the end of the year. The current forecast only sees CPIX (temporarily) dipping back below 6% in December 2008. CPIX is set to average 7.4% in 2008, before easing to an average of 5.8% during 2009. The forecast is somewhat more negative than the one presented by the SARB at its January MPC meeting. The central forecast of the central bank is also for CPIX to only move below 6% in 2008Q4, but to then remain around the 5.6% level for most of 2009.
The SA Reserve Bank’s (SARB) targeted inflation measure (CPIX) increased by an average of 6.5% during 2007, some way above the upper 6% band of the inflation target. A worrisome trend is that analysts, including the BER, have tended to underestimate inflation in recent months with the actual data coming in higher than forecast. The BER now sees CPIX peaking around 9% in February, before gradually easing towards the end of the year. The current forecast only sees CPIX (temporarily) dipping back below 6% in December 2008. CPIX is set to average 7.4% in 2008, before easing to an average of 5.8% during 2009. The forecast is somewhat more negative than the one presented by the SARB at its January MPC meeting. The central forecast of the central bank is also for CPIX to only move below 6% in 2008Q4, but to then remain around the 5.6% level for most of 2009.Despite the worsening inflation picture, the BER is of the view that interest rates are likely to remain unchanged for the rest of 2008. This view is supported by gathering evidence (highlighted in the January MPC statement) that the consumer is reacting to the 400bps worth of interest rate hikes implemented since mid-2006. Given that our updated inflation forecast indicates that CPIX is set to average just below 6% in 2009, there seems to be very little room (except if growth slows significantly more than forecast) to cut rates before the end of 2008. We do, however, foresee marginal interest rate cuts (50 to 100bps) in 2009. It is important to emphasise that interest rates are not expected to fall back to the low levels (prime rate at 10.5%) witnessed in 2005/early 2006. For one thing global price pressures are unlikely to be as favourable for local inflation dynamics as was the case during 2003 to 2005.
Current account funding more challenging, rand weakness may persist
For some time the BER has been concerned about the funding of the large current account deficit, which at 8.1% of GDP reached a 25-year peak during the third quarter of 2007. Although the current account shortfall was handsomely financed in recent years by mainly foreign buying of SA stocks and bonds, the projected slowdown in world economic growth, domestic political uncertainty after the dramatic developments at the ANC’s December conference and the power woes heightened the concern. In the three months to end January 2008, foreigners were net sellers of local stocks and bonds to the tune of R33.3bn.
For some time the BER has been concerned about the funding of the large current account deficit, which at 8.1% of GDP reached a 25-year peak during the third quarter of 2007. Although the current account shortfall was handsomely financed in recent years by mainly foreign buying of SA stocks and bonds, the projected slowdown in world economic growth, domestic political uncertainty after the dramatic developments at the ANC’s December conference and the power woes heightened the concern. In the three months to end January 2008, foreigners were net sellers of local stocks and bonds to the tune of R33.3bn.Of interest is that more than R12bn (or about 36%) of the outflow occurred in the week following the mine closures. The capital outflow can help explain why the rand has weakened sharply, particularly in early 2008. From the end of October 2007, the currency declined from R6.47/$ to the current rate around R7.80/$, representing a 21% fall.
The BER expects that the current account will remain large (and may even deteriorate further) for the foreseeable future, requiring substantial foreign capital inflows. “At this stage it is unlikely that the inflows will be sufficient to finance the current account shortfall in 2008 and 2009,” said Pienaar. While this may result in the rand weakening further from current levels, there could be countervailing factors. The most recent rand weakness has been compounded by the US dollar strengthening against the Euro. There remains a real possibility that the dollar could reach new record lows versus the Euro later in 2008, which along with record high gold and platinum prices, may see a continuation of robust two-way trade in the rand i.e. it is not inconceivable that the currency may bounce back from the current weakness. This view is reflected in our rand forecast, which sees the currency weakening to an average of R7.80/$ during the final quarter of 2008 and R8.30/$ in 2009Q4. There is a significant risk of a sharper depreciation over the short term, particularly in the event of a sharp correction in commodity prices.
