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Tuesday, February 17, 2009

What is the future for SA economy?

Can the country head off the shocks laying us low?

This needs a qualifier. Just how big will the external shocks still become? A global meltdown-cum-depression-cum-deflation would be in a class all of its own.

Such an ultimate shock is not what we face today. At least, that is the current reading. Even so, the actual reality is still daunting in the extreme.

The global banking system is bankrupt in important parts, with $2 trill of bad assets still to be written off.

There is a deep sense of fear and therefore defensiveness encouraging private spending withdrawal, abruptly pushing the global economy into deep recession.

What we face needs to be unpacked and compartmentalised.

There is the aftermath from last year: electricity shock cutting output, commodity inflation shock cutting real buying power, interest rate response increasing the debt servicing burden, national credit act inviting banks to be more conservative in granting credit, and a pervasive fear of more bad news to come deepening defensiveness.

All of that very expertly floored the economy, especially household consumption spending but also critical parts of private fixed investment. From July 2008 non-agricultural GDP (98% of the total) entered recession (-0.1% annualized). It only got (much) worse since then.

At the very moment the economy entered recession in mid-2008, some of the recession drivers abruptly let up.

Oil started collapsing, with food price inflation following more sedately. From December the SARB followed with its first interest rate cut of 0.5%. Throughout the Minister of Finance quietly accepted his tax receipts were falling (especially VAT, sin taxes, customs and excise, and above all property transfer fees), borrowing the difference rather than add insult to injury and start cutting his own spending, too.

Thus throughout 2H2008, we had many shock absorbers coming to the rescue.

The Rand went 40% down compared to 2007. The Finance Minister accepted an R14bn revenue shortfall while allowing R29bn of additional spending overruns (we now know). The SARB, not before time, decided to relent from December 2008, cutting rates by 0.5%. Oil dropped by over $110. Infrastructure spending continued at full throttle.

Yet in that very period, Lehman Brothers lost its battle and Paulson/Bernanke succeeded in frightening a world audience. The financial hit spilled over, pushing the world economy into deep recession overnight.

From October onward, it was obvious South Africa would be hit hard in a number of ways. Directly, there was to be fallout for our exporters. Indirectly, would external financing remain accessible?

This kind of shock event needs to be addressed on two levels. Foremost, the currency needs to absorb part of the external shock. And domestically there needs to be accommodation.

Happily, imported oil turned out to be our biggest shock absorber, falling over $100, thereby neutralizing most of our export commodity price declines. Although the Rand still needed to complement the oil shock absorber by also declining to compensate for net export volume losses (possibly of the order of 0%-5% this year), not all the burden would fall on it.

The Rand settling at 10:$ may have been enough, but coming months will tell whether more would have been better.

Meanwhile, what’s the use of accumulated economic strength if you don’t use it?

The Finance Minister has reduced the national debt from over 50% of GDP 15 years ago to nearer 22% today, allowing his budget two years ago to gradually drift anti-cyclically into surplus.

Following last year’s many hits to the economy, not only did he need to cover the revenue shortfall without cutting his spending, but ideally he would find ways to increase critical spending to prevent too much of a slide below growth potential.

The Minister did so by allowing a swing from 1% of GDP surplus to 4% of GDP deficit spread over two years, with half the swing accounted by tax shortfalls and half by extra spending, mostly focused on the poor.

Meanwhile what’s the use of high real interest rates? Well, you can cut them drastically in an emergency. From prime 15.5% in the crisis month October 2008, the SARB cut by 0.5% in December 2008, and by a further 1% in February 2009.

Further 1% cuts are expected in March and April, and possibly June 2009, with 0.5% rate cuts also still possible, prime now aiming for 10%-11% by 3Q2009, as already fully discounted by markets, realistically so.

Also, with political pressures independently building to do more for the poor, these stressful times create the opportunity to increase public spending on the poor without too many questions asked.

Exactly that has happened.

In this manner we are now addressing four shock demands within a year, counting local electricity and politics, and global commodity and financial upheavals.

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on

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