Positive structural SA economic outlook still in tact

Although the economic risks to global and local financial markets have increased significantly during the first half of this year, the SA economy is still on track to experience a "back to the sixties" structural economic environment of low and steady inflation and solid economic growth, says Old Mutual Asset Managers chief economist Rian le Roux.

Le Roux notes that this outlook does not count out the possibility of a short-term cycle of higher interest rates and lower growth. "Global developments have raised the question of whether the outlook for SA is in the process of turning considerably less rosy. In our view none of the supporting pillars to our long-held optimistic structural outlook for SA have changed fundamentally."

These three pillars are: a healthy global economy characterised by strong growth and structurally well supported commodity prices; an end to the painful growth-inhibiting structural economic adjustment that took place post-1994 and significant policy support for growth.

Le Roux says on the global front policymakers do face a daunting task of blunting inflation risks through policy tightening, without causing a sharp global downturn. "However, even though the risks that things could go wrong have risen, we remain confident that the present global expansion will continue into 2007, albeit at a more moderate pace than has been the case for the past few years."

He adds that in order for the relatively comfortable global environment to remain in place in the medium-term, a slowdown in global activity will be required during the months ahead to stave off potential inflation pressures arising from stronger-than-expected world growth and higher oil prices.

In SA, growth has become increasingly unbalanced as domestic demand has continued to boom and a strong rand has weighed on producers, particularly exporters. Le Roux notes that this showed up strongly in a significant further widening in the current account deficit during the first quarter. "While the deficit has so far been adequately covered by capital inflows, the sudden weakening in the rand towards mid-year served as a timely reminder of the inherent risks to the currency of running such a large deficit."

Though he believes it is questionable whether the extent of the currency and interest rate adjustment to date is sufficient to meaningfully improve the foreign trade shortfall, he advises guarding against becoming to pessimistic about the current account situation: "With SA firmly back in the international arena, our economic fundamentals generally healthy and the economy growing at a fairly robust pace, we should be able to continue to attract fairly sizeable amounts of capital inflows."

On the domestic inflation and monetary policy front, Le Roux says "there can be no denying that the forward-looking inflation risks have increased." But he does not expect inflation excluding mortgages (CPIX) to breach the top end of the inflation target range for the foreseeable future, as long as the rand and oil price at least stabilise at current levels.

He says the extent to which interest rates are likely to rise further depends largely on global developments, especially how far and how fast global central banks raise rates during the second half of the year. "While we remain optimistic that a repeat of the previous strong up cycles in local rates can be avoided, the risk that it may not must be factored in by investors, businesses and consumers."

Given the increased uncertainty, he says consumers are well advised to lower their reliance on credit-based spending, warning: "Indebted consumers may be hard hit should a more vicious interest rate cycle materialise than is currently expected."

He concludes that although a short-term setback, with higher interest rates and some growth slowdown, is not out of the question, this could well reinforce a medium- to long-term positive outlook for the economy because "an early strike against inflation may go a long way in keeping inflation in check at the lower levels of recent years, while a softer rand is also welcome from a longer-term growth perspective."