Shock decline has minimal immediate impact on markets
South Africa’s economy contracted in the fourth quarter of 2022, which was no surprise given the debilitating impact that intensifying load shedding had on day-to-day life. Yet it was the extent of the contraction relative to the -0.7% to +0.6% consensus forecast range (based on the ever-shrinking Bloomberg poll) that was the shock to analysts. The markets were unperturbed with only minor weakness in the rand and a few basis points declines in rates. Despite ending on such a low note, full year GDP growth still came in at 2.0%, which is above trend GDP growth.
This highlights the significant impact the first quarter number has on full-year growth. Recall that 1Q22 GDP growth of 1.9% was a notable upside surprise versus the consensus median of 1.2%. This strong start to the year provided a buffer to the Q2 and Q4 contractions.
Yet this means that growing in 2023 will be tough going as it is widely expected that there will be sequential contraction in 1Q23, again due to load shedding.
Exports and inventories introduce quarter-to-quarter volatility
On the production side, the weakness was broad based with only transport, storage and communications (TSC), construction, and personal services expanding in Q4. Despite the weaker production, inventory levels still rose, by R29.5bn in real seasonally adjusted and annualised (saa) terms, driven by the mining, manufacturing, and trade sectors. This reflects a combination of 1) weaker global demand, 2) an unexpected domestic inventory build despite reasonable domestic demand, and 3) the Transnet strike in October, which very likely limited exports.
Yet even though inventory levels were higher, the contribution to GDP growth, which is a flow and not a stock measure, was negative given that it was smaller than the R69.5bn inventory build in Q3. Whereas the change in in inventories contributed 0.7 percentage points (ppt) to growth in 3Q22, it detracted 0.9ppt in Q4. Similarly, net exports contributed 1.0ppt in Q3 only to take off 1.1ppt in Q4.
This highlights that there is often notable volatility underlying the GDP data from one quarter the next.
Underlying momentum looked a bit better, with improved growth quality
The positive aspects within this latest data set are that fixed investment and household consumption expenditure were stronger than expected.
Household consumption was less defensive, i.e. there was reasonable spending on restaurants and hotels, furniture and appliances, and clothing and footwear. Some of this may have been driven by the ongoing recovery in inbound tourism. The caveat is of course that inflation persistence globally could continue to depress real income growth and so the ability of people to travel. Yet this may be offset by the relative cheapness of the rand and SA as a tourist destination.
Within fixed investment, the outstanding driver was a large increase in transport equipment, but machinery, non-residential buildings, and construction works also expanded. The latter two accounted for the positive surprise in construction on the production side.
As such, we would argue that the quality of growth in Q4 was better than in Q3 given that final domestic demand recovered from -0.1% in Q3 to +0.7% in Q4, with the swings and roundabouts in inventories and net exports causing the volatility. In addition, there is potential upside for GDP growth in the medium term from renewables and solar investment.
No obvious inflation threats in Q4, but load shedding a risk
Yet we would not get ahead of ourselves as profit growth slowed from 13.3% in Q3 to 8.8% in Q4, based on the gross operating surplus. On a calendar year basis, this is a moderation from 15.3% in 2022 to 8.4% in 2023, and aligns with the rollover in the terms of trade.
Compensation growth eased from 5.1% to 4.1%, despite headlines about wage settlements well in excess of inflation. This suggests that in the bulk of the private sector labour pricing power is still relatively subdued, particularly for middle to lower skill levels. In addition, the fact that National Treasury is still holding the line on the wage bill is also contributing to dampening pay growth.
Although GDP inflation and unit labour cost growth picked up, they are not at levels that would necessarily drive consumer price inflation higher. However, here too there are numerous caveats. One of the primary risks (and debates) is about the inflation effects of load shedding. While load shedding may ultimately be disinflationary via job cuts and weaker demand, the short- to medium-term impact is likely to be inflationary. Businesses need to invest more in independent power production (generators and solar), higher running costs (in the case of generators), and potentially being forced to pay employees despite inactivity due to power cuts or to pay them overtime to make up for lost production. This is probably in part what drove food prices sharply higher in January. In addition, this type of investment is import-intensive and with the rand relatively weak, businesses may try to recoup some of this fixed investment cost in selling prices over time.
SARB to stay hawkish despite backward-looking weakness
The contraction should result in a wider, i.e. more negative output gap, which would lower the South African Reserve Bank’s (SARB’s) policy rate projection deterministically in its model. Yet, with the data already three months old, the SARB will more than likely focus on the outlook and the inflation implications of the underlying dynamics. On this front, it would seem that near-term stickiness in inflation should keep the SARB on the hawkish side until disinflation becomes more pronounced during 2Q23.
Importantly, the US Federal Reserve still sets the base level for global interest rates. With a tight labour market and sticky inflation, a higher terminal rate in the US would make it difficult for the SARB to call the all clear on policy tightening now.