SA’S ONE-PERCENT FIX

Firmer global growth, a softer oil price and a cautious Fed are ideal economic conditions for SA. It’s a pity it has been unable to turn them into growth in the midst of ‘the broadest synchronised upswing’ in years

Prior to the global financial crisis, SA thought of itself as a 3% economy, but by 2015 its growth potential had fallen to 2%. Last week the Reserve Bank made it official: SA’S growth potential is now just 1.1%, and may have further to fall.

“SA’S falling growth potential is a function of consistently disappointing GDP growth since 2009,” says the Bank’s head of research and statistics, Rashad Cassim.

“The decline in SA’S potential growth rate shows you that this is a stagnant economy . . . in fact, it is coming to a grinding halt,” he says.

The measurement of potential growth (how fast an economy can grow without stoking inflation) is based on actual data as opposed to forecasts, including what’s happening to indicators such as fixed investment, employment, capital extension, capacity utilisation and GDP.

Rand Merchant Bank chief economist Ettienne le Roux says job-shedding, the contraction in real fixed investment and the drop in total factor productivity (potentially due to falling investment in machinery and equipment, stagnant spending on research and development, and poor skills development) explain the continuous decline in SA’S potential growth rate over the past five years.

Cassim cautions against becoming too hung up on a precise figure for SA’S potential growth rate, given the large margin of error in measurements of this kind. But though the Bank is not very confident about the precise number, it is relatively certain about the direction of change — ever downward (see graph).

So how much lower could SA’S growth potential go?

If SA experiences several more quarters of negative GDP growth, its growth potential could become “incredibly low”, according to Cassim. But if it rises in line with the Bank’s real GDP growth forecast (0.5% this year, 1.2% next year and 1.5% in 2019), then it should remain at about 1%.

Cassim is a member of the monetary policy committee that voted to cut interest rates last week on the basis of SA’S improving inflation profile and worsening growth outlook.

Noting that a number of sentiment indicators and data points have reached levels last seen in 2009, at the height of the global financial crisis, the Bank halved its 2017 real GDP growth forecast to 0.5%, cut the country’s growth potential from 1.3% to 1.1% and widened its output gap projection (the gap between actual and potential output) from -1.6% to -1.9%.

“The fact that SA’S output gap has got wider even though the potential GDP growth rate was revised down is saying that there is more slack in the economy than we thought there was,” explains Cassim.

In other words, the Bank can afford to be a little more complacent about inflation.

Thanks mainly to lower oil prices, falling food inflation and a resilient rand, consumer inflation has softened in recent months.

The Bank now expects the consumer price index to trough at 4.6% in the first quarter of 2018 and to average 5.3% this year and 4.9% next year.

Inflation has been falling faster than expected in many emerging market countries, thanks mainly to a sharp fall in global oil price inflation. Brazil, Russia and India have all cut rates recently.

The rand remains the biggest risk to SA’S inflation outlook. Its resilience so far this year is partly due to the positive global sentiment towards emerging markets as a whole, the high yield differential between SA and developed markets, and SA’S improved current account balance.

Even so, most economists had expected the Bank to delay the start of its rate-cutting cycle for fear that the rand remains too exposed to possible capital outflows, whether triggered by the US Federal Reserve’s rate-hiking cycle or by further domestic credit downgrades and political contestation.

Last week, however, the monetary policy committee sounded more sanguine regarding the risks posed by US monetary policy normalisation. It noted that the gradual nature of the Fed’s balance-sheet contraction has been well-communicated and appears largely priced in by the markets, and that — so far — the reaction of emerging market assets has been “relatively muted”. As such, a repeat of the 2013 “taper tantrum” is not expected.

This position chimes with the global consensus that emerging market countries are better poised to weather a Fed hiking cycle than previously.

David Lubin and Michel Nies of Citibank identify a number of reasons why this is so: developed countries’ monetary-policy adjustments are gradual and priced in; capital outflows from China are under control and the country’s growth is supporting emerging countries’ current account balances; and emerging markets’ financing gaps have fallen as external balance sheets have improved, real interest rates are high and their currencies are sufficiently cheap.

This prognosis is reinforced by the International Monetary Fund’s (IMF) July World Economic Outlook, which lowers the US economy’s growth prospects very slightly

What it means: SA’S growth potential has officially declined to 1.1% and it is performing below even that reduced mark