The strong rand conundrum
Developed countries used every weapon in their respective monetary policy arsenals to prop up their economies through recession. The United States and Britain, for example, cut interest rates to the bare bones to ward off depression. As the United Nations bumps up its estimates for global 2010 GDP, we wondered how robust the recovery really is. To find answers to our musings we attended an Old Mutual Investment Group SA (OMIGSA) quarterly press conference, held in Johannesburg on April 2010.
“The rebound has been stronger than most expected,” says Johann Els, senior economist at OMIGSA. While many economists waited for a second economic downturn – the ‘double dip’ or so-called W-shaped recession – world economies powered ahead, evidenced by the exponential improvements in leading indicators, industrial production, manufacturing, exports and imports among others. Can this growth momentum last?
Medium term prospects uncertain
“Medium term growth won’t be as strong as in previous recoveries,” says Els. Major threats to the global economic recovery include country deficits. The PIIGS (Portugal, Italy, Ireland, Greece and Spain) are in huge trouble, with debt as a percentage of GDP approaching 125% in Portugal and Greece. Interest payments on these debts make it almost impossible for such countries to maintain growth. The entire Euro-zone is teetering as the European Union struggles to come up with a workable solution.
Another major obstacle is deflation. Core inflation numbers (with energy and food stripped out) have been in decline through recession, the trend continues. The reason for this deflationary pressure is best explained by the massive decline in unit labour cost of production across the developed world. Labour costs in the US, for instance, are contracting 5% year-on-year at March 2010. Els notes: “This development has surprised many people; but we know that inflation lags the cycle!” Despite deflation fears the US Federal Reserve and European Central Bank (ECB) are unlikely to hike interest rates any time soon. Their monetary policy response is severely curtailed due to the sensitive nature of the recovery.
Emerging economies rule the roost!
Without inflation and a boost to interest rates the developed economies will play second fiddle to the developing world. The BRICs (Brazil, Russia, India and China) are on fire, and “experienced the biggest uplift in growth through 2009,” observes Els. A comparison of the growth in GDP between Q1 and Q4 last year, shows China (+8.6%), Russia (+5.6%), India (+4.2%) and Brazil (+4.2%) totally outclassing the likes of the US, UK, Germany and France, where growth was pegged at 1.1% to 1.7%! South Africa only managed a 0.3%! While emerging economies have reached pre-recession levels on a number of economic measures, the developed countries have only bounced back part of the way.
Consumers remain central to long-term economic recovery. “The US consumer may seem depressed – consumer confidence in the US is still weak – but they are spending,” notes Els. It seems consumers in the emerging economies are more upbeat over prospects. In China, both industrial production and retail sales are growing strongly. There are concerns China will have to rein in rampant consumer spending by raising its lending rates, but the nation has proven extremely successful in handling ‘soft landings’ in the past.
Three-year macro forecasts for South Africa
The domestic economic recovery proceeded at a faster pace than expected too, bolstered by a firm rand and historically low interest rates. The rand’s continued strength against a basket of currencies should continue for some time. When the trend reverses South Africa could be in for a few shocks – the rand, thanks to its tradability, is extremely volatile. But the rand is a double-edged sword. On the one hand a strong rand benefits the economy by keeping inflation in check – on the other it impacts on export sales volumes and crimps domestic revenues across a number of sectors. Another serious problem is the ‘gap’ between manufacturing production and electricity production. The country’s manufacturing index is some way from its peak, while electricity production is dangerously close to January 2008 levels. If the country experiences a second round of power cuts the damage to its recovery would be far-reaching.
Local consumers are still struggling. There have been improvements in total credit, but lease and instalment statistics are still lagging. And recent improvements in motor vehicle sales could stem from large orders by rental car companies in the run up to the FIFA 2010 World Cup ™. Els notes that Associated Motor Holdings’ (AMH) statistics point to a quicker recovery than its Naamsa peer, confirming a shift among consumers to cheaper vehicle alternatives. “The limiting factors on the consumer include after tax income growth, which is still below inflation, and will inhibit consumer spending,” he said.
Predictions 2010 to 2012
What can investors expect over the next three years? Els shared the OMIGSA house view for the rand, inflation, interest rates and GDP growth, among others. He says the rand is likely to depreciate against the dollar over the period, ending 2010 at R8.20/$ and falling to R8.80/$ and $9.40/$ over the next two years. “On a trade weighted basis the rand is showing quite a strong improvement, because our fundamentals are so much better than the rest of the world!” he says. Inflation should remain within the Reserve Bank’s 3% to 6% target range with the result interest rates will remain fairly stable too. Inflation drivers are looking a lot better thanks to the strong rand, declining food prices etc. The group expects prime interest to remain at 10% (with a very slight chance of another 50 basis points in May this year) until the first quarter 2011. Thereafter the Reserve Bank will probably tighten monetary policy, hiking rates to end 2011 at 12%. GDP growth is forecast at 3.5% in 2010 accelerating to 4% in 2010 and 2012.
Editor’s thoughts: Rand strength is good for some sectors, bad for others. While investment advisers urge those who can to take part of their rand assets offshore, the rest of us sit waiting for the next spectacular rand collapse. Do you think the rand will repeat its 2001 / 2008 antics by going into freefall against the US dollar and British pound? Add your comment below, or send it to [email protected]
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