By Cees Bruggemans, Chief Economist FNB

26 July 2010

Following the disruptive global events of 2007-2010, South Africa finds itself today on a new growth trajectory with very specific growth drivers (tailwinds) and many challenges (headwinds).

The rather unique set of circumstances that has lately come into being can be said to have created New Growth Patterns for the economy. The format so created could well remain influential during most of the 2010s decade.

This latest format was created by changed circumstances rather than policy decisions, except for government remaining inclined to adhere to a disciplined set of macro policies with a strong global market orientation.

This format can be expected to remain in place until global circumstances change once again fundamentally and/or different policy preferences become exercised locally.

The External Dimension

Externally, South Africa faces a highly diverse global environment, potentially for many years, as emphasized recently by SARB Governor Marcus in a landmark speech.

Structurally:

• the US hopes to end its role as consumer of last global resort as its households deleverage their balance sheets and the US credit culture changes in favour of greater austerity/abstinence
• China will draw less capital from the West, the Chinese comparative advantage in terms of its cheap labour will lessen as internal pressures increase for higher labour remuneration, and the Chinese currency will probably appreciate (short of becoming a free-floater soon)
• China will probably also invest even more in Africa to safeguard/defend the stability of its commodity supply and prices
• European welfare states are reversing direction, lowering their ideals and reducing their public largesse in an attempt to achieve sustainability

Growth wise this potentially yields

• high growth performers in especially Asia supporting global commodity demand and high prices
• slow growth performers such as Europe stunting the export growth potential of South African manufactures
• slow growth performers with very low inflation in mainly Europe, UK, Japan and America experiencing constrained public finances and maintaining very accommodative monetary policies (low interest rates)
• global asset markets still uncertain, intimidated by the lingering crisis aftermath and its risks even as corporate earnings experience steady revival

Unlike the early 1990s when weak US growth and lowered interest rates coincided with inflationary consequences of German unification and heightened European interest rates, giving rise to brutal and prolonged currency turmoil, or the similarly disturbed 1970s decade, the present global lineup is quite (quite) different.

The US, Europe and Japan, still representing just over half global GDP, are all economically underperforming at near zero inflation while becoming fiscally restrained, necessitating extremely low interest rates for a long length of time.

This favours a steady outflow of their capital in search of better yield in the still much better performing global periphery, now increasingly empowered by its own emerging growth dynamic, and generating trade surpluses.

Thus the developed country capital outflows are being reinforced by emerging country and commodity country trade surpluses as they search for higher yielding peripheral bond, equity and commodity opportunities.

It is a reality that offers South Africa

• firm commodity export prices
• poor demand growth for half its manufactured exports
• generous capital inflows, sufficient to fund a high current account deficit while maintaining a relative firm anti-inflation Rand exchange rate

These sketched conditions in their purest form, as already experienced during 2009 and 1H2010, could possibly last through 2011.

Thereafter, a gradual transition may come into being covering 2012-2016. During this period

• the global peripheral growth experience (led by Asia) may reaccelerate a notch (or two) after recent cyclically slowing
• America may regain growth cruising speed, though with much resource slack only gradually dwindling
• Growth in Europe/Japan may remain relatively subdued though a less overvalued Euro may boost Europe
• Cyclical fiscal adjustment in Europe and US is completed (budget deficits reined in), though with many years of constraint and falling public debt ratios still ahead thereafter
• Fed and ECB follow earlier examples of peripheral central banks and ‘normalise’ their interest rate regimes, though only to half speed (Fedfunds of 3% rather than 5%), with US 10-year bonds in 4% territory and inflation of 1%-2%
• Global equity prices rising throughout, but short of bubble conditions (or policy concern)
• Gradually stronger Dollar, Euro and leading Emerging currencies relative to commodity currencies

This condition could affect South Africa variously

• slightly more export growth potential
• less Rand firmness, but probably only gradually losing ground, also as domestic growth conditions generate higher current account deficits
• more global inflation resurgence via higher commodity import prices and somewhat weaker Rand, making for modestly higher nominal interest rates

The period 2017-2020 (plus), though not devoid of global cyclical tendencies, could see return to full (non-inflationary) resource utilization in America and Europe.

Also, the completion of fiscal retrenchment in Europe, with its welfare state by now a poor shadow of its late 20^th century heyday, but ongoing in the US as long term adjustments there were delayed but are still required.

And a fuller normalization of interest rate policy, with Dollar and Euro supported by higher interest rate regimes (yet held down by unresolved structural issues).

In sum, this external format suggests that South Africa may experience only limited balance of payments pressures for most of this period (aside of any shock surprise events), restrained export growth, easy import funding, good asset market support and modest inflation pressure.

The Internal Dimension

Until internal policy changes the emphasis, South Africa retains a social market framework, with mainly private asset ownership and initiative driving private investment decisions and employment creation.

In contrast, the state is primarily a redistribution engine investing in capital goods (infrastructure) and social goods (education, health, housing, safety) while supporting social welfare extensively to compensate for extreme social inequality.

Whereas the economy exited recession a year ago, and is since then back on a growth trajectory, its vigour differs deeply from the 2004-2007 high prosperity condition of 5.5% average growth.

This has various reasons, which likely will continue to exert headwind influences, keeping growth modest for some years, and potentially below the long-term average rather than above it, maintaining at least to some degree (labour supply) the output gap brought into being by the 2008/2009 recession.

These headwinds include for households:

• a high debt burden, though a manageable debt servicing burden
• low employment growth
• nominal disposable income growth kept down by large permanent public sector tariff transfers
• a more modest speculative and hedonistic appetite initially (2010, 2011) which will likely only heat up again as the economic expansion lengthens, memories of recent bad experiences recede, tax and interest burdens remain non-threatening and asset markets keep reviving.

This profile suggests only a relatively short transition of tempered consumption before more lively responses may again be expected beyond 2011 (2009-2011 being a replay of 1999-2003 without the 2001-2002 Rand and interest rate mini-disruption, though watch China?).

The risk here is that the full household recuperation takes much longer, as was the case during 1999-2003.

Headwinds for private business appear more intimidating:

• a firm Rand and poor growth prospects in key export markets keeping our export growth subdued (cyclical)
• infrastructure constraints (electricity) and higher public tariff charges constraining industrial output gains (temporary)
• fiscal consolidation (budget deficit reduction) meaning higher tax revenue flows being partially sterilized rather than fully ploughed back by high government spending growth (cyclical)
• public sector shortcomings constraining growth in infrastructure and not quite offering the locomotive pull of 2004-2008 (structural)
• slow household consumption take-off, though offering varied experiences. Normalizing of replacement cycle in vehicles, furniture and appliances promising fast growth; oversupply in residential property except for lower incomes promises long indigestion as in 1970s; constrained job growth limiting non-durable spending gains; this in contrast with semi-durable goods and services offering life style gains and doing well, except where price effects are corrosive
• low capacity utilization and the reality check of the 2008/2009 crisis (globally and locally) keeping investment appetite initially subdued (through 2011)

But as with households, business spirits should be lifted by enduring expansion (success), reviving asset markets (gains) and improving capacity utilization (less strain).

Provided there is no mini-disruption as in 2001/2002 extending the initial period of growth modesty, from 2012 onward it may be possible to see more business support for faster growth as memories of 2008/2009 recede.

Despite this ‘early’ change for the better (change of pace) for both households and businesses post-2011 coinciding with a gradual change (normalizing) in global conditions, with the main impact being somewhat weaker Rand (8-10:$ rather than 6-8:$) and higher prime interest rate (11%-13% rather than 9%-11%), the pickup in growth momentum should not become neutralized, for the global growth tide should remain strong throughout the decade as it tries to make up for lost ground (the West) or enjoys robust catch-up growth (Asia), while the domestic growth tide should also remain forceful.

Only shock events or overheating (or both) will eventually check the growth engines globally and locally.

The Overall Condition

After a 1.8% GDP pullback in 2009, the economy may be on course for 3% growth in 2010-2011 (slightly below the 3.5% century long average), but may post-2011 accelerate to slightly above-average growth nearer 4%.

This still implies a wide output gap in 2009-2011, but a more noticeable narrowing beyond it, possibly through 2016, and coinciding with the Western transition to fuller policy normalization.

If nothing interferes (locally or abroad), always a big assumption in an economy already by 2016 over seven years into expansion (only the 1960s and 2000s expansions were longer), we may finally have arrived at the point where renewed outperformance (and overheating) beyond 4% GDP growth becomes a possibility, provided global (windfall) conditions remain accommodative.

The likelihood of this happening is probably small, but it is not negligible, given current global recuperation prospects and our own past experiences. Still, a health warning is in order for events so far out in the future.

If a short burst of GDP growth in the 5% range post-2016 (imitating the mid-1960s and mid-2000s) were to eventuate, however, it would in all probability not reflect a fundamental improvement in growth potential.

No infrastructure, education, labour market or private investment prospects today suggest such exceptional supply side flowering in the second half of the 2010s, decisively breaking the enduring growth mould of a century now past.

But as in the mid-2000s this doesn’t mean that lingering favourable conditions externally and maturing appetites domestically couldn’t ignite anew, driving consumption and investment decisions that could well generate high spending growth, high import gains and be accompanied by fast domestic output growth, good employment and asset market gains.

At least temporarily, of course, as per the earlier examples, for one cannot sustain supply overheating too long before something comes along to pull its plug.

It would presumably be entirely coincidental if during such a three-to-five year period of growth outperformance the country were to be gearing up to host the 2020 Olympics?

Like a sumptuous banquet of ghosts past? But then the future is likely to be full of surprises, this being the real continuation of the past.

Outlook Qualifications

The main external qualifications to another uninterrupted ten to fifteen year economic expansion come from unforeseen future shocks:

• an unexpected major Chinese slowdown (equivalent replay for us of 2000-2002)
• an emerging market asset bubble blowing its top and creating a contagion (replay of 1998-1999)
• another commodity inflation surge inviting a SARB interest rate response, puncturing the expansion (replay of 2006-2008)
• A Western economic and financial relapse (variation of 2008/2009 for us)

The main domestic qualifications come from unforeseen shocks emanating:

• in politics (if disruptive enough, thereby eroding confidence of all role players)
• in policy (jettison of macro prudential policies in favour of greater policy adventurism and/or disruptive changes in micro policies failing to yield good results, including the decisive narrowing of private asset ownership and initiative).

The world has never ceased to generate shock surprises. Our politics remain lively, with the ‘soul’ of the governing party always a target to be captured, and alternative policy preferences favouring currency, trade, interest rate and other interventions remaining current.

As can perhaps be seen from these (many) qualifications, it is actually very difficult to generate an over-aged, outperforming business expansion. But it can be done.

Over to you. And lots of luck, of which we have had so far a very rich legacy (if you don’t count apartheid, the Boer War and the Border Wars these past 300 years but only count the global economic windfalls coming our way these past 200 years).  

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics

By Cees Bruggemans, Chief Economist FNB

26 July 2010

When the world is confronted with fundamental financial flaws and then panics in style, markets show their destructive side as they viciously adjust asset prices lower to reflect the new reality, fear consuming all.

But once the crisis has become well defined, and repair and rescue efforts get mounted, financial markets function as enormous virtuous crucibles.

Millions of fearful, angry, assertive individuals can be found daily absorbing information and debating what has gone wrong, what is being proposed, where the delays are, what new potential mistakes are being made, what ideally should be done, what’s viable and what’s not.

And like at any lively dinner party where no subject is left untouched by an energetic, critical, searching, dissecting multitude, this continuous search for answers and penalizing of officious foolishness assists in bringing clarity while shepherding the rescue efforts in mostly desired directions.

Thus the interplay between policymakers and responding financial markets becomes virtuous, even if on a daily basis the noise levels and periodic sell-offs may create a far more despairing image.

The world has been brought low by two major financial crises these past two years, one focusing on the Anglo-Saxon world and the other on Europe.

It has been fascinating to monitor the interplay between policy rescues and financial market responses, and see the right things being done, one after the other.

As things stand today, we aren’t quite at the end of this process. There remain searching questions, about whether governments can really arrest runaway fiscal conditions, whether central banks can really unwind their huge asset accumulations without accident, and whether global growth recovery can really be sustained through all this, given the fragile global state of mind.

But posing the outstanding challenges in these terms already reflects the fact that fundamental market skepticism is looking for answers which policymakers everywhere are forced to satisfy in good time or become penalized, in essence a very productive partnership.

For the remainder, human creativity and impatience for results are the key ingredients in getting things done.

And so we tend to get positively surprised at nearly every turn once fully into repair mode.

The bigger the noise, the more desperate the questioning, the greater the insecurities, the more the danger of crisis relapses, the more likely we find the right decisions being made alleviating strains in the system.

There remain many very anxious people worldwide still expecting or fearing the worst. A new relapse financially as asset markets implode anew, growth collapses and/or inflation exploding, delivering devastation on the grand scale are some of the things furiously exercising people.

Yet every weakness is addressed in turn, mindsets slowly put to rest, appetite for risk gradually and in fits and starts reawakened and market functionality regained.

Success can’t be guaranteed as a matter of fact, but the way we are organized and personal interest is brought to bear by millions seeking desired outcomes, tends to make for a focus and urgency that delivers consistent results.

The world is well away from the brink and gradually regaining its composure while technically restoring functionality. Throughout it maintains a skeptic mien.

That’s okay if it delivers results. Don’t assume inevitable failure just because anxiety remains in evidence. Just the opposite conclusion should apply.

Nothing is as productive as creative tension.

It is the absence of policy rescues, in the presence of many twiddling thumbs, and a carefree attitude, that one should fear most deeply for what still waits.

None of that applies globally at present as the world keeps anxiously seeking for the right answers to the many crisis questions currently still facing it.

Given time, this will work out, even if the detail often appears mysterious. One should plan accordingly.     

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics

By Cees Bruggemans, Chief Economist FNB

26 July 2010

Risk is a matter of getting things wrong, but not only to the downside. Risk is simply getting a different outcome from the one expected. This does not rule out the upside, no matter how unfashionable that may be at times.

Downside risk is preponderant when things go wrong. It is when one starts to recover from disaster that upside surprises have a way of multiplying as we don’t adjust our collective moroseness fast enough.

After three years of global crisis stations, with the last dragon yet to be slain, preoccupation with the downside has become all pervasive.

It is the one direction all lookouts are focused on. With many remaining doubtful, it prompted Fed chairman Bernanke last week to talk of the times being “unusually uncertain”, thereby pandering to his watching gallery.

Meanwhile no ship lookout is supposed to focus on only one quadrant of the horizon, but regularly do 360 degree sweeps, otherwise running the danger of being blindsided.

Last week gave much food for thought.

It turns out that Germany is having a party, Britain suddenly showed stronger growth well in excess of what was expected, the European bank stress tests showed up anything but stress except in a few insignificant peripheral institutions and US corporate earning results in many instances were excellent and well ahead of expectations (with European company results next).

Such data will not ever prevent the heavy-hearted from still emphasizing the imminent downside.

The Germans are supposedly too dependent on exports. With the US and China slowing down a few notches it is a matter of time before the Germans also slow once again.

Try telling it to the Germans, whose industrialists are rapidly taking their idled labour force members back to full time employment, even apparently wanting to cut short summer holidays in some instances because of rising order books.

British GDP data is notorious for needing later revision. After many quarters of weakness all of a sudden a much more broadbased recovery is lately shining through.

This is also in line with the broader European reality as we move deeper into 3Q2010. Europe is simply performing to the upside at present.

US analysts are quick to point out that since Europe usually lags the US by one or two quarters, the recent US slowing will inevitably show up in Europe ere long, too.

By all means economic data doesn’t move in a straight line, but what we do see is recovery proceeding, with the leaders alternating.

China is not expected to keep on repressing its property sector indefinitely, not wanting too much of an economic slowdown. And in the US the Bernanke sentiments are being interpreted as a growing willingness to do more to bolster flagging growth if that were to prove necessary.

As to European bank tests, the proof will be in the broader market pudding. If there is no recoiling in coming days and weeks, the market signal will be one of acceptance.

Greater transparency about bank exposures, especially to sovereign debt, will have been obtained. It will be up to every individual investor to decide how much risk of renewed recession (and increased bad debt) and sovereign debt default (and resulting haircuts) really need to be discounted.

Don’t be surprised if markets prove increasingly willing NOT to discount a recession relapse or hairy haircuts. The whole exercise was about confidence and dispelling rumour. Merely creating a different view on reality may then shift perception.

Not for the diehard skeptic but for the broader market.

The underlying corporate condition may be most important for equities with US companies already back to their all time high pre-crisis earnings levels, and the business expansion still so very young.

With many global corporates increasingly cash rich, surprise risk is certainly building but it is not on the downside. As defensiveness wanes, payout surprise lurks on the upside, as do increased investment and hiring surprises.

As to bond markets, their focus remains on governments (and growth), in the manner fiscal deficits are reined in and spiraling debt eventually stabilized.

It isn’t only Greece that is fulfilling its promises to the letter, with its budget deficit so far this year already over 40% down on a year ago. German fiscal deficit projections are being favourably revised (with projected deficits steadily evaporating as growth and policy action make themselves felt). More such surprises can be expected elsewhere, too.

After three years of increasingly fearing downside outcomes the world is now instead being blindsided by more and more upside surprise. Global repair is well in hand and advancing as scheduled.

Financial markets reflect this pleasant turn of events by regaining their risk appetite. Though safe havens remain popular for many, and continue attracting large inflows, we can still observe the global risk tide turning.

Prematurely, some will claim. Possibly not, going by the nature of the surprises now shaping.

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics 

By Cees Bruggemans, Chief Economist FNB

28 June 2010

After gaining 22% on real trade-weighted this past year, from undervalued to overvalued, the Rand is not going to stand still during 2010-2013.

But what will it be, feast or famine, and in what order?

It doesn’t help the order of battle keeps changing, making it difficult to foresee the next move.

Only recently the Euro was a bastion of strength, the US consciously favouring a weaker Dollar through low interest rates and bond buying.

This was Rand supportive, drifting back nearer 7:$.

Then the Eurozone proved to have inherent flows. Not only was Club Med Europe debt distressed, but some European banks also proved vulnerable.

The whole European Project became deeply questioned, something many skeptics had in any case done from the beginning, claiming you can’t have a monetary union without a political/fiscal one, while the various European regions were also structurally unfit to be joined together.

Down plunged the Euro, with the associated loss of risk appetite reinvigorating safe havens, especially US bonds. Up went the Dollar.

Sterling suffered as its fiscal deficit reached wartime levels, with growth undermined.

Since 3Q2009 the Rand became largely directionless against the Dollar in 7.20-7.80 territory.

In contrast, the Rand’s ascent against Sterling and Euro continued, reaching 10.90 and 9.25 respectively.

Meanwhile, US attempts to get successful Asia to revalue had come to a standstill in mid-2008 when global shock first reached full intensity.

After much criticism and successful crisis exit in 2009, something the Euro troubles apparently did not ultimately jeopardize in Chinese eyes, Yuan ‘floating’ resumed very slowly from this month, taking much of Asia with it.

For the Rand this means minor downward adjustment against Asian currencies, also in coming months.

Going forward, a number of propositions offer themselves regarding Euro and Dollar.

Though the US seems institutionally the more stable story at present (banks sorted out, growth reviving if already moderating), it isn’t as if Europe is necessarily going to be a sinkhole forever, though optimists and pessimists differ.

It creates a simple two-step scenario proposition.

The Euro could have more downside shortly if its troubles have further to run (distressed countries, insolvent banks, doubtful ECB, squabbling politicians disagreeing on fiscal and structural growth-oriented reforms).

In that case expect to move near Dollar/Euro parity and Rand/Euro nearer 7.50-8.50.

If European reform advances well, with further cleanups of banks and countries successfully undertaken, the right political decisions and European growth not falling away completely (with renewed relapse into recession averted), the Euro need not sink much further.

With interest rates low in both US and Europe, and liquidity support remaining high through next year, this could favour renewed global risk appetite, capital flows into emerging markets and higher commodity prices.

Further Rand firming could reach 6-7:$ and 8-9:€.

If, however, this transitional period witnessed much uncertainty because of unresolved crisis issues (sovereign debt haircuts, bank defaults, growth relapse), the resulting “strapless bra” (suspended animation) condition might continue, keeping safe havens (US, Germany) fashionable and global risk appetite subdued.

This could keep Rand directionless near 7-8:$ and 9-10:€.

If a new crisis were still to erupt with full force, with the BoE suggesting a European sovereign debt default potentially offering a Lehman moment, revisiting the hell of 4Q2008, the Rand could be subjected to sudden capital reversals and massive decline against Dollar and Euro towards 11-15.

That would probably result in (temporary) higher interest rates for us (replaying 2002).

But if a crisis doesn’t erupt, the world will eventually approach crisis ending and start of policy normalization in major countries.

If the Fed were to start earlier (late 2011 or early 2012), it could mean the Dollar to restart for higher levels from 2H2011 onward.

If worth +10%, it could lead to the Rand topping 8:$ in 2012 and 9:$ in 2013.

The ECB won’t necessarily lag the Fed that much, depending on European reforms and how much the US growth story really leads.

Still, the Rand could top 10:€ by 2012 and more by 2013 if things work out.

Except that throughout such Fed/ECB policy normalization global growth should be performing adequately, commodity prices should be zippy, and capital flows may continue favouring higher risk appetite.

That could keep the Rand firm-like even into 2013.

The wildcard option is for our policymakers to shift fundamentally, favouring a weaker Rand.

Many things could happen here, none of it clearcut. It is for now an outside chance but feeds Rand uncertainty.

In summary, when discounting another global crisis or a major domestic policy shift as low-probability tail risk for now, current prospects suggest continuation of Rand/Dollar for 2010 at 7-8 and Rand/Euro at 9-10 (the global ‘strapless bra’ condition continuing).

Some Rand firming is still possible into 2011, followed by mild easing in 2012-2013, but makes for relatively narrow trading ranges of 7-9 Rand/Dollar and 9-11 Rand/Euro.

Only shortly ending the global ‘strapless bra’ condition could rocket the Rand firmer, while shock events or policy shift could plunge the Rand weaker.  

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics