Stability key to keeping downgrade hounds at bay

GLOBAL and domestic macroeconomic trends have evolved roughly in line with expectations in the first half of the year.

Developed economies continue to track trend-like growth despite rising downside risks coming from poor corporate earnings and, more recently, employment creation.

June’s weak US jobs data served as a reminder that although the economy continues to expand, the recovery remains fragile.

However, the gradual Fed hiking cycle implies only moderate further dollar strength, placing less pressure on emerging market currencies such as the rand.

Brazil and Russia appear to have weathered the worst of the recession and fears of a disorderly Chinese slowdown have decreased.

China’s nonbank corporates remain highly indebted and the industrial sector has excess capacity, causing deflation. Although these constraints will act as a drag on growth over the longer term, the stimulus authorities have injected in recent quarters has stabilised economic activity in the short term.

Unfortunately, there is growing evidence that the global economy’s potential growth rate is declining due to falling productivity, and global growth will remain moderate. Highly indebted governments, corporates and households will struggle to significantly reduce their debt levels, which will increase the risk of financial market stress.

Lower potential growth also increases the danger of socioeconomic and political discord as well as policy errors. This is evident in the global rise of populist political parties and candidates.

South Africa’s real GDP contracted sharply in the first quarter, a decline concentrated in agriculture, mining and utilities. A minor caveat is that output in these sectors can swing widely from one quarter to the next.

Also, the impact of the drought should soon begin to fade, while work stoppages due to an accident at a large mine are unlikely to be repeated in the second quarter.

Further, the recent increase in commodity prices should support production in mining and related sectors such as utilities.

However, the economy will remain weak over the next 18 months as higher interest rates, fiscal consolidation and low levels of business and consumer confidence weigh on domestic spending.

There is a silver lining, though. The upshot of weak domestic demand is that import growth will continue to slow. This is good news for the trade deficit, which is already narrowing. Such rebalancing of the trade account is encouraging, especially given evidence of large outflows of dividend and interest payments that are preventing a meaningful narrowing of the current account deficit.

The Reserve Bank’s inflationfighting credentials have convinced ratings agencies and foreign investors that monetary policy is conducted independently, focused on containing long-term inflation within the 3%-6% target band.

With inflation forecast to rise well above the top end of the band towards year-end, the bank is expected to continue hiking rates a little further. Beyond this year, however, the repo rate is likely to remain steady as a gradual lift in the Fed Funds rate and a vision to anchor inflation expectations at the mid-point of the target band keep the Reserve Bank from cutting rates.

Although the business cycle downswing seems to be approaching its turning point, the political environment continues to cloud prospects.

Uncertainty regarding the stability of the government’s executive branch undermines the credibility of pending reform programmes.

Escalating socioeconomic tensions and increased concerns about public sector corruption are also weighing on confidence and economic growth.

Consequently, we are not yet out of the rating downgrade woods. A meaningful turnaround in South Africa’s macroeconomic outlook will come about as a result of a favourable and sustained shift in policy direction and execution.

Nxedlana is FNB’s chief economist