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Tuesday, September 22, 2009

What is South Africa's economic future? What comes next?

By Cees Bruggemans, Chief Economist FNB
21 September 2009

After the hottest boom in decades came the slowdown. And after the slowdown came recession (and recession, and yet more recession). After recession came recovery.

What comes next?

Whereas some of our sectors (government service) haven’t slackened, the recovery has already been with us from very early in other sectors (mining, electricity) since mid-1Q2009, while slightly lagging in yet others (manufacturing recovering from mid-2Q2009).

But now that the world at large is feeling the strong undertow from synchronized industrial recovery, and financial markets are celebrating survival from disaster, made possible by exceptional intense and synchronized global policy action, it is time to lift our sights.

First thought is that we are starting yet another very long expansion, certainly globally. Resource utilization has been much reduced in the West, allowing a long period of growth without generalized overheating.

With financial imbalances defused and asset market valuations greatly reduced, it isn’t obvious what could catch out the world any time soon, despite wartime-like financial commitments by governments and central banks.

To this we must add Asia’s development impatience and the apparent ability to drive its own agenda now.

For South Africa, this first reading of the longish global tealeaves is similarly encouraging.

We also acquired substantial resource slack during this latest cyclical disruption, probably equivalent to some 10% of the 13 million deployed labour force, when thinking of those who have lost jobs, those newly joining the labour force, returnees from abroad and the large unskilled labour reservoir on tap.

We also successfully demolished and removed any trace of the long-running prosperity boom of 2004-2007. Not only have car sales and property transactions halved compared to cyclical peaks, but we have also shrunk imports and thereby the current account deficit despite horrific export contractions in places.

All this suggests that we too could have a long run without overheating either our economy or asset markets.

But what comes next will not be without challenges, and undoubtedly accompanied by much uncertainty.

The exotic surprise could be a major inland drought. Exotic in that predicting the long-term weather is an uncertain business. But we have been favoured by good agricultural growing seasons for so long now that the dice seems to be increasingly stacked against us.

Somewhere out there, given long-term cycles, looms a devastating drought and everything that implies (loss of national income, upward pressure on food inflation, potentially intense political pressures).

Probably more certain than the weather are the short-term antics of man and bankers.

The world’s comeback from the brink has been structured in such a way that Asian commodity demand is an early locomotive (favouring emerging market producers). Also, the determined and generous policy accommodation throughout most of the world has created much liquidity, suppressed safe haven asset returns, even as more risky destinations look relatively attractive (and their risk underwritten by nearly all of this).

Thus we again find ourselves flooded, only partly by higher commodity prices (gold hugging $1000, platinum $1300), but especially footloose capital seeking out our high-quality corporate assets, our safe public bonds and our drooling equities (up over 40% since March).

This flood of capital shapes us just as much as its episodic withholdings do, in a rhythmic global cadence by now over 150 years old.

This is one very important reason for recognizing early what is happening here. There is so very little new to this process, not unlike living in monsoon parts of the world, where the seasons have a very different logic compared to say deserts.

The capital flood has so far undone the Rand shock decline from last year (nearly touching 12:$ last October) and has already pushed us into overvalued territory near 7.40:$.

More Rand firming is presumably to come, as we are still only in the foothills of the global episode driving this.

This will badly confront exporters and import-competing businesses (60% of the economy), like a withering heat wave laying waste among many of our producers.

Meanwhile bankers are determined to price risk adequately in a capital-constrained world, also letting borrowers carry a greater part of any risk through increased equity participation as in days of old.

Such credit restrictiveness won’t prevent recovery, but should make it very slow in interest rate-sensitive sectors (another 10% of the economy).

All of these factors could inhibit long-term commitment to private fixed investment (another 15% of GDP) even as our star sector performer (construction) has started to experience headwinds.

Thus the forces aligned against us could be very powerful as we embark on long-term recovery. A reason to suspect that policy may not be quite finished actively supporting the economy as it tries to find its way.

With fiscal policy fully committed, the onus may fall yet more on monetary policy to ensure a balanced recovery from recession, narrowing our output gap to more acceptable limits and sustaining a longish expansion within our reach.

It suggests yet lower nominal interest rates, mindful that inflation has further to fade.

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

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