Some short-term suffering before the patient recovers next year — that’s the diagnosis for the South African economy by the Bureau for Economic Research (BER) of the University of Stellenbosch.
In its latest economic forecast, the bureau said the economic slowdown during the first half of the year had been stronger than expected, and that the productive capacity of the economy seemed under particular pressure. It scaled down its forecast for real gross domestic product growth (GDP) for 2003 from 2,6% to 2,2%.
However, the bureau believed the demand side of the economy remained resilient and the expected macro-economic environment favourable.
“This should benefit domestic production conditions over the short term. The economy is expected to re-accelerate towards the end of the year, with real GDP growth projected to measure 3,5% next year,” said BER senior economist Pieter Laubscher.
The institution is not alone in its optimism — other leading financial institutions, including Standard Bank, believe declining inflation and the subsequent decline in interest rates will positively affect growth.
The cherry on the cake is the bureau’s forecast for CPIX (consumer inflation less mortgages) at 5,4% on average next year. That is within the Reserve Bank’s inflation target range and could translate into another three percentage point interest rate cut before February next year.
This forecast for CPIX inflation is higher than the current consensus among economists. The major reason for the BER’s caution is the fact that price inflation in the services sector is still running well ahead of the inflation target. It was also not clear whether the factors driving goods inflation lower would have an impact on services inflation.
“Given the current favourable inflation prospects, the strength of the currency and the tight conditions in the tradeable goods producing sectors, the case for further interest rate cuts is most compelling,” Laubscher said.
The bureau assumes that under these conditions — and with the world economy continuing to recover — the current economic slowdown is unlikely to evolve into a recession.
The view was given further impetus this week when Alan Greenspan, the chairperson of the Federal Reserve, depicted the United States’s economy as poised to recover from the recession that began in 2001.
Greenspan also sought to boost confidence in the US by pledging to keep interest rates low for as long as it took to restore growth. Borrowing costs in the US are already at their lowest level since 1958, after the Federal Reserve made a 0,25% cut in interest rates at its meeting on June 25, taking them to 1%.
News that retail sales were up 0,5% in June — the strongest performance for three months in a row — buttressed Greenspan’s optimism.
In South Africa, the real domestic economy has deteriorated significantly over the past three quarters as production came under pressure from weak world conditions, the strengthening rand and the higher interest rates.
The weak dollar, recovering industrial commodity prices, an eliminated net open forward position — the Reserve Bank’s overdraft in dollars — and improved market sentiment bolstered the rand over the short term. Factors behind some weakening of the rand, particularly next year, include a narrowing interest rate differential and a widening current account deficit.
The BER expects the rand to trade closer to a fair value over the short to medium term, with the currency’s undervaluation during 2000/1 being eliminated. However, Laubscher said the rand’s volatility would only stabilise once South Africa’s external liquidity levels rose to more respectable levels.
Standard Bank group economist Iraj Abedian said this week that future interest rate cuts would not necessarily have a negative effect on the rand. South Africa would still offer a good return, with a minimal risk of outflow of short-term capital to other emerging economies, Abedian said.
South Africa still has one of the highest real interest rates, with the CPI-deflated bank rate at 4,2% compared with -1,1% in the US and 0,1% in Europe.
Abedian also believed that in the medium to longer term South Africa’s competitiveness was key in determining the rand’s value.
The World Economic Forum’s Global Growth Competitiveness Index ranks South Africa 32 out of 81 countries, placing it ahead of other emerging markets such as China, Mexico and Brazil. This was bound to add to the value of the currency, Abedian said.
The BER said the tradeable goods producing sectors, including mining and manufacturing, were under pressure from the strong rand and the weak world economy.
However, there was resilience in demand: Growth in real household consumption expenditure measured 2,5% (quarterly annualised) in the first quarter of 2003 and real gross domestic fixed investment was 8,5%.
While mining and manufacturing fixed investment were expected to slow, real domestic expenditure should receive a boost from lower interest rates and inflation, in addition to the substantial tax cuts.
To the extent that the world economic recovery remained sluggish and the rand strength persisted, the recovery in the mining and manufacturing sectors would be dampened, the BER said.
On the other hand, Abedian noted that the economy had become less dependent on the primary sector, including mining and agriculture. This now accounted for 10% of GDP while tourism accounted for about 12%.
The BER also expected world economic conditions to improve, though it was likely to be a “modest affair”.
Martin Jankelowitz of Investment Solutions, South Africa’s largest multi-manager, noted that US manufacturing activity, as reflected by the Chicago PMI and the ISM Index, was already showing signs of stabilising, while consumer sentiment had turned positive.
Recent industrial production data also indicated that Japan, the world’s second-largest economy, was on the mend. The EU remained a concern, with manufacturing data and consumer and industrial confidence continuing to reflect difficult conditions. GDP growth in the first quarter was zero.