The domestic economy enters an economic correction trajectory

The South African economy has entered into a trajectory of "economic correction" after experiencing above-average economic growth that coincided with a significant strengthening of the rand against the currencies of SA's major trading partners over the past three years, says Christo Lus, Absa chief economist.

Lus points out that the corrective measures include the latest interest rates hikes and the weakening rand. The domestic currency has lost around 14% of its value against the US dollar and about 20% against the Euro since the beginning of the year.

"Interest rates are likely to force households to live within their means, spending less on both foreign domestically produced goods. However, higher interest rates not only depress household consumption expenditure, but also make further investment in the production side of the economy more expensive."

Lus adds that the weak rand will lead to a moderation in domestic consumption that will affect the current account positively because South African exports will become more competitive in the international trade market.

"With the slowdown in household consumption expenditure likely to be offset by a pick-up in the external sector, economic growth will become more balanced. However, the medium-term prospects for the rand have become more bearish over the past number of months because of higher domestic inflation rates, the widening current account deficit and some re-assessment of emerging market risks by foreign investors."

But nevertheless, all is not lost. Lus says despite the projected interest rate hikes, the domestic economy is not on the brink of a hard landing.

"Our projections show that an above-trend economic growth of 4% can be expected during 2006 and 2007, picking up to 4,7% in 2008- barring any external shocks. Demand-stimulating interest rate cuts are expected to be resumed in late 2008, pushing economic growth higher in the following year."

Ridle Markus, Absa senior economist says the current economic expansion is set to accelerate in the coming years.

"Gross fixed capital formation, underpinned by the government's R400 billion infrastructure spending will further stimulate economic growth. This activity will create more jobs and make the current economic expansion more sustainable."

Markus believes the current levels of the domestic currency provide exporters with an opportunity to sell their goods at a more competitive price in foreign markets.

"Imports are likely to be more expensive and this would eventually lead to a correction in the current account balance. However, the key challenge for the monetary authorities is to find the right balance- a rand weak enough to boost growth in export-oriented sectors, but not so weak that it fuels inflation."