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An Economic Update: July 2019

  • SA total debt (government, households and business) has risen by a staggering 122% in the past nine years to a total of R7.5 trillion. What did the country do with the money?
  • SA headline producer inflation eased considerably in June to 5.8%y/y. This is the first time headline producer inflation is below 6% since February 2019.
  • Fitch kept South Africa’s international and domestic credit rating unchanged at BB+, BUT revised the outlook down from stable to negative. Worthwhile reading their concerns when considering what Moody’s might decide later this year.
  • US GDP grew by 2.1%q/q in Q2 2019, boosted overwhelmingly by consumer spending. Fixed investment spending was weak and net exports declined further. Why does the Fed need to cut rates?
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Since the global financial market crisis in 2008/2009 many countries, including both developed as well as emerging economies, experienced a substantial increase in debt. This increase in debt (which includes households, businesses and governments debt) was initially driven by the need for various governments to support failing institutions such as banks and insurance companies, in the aftermath of the global financial market crisis. More recently, the increase in debt has been driven by the low interest rate environment that has largely persisted over the past nine years.

In Q1 2019 world debt totalled a record US$246.5 trillion or 319% of world GDP, up 33.7% from US$184.4 trillion in Q1 2010. In some instances, this increase in debt was used for infrastructural development as well as the upgrading of machinery and equipment, aircraft, and technology. There has however, also been a surge in student debt and distress credit in recent years.

In comparison, South Africa’s total debt (households, businesses and government) has risen from 129.5% of GDP in the first quarter of 2010 to 158.2% of GDP in the first quarter of 2019. That is an increase of 28.7% of GDP or 121.7% in rand terms in just nine years! This means that in value terms, South Africa’s total debt has grown from R3.382 trillion in Q1 2010 to R7.499 trillion in the first quarter of 2019. That is a mind-numbing increase of R4.117 trillion or roughly R1.25 billion every day! The key question is what did the country do with the money? Was it used productively?

It should be no surprise that a portion of the increase in South Africa’s debt over the past nine years simply relates to currency weakness. In other words, the value of any foreign currency denominated debt increases in rand terms as the rand weakens. During the period from Q1 2010 to Q1 2019 the rand weakened by around 50% against the US Dollar. Fortunately, South Africa has a relatively modest level of foreign debt by international standards. Instead, the bulk of the increase in South Africa’s debt since 2010 was incurred by the public sector including central government as well as the major State Owned Enterprises (SOEs) such as Eskom. In fact, since 2010 government debt (excluding SOEs) has increased by an astounding 222%. In comparison, household debt rose by only 50% over the same period.

Despite this massive increase in South Africa’s total debt since 2010:

  • Economic growth slowed systematically from 3.0% in 2010 to 0.8% in 2018 and an estimated 0.6% in 2019, with an average growth rate of only 1.1% over the past five year
  • Bizarrely, from Q1 2010 to Q1 2019, South Africa’s GDP rose by only R2.25trillion in nominal terms, which is less than the total increase in debt, highlighting that most of the debt was not used productively, with a large portion spent on imported goods.
  • The unemployment rate has risen to over 27%, with youth unemployment up at 55%
  • Fixed investment spending has dwindled from 20% of GDP in Q1 2010 to 18.1% of GDP in Q1 2019
  • The gross savings rate of the country reached an all-time record low of 14% of GDP at the end of 2018, down from 17.4% of GDP in the beginning of 2010
  • Income and wealth inequality has remained extremely high, with the number of social grant recipients rising to almost 18 million a month
  • The number of social delivery protests has reached a record high in the past 12 months
  • Government tax receipts have underperformed budget in each of the past five fiscal years, and is likely to under-perform again in 2019/2020
  • Key areas of infrastructure delivery have deteriorated especially electricity, water and sanitation
  • Business confidence has remained well below the long-term average since early 2008
  • The country’s international credit rating has been revised systematically lower

All of this implies that the South African economy went from “the strongest it has ever been” in 2008 to a point of extreme fragility in 2019, requiring “intensive care and more effective management”. At its core, the economic management of any country is about how best to utilise scarce resources to achieve the best outcome possible. Clearly, South Africa squandered much of its scarce financial resources during the past nine years, and hence the road to a full recovery is going to take time given the damage inflicted.

In June 2019, SA’s producer inflation (PPI) rose by 0.4% m/m, marginally lower than the 0.5% increase recorded in May and in line with market expectations (Bloomberg). Annually, headline producer inflation eased considerably in June to 5.8% y/y, compared to 6.4%y/y in May. This was also in line with expectations. Agricultural prices continued to record negative growth, while mining and electricity prices decelerated, helping to pull producer price inflation lower. For the first time since February 2019, headline producer inflation came in below 6%.

During June, seven of the nine broad categories that make up manufactured PPI accelerated, one decelerated, and the remaining category was unchanged. As with the previous month, the main contributors to the monthly increase of 0.4% were food products, beverages and tobacco (contributing 0.2 percentage points), with coke, petroleum, chemicals, rubber and plastic products contributing a further 0.2 percentage points.

While agricultural prices continued to deflate, with prices decreasing by 3.7%y/y in June, food producer inflation continued on its upward trend, edging closer to 6%, (increasing by 5.7%y/y in June). The increase in food prices was relatively broad-based, with meat prices finally moving out of deflation after a number of countries lifted the ban on SA’s beef exports as the foot and mouth outbreak dissipated. The price for grain products also continued drive the increase in food prices, as global cereal prices rose on a monthly basis, moving out of deflation.

Overall, producer inflation remains largely under-control, albeit near the upper-end of the inflation target, despite recent fluctuations in the rand as well as the oil price. However, higher food producer prices are starting to slowly feed into higher consumer food prices, even as food inflation remains under control. It seems that retailers are starting to pass on higher prices to consumers as meat inflation starts ticking up. This is something that the SARB will keep an eye on.

Fitch announced last week that they have decided to leave South Africa’s international and domestic credit rating unchanged at BB+, which in one notch below investment grade, BUT have revised the outlook down from stable to negative. The decision is not especially surprising given recent economic and political developments. Fitch had downgraded South Africa to below investment grade on 7 April 2017.

In making the decision, Fitch highlighted the following key concerns. These are worth noting given the acute focus on the next credit rating review by Moody’s:

  • The renewed downward revisions to GDP growth in 2019 have led to new questions about South Africa’s GDP growth potential
  • Fitch currently estimates SA’s potential GDP growth at just 1.7%, compared with a current ‘BB’ category median of 2019 GDP growth of 3.4%
  • South Africa’s social context of exceptionally high inequality will constrain the government’s policy response various key economic challenges
  • There has been a marked widening in the budget deficit as a result of lower GDP growth and increased spending, including support for state-owned enterprises (SOE)
  • Fiscal metrics have deteriorated significantly due to under-performance of revenue, which is expected to worsen in the current fiscal year as growth has turned out to be weaker than expected
  • As a result of the recent special appropriations bill, Fitch expects the consolidated general government deficit to widen to 6.3% of GDP FY19/20, significantly higher than the outcome of 4.2% for FY18/19 and the government’s forecast of 4.5% for FY19/20 from the February budget
  • Although government will seek to implement significant fiscal consolidation measures, the already high tax burden and social pressures on spending limit its room for manoeuvre
  • Fitch forecasts government debt to increase further to 68% of GDP in FY21/22, and debt may continue rising after that
  • While the government is investigating options to secure the longer-term viability of Eskom, trade unions, fearing privatisation and job losses, are strongly opposed to these measures and Fitch believes significant progress will be challenging
  • The scale of government measures to revive economic growth together with the slow pace of implementation suggests that the impact on growth is likely to remain muted
  • The government will also continue to struggle to manage competing objectives of reducing exceptionally high inequality, boosting GDP growth and containing populist pressures, while maintaining macroeconomic stability
Low foreign debt, the credibility of the South African Reserve Bank (SARB) and its inflation targeting regime as well as the health and regulation of the banking sector remain South Africa’s key positives.

Overall, it is hard argue against the concerns raised by Fitch. South Africa’s economic growth remains desperately weak at only 0.6% in 2019, while the fiscal parameters have continued to deteriorate including a looming large revenue shortfall as well as further funding needed to support the failing SOEs. It is also clear that Moody’s will share many of the same concerns highlighted by Fitch today when they next review South Africa’s credit rating later in the year. At this stage our base expectation is that Moody’s will keep South Africa on an investment grade credit rating later this year, but revise the outlook down from stable to negative. The South African fiscal authorities have a lot of work to do over the coming months if the country is to avoid such an outcome.

In the second quarter of 2019, US GDP grew by 2.1%q/q, annualised. This compares with growth of 3.1%q/q in Q1 2019 and 2.9% for 2018 as a whole. The GDP performance in Q2 2019 was better than market expectations for growth of 1.8% (Bloomberg). If the decline in inventories is excluded from the data, then in Q2 2019 real final sales (GDP less inventories) grew by a still very respectable 3.0%q/q. In other words, the decline in inventory levels during Q2 2019 had a meaningful impact of the headline GDP growth rate.

The key areas of strength in Q2 2019 were focused exclusively around consumer spending, especially household consumption on services such as healthcare, but also restaurants and hotels. In addition, consumer spending on durable consumer goods rose sharply (including recreational vehicles), while household consumption of non-durables in the form of food and clothing recorded solid growth. The key areas of weakness in the US economy remain investment spending on residential property and exports. There was also a slump in business spending, including investment in commercial buildings as well as machinery and equipment. As mentioned above, there was also a sharp, but not unexpected, contraction in inventory levels after many companies build-up stock levels in late 2018 and early 2019 as the trade dispute between the US and China intensified. Hopefully, the latest unwind of some excess inventories will encourages a pick-up in US industrial production. Overall, the consumer remains the backbone of the US economy and is still responsible for the bulk of economic growth. This is partly a reflection of the low unemployment rate and steady gains in household income.

This GDP estimate represents an initial assessment of US economic activity in Q2 2019, and is based on source data that are incomplete or subject to further revision. The second estimate of Q2 2019 GDP will be released on 29 August 2019. The US GDP data is readily available from the US Department of Commerce, specifically the Bureau of Economic Analysis.

For 2018 as a whole, the US economy grew by 2.9%, significantly up from a revised 2.4% in 2017 and 1.6% in 2016. The improvement in 2018 was partly driven by President Trump’s fiscal stimulus package, which included a combination of tax cuts and increase government spending, including spending on defense. As mentioned above, the most encouraging component of the Q2 2019 GDP performance was the growth in consumer spending. Under these circumstances any deterioration in the labour market would be extremely concerning.

A fairly wide range of US forward looking indicators have softened in recent months. This includes the ISM manufacturing index, the leading economic indicator and various confidence indices. This would suggest that despite the latest GDP growth rate the US economy is still expected to slow into 2020. However, the forward looking data is not yet reflecting a significant slump in economic activity, but rather a moderation in the rate of growth – suggesting that in 2020 GDP growth could moderate to somewhere between 1.5% and 2.0%. We are currently forecasting that the US economy will grow by 1.6% in 2020, after expanding by around 2.3% in 2019.

Critically, the most recent policy response from the Federal Reserve indicated that interest rates are to be cut twice, by 25bps on each occasion, during the remainder of 2019 (once at the end of July and again in September /October). At the margin, a cut in US interest rates should help to buoy the economy in 2020, but more importantly the expected cut in rates reflects the Fed’s growing concerns about the lack of any inflationary pressure in the system and therefore the increased risk of sustained disinflation or even deflation in 2020.

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