By Cees Bruggemans, Chief Economist FNB.
After a great fall (2008), success in arresting the fall and stabilizing the economy on a low level of capacity utilization (2009), growth prospects tend to be very promising as slack resources as well as new inputs will be available to be put to work. Demand needs to grow in order to put such available resources to work.
Potentially this will be so for years to come (2010-2020) as any new supply imbalances eventually ending the next growth expansion (balance of payments, inflation) could remain manageable for the time being.
This, in a nutshell, is the case for growth.
It then gets better, but it also gets worse. For the global environment looks even better than this simple base case, offering piggyback opportunities for small open economies like ourselves.
This very favourable global environment, however, may also prove to offer a too rich diet of windfalls, something we may have difficulty in digesting. If simultaneously we create a few headwinds of our own making domestically, there may yet be major hurdles to get the growth engine fully back on the road.
Thus the base case for growth is a simple one (picking yourself up after a great fall), and the global outlook potentially further underwrites this by promising to be very accommodating. Yet one places footnotes, externally and domestically, as to the hurdles we may face in fully realising our growth potential.
The Global Outlook
It is with great difficulty that one leaves the Great Financial Crisis of 2007-2008 behind. It is like abandoning a favourite child, a most unnatural act. The reason is again simple. So intense was the shock experience of being taking to the edge of ruin globally that few of those intimately involved in these events can quite forget all the emotions and preoccupations that dominated daily life during this intense period.
Also the sense of risk deepened to a degree that one now tends to see danger everywhere, ready to strike anew at any time, making for sharpened awareness and an endless questioning of the road being traveled, even when it is quite safe to do so.
Once bitten, twice shy. This sensation will be with us for some time, probably for many years. This could be unhealthy in that it may inhibit risk-taking, but it can be extremely healthy as insurance against excesses for the time being.
What the global environment offers us today, therefore, is a rich mixture of opportunity and risk awareness (mainly in the rich Western industrialized countries).
Simultaneously, the emerging East (and other Latino and East-European hangers-on, including many dispersed commodity producers) show evidence of aggressive long-run growth stories, impatiently determined to catch-up with the leading global edge, and wanting to do so in two or three generations (one lifetime, start to finish, in many cases after a century of preparation or centuries of dormancy).
This creates a rather explosive global growth prospect for this coming decade. With America, Europe and Japan at low levels of resource use, in the West now at over 10% unemployment where 4%-5% would do, popular democracy and technical expertise will not allow such waste of resource opportunity to linger for any length of time.
Thus the push to restore demand levels and get economies back towards fuller resource use, even if the recession has lowered potential growth levels (and growth rates), in terms of spare capacities written off, skills lost and working experience no longer relevant as economies have changed their resource demands, at least in parts.
The true measure of this historic opportunity, however, is the US economy’s ability to reabsorb unemployed labour even after a traumatic wrenching change as incurred these past two years. So that remains the objective: full employment or bust! It may sound somewhat unworldly, but that is how they do things over there. And it tends to shape the rest of the world in turn.
Politically, America has used up most of its fiscal space to support failed banks and to give its economy demand support. Indeed, its political agenda will need to be more fully occupied in coming years with domestic choices regarding social provisioning (medical, social security).
Though there will still be extended US fiscal support through 2011-2012 (such as extended unemployment benefits and postponed ending of the Bush tax cuts), this reality surrenders the short-term management of the US economy mostly to the Federal Reserve and the way it flexibly manages monetary policy, primarily interest rates and the provisioning of liquidity.
Besides a major fiscal push (the $787bn emergency package of 2009-2010 and any extensions) and the ongoing Fed ministrations in terms of 0% interest rates and a tripled Fed balance sheet providing emergency liquidity to the US economy, there is the contribution to be extracted from the rest of the world.
This is done by way of a somewhat cheaper Dollar, and the much greater exertions in many other countries in pushing internal demand from pure self-interest, greatly reducing (though probably not quite ending) the role of US households as global consumer of last resort.
Many countries are being forced by circumstance to do more themselves to balance their internal demand absorption with their growing output abilities (seeing that the US consumer will not be quite there for them for some time, if not forever).
Thus the world is embarked on many ambitious agendas.
Firstly, getting the global show back on the road while simultaneously also getting global imbalances reduced (as much by regulating banks more as getting peripheral producers to save less and consume more while Anglo-Saxons attempt to do the opposite).
Secondly, there will follow the eventual normalization of policy everywhere, a very uneven business, as much between countries (some leading, others lagging) as between policy stances (fiscal policy leading, also liquidity provisioning, with interest rate policy in many instances lagging, with currency adjustments throughout).
One important trick is not to get lost among this veritable forest of moving trees being uprooted and seemingly embarked on their own individual journeys. There is a bigger picture and it is a coherent one.
Meanwhile, it isn’t only the Anglo-Saxons (or Chinese) who are still proactive in maintaining large fiscal emergency packages and quantitative easing.
Germany last week announced what amounted to its third fiscal support package, some $34bn of tax cuts annually for four years (through 2013), mostly skewed to the corporate sector, in particular to assist with its trade competitiveness.
Also, this decision seems to meet many political agendas. It was a demand from the FDP as part of its coalition talks with Chancellor Merkel’s CDU. And it meets the American demand that Germany does more, with Chancellor Merkel remarking to her local audience that ’save, save, save’ won’t get them anywhere in the present global situation. So more demand push is apparently needed, even as Germany is already leading Europe out of recession since 2Q2009.
Lastly, this latest Merkel change-of-heart reminds of US Republicans such as President Reagan who in the early 1980s first cut taxes to the bone, thereby creating Congressional urgency to rein in spending in order to contain the looming budget deficits. George Bush the Younger tried something similar in the early 2000s, but it was really the faster GDP growth post-2002 that reduced his budget deficits.
Chancellor Merkel had already boosted Germany’s budget deficit by her earlier support actions, but this latest initiative will really boost the German budget deficit. Many political players sense that this will lead to social spending reforms and cutbacks soon (something Chancellor Merkel favoured back in 2005 but did not succeed in pushing through).
Meanwhile Europe is getting another fiscal shot in the arm even as the ECB, like the Fed, is probably not finished yet in remaining accommodative (though the ECB making careful noises about ending its emergency liquidity provisioning next year, wanting to wean its financial system off such artificial supports as soon as is feasible).
The major central banks will not remain totally aggressive indefinitely. Quantitative easing (bond buying) will probably start tailing off in 1H2010, with central bank balance sheets starting a long gradual shrinkage.
But that is advisable as financial markets are functional again, with less need for such extra bond demand. As to the macro situation of these economies, growth may have resumed from mid-2009, but output gaps of 5% of GDP and still falling core inflation (approaching zero in the coming year), with five and ten year market expectations of 2%-2.5% inflation, indicates the need for major central banks to maintain 0%-1% interest rates, at least through 2010, after which rate ‘normalisation’ will be a function of economic circumstances.
Such super low interest rates minimizes safe haven yields and wets risk-taking appetite, reshaping asset markets and thereby creating economic impulses. This constitutes the monetary transmission channel through which one can get economies to outperform above potential and shrink their output gaps.
It pushes money from cash into other assets. Because of lingering uncertainty among many investors regarding future shocks, the great investment favourite of the moment remains bonds (at very low yields). Beyond that loom equities, whose relative returns are increasingly promising in the US (and Europe), with the emerging world promising by far the higher growth potential.
Thus the global centre is pushing liquidity out towards high potential periphery destinations, while these are pulling such cash in through their own attractiveness. This push-pull force gets further reinforced by periphery central banks (Israel, Aussie, Norway already, with India, Turkey next) gradually now raising their interest rates, increasing their yield differential with the global centre.
This makes for EM currency appreciation and also higher commodity prices as the Dollar dips lower, further enhancing the attraction of commodity producers yet more, already favoured by increasing export prospects, given the favourable Asian growth outlook.
With Western governments taking between four and eight years to gradually reduce their fiscal emergency packages back to pre-crisis mode, and the major central banks probably taking a similar period to fully restore policy normalization as output gaps are fully shrunk, the world economy is probably looking at a full decade (or more) of uninterrupted (if variable) expansion, starting mid-2009.
The Best Part (95%) of this long global expansion is therefore probably still to come. Makes you think?
South Africa
South Africa had a relative ‘good’ crisis-cum-recession, as our banks were not in any way contaminated by global events and our GDP dropped by ‘only’ about 1.5% to 2% in 2009 compared to the horror stories observable in America, Britain, Europe and Japan, with many of their major banks effectively bankrupt and their GDP shrinking by between 3% and 6% in 2009.
Yet our recovery seems to be late and lethargic, even as our 4Q2008 industrial collapse was in tandem with the world and did not go beyond the global parameters.
Part explanation may be that we were already in the grip of a much longer recessionary workout prior to the 4Q2008 global financial hit, as electricity shortages, commodity inflation surges and a two-year interest rate tightening cycle left their imprint on 2007-2008.
Also, the Government had already imposed a new National Credit Act from mid-2007, aimed to get banks to be more circumspect in granting credit. This new credit culture was cyclically reinforced by the recessionary conditions of 2H2008 and 1H2009, further aggressively boosted structurally by the global financial hiccup and its perceived subprime origins, and yet further topped off by a standoffish attitude among South African households to new debt, once all these other factors had bitten deep.
Besides all this, there was also a political variety show playing out domestically, with many bit actors, each reinforcing a greater theme, engendering anything but positivism in a mostly wary and weary audience, seeing performance going out of the window, inefficiencies rising, fairness often a victim of good intentions and tax burdens probably also eventually rising as everything costs money. Not something to ease domestic uncertainties among those that save and do most of the investing.
While this was playing domestically, the global condition channeled R70bn of new portfolio capital our way, together with other sources of finance more than adequately funding our shrinking current account deficit, in the process firming the Rand from 10:$ to near 7:$.
And this in only a relatively short period of six months during which the JSE All Share Index recovered by 50%.
It offered a glimpse of the riches potentially available to us as the world economy proceeds along its new growth trajectory, ably assisted along the way by governments and central bank support.
As in the course of 2009 industrial markers started to signal the end of our recession and signaled the start of recovery, we had to discover that we weren’t coming out of our dip all that fast.
Non-gold mining output had shrunk by a quarter in 4Q2008, but had only recovered 6% from its low by August. Manufacturing output had shrunk 15% but had recovered nothing, with the Kagiso PMI for September at 47 still short of the magic 50.
Retail conditions remained submerged, and new passenger car sales stabilized at half their peak monthly level of mid-2006. Building trades were in deep recession, and construction activity was tailing off slowly due to public sector funding problems and project decision holdups, even if activity was still at very high levels.
So a business recovery was imminent, going by the rising SARB leading indicator, probably active from 4Q2009, but it looked like slow going indeed, with the Minister of Finance projecting only 1.5% growth next year (whereas our 90-year average has been 3.5% annually).
One observes various tailwinds ending recession and supporting recovery:
• inventory destocking ending
• global industrial and trade collapse reversing
• strong global policy support for cyclical recovery
• our own fiscal stance swinging from a 1.5% of GDP surplus to 7.6% of GDP deficit over two years
• SARB monetary interest rate easing of 500 points between December 2008 and September 2009, prime interest rate easing from 15.5% to 10.5%.
These are all major supports that should right any faltering economy. Yet one can also observe various headwinds, however, to our local economic recovery:
• constrained credit access and higher effective cost of credit as charged by banks and retailers
• firm Rand approaching overvalued territory below 7.50:$
• key foreign export markets alsostill doing relatively poorly and only recovering slowly
• low business and consumer confidence, especially regarding fixed investment decisions and the willingness to buy durable consumer goods.
As we enter 2010, we have the promise of the World Cup Soccer lifting our economic prospects, but a firm Rand on the back of global tendencies, restrained domestic credit appetite and fragile confidence may tend to hold back important parts of spending and output, making for only a slow cyclical growth take-off.
The pace should improve somewhat beyond 2010, but one can see how we will battle externally with too much of a capital inflow and firming Rand, while at home we may be held back by credit restraint and confidence issues, limiting us perhaps to our traditional long-term growth trend of 3%-3.5%, rather than attempting outperformance in the 4%-5% league warranted by our large output gap and limited balance of payments constraint.
Even with such a modest growth outlook, there could still be early problems preventing eventual outperformance.
At some point we may experience another commodity-led inflation surge (oil, food), in turn inviting modest SARB rate tightening to prevent a breakout of inflation expectations.
Furthermore, electricity supply may eventually again prove to be a supply constraint, even if substantial higher electricity tariffs should enforce conservation and substitution.
Also, we face political policy choices which in some cases could prove costly in efficiency sacrificed and therefore national income foregone while others may keep boosting the inflation potential, by implication keeping interest rates unnecessarily high and the Rand unnecessarily firm, sacrificing yet more growth space.
Conclusion
In a world geared for renewed vigorous growth after the Greatest Financial Crisis and Recession since the Great Depression eighty years ago, South Africa is also lumbering up to embark on another long expansion cycle.
While favoured by probably exceptional global conditions, potentially for as much as a decade, even if changing in composition, South Africa will also face headwinds, some of its own making.
This combination of events suggests only a modest growth path of 3%-3.5% for some years, following the 5% GDP years of 2003-2007.
Though inflation will likely be single-digit in coming years, its long-term convergence with the OECD norm of nearer 2% will struggle to make much headway beyond 5%, primarily because of a roguish public sector pursuing redistribution and accepting inefficiencies, while our labour market and industry concentration also carry an inflation bias. New global commodity price surges could also again prove to be problematical at some point, possibly beyond 2012.
The Rand could be firm in 5-8:$ territory for some while, and thus be richly valued, if not severely overvalued at times, assisting in suppressing domestic inflation impulses, but also limiting trade competitiveness and the growth potential.
Our asset markets (bonds, equities, housing) should do well in a reduced interest rate environment (at least in 2010, but probably also more moderately through 2011-2014), as domestic earnings growth and foreign portfolio inflows ensure another asset price cycle.
Though employment losses were heavy in 2009 and growth bound to be mostly jobless through 2010, thereafter we should see a gradual resumption of structural change, with employment growth starting up again and unemployment falling anew, though these changes are bound to be gradual as we proceed through the next decade and two Zuma Presidential Terms.
The next decade will in all likelihood prove to be a prosperous one, even if only modestly so, and off to a very slow start. This would reflect as much our external positioning as our own institutional fabric and should not come as such a big surprise.
Source: Cees Bruggemans, FNB, November 10, 2009.
