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RSA Business and Economic Review May 2010

20 May 2010 Credit Guarantee Insurance Corporation
Luke Doig, Senior Economist, CGI

Luke Doig, Senior Economist, CGI

As clouds have gathered over Europe - both metaphorically and physically - governments increasingly have to face stark choices as debt levels escalate sharply. Ongoing job-shedding similarly highlights the challenges that face the domestic economy.

First the good news

Hungary has emerged from recession, with 1st quarter 2010 GDP (Gross Domestic Product) registering 0.9% from the previous quarters revised 0.2% (previously -0.4%) while Spain also managed to shrug off the depressed conditions and eke out a 0.1% 1st quarter 2010 expansion. France grew 0.1% in the 1st quarter 2010 from 0.5% in 4th quarter 2009. The JP Morgan Global Manufacturing PMI (Purchasing Managers Index) recorded a robust start to 2nd quarter 2010 with a reading of 57.8 in April, its joint second-highest level in the series history which has signalled expansion for the last 10 months. Manufacturing production grew at the fastest pace since January 2004, new orders exhibited the sharpest rise in six years and new export orders rose for the tenth straight month and at the fastest pace in the survey history. The outlook painted by the survey also appears strong with the orders-to-inventory ratio above its long-term average and order backlogs rose to the highest level in over four years. Regionally, the US output growth was at a 75-month high, Chinas level remained elevated while that for the Euro zone was the fastest in almost ten years. It is expected that this rate of expansion will cool in coming months, but remain positive in tandem with improving orders and sales and inventory accumulation.

The siesta is over

The previous Review noted that Nouriel Roubini remained concerned that Europe may even provide impetus to faltering global demand growth, contributing to the threat of a wider double dip across high-income countries. The austerity measures imposed on Greece in the wake of their 110 billion bailout were harsh because they were so long overdue. Roubini argues that debt restructuring (extending the maturity profile) would have been a far more workable solution for Greece than the punitive interest rates that the current package entails. High growth rates in many southern European states, abetted by low interest rates after the introduction of the Euro, drove up wage levels and undermined competitiveness argues an ECR research note. The credit crunch has finally exposed the fiscal crisis and hence the unprecedented 750 billion Euro zone package of loans, guarantees and credits in an effort to ease fears over highly indebted countries ability to cut deficits and service their debts. The challenge will be to curb wage growth, improve productivity, trim social service (pension) benefits and even pare public sector employment. The problem they face as they seek to slash budget deficits is sluggish growth which in turn cuts into revenue streams. This could well give rise to social unrest and heightened political tensions. How long can - and will - the north continue to sponsor the south? ECR highlights that unless flows (subsidies) to the south continue as they seek to sort themselves out, an ultimate outcome may well be the collapse of the European Monetary Union. Can sovereign defaults be excluded? Austerity will have to become the order of the day.

Europes pre-eminent position as a South African export destination has been usurped and, given its low demand outlook, seems set to lose further attraction. Africa and especially Asia look set to continue to cement their position.

Gradual local improvement

The SA Reserve Banks leading business cycle indicator edged up to 125 in February 2010 from 124.7 the month before, while after crimping 4.9% in real terms in 2009, retail sales shrank by 1.5% in the first two months of this year. Manufacturing output grew 6.3% year-on-year in March (February 2010 = +2.7%); note that the manufacturing sector contracted by 25.5% and 11.1% in 2nd quarter 2009 (saar).

The Kagiso Purchasing Managers Index has been above 50 for six months, although Aprils 55.2 level was marginally below that for March; the long-term average for the index is 52.3 so this figure can still be regarded as a positive signal. Hearteningly, and despite a year-on-year loss of 833,000 jobs in 1st Quarter 2010 (source Stats SA, QLFS), the employment sub-indice rose to 56.3, the highest level since August 2007. New sales orders also rose to 56.2 in April 2010 from 54.8 the month before but any tapering off in expected business conditions may thwart intentions of job creation from becoming reality.

Private sector borrowing has fallen for six consecutive months, although the March contraction of 0.7% was off the low of -1.1% seen in November 2009. Within this, credit taken up by households bottomed out at 2.6% year-on-year growth in November, subsequently rising to 3.6% in March 2010. Businesses continue to bear the brunt with a 5.1% year-on-year fall seen in March 2010. It would appear that cost pressures, margin squeezes and cashflow management continue to bedevil corporates and a sustained recovery requires improved consumer demand both locally and abroad.

Debt indicators

Official debt indicators offer a less reliable trend pointer for a variety of reasons, including the promulgation of the National Credit Act. Nonetheless, despite March 2010 liquidations rising 18.2% year-on-year, the first quarter total is 6.3% lower than in the 1st quarter of 2009, although we hasten to add that this does in no way imply that the tide has turned in respect of company closures. The overhang from the depressed conditions of 2009 will linger. However, with interest rates now at all but thirty-year lows, we look forward to an eventual easing in this lagging indicator. This is supported by our own figures on threatening losses, with the first four months of 2010 experiencing a 28% decline in the number of overdue advised accounts involving values some 11.5% lower (not inflation adjusted).

Local challenges

Much is being made of the supposed desirability of a weaker exchange rate in order to improve competitiveness. One could expect that wages should serve as a mechanism to clear or at least alleviate unemployment, although the local situation has many nuances, not least of which is the lamentable state of education and skills enhancement. It is, however, worth noting that the average output/labour ratio was R87,400 in 1980 and at R86,400 last year (at constant 2005 prices); admittedly this has improved strongly over the past decade. Further, labour productivity in the manufacturing sector attained a level of 126.2 in 3rd quarter 2009 versus unit labour costs of 162.3 (2000 = 100). While strike action backing wage demands to secure a living wage are understandable, an unemployment rate of 25.2% reveals the true extent of the challenge. Weak growth, rising operating costs including wage demands and tax imposts, risk undermining the recovery prospects for many businesses.

Fiscal concerns

Repeatedly we are being warned that tax increases cannot be ruled out In the future for that, read next year. South Africa faces similar threats to those of Europe over ever-burgeoning social welfare payments. While these may be classified as justified and unavoidable, almost 14 million people received some form of social grant in fiscal 2009/10, costing some R118.2 billion (out of consolidated government expenditure of R835.3 billion) with these payments having increased 14.5% per annum over the last three years. This is not sustainable. The public sector wage bill has almost doubled over the last five years, accounting for R270.9 billion in 2009/10, although Government estimates that this has peaked as a percentage of GDP and will edge lower over the next three years. However, a public sector wage increase demand of 11% gives lie to this.

There is a planning deficiency among many municipalities, with little or no attention being given to maintenance. Following hard on the heels of the electricity debacle, will be rapidly escalating water tariffs. The solution to every crisis is a massive price increase which, business, taxpayers and society at large have done very little to thwart.

Current outlook

The SA Reserve Bank (SARB) expects consumer inflation to remain within the target guidelines and decided to keep the Repo rate unchanged at their 13 May 2010 meeting. The SARB did note that, despite an improving growth outlook, currency and financial market vulnerability and risk aversion were risks that require ongoing monitoring. In 2009 producer prices averaged just 0.2% and consumer prices 7.2%; hence PPI of above 5% this year implies a margin squeeze for local businesses. The Reuters Econometer sees prime at 10% at year-end (same as current level) but at 11.5% at end-2011 as CPI picks up while growth expectations are put at 3% and 3.6% in 2010 and 2011 respectively.

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