SA consumers reap the benefits of the emerging markets boom

Interest rates and inflation to remain low for longer

Although recent news headlines have highlighted the negative impact of the strong rand o¬n the SA economy, the current global environment of easy money and low price pressures, along with the economic troubles in many developed countries, is proving to be surprisingly positive for most South African consumers, who are benefiting from exceptionally low interest rates and inflation. And the good news for SA is that these conditions are likely to continue through 2011 and even 2012, barring unforeseen shocks, according to Johann Els, senior economist at Old Mutual Investment Group SA (OMIGSA).

“As we all know, governments and individuals in developed economies in Europe, the US and UK are tightening their belts in order to repay the excessive debt built up both before, and as a result of, the financial crisis,” Els explained. “Coming on top of the slow and uneven recovery from the global recession, the developed world is facing several years of slower-than-average economic growth. This, in turn, is forcing central banks to keep interest rates extremely low, until growth is decisively established and strong enough to create new jobs at a healthy rate.”

Meanwhile, emerging economies have recovered much more quickly than their developed counterparts and are set to expand at a much faster pace going forward, offering higher interest rates and more attractive potential returns for investors.

“The consequences of this ‘two-speed’ economic environment, with deflationary forces at work around the globe, have been significant for South Africa,” says Els. “It has sparked a huge search for yield, with a wave of funds being invested into emerging market bonds and equities that has driven many emerging market currencies, the rand included, much stronger. And although our recovery has been slower than that in some other emerging economies, our growth has still picked up, we have been able to cut interest rates to a 30-year low (to 9.5%), and inflation (at 3.5% p.a. in August) is at its lowest rate in five years.”

These conditions have been very favourable for South African consumers, who have helped to lead the recovery. Those who were able to hold o¬n to their jobs have seen their real disposable incomes rise significantly due to lower inflation and improving income growth, notes Els. At the same time, households are paying far less interest o¬n their mortgage bonds and other outstanding debts: those with a bond of R500,000 would have paid around R6,700 per month in repayments in August 2008; this would have fallen to around R4,600 in September 2010. Food inflation has also dropped dramatically, from 18% in May 2008 to 1.5% currently, and the lower petrol price has also offered some relief: those buying 200 litres of petrol per month would have paid about R2,100 in August 2008, but two years later were o¬nly spending about R1,600 for the same amount.

“Even the much-feared administered price inflation, which includes electricity tariffs and municipal rates, has been falling – from 14.5% at the beginning of the year to 8.3% currently,” he comments. “And the stronger rand has helped push inflation for consumer goods like cars, appliances and furniture into negative territory.”

South African financial markets have also benefited. “As part of the emerging markets boom, foreign investors are pouring into our bond and equity markets in search of higher yields. They are less worried about the risk these days, as our own government debt/GDP ratio was o¬nly 22.2% in 2009, which looks highly responsible and creditworthy compared to 72.1% in the US, 62.3% in the UK, and 115.8% in Italy,” Els says.

South African investments do look attractive o¬n a relative basis, he points out. The SA 10-year government bond is yielding 7.9% o¬n a nominal basis and 4.4% in real terms, with India the o¬nly country in the world able to offer a higher nominal yield (8.2%), and no other country able to top SA o¬n a real basis – the closest competitor is Italy’s 10-year bond at 2.1%. This has led to record foreign inflows into our bond and equity markets so far this year of R99bn through the end of September.

And the downside of the current global conditions? This is primarily two-fold, explains Els: the strong rand’s impact o¬n our competitiveness and job creation. “Although the strong rand is acting as a strong deflationary influence (having gained 10% against the US dollar in the quarter to end September) its strength is certainly detrimental for our exporters, particularly in the agriculture, manufacturing and mining sectors. Our miners are unable to take advantage of much higher commodity prices – for example, the gold price has risen by 21% in dollar terms so far this year, but in rand terms it is o¬nly up 13%.”

Other emerging markets like Brazil, and commodity-producing countries like Australia, are experiencing similar currency appreciations, with their exporters cutting costs to stay competitive. And while South African exporters are also attempting to stay competitive, they are finding it much more difficult to reduce costs – for various reasons, says Els.

“Although there are no definitive studies, it is fairly widely believed that our input costs are higher than those of many other emerging markets, so our exporters are going to have to redouble their efforts to find cost savings to remain competitive in the current global environment, where some countries are racing down the cost curve to stay ahead of their neighbours. This implies that job creation will remain slow – in SA and around the world - and we do expect this recovery to be particularly difficult for employment from an historical perspective.”

There is no easy solution for curbing the rand’s strength, Els observes. Significant Reserve Bank intervention is very costly, and has been proven time and again worldwide to be ineffective against global market forces. “We agree with recent remarks by Finance Minister Pravin Gordhan that SA cannot go it alone, given that the structural problems behind the appreciation of emerging market currencies are global in nature. The G20 would need to come up with an agreed framework to address the problem of overvalued currencies, but we also don’t expect that to happen, given the US intent to maintain an easy monetary policy.

“Looking ahead,” he says, “we expect the exceptionally low interest rates around the world to support a continued gradual recovery – both globally and in SA – as investment recovers and consumers repay their debt. SA consumers should continue to benefit from low interest rates and inflation for much longer than we had originally expected – currently we see interest rates remaining steady and o¬nly starting to rise at the end of 2011, and then o¬nly gradually. Inflation is also likely to remain within the Reserve Bank’s 3%-6% CPI target range for the next two years, assuming no global shocks.

“Consumers would be wise to take advantage of this and try to pay down their debt more quickly, and save and invest more for the future,” Els points out. “While investments linked to interest rates like money market funds are not attractive in these conditions, growth assets like equities are likely to offer the best returns over the medium- to longer-term,” he concludes.