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Is SA heading for an economic recession?

01 September 2008 Prof Chris Harmse, Dynamic Wealth

The resilience of the South African economy was never better illustrated than this year when it maintained a healthy growth rate above 4% during the first half of 2008 notwithstanding the pressures of three international and one local crisis (sub-prime, oil price, food price and electricity).

Though economic growth might slow during the second half of this year, chances are slim for the economy to fall into a recession (defined as two or more quarters of contraction).

Up till very recently the notion of the economy transforming from growth to recession was a popular topic of discussion. Negative consumer indicators such as the drop of 20% in the sales of passenger cars, the 2-3% contraction in retail sales, the consumer confidence index falling into negative territory and the contraction in durable goods sales were the main reason for this negativity. Add to that the impact of the sub-prime crisis, sharp increases in oil and agricultural prices, constraints on production due to the electricity shortage and increases in interest rates recession talks become understandable.

However, the analysis of the South African economy should be based on total information and not on selective spots such as consumer indicators. For example, car sales, whilst down 20%, it only comprises 4% of GDP. On the other hand, household consumption spending on services - which is not measured monthly but at 26% of GDP is households’ largest spending item - possess an intrinsic stickiness and will not easily fall into negative growth territory.

In addition, the real motor of economic growth – investment – is growing at a strong pace. Research showed that whenever investment spending is growing at a healthy pace, chances of the economy slipping into negative territory are small. This can be traced to the impact of the investment accelerator exceeding that of the consumption multiplier. For example, an increase of 10% in investment may increase GDP by 25%, whilst an increase of 10% in household spending increases GDP by 1% only. (The multiplier effect of consumption spending is accelerated by investment spending which leads to additional multipliers).

Thus, though household consumption growth is slowing, government’s infrastructure and Soccer World Cup needs will keep investment growing, making it very difficult for the economy to slip into a recession. Furthermore, many turning points are emerging.

Yes, consumer price inflation will still accelerate due to increases in the fuel price, municipal tariffs and price increases stemming from producers (e.g. wages and import prices), but the turning point should be in the latter part of the third quarter at above 13%. The major sources of slower inflation stem from slower world growth, which will contain huge increases in oil prices. Another huge inflation driven increase in the oil price ($200 per barrel this year), is not foreseen.

In addition, credit growth is on the verge of subsiding. In fact credit growth by households should be less than 10% next year. This should put less pressure on M3-money supply to increase at current unsustainable levels.

This should see the turning point in the current up cycle in interest rates. Should the oil price hold and not double during the course of the next year, and expectations of wage increases subside next year, interest rates might decrease from the second quarter onwards.

This may induce another turning point, namely faster GDP growth from the second half of next year onward. However, electricity and other socio-economic constraints will limit the growth potential.

In order to avoid another inflation spiral, it has become imperative that government start taking the correct policy actions. This include a real skills development and acquisition programme, abolishing foreign exchange controls to reduce the current account deficit (more investments abroad will neutralise the current dividend and interest payments to foreigners), and investment incentives to attract greenfield foreign direct investments.

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