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One small window remaining for further rate relief?

11 September 2009 Credit Guarantee Insurance Corporation]
Luke Doig, Senior Economist, Credit Guarantee Insurance Corporation

Luke Doig, Senior Economist, Credit Guarantee Insurance Corporation

Economic Comment by Luke Doig, Senior Economist, Credit Guarantee Insurance Corporation]

The Kagiso Purchasing Managers Index rose to its highest level in August since January this year, registering 39.3 from 37.3 in July although this level still indicates net pessimism amongst manufacturers. The three most significant improvements were in respect of output volumes (business activity) which rose to 38.3 from 33.8 a month earlier, new sales orders at

39.5 from 35.8 in July and expected business conditions 6 months hence which rose to 59.3 from 55.1. Significantly the latter figure represents the strongest optimistic outlook since December 2007.

Indeed if one takes into account the recent improvements in global manufacturing, there may be faint optimism that the traditional Christmas splurge may serve to rescue many operations from an otherwise dismal year.

However, we would advise against overt optimism. Disposable income per household has been negative for four successive quarters (3rd Quarter 2008 to 2nd Quarter 2009) and this has been closely matched by household consumption expenditure. Consequently, final demand (Gross Domestic

Expenditure) fell by 14.5% in 2nd Quarter 2009 (Seasonally Adjusted Annual Rate), the worst performance since 4th Quarter 1986 -19.2%. It is, therefore, no wonder that wholesale and retail trade (13.8% of Gross Domestic Product) has seen five consecutive quarters of negative growth, more than the four of manufacturing and three of electricity, gas and water.

Further dampening any optimism is the fact that household debt to disposable income remains stubbornly high at over 76%, a level which has endured for eight of the last nine quarters. Hence despite prime retreating to the low point of the previous cycle at 10.5%, it would appear that households remain ensnared with high debt levels with little ability for discretionary spend.

Despite tentative signs that the sharp contraction in motor vehicle sales may be nearing an end, at issue will be how strong any recovery will be.

The Rode June 2009 Consensus survey indicates that durable sales are expected to contract by 7.9% this year before gaining traction to register growth of 1.9% next year. Given that durable goods sales (in constant 2000 terms) declined by 14.2% in the first half of 2009, this implies that second half 2009 sales of cars, furniture, household appliances and electronics will only fall by 1.4%. This may yet prove to be over-optimistic.

Real sales of semi-durables (clothing and footwear, household textiles, sports goods and vehicle spares) fell by 2.1% in the first quarter of 2009 but may begin to show tentative signs of recovery in the near term, gathering momentum over the Christmas period. However, we would expect to see lacklustre growth in consumption expenditure on large ticket items until the new year, with even spend on necessities having displayed buying-down trends. From a manufacturing and wholesaler perspective, we would caution against the placing of large orders in the absence of any firm recovery in final demand.

Manufacturers and consumers alike may receive a small shot in the arm if over-recoveries on fuel prices are extended. Current daily over-recoveries of around 39c per litre and 35c per litre for petrol and diesel have brought the month-to-date figures to 22cents per litre and 17cents per litre respectively. This will mark a welcome change from the ongoing tick-up in petrol prices which began the year in January at low of R6-01 per litre (Gauteng 95 ULP) before attaining R8-05 per litre at the start of September.

Monetary policy has become the opinion of all and sundry of late.

Bedevilling the matter has been the fact that despite the inflation outlook remaining fairly static, the last three Monetary Policy Committee meetings have delivered three different outcomes. Reference to the graph below shows that real interest rates (prime less CPI) were around the 6% level at the height of the 2005-2007 expansion and are now in the 2% region. However, reference to the above discussion would appear to indicate that they have had little impact – admittedly to date – on arresting the economic decline.

We were strong advocates of front-loading the interest rate cuts late in the first quarter of 2009 to early in the second quarter of 2009 due to the long lag effect and as an attempt to proactively lessen the impacts of the slowdown. Instead the South African Reserve Bank has seen fit to make smaller regular adjustments. Looking ahead, CPI may decline marginally in the near-term from the current 6.7% recorded in July, especially considering the recent rand strength, but may edge up at year-end / beginning 2010 before hopefully approaching the upper target guideline by the 2nd quarter of 2010. This may allow for a small window of opportunity to justify another 50 basis points cut at the October meeting; otherwise such relief may only eventuate in mid-2010.

So while spring may be in the air, we are hopeful that the worst is behind – despite Roubini’s warning of a possible dip back into recession in late 2010 due to rising government debt, higher oil prices and a lack of job growth.

Hence why leaders of the major industrialised countries are heeding warnings that they may have to do more – read additional stimulus measures – to avert such a scenario. We do however expect the recovery to be gradual, hopefully with a firm boost around the 2nd quarter of 2010 as World Cup fever and improved balance sheets allow for a return to more normal demand and spending patterns.

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