While real gross domestic expenditure is expected to grow by 4,5% this year, South Africa’s overall economy might fail to grow to grow faster than 2,7% this year due to a negative contribution from net exports, the Bureau for Economic Research (BER) said on Tuesday.
Furthermore, South Africa also runs the risk of balance of payments problems should the rand continue to outperform expectations, it said.
Nevertheless, the Stellenbosch-based bureau said the domestic economic picture is bright at this stage, complemented by a robust improvement in global economic conditions. It pointed out that both business and consumer confidence have reached historical highs during the second quarter, with real household expenditure increasing by an annualised rate of 5% and real private fixed capital formation by close to 10% during the first quarter of 2004.
It added that the current macro-economic environment of low interest rates, a strong currency, negligible inflation pressures and above-inflation wage growth is proving a boon to the domestic market and is expected to persist for the near future.
But it cautioned that the export sector is battling and not benefiting from the buoyancy abroad.
“With the rand crashing through to below the R6 a dollar level recently, South Africa’s exports are being priced out of the market and this is having a negative impact on formal sector employment. Including keen import demand, South Africa’s trade balance already deteriorated into a deficit during April/May 2004,” it said.
It added: “In its baseline forecast, the BER argues that the rand’s overvaluation will gradually cease once the external financing environment for developing countries changes next year. A more competitive currency could go a long way in boosting the appropriate supply response in the South African economy.
“Less-than-robust manufacturing activity and fixed investment intentions as well as sustained job cuts attest to an unsatisfactory supply response in the economy at the present point in time, given the keen domestic spending we are witnessing.”
The BER added that domestic demand is strong and low interest rates and inflation and high business and consumer confidence (stimulating credit demand) are likely to underpin spending over the short term.
It forecast real domestic expenditure to accelerate to 4,5% on average during 2004 and to accelerate only moderately to 4,3% next year.
The supply response of the economy, it said, is strong enough to sustain the favourable economic growth performance.
“However, manufacturing conditions are not as buoyant as the retail side of the economy. Exports remain under pressure. The rand is expected to remain strong well into next year and to inhibit growth in the manufacturing sector. The result could be that, while real domestic expenditure is strong, weak net exports (ie, exports minus imports) could subtract substantially from growth,” it cautioned.
“The BER forecasts real GDP [gross domestic product] growth of only 2,7% this year. However, growth should be accelerating and is expected to come in at a more robust 3,6% next year. The BER anticipates a strong recovery in exports next year on the back of keen world economic conditions and a more competitive rand.”
Turning to CPIX — South Africa’s measure of inflation, which excludes mortgages — it added that while base effects could still present some problems during the second half of the year, it does not expect the upper band of the inflation target to be breached further.
“Moreover, inflation is expected to decelerate again towards the middle of next year before demand-pull factors are expected to begin to impact.
“Overall,” it said, “CPIX inflation is projected to average 5% during 2004, accelerating to 5,4% next year.”
On a forward-looking basis, the South African Reserve Bank (SARB) therefore need not tighten monetary policy before the end of the year.
“However, the picture changes going into next year as the SARB becomes focused on inflation possibly accelerating above 6% in 2006. The BER factored a 50 basis-point hike in the repo rate into the forecast by mid-2005 and a further 100 basis points during the second half of 2005.
“Bar unforeseen shocks, the BER expects the total increase in interest rates to be on a limited scale in the current upward phase of the business cycle due to a lower inflation trend. There is even a possibility of lower interest rates than projected by the BER, should the rand turn out stronger and inflation lower,” the BER stated.
On the rand, the BER said that according to its analysis the local currency has currently strengthened beyond its purchasing power parity value against the dollar and is trading at overvalued levels.
While the SARB’s improved net international liquidity position is a supporting fundamental, the BER believes that external factors are the dominant drivers, for example United States dollar weakness, large interest-rate differentials with foreign currencies and a positive outlook for commodities.
“These factors may only reverse well into next year, in which case the rand may come under increasing selling pressure to revert back to a ‘fairer’ value. However, should the capital inflows that South Africa currently succeeds in attracting remain favourable to finance a widening current account deficit, the rand’s strength could also persist.
“This in turn could provide for lower-than-projected inflation, a cut in interest rates next year and sustained strong growth in real domestic expenditure, but with weaker net exports dissipating the real economic growth gains and posing a serious balance of payments risk,” it added. — I-Net Bridge