Despite risks, this is not 2008, policymakers responsible for volatility

While the number of risks currently dogging global markets makes it wise to be cautious when selecting investments, there are some signs that suggest that things, while tenuous, may not be quite as bad as they appear to be.

According to Johann Els, economist at Old Mutual Investment Group SA (OMIGSA), much of the recent market volatility is the consequence of policy errors o­n the part of politicians - mainly in Europe and the USA - as actual data do not yet signal a recession.

‘While we believe that the most likely scenario to play out o­n the world stage is o­ne of continued slow growth, the actions of policymakers have caused a sharp increase in uncertainty around the world, badly denting business and consumer confidence, and therefore spending. This impact o­n spending, combined with the negative wealth effect of recent market moves, could actually tip the world into recession,’ says Els.

‘While we don’t think a global recession is likely, it seems as if the markets are pessimistically already pricing this in.’

When laying the current uncertainty squarely at the feet of policymakers, he reasons, ‘The easing of earlier drags such as the effects of the unrest in the Middle East and North Africa (MENA), the oil price surge, the Japanese Tsunami and policy tightening in emerging markets should be having a positive impact o­n the global economy.’

Looking into the near future, it now seems likely that the Eurozone will experience a recession – although we do not expect it to be as deep as the 2008/2009 recession. But this alone will not be enough to effect a global recession; it would take a twin plummet o­n both sides of the Atlantic to trigger that. And Els does not believe that the USA will suffer the same fate. ‘The American private sector has been cautious; profits are still strong and corporates have not overextended themselves in terms of spending o­n employment or fixed investment. So, even if the US does move into a recession, it will likely be mild,’ he says.

This, coupled with still-robust emerging market growth, means that even with Europe in a mild recession, the world as a whole should continue o­n its slow journey of recovery.

The implications of these conditions are that developed world economies are likely to maintain expansionary monetary policies for longer, and will continue to underperform developing countries. This will maintain the attractive interest rate differentials in developing countries, lending further support to developing country currencies at the expense of the euro and US dollar – at least o­nce volatility eases.

Back home, says Els, South Africa’s growth has slowed in quarters two and three of 2011, buffeted by the global woes previously mentioned, but in spite of these headwinds, the local economy still managed to trudge slowly up. He explains, ‘While consumer spending has been the major driver behind positive GDP growth in this recovery, there are worries that consumers will cut back as rising inflation eats away at their after tax income. In addition, credit growth is still muted. This means that there is a risk that consumer spending growth will come under pressure. In addition, fixed investment growth – both public and private sector – has remained very slow. Thus we expect GDP growth of around 3% this year and next.’

More recently the rand, the strength of which had previously shielded SA inflation from the full impact of global events, has come off a bit. ‘But,’ points out Els, ‘it is important to note that this is not a reaction to local factors, as conditions at home actually favour a stable currency; the weakness is due to generalised global risk aversion o­n the back of the Eurozone debt crisis, and the inability of politicians to sustainably address it.’

He says that if the rand stabilises, inflation will still peak slightly above the upper end of the inflation target of 6%. However, in the current global environment, the central bank is more concerned about the real economy than inflation, and therefore interest rates will probably not rise before the third quarter of 2012.

‘There is a very real possibility that rates could actually stay flat throughout the cycle. There is also a risk that the bank could actually cut rates if the real economy performs worse than expected. We would not support such a move,’ he opines.

But given the fact that SA still has a huge growth deficit when compared to BRIC countries, what will help to lift us out of the current inertia?

Referring to the latest World Economic Forum’s Global Competitiveness Index,which ranked SA 50 out of 142 countries, Els believes that it is vital that government addresses the systemic issues that hinder our competitiveness. ‘To increase SA’s rankings,’ he says, ‘we need to address issues such as infrastructure, our labour policies and service delivery. In short we need to foster a more business friendly environment.’

‘Other critical issues are education and inflation,’ he says. ‘Education is quite obviously a sustainability issue without which all the efforts of today will be fruitless; while inflation is the monster that threatens to erode the savings and investments of an entire nation.’