The GDP growth figure for the second quarter of this year, reported this week at 4,9%, is a strong surge from the paltry first-quarter figure of just 2,1%. Although this number may be encouraging at first glance, closer inspection will reveal a still-weakening underlying economy. The worst news comes from the consumer sectors, including retail and wholesale goods, tourism and catering.
Because there is a time lag in the reporting of GDP numbers, this week’s number gives us information about the economy only up to the end of June. However, the weakness in the consumer-related sectors can still be seen in the still-declining retail and vehicle sales figures, which are more frequently available. The most recently released numbers for these sectors show that the consumer is still feeling the pressure of high interest rates.
In South Africa interest rate movements usually take about 12 to 18 months to feed through to the economy. In all free-market economies, consumer behaviour tends to change slowly and over time. When interest rates are hiked, consumers don’t change spending patterns immediately. They will first draw on savings or switch to cheaper goods before actually reducing overall consumption. Thus the dampening effect that higher interest rates have on an economy may be felt only after a year or 18 months from the start of the hiking cycle.
A similar pattern can be seen with declining interest rates, when consumers need to be convinced that rates will remain low for a reasonable period before they will borrow to increase their consumption.
In the current business cycle the South African Reserve Bank first started increasing interest rates in mid-2006. Since then the prime lending rate has risen by a full five percentage points from 10,5% to 15,5%. Given how long it takes for any change in interest rates to feed through to the broader economy, only about half of the probable effect of these increases has been felt thus far.
Although the Reserve Bank elected not to raise rates further at the last monetary policy committee meeting on August 14, there is no way to escape the effect of the interest rate rises that have already happened. Even if the Reserve Bank starts cutting interest rates in June next year, which is what the most optimistic forecasters have pencilled in, the economy will start to bounce back only in June 2010 at the earliest.
That said, it is important to remember that this is merely a cyclical dip in the South African economy and not a structural change for the worse. The economy will pick up, as free-market economies do, when it emerges from the down cycle over the next 18 months or so.
In free-market, capitalist economies, business cycles are natural phenomena. Central banks cannot avoid their effects but can try to smooth them out through the manipulation of interest rates. As an economy grows, the demand for goods and services rises. If demand exceeds the economy’s capacity to produce goods and services, prices rise. This can lead to inflationary pressures. In the long term a low-inflationary environment is essential for robust, sustainable economic growth. By raising interest rates when the economy looks to be exceeding its growth potential because of infrastructural and other capacity constraints, central banks can dampen inflationary pressures and smooth out the ups and downs. This results in less severe boom-and-bust cycles, with less painful macroeconomic adjustments from the peaks to the troughs in the economic cycle.
Since the coming of democracy the business cycle in South Africa has been markedly smoother. During the 1980s and early 1990s the economy experienced several periods of the annual GDP moving from positive to negative growth rates from one year to the next — as far as 9% to 4%. In the past 10 years GDP growth has risen steadily year on year.
While the economy will probably always go through peaks and troughs for short periods, it is increasing overall capacity and growth potential that leads to long-term sustainable growth. Encouragingly, construction and physical infrastructure development by both the private and public sectors has picked up significantly, which increases the structural, long-term capacity and growth potential of the South African economy. Investing in education and skills development, one of our biggest long-term growth constraints, will grow our human capital and contribute significantly to economic capacity. By increasing output capacity the economy can sustainably reach a higher growth level within a relatively low-inflationary environment and insulate the economy from large ebbs and flows in the economic cycle.
Although it may be prudent to keep those belts tightened in the near term while we ride out this dip, it is encouraging to know that the longer-term potential of the South African economy is still increasing steadily, albeit at a slower annual growth rate.
Réjane Woodroffe is an economist at Metropolitan Asset Managers