Thursday 22 January 2009

The global economic crisis and the prospects for SA's economy

Kevin Lings, economist at Stanlib, one of SA's leading asset managers, argues there are some specific positives which will lessen the impact of the global economic crisis on the country's economic performance in the next couple of years:
A rapid fall in inflation
The sharp drop in the oil price, together with the slowdown in domestic demand, has significantly eased domestic inflationary concerns in South Africa. The 12-month CPIX inflation rate fell from a peak of 13.6% in August 2008 to 12.1% in November and is set to fall sharply over the coming months as base effects, a lower petrol price and the reweighting of the CPI basket take effect.
The recent depreciation of the rand (which declined by 28.5% against the Dollar during 2008) will push up the cost of some imported goods, partly counterbalancing the downward trend in inflation, but we still expect inflation to enter the target range of 3% to 6% before the middle of 2009.

Currently the consumer remains under enormous pressure from a cash flow perspective. However, the recent declines in the petrol price (which has now fallen by 44% since the peak in mid-2008), as well as the expected further easing of interest rates should start to provide some relief. In addition, as inflation falls further in 2009, salaries and wage increases should start to rise in real terms. This will add to the consumer’s ability to weather the current economic storm. Importantly, these benefits are rapidly eroded if unemployment rises dramatically.

Significant monetary and fiscal stimulus
The SA Reserve Bank opted to cut the Repo rate by 50bps to 11.50% with effect from 12 December 2008. This was the first cut in rates since April 2005.

The interest rate reduction in December 2008 sets the tone for successive interest rate cuts of 50bps in each MPC meeting this year, as long as it does not result in undue volatility in the financial markets. While we expect the repo rate to bottom out at a higher level than in the previous cycle, the reduction should ensure at least a modest recovery in consumer demand during 2010.

Fiscal policy should also support economic growth through an ongoing improvement in infrastructure spending. The Medium Term Budget Policy Statement published in October 2008 projected that the budget deficit will widen to 2.0% of GDP in fiscal year 2009/10, however, it is possible that some extra spending initiatives could be introduced in February’s budget to stimulate activity further. Nevertheless, we do not anticipate the deficit widening beyond about 3% of GDP unless the slowdown in activity becomes more pronounced, reducing tax revenue by more than anticipated.

Fortunately, over the past few years the Minister of Finance has substantially curtailed the build-up of Government’s debt, as well as generating a fiscal surplus. While it is unlikely that the Minister will greatly reduce taxes in this year’s budget; the generally healthy fiscal position should ensure that government will not have to increase taxes in the face of a revenue slowdown.

A sound banking sector
At a time when the global banking system is under enormous pressure, South Africa’s banking system remains incredibly sound, having had almost no exposure to subprime debt, or other ‘toxic’ assets. This is simply not the type of business SA banks would typically get involved in; which is partly due to prudent management, but also a general avoidance of derivate structures.

The local interbank market has been functioning normally throughout the crisis. The SA Reserve Bank has not had to supply any additional liquidity to SA Banks. In fact, no action by the Reserve Bank has been needed to specifically support the banking system.

The banking system’s exposure to external liquidity pressures is extremely limited. Total liabilities to the public amounted to R2 357 billion at the end of June 2008, of which foreign currency deposits were a mere R69 billion (2.9% of total), foreign loans received under repurchase agreements were R31 billion (1.3%) and foreign currency funding to the domestic and foreign sector R60 billion (2.6%).

Overall, the SA banking sector is well placed to cope with the current global financial market crisis. Obviously, given the current state of the domestic economy, the provisions for bad debts are on the rise, while at the same time higher costs and lower revenue implies lower profitability. However, these trends are not expected to become alarming or detrimental to an economic recovery.

Well advanced infrastructural development programme
Unlike many of the developed countries in the world, South Africa already has a well advanced infrastructural developments programme, with major projects that are currently well underway. This is evident in the incredible 28% quarter-on-quarter growth in public sector fixed investment spending during Q3 2008. This growth contributed around 80% of the total quarterly increase South Africa’s in fixed investment activity.

The public sector’s investment spending is obviously coming off a very low base, but nevertheless the rate of increase since the end of 2006 has been spectacular and is clearly providing a very significant offset to the general economic slowdown in South Africa. In fact, the increase in public investment spending in 2008, up until end Q3 2008, accounted for around 60% of the overall GDP performance in 2008.

According to the latest Medium Term Budget Policy Statement, the solid growth in public sector fixed investment spending, especially by public corporations is expected to be maintained over the next few years. This is reflected in the budgeted increases in public sector investment activity across a broad range of infrastructural activity including electricity, roads, harbours, airports, stadium, rail and water.

Impending 2010 World Cup Soccer Tournament
Hosting the Soccer World Cup represents a major focal point for economic activity. The financial impact of the event is substantial, both in terms of the cost of hosting the event as well as in terms of the potential revenue earned. The benefits of hosting the 2010 FIFA World Cup lie less in the event itself than in the long-term benefits of transport, sports and other infrastructure investment. Exposure from the event will hopefully benefit the economy for years to follow. Furthermore, it provides a vital catalyst to fast track urban development, to improve the basic infrastructure and to broadly promote economic development.

This process to host the event is well advanced with government and private business having established multi-billion Rand capital projects in order to finance the necessary infrastructural development. These projects are centered on the building of stadiums, the improvement of transport infrastructure and the enhancement of telecommunications. As many as three-million tourists are expected during the World Cup. That's 40% more than the average annual number of tourists. With this, the World Cup is expected to directly create 159 000 new jobs and provide a welcome boost to the economy at a critical time.

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