We’ll battle on while global picture eases

THE downside risks to global economic activity that have created significant angst among analysts and investors since the start of the year have receded somewhat.

Commodity prices have stabilised. There is nascent evidence that stimulus in China is gaining traction and beginning to affect that economy positively. The US Fed’s most recent guidance that it will increase interest rates very slowly has also reduced global risk aversion.

Financial markets have reacted favourably to these developments and reversed a significant portion of the losses sustained at the start of this year. The dollar has also weakened substantially.

These recent developments support the following broad but important assumptions about the global economic outlook.

First, that economic growth in developed economies will not collapse but rather continue to muddle along at rates similar to those delivered last year. Second, that there will be abatement in the significant growth slowdown experienced in some large emerging countries over the past two years. Third, the Fed’s interest rate hiking cycle will be very gradual. Fourth, the dollar will strengthen at a much slower pace than over the past few years. Finally, commodity prices will stabilise during the year and start to drift higher towards year-end.

However, the outlook for the South African economy remains poor. Stagflation remains the most likely outcome, with growth averaging around 0.5% this year and inflation between 6.5% and 7%.

There are several important reasons for this. On the fiscal front, the government is on a belttightening exercise aimed at reducing its budget deficit.

The goal is to stabilise and eventually reduce government debt relative to the economy to stave off a sovereign rating downgrade.

This attempt to make government finances more sustainable will hurt growth in the short term.

Regarding monetary policy, the Reserve Bank, which has raised interest rates by 200 basis points since January 2014, is likely to nudge rates upward a little more. Drought conditions, exchange-rate weakness and the fading benefits of the lower oil price are pushing our inflation rate higher. Food price inflation in particular is set to lift by double digits in coming months, which will push inflation to 7.5% by year-end.

There is also growing concern that previous exchange-rate depreciation is starting to push other goods and service prices higher. With a squeeze on profits, corporations may have to pass higher input costs on to consumers, and/or lay off workers.

These factors suggest that the risks of a higher-than-expected inflation peak have increased.

While the Reserve Bank is concerned about the weak growth outlook, it is unlikely to remain completely on hold given the deteriorating inflation outlook.

Moreover, growth in credit extension is likely to slow from what are relatively low levels this year. This will be due to both demand and supply concerns.

On the demand side, business and consumer confidence is low.

Finally, it is difficult to argue with high conviction that domestic political arrangements will deliver the necessary structural reforms that will boost business confidence, private fixed investment and deliver growth via a meaningful increase in domestic production and exports, our holy grail.

Thus, lower income growth, rising inflation, tighter monetary policy and heightened political uncertainty will push South Africa’s growth rate down over the next few quarters. The weak growth backdrop will be reflected in weak domestic demand growth and downward pressure on the sovereign currency debt rating.

The upshot of weak domestic demand growth, currency weakness and a more stable global commodity price backdrop is that South Africa’s current account deficit should narrow in coming months. This should support the exchange rate if political developments do not decrease foreign investment appetite for South Africa’s assets.

Nxedlana is FNB chief economist