The state of the SA economy – reading the tea leaves and providing a recipe for a stronger reviving brew
The trend in retail sales volumes in 2015, now updated to May, help confirm that the SA economic engine is stuck in a slow growth gear of between 2% and 2.5% a year. Year on year retail inflation is also fairly stable between 4% and 5%.
Our Hard Number Index (HNI) of SA economic activity, based on new vehicle sales and cash issued by the Reserve Bank, adjusted for consumer prices, updated to the June month end, indicates a very similar pattern to that of retail, a pattern of slow growth. This is predicted to continue for the next 12 months at its current very pedestrian pace. We add the Reserve Bank Co-incident Business Cycle Indicator, based on 12 economic time series, for comparison, also smoothed and extrapolated beyond March 2015, the latest data point for this series. All of these indicators of reveal similar trends and cyclical turning points that provide very little sense of a cyclical upswing. The HNI shows up as a very reliable leading indicator of retail volumes and the more broadly measured business cycle.
It may be of some consolation that the indicators still predict some positive growth, though higher interest rates, if imposed by the Reserve Bank, may threaten even these predictions of slow growth. There is no suggestion that spending growth is about to pick up to add to inflationary pressures that are almost entirely the result of higher taxes on fuel and energy and municipal services generally.
The series for import and export prices to March 2015 suggest deflation rather than inflation emanating from the balance of payments and the exchange rate. The rand is weaker against the US dollar but stronger against the euro and only marginally weaker on a trade weighted basis compared to a year ago. Import or export prices (measured by the export or import deflator) were lower in Q1 2015 than they were a year before and so are not adding pressure to SA inflation rates: nor is domestic spending. The tax increases and the drought in the maize belt that have pushed the CPI temporarily higher, will not respond favourably to higher interest rates that the Reserve Bank seems intent on imposing on a highly fragile economy.
The case for raising short term interest rates in these circumstances is, in our judgment. a very poor one. It is certain only to further depress domestic spending without promising to have any predictably favourable influence on inflation or inflation expected over the next 12 – 18 months. As we will show SA needs lower rather than higher interest rates if it is to escape from slow growth forever.
The question the Reserve Bank should be considering – as should all those with responsibility for economic policy – is how can the economy hope to break out of this seemingly indefinite prospect of slow growth? Ideally it would be increased exports that lead the economy to faster growth. But exports from SA will be constrained by the weakness in metal and mineral prices associated with slow global growth and the fact that global supplies of metals have caught up with the extra demand that came from China in the boom years before 2008, though as we have seen recently, merely keeping the factories and mines working rather than shut down through strike action can help to add to exports and employment and incomes.
Stimulus from government spending has also run its course – it was ended by rising government debt and interest payments and threats to credit ratings accompanying these adverse trends. Increased duties on fuel and energy as well as higher income tax rates are not only adding to inflation- they are an extra burden on household budgets. And to look to the capital expenditure programmes of publicly owned corporations to lift the economy, as was the official case made a few years ago, would seem only to court further disaster. The clear reluctance of private business to invest more in their SA operations will continue until their capacity to produce more is challenged by increased demands form their customers. Private businesses in Q1 2015 reduced their capital expenditure and their payrolls.
The essential condition for any step up in SA growth rates is an increased willingness of households to spend and borrow more. Household spending accounts for about 60% of all spending and without encouragement for the rest of the economy from the household sector (encouragement now clearly lacking), the economy will not grow faster. How then could this come about? A look back at how the economy managed to grow much faster between 2003 and 2008 may be instructive.
In figure 3 below we show how spending in 2008 collapsed as retail prices rose sharply after the rand weakened in response to the Global Financial Crisis. Notice also the extraordinary growth in retail volumes between 2003 and 2007 as retail inflation subsided. Inflation subsided then as the rand strengthened and lower interest rates followed lower inflation so stimulating consumption spending further. Bank lending, as mentioned (particularly mortgage lending to households), grew even faster than consumption spending, so providing strong support for the spending intentions of households.
At the peak of the growth cycle in mid 2006, bank lending to the private sector was 26% up on a year before and mortgage lending had grown by about 30% on a year before. The value of residences owned by households increased by an average 21% a year between 2003 and 2007, adding significantly to the willingness of households to borrow and spend and banks to lend to them on the security of rising house prices. See figure 5 below that illustrates these housing and household wealth effects.
SA spending grew faster than output between 2003 and 2008 and the current account went into deficit, having remained in balance throughout the slow growth years that preceded the boom. Foreign capital more than made up the shortfall in domestic savings. The boom in spending and growth between 2003 and 2008 could not have continued without support from foreign capital that proved very forthcoming.
This helps make an essential point: growth improves returns on capital and attracts additional savings from all sources, domestic and foreign, to fund faster growth and benefit from higher returns on capital invested. Slow growth repels capital because expected returns fall away. The limits to spending and growth are set by the supply of savings from domestic and foreign sources. But to attract capital, conditions for it need to be attractive. Expected growth rather than stagnation or worse is the essential lure for capital.
If the economy were to grow faster in response to a pick-up in household spending, the lack of domestic savings might prove a constraint, should foreign capital not be fully forthcoming. If this were to happen, the rand would come under pressure and higher inflation would then call for higher interest rates – trends that would in turn inhibit any incipient recovery in household spending.
The point to be recognised is that unless the economy asks for more foreign capital the answer as to how much would be made available, only time and evidence would be able to tell. But there would be no point in inhibiting any recovery in household spending for fear that it might soon run into the sands. Entry into a virtuous circle of something like the 2003-2007 episode of faster growth will hopefully be attempted sometime in the not too distant future and would have to be led by faster growth in household spending. South Africans can only hope for the chance to test the market for capital to fund our growth.
One positive influence on spending will be the improved state of household balance sheets. The household ratios of debts to assets have declined – helped by a recent improvement in the value of houses, which are up by about 10%.
Lower, not higher short term and mortgage interest rates, would be helpful to this end. A recovery in the prospects for emerging equity and bond markets that have underperformed developed markets since 2011 would be very helpful indeed. The rand would attract a share of additional flows into emerging markets and so help add strength to its value, improve the outlook for lower inflation and lower interest rates. In other words, 2003-2007 reprised. We live in hope for more favourable tail winds from off shore.
But there is much South Africa could do to improve its economic prospects and its attractions to foreign capital, which are essential to any attempt to lift growth rates. They come under the broad rubric of reducing the risks of investing in SA business. Planning for more competitive labour and energy markets (less power to the unions and privatisation of generating capacity very much included) would go a long way to raising the bar for the SA economy and attracting capital to the all-important purpose of faster growth in incomes.