Cards stacked against SA's economic outlook

17 January 2016 - 02:00 By Sizwe Nxedlana
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The South African Reserve Bank building in Pretoria. File photo.
The South African Reserve Bank building in Pretoria. File photo.
Image: GALLO IMAGES

Global economic growth should lift over the next two years as activity in major developed countries grinds higher while the severe deceleration experienced by several major emerging countries fades.

However, this is unlikely to provide a meaningful boost to emerging economies that are dependent on exporting commodities and are highly indebted, such as Brazil, Russia and South Africa.

This is even more the case given the uncertainty surrounding China's growth prospects.

While the steady improvement in US economic activity is good news for the global economy, it gave the Federal Reserve scope to begin raising its policy rate in December. This was the first hike in more than a decade.

We expect more rate hikes from the Fed over the next two years. Higher dollar funding costs will pose a challenge to indebted governments, households and corporates the world over.

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Against this global backdrop, South Africa's growth outlook has deteriorated further over the past few weeks.

Significant policy uncertainty following the recent changes in the National Treasury, negative rating actions from credit rating agencies, slowing foreign capital inflows - in part related to the latest asset sell-off in emerging markets, particularly China - and the growing risk of an even more aggressive pro-cyclical monetary policy response are to blame.

In addition, ongoing structural constraints will restrict South Africa's ability to grow employment, increase private sector investment and reap the full benefits of both a weak exchange rate and the somewhat stronger global growth in advanced economies.

As a result, growth in household, corporate and government income will remain limited, while rising inflation and higher interest rates will erode real purchasing power.

Inflation is likely to breach the top end of the target band in the first quarter of 2016. While it should fall back within the target in the middle months of the year, it is expected to move back above the target band towards the end of 2016 and to remain above 6% for a prolonged period thereafter.

The potential for significant drought-induced food price increases, coupled with sharp electricity tariff hikes and more pronounced currency pass-through, pose upside risk to this relatively negative inflation projection.

Despite the weak growth backdrop, the Reserve Bank is likely to continue to raise interest rates. Given the deterioration in South Africa's sovereign credibility, it doesn't have a choice.

We will need higher rates to entice foreign investors to compensate for the additional country risk they face. That we are now perceived as a riskier investment destination is reflected in the sharp increase in government borrowing costs since early December.

Failure by the Reserve Bank to react to this with higher interest rates will threaten even more rand weakness and higher inflation. Apart from a significantly weaker exchange rate and inflation outlook, recent communications from the bank suggest a lower tolerance level for above-target inflation and for elevated inflation expectations.

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This pessimistic scenario could get even worse. Several events and developments could result in even slower growth, higher inflation and higher interest rates.

Domestically these include a severe drought, a February budget that fails to restore credibility, and the potential for protracted labour unrest should wage negotiations in the platinum sector, which are scheduled for around mid-year, not be concluded amicably.

On the global front, how aggressively (or not) the Fed hikes interest rates will be important to monitor, as will growth developments in China and, related to that, dynamics in commodity markets.

Prioritisation of economic growth that leads to accelerated implementation of much-delayed structural change would represent a positive surprise.

In such a case, the rand would in all likelihood respond favourably, with inflation and interest rates turning out lower and economic growth higher than we currently forecast. Nevertheless, there has been little evidence of this over the past half decade.

In sum, expect even lower growth and higher inflation. It's also called stagflation.

Nxedlana is FNB chief economist

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