The Outlook for the South African Economy: Address by Gill Marcus, Governor of the South African Reserve Bank, at a dinner hosted by BMW South Africa for German Business and Financial Media, Pretoria
4 Feb 2011The Outlook for the South African Economy: Address by Gill Marcus, Governor of the South African Reserve Bank, at a dinner hosted by BMW South Africa for German Business and Financial Media, Pretoria, 4 February 2011.
Thank you for the invitation to address you this evening on the prospects for the South African economy. My remarks will focus mainly on the manufacturing sector, and given that this function in being hosted by BMW, it is particularly appropriate that the motor vehicle sub-sector is currently providing much needed impetus to the manufacturing sector.
We live in uncertain and rapidly changing times, as evidenced by recent developments in North Africa and the Middle East. The prevailing political uncertainty will no doubt impact on the global economic outlook, as can be seen by the oil price breaching the $100p/b level.
The past two years have been a difficult time for the global economy, but there are signs of a recovery, despite a number of significant risks that still prevail. The recovery has been characterised as being multispeed in nature, with emerging markets outperforming the developed economies, a number of which are still dependent on policy stimuli to sustain their growth.
The South African recovery has been relatively hesitant, and while we are an emerging market economy, some of the characteristics of our recovery have been more in line with those of the advanced economies. However recent indicators are more positive and suggest that the recovery will be sustained and we can look forward to more vibrant growth in the coming years. But significant challenges remain.
The South African economy began to recover from the crisis in the second half of 2009, after three consecutive quarters of contraction. Growth in 2010 is estimated to have been in the order of 2,7 percent, but more favourable outcomes are expected in 2011 and 2012.
The current Reserve Bank forecasts, which are somewhat below the market consensus, are for growth to average 3,4 percent in 2011 and 3,6 percent the following year, suggesting the persistence of the negative output gap. While these levels of growth are an improvement on the recent past, they are significantly below the levels achieved in the period before the global crisis, when growth averaged in excess of five percent from 2004.
The current growth rates are also insufficient to make significant inroads into the unemployment rate which increased from 21,9 percent in the fourth quarter of 2008 to 25,3 percent by the third quarter of 2010. This underlines the need to generate higher levels of growth.
However, as much of South Africa’s unemployment problem is structural in nature, it needs to be addressed through structural microeconomic interventions, and the new growth path, as outlined by government, goes some way in this direction. A constraining factor in the performance of the economy has been the relatively slow growth in the manufacturing sector.
This sector accounts for 16,4 percent of real value added in the economy, second only to the finance, real estate and business services sector, and is a major employer in the economy. In 2009 the manufacturing sector contracted by 10,4 percent, despite positive quarter-on-quarter growth in the final two quarters of that year.
After making a moderately positive contribution to gross domestic product (GDP) growth in the first two quarters of 2010, the sector contracted at an annualised rate of five percent in the third quarter, mainly due to widespread industrial action.
Since then, the high frequency data indicate a more positive performance and outlook. Manufacturing grew at a year-on-year rate of 4,6 percent in November and the forward looking indicators are also positive: the Kagiso Purchasing Managers Index (PMI) has been above the neutral 50 level since November, and improved strongly in January to 54,6. Similarly the FNB/BER Business Confidence Indicator showed a very strong recovery in confidence in the sector during final quarter of 2010.
Nevertheless the sector still remains under pressure, and there is evidence of significant excess capacity. The utilisation of productive capacity in manufacturing measured 79,6 percent in the third quarter of 2010 but improved to 81,6 percent in the fourth quarter. In the third quarter of 2007 utilisation stood at 85,4 percent. The level of real output in the sector is still about 15 percent below its peak in 2008.
The nature of the global recovery impacted on the performance of the manufacturing sector, with respect to both the demand for South African exports and the exchange rate. The recovery has been more pronounced in the emerging markets, and Asia in particular. Strong growth in China has resulted in a surge in commodity prices which has helped to underpin the value of South Africa’s commodity exports, and our terms of trade have improved significantly, despite the increase in the international oil price.
Manufacturers are therefore not only faced with higher input costs, they are also affected by the slow growth of our main trading partners, particularly in Europe, which has constrained our manufactured exports to these regions. By way of example, in 2007, 38 percent of our manufacturing exports by value went to Europe. In 2010, this ratio had declined to 32 percent. Over the same period, manufacturing exports as a percentage of total exports declined from 38 percent to 36 per cent. The challenge for our exporters will be to try and diversify their export markets, and focus more on the fast-growing emerging market economies.
The other element of the global recovery that has affected the sector relates to the pattern of global capital flows. The unusually low interest rate environment in the advanced economies has resulted in increased capital flows to emerging markets which have generally higher interest rates and higher growth rates. South Africa has also been a recipient of these flows which have contributed to the appreciation of the effective rand exchange rate by approximately 27 percent since the beginning of 2009. This has adversely affected the competitiveness of the sector.
The appreciation of the rand exchange rate has occurred despite the continued purchase of foreign exchange by the Reserve Bank and the National Treasury. During 2010 total direct foreign exchange reserve accumulation by the Bank and the National Treasury amounted to US$7,4 billion, or a spend of just over R53 billion. Portfolio and foreign direct investment inflows continued and the net purchases of bonds and equities by non-residents amounted to R89,5 billion in 2010.
The good news on the manufacturing front has been the recovery in the motor vehicle sector in recent months. After a number of extremely difficult years for the motor industry, total vehicle sales figures for the year 2010 recorded growth of 24,7 percent. The index of the physical volume of domestic motor vehicle production reached a low point of 59,3 in April 2009, compared with 123,8 in April 2008.
A steady increase was observed during 2010, apart from August and September when production was affected by industrial action. In November and December the index had increased to 93,4 and 109,4 respectively. Export sales also recorded substantial gains during December 2010 and at 22 148 vehicles reflected an improvement in exports of 5802 vehicles or a gain of 35,5 percent compared the number exported during the corresponding month of 2009.
Investments in the automotive industry have supported the domestic economic recovery and include a number of significant projects that are related to recent export contracts being secured by local assembly plants. South Africa is making a name for itself as a low-volume, high-quality niche car supplier and local companies have distinguished themselves internationally by exporting more advanced automotive products than most other centres in major competing countries. More investments are expected to flow into the automotive industry and the components producers, and this augurs well for the broader manufacturing industry outlook.
A disappointing aspect of the current recovery is the sluggish growth in gross fixed capital formation. Investment growth in the third quarter was still less than one per cent, but the trend suggests that this may accelerate in the coming quarters. In particular, there is an expectation of a recovery of fixed capital formation by the state owned enterprises, for example Eskom, where the infrastructure spending programme is likely to pick up.
Private sector investment, particularly in the manufacturing sector is expected to lag somewhat, particularly in the light of spare capacity in that sector. But in the meantime it appears that the growth impetus will be reliant on the recovery in consumption expenditure which grew at an annualised rate of almost six percent in the third quarter of 2010. In this quarter, household consumption expenditure contributed 3,7 percentage points to the growth of 2,6 percent, while gross fixed capital formation contributed 0,2 percent. Net exports subtracted 3,4 percentage points.
The domestic recovery has been reinforced by supportive macroeconomic policies. During the crisis, the fiscal deficit expanded, partly through direct spending increases, and partly through the workings of the automatic stabilisers which allowed the decline in tax revenues to be accommodated. Fortunately, the fiscal authorities had sufficient fiscal space to do this: fiscal consolidation during the previous decade meant that by 2006/07 fiscal year, budget surpluses were achieved. In the wake of crisis, the deficit expanded to 6,7 percent in 2009/10.
Increased revenues associated with the economic recovery has allowed for the expected deficit for the current fiscal year to decline to 5,3 percent, and by 2013/14 the deficit is expected to moderate to 3,2 percent.
At the same time, total government debt increased from 27 percent of GDP to current levels of around 37 per cent, and is expected to peak at around 41 percent in 2013/14. The fiscal stimulus is therefore being withdrawn in a responsible way, without derailing recovery, but at the same time ensuring fiscal sustainability. In this respect we have not had the banking, fiscal and sovereign debt problems associated with a number of the advanced economies.
Monetary policy has also been supportive of the economic recovery. Inflation has beenrelatively benign, and reached a recent low of 3,2 percent in September 2010, well within the inflation target of three to six percent. The improved inflation outcome, a result of subdued domestic demand and a relatively strong exchange rate of the rand, allowed for a more accommodative monetary policy stance. Since the beginning of the crisis, the repurchase rate was reduced by a total of 650 basis points to 5,5 percent, to record the lowest official rate in 30 years. Real interest rates in South Africa are also at low levels. In the 10 years up to the crisis, the real policy rate averaged between 3 and 3,5 percent. Since the crisis, the policy rate has averaged 1 per cent or less.
As was indicated in the most recent Monetary Policy Committee statement, the likelihood of further monetary accommodation is limited, and all things being equal the monetary policy stance is likely to remain relatively stable for some time. Household consumption expenditure is exhibiting signs of a sustained recovery, and bank credit extension, while still relatively subdued, is also improving. Consequently, additional stimulus is not called for at this stage.
While inflation appears to be under control, there are increasing risks to the outlook posed by rising global commodity prices, particularly food and oil prices. South Africa’s food price inflation is still low, but there are signs of incipient upward pressures. To date, domestic prices have been insulated to some extent from the global food supply shock by the bumper domestic maize crop. However it is inevitable that global developments will eventually filter through to domestic prices. The impact of the oil price has been more evident, as evidenced in the 11,4 percent increase in the domestic petrol price since September 2010.
These developments are likely to pose a challenge to monetary policy in the coming months. Should food and oil prices impact on domestic inflation by more than is currently expected, we may see inflation moving towards the upper end of the target range sooner than expected.
This is a dilemma already faced in a number of emerging market economies, but also in a number of the advanced economies such as the United Kingdom, where growth is slow yet inflation is significantly above the target range. Under such circumstances, raising interest rates will not only exacerbate the fragility of the recovery but may not do much to alleviate the first-round effects of these shocks. The faster growing emerging market economies face the dilemma that higher interest rates to combat these inflation pressures, and higher economic growth rates, may attract further capital inflows which may be present challenges from an exchange rate perspective.
In conclusion, South Africa’s macroeconomic fundamentals are sound. As I outlined above, we do not have the same problems thata number of European countries face. Inflation is within the inflation target band, our fiscal deficit and public debt ratios are relatively low and under control, and our banking system is sound and barring the proposed liquidity requirement ratios, already meet the proposed Basel III capital and leverage ratios.
The economy therefore has a sound springboard from which to achieve higher levels of growth in the future. We have many well managed companies that are on a par with the best in rest of the world, and the motor vehicle sector is a good example of this. We are part of the African continent which is also experiencing improved growth prospects.
To achieve higher growth rates we need to implement appropriate structural and microeconomic reforms, as outlined in the New Growth Path, in order to increase the potential output of the economy and to bring about higher employment. There is no reason why this cannot happen if there is unity of purpose, coordination and consistency of policy, and appropriate sequencing.
Source: South African Reserve Bank
Issued by: South African Reserve Bank
4 Feb 2011
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