Article written by Prieur du Plessis, editor of the Investment Postcards from Cape Town blog.
By Cees Bruggemans, Chief Economist of FNB.
With the dominant global themes still harbouring substantial event risk (Arab World, Europe) even while shifting towards typical cyclical expansion themes (growth and inflation) what can we expect to be the major South African themes of 2011?
I would opt now for three major themes, namely Unbalanced Growth, Resurgent Inflation and Job Market Duality (destruction and creation).
Another risk would be the drying up of capital inflows if South Africa were no longer to be seen as a typical emerging country (too low growth, with legislation uncertainty a rising risk), but that may still only be a low probability event.
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The strong side of our unbalanced growth is a very robust consumption revival and sharp commodity export earnings revival.
In the case of households this is driven by income gains (primarily high real wage gains and social welfare expansion and THIS time NOT mainly credit-assisted).
In the case of government it is driven by political imperatives (a long list of favoured activities progressively gaining the nod as the political cycle advances and the need to do something for an increasingly restive electorate visibly increases).
The combination of very real skill shortages and strong labour union presence creates an environment enabling high real wage demand for insiders and a loss of jobs in mainly general work categories in favour of greater capital deepening (emphasizing productivity gains).
The country’s many social backlogs and other challenges creates increased demand for government involvement and yet higher levels of public spending relative to GDP.
Between them, these private and public pressures support good ongoing income growth and spending potential, ensuring a robust consumption revival only partially dependent on credit access (cars, furniture, clothing doing well but housing less well supported).
In addition, some industrial activities may benefit from the import substitution emphasis inherent in the new industrial policy direction being championed.
The sharp commodity export earnings revival is largely a matter of higher prices reflecting global conditions, although lately mining output volumes have reached pre-2008 levels.
Precious metal prices remains a ‘special’ space for us, given it still large share in our export earnings, with coal exports a natural (though not equivalent) hedge against oil imports. With geopolitical risk lively, we may yet get unexpected surprises from this source.
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The dismal side of our unbalanced growth is anchored in the many structural constraints hampering the economy today (and in too many instances will probably endure for a couple of years, offering headwind to growth, in certain respects severely).
The main areas of constraint are electricity supply, transport infrastructure, credit access and public sector capacity, with overvalued Rand and confidence-undermining rulemaking (mining rights, labour market, immigration) important additional features.
Some of these constitute critical breaks with the past.
The main sectors affected include building trades, construction, property, banking, mining, heavy industry (manufacturing) while other dimensions would include credit-dependent consumption purchases, fixed investment, commodity exports and labour market (job creation).
Electricity supply is not soon expected to regain a safe 15% operational buffer, not during this decade while Eskom is engaging with catching up in electricity supply capacity and not in the following one either when Eskom replacement needs will become critical.
This places a real cap on expansion ability in mining, heavy industry and property development.
Mining commodity exports from distant inland sources are critically dependent on rail infrastructure which so far has largely failed to keep up with the opportunities offered by the global commodity booms of recent decades.
Credit access is being shaped by the National Credit Act, the Basel 11 bank capital requirements and risk pricing, and the new found risk awareness of banks following subprime events overseas.
These new realities don’t prevent lending, but do restrain its growth, at least for the time being as the country adjusts to these new realities, especially in the mortgage area and property development.
Households are expected to increase savings, make a larger own equity contribution, while qualifying less easily for credit.
For some years this may add to property oversupply while restraining demand, causing house values to retreat (in real terms and perhaps even in nominal terms), thereby undermining housing as an investment, further prolonging and deepening the structural adjustment underway.
Reduced technical manpower capacity across the public sector in recent years has affected the ability to sustain infrastructure maintenance, replacement and expansion.
Though the investment-to-GDP ratio has been increased in recent years, its continuation remains in doubt as sustained levels of tendering and project commissioning can apparently not be maintained beyond a certain level.
An overvalued Rand and confidence-undermining rulemaking further erode fixed investment initiative, limiting growth potential.
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Resurgent inflation has various dimensions.
There is a base effect, where annual inflation dropped off in 2010 (relative to a rapidly increasing 2009 base) and may ‘normalise’ again in 2011 towards 5%-6% from 3%.
In addition, there are upside risks.
These are primarily of a commodity nature (imported oil and global agricultural commodity prices). The weaker Rand this year relative to 2H2010 may also allow higher import price pass-through.
Then there is the labour market, with this year and next highly intensive political years, and this expected to be registered in ongoing high wage and salary demands and settlements.
Public sector driven administered prices do not seem subject to inflation targeting constraints, in some instances featuring as new tax bases (electricity, road tolls, fuel levy, airport levies, property developer infrastructure requirements). The new national health insurance scheme could add substantially further to these (price) burdens in the coming decade.
Taken together, inflation is likely to test the upper boundary of the 3%-6% target range in 2012, with global oil prices at present a very special risk.
Its implication for interest rates (up) is obvious, with policy remaining very much anchored in an inflation-targeting approach.
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The downside of our Job Market Duality will likely show itself in the ongoing destruction of lower and middle level formal jobs where economic activity is simply not robust enough to sustain existing manpower levels and/or where such labour can be substituted with technology and capital deepening in response to ongoing high wage and salary demands.
The upside of our Job Market Duality will likely show itself in ongoing expansion of the public sector, absorbing some of the formal labour not finding a home in the private sector, in addition to many schemes implemented to create as much work opportunity as possible at the lower levels of income.
In addition, targeted industrial policy actions may lead in certain instances to labour force expansions at company level.
This uneven progression in labour demand will probably expand the number of total jobs (employment) in the economy in coming years.
Consumption-related sectors can be expected to expand jobs naturally, while sectors hampered by constraints (as discussed) may still shed labour. The public sector will likely be a major initiator of labour absorption across the full spectrum of education and skill sets.
Source: Cees Bruggemans, FNB, February 22, 2011.
Dominant South African themes for 2011 was first posted on February 23, 2011 at 6:00 am.
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