Global inflation is already at its highest level since 2008, while in emerging market and developing economies, inflation has reached its highest rate since 2011. This means that many emerging and developing economies, including South Africa, are having to raise interest rates, to contain inflationary pressures, well before the economic recovery is complete.

The slowdown in global growth over the next year is also likely to coincide with a widening divergence in growth rates between advanced economies and emerging and developing economies. In particular, economic growth in advanced economies is expected to slow from 5% in 2021 to 3.8% in 2022. While this reflects a significant moderation in the rate of expansion, the rate of growth will probably still be sufficient to restore output and investment to their pre-pandemic trend. In contrast, within emerging and developing economies, economic growth is expected to drop from 6.3% in 2021 to 4.6% in 2022. While 4% growth is still fairly robust, it means that by 2023 output in emerging and developing economies will still be 4% below its pre-pandemic trend. The notable exception is China, which has already seen output rise to well above pre-pandemic levels.

US growth:  hurt by a surge in Covid-19 infections and higher inflation

In the third quarter of 2021, US GDP grew by only 2.3% quarter-on-quarter, annualised, after expanding by a robust 6.7% in the second quarter and 6.3% in the first three months of the year. The third quarter’s key areas of weakness included:

• Consumer spending on goods, especially durable goods such as motor vehicles
• Exports
• A fall-off in fixed investment into housing.
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Fortunately, the growth rate is expected to have improved meaningfully in the final quarter of the year, pushing the annual rate of expansion for 2021 up to an average of around 5.6%. In 2020 the US economy contracted by -3.4%, hurt by the severe lockdown restrictions associated with the start of Covid-19.

Economic recovery in 2021 was boosted by a substantial increase in government spending, especially spending on unemployment benefits and other social transfers. However, consumer income (and spending) is now largely driven by employment gains and salary increases, rather than social payments. Fortunately, both job growth and salary adjustments remain fairly robust overall. Encouragingly, the level of US household savings remains high and it can easily be used by households to fuel future consumption spending.

In December 2021, US headline consumer inflation, at 7%, had reached its highest level since 1982. US consumer inflation averaged 4.7% in 2021, up from only 1.2% in 2020 and its highest annual average since 1990.

Overall, inflationary pressure in the US has arguably broadened significantly in recent months, and, with core consumer inflation well above target, the US Federal Reserve will be under increasing pressure to become more aggressive in tightening monetary policy.

The latest US CPI report, together with the US unemployment rate falling to 3.9% in December 2021, supports the view that the Federal Reserve is well behind the curve in removing its highly accommodative monetary policy. While the Federal Open Market Committee (FOMC) recently announced an acceleration of QE tapering, it seems increasingly likely that at the next FOMC meeting the Chairman of the Federal Reserve will announce that the economy is at full employment and that inflation has become more concerning, signalling that the first rate hike during the current economic cycle is likely to occur in March 2022.

Euro area: activity rebounded strongly in 2021, but ongoing risks point to a delayed recovery

The solid economic growth in the euro area in the third quarter of 2021 continued to be driven by private consumption, as the region re-opened after pandemic lockdowns. These have unfortunately returned in some parts of the continent. The ongoing strong performance means that the region’s GDP is now only 0.3% below its pre-pandemic level, and will return to its pre-pandemic output level in 2022.

Despite the strong rebound, the trajectory and pace of economic recovery in the euro area remains complex, as it faces some ongoing headwinds. Recovery over the course of 2021 was affected by increasing global supply chain disruptions, which may continue with the recent surge in Covid-19 cases around the world (driven by the Omicron variant).

In addition, the latest surge in Covid-19 cases resulted in the re-introduction of some lockdown measures in many countries in the region, which has negatively affected the pace of economic recovery. However, the economic impact of this new wave is likely to be less severe than in previous waves of the virus, given the higher vaccination rate and lower severity of disease.

Similar to the US, euro area inflation surged in the second half of 2021, ending the year at 5% year-on-year, well above the European Central Bank (ECB)’s 2% target and the highest rate of inflation since the euro area was created two decades ago. While it is expected that headline inflation will fall in 2022, there is a significant risk that the emergence of the Omicron variant, which threatens to prolong the pandemic and supply chain bottlenecks, could fuel further price increases or slow the rate of price falls.

In response to the rapidly rising consumer prices, the ECB announced that its €1.85 trillion Pandemic Emergency Purchase Programme (PEPP) would stop asset purchases in March 2022. However, to avoid interrupting the economic recovery, especially the possible risks posed by the Omicron variant, the ECB committed to expanding its older asset purchase programme (APP) for at least 10 months and ruled out raising interest rates in 2022. Ongoing fiscal support remains crucial, as a premature withdrawal would risk weakening the recovery.

The Chinese economy showed some resilience at the end of 2021

Chinese GDP showed some resilience at the end of 2021. The slowdown in economic growth was not as sharp as expected, although the economy continues to face headwinds. Chinese GDP grew by 4% year-on-year in the final quarter of the year, the slowest growth rate since Q2 2020.

As expected, China’s economy easily exceeded government’s growth target of more than 6% in 2021, with the economy growing by an impressive 8.1% for the year, helped by base effects and strong global trade conditions throughout the year. This was a significant rebound from the 2.3% growth rate in 2020, when the Covid-19 pandemic battered the economy.

From a supply side perspective, industrial production led the economic recovery in China in 2021, growing 9.6%. Although it has moderated, it remains resilient, supported by strong global trade conditions and robust external demand.

In contrast, Chinese retail sales data show that the demand side of the economy remains weak, as the outbreak of new variants throughout the year and China’s zero-Covid policy continued to affect domestic consumption activity. Despite this, retail sales for the year as a whole also rebounded strongly, growing by 12.5% and helped by significant base effects, following a -3.9% fall in 2020.

The outbreak of the Omicron variant and China’s zero-Covid policy are likely to weigh on economic activity in early 2022. Additional government policy support is expected and needed to keep the economic recovery on track. China’s GDP is expected to grow by 5.2% in 2022, driven by infrastructure investment and the drive to support household consumption.

Unlike the rest of the world, consumer inflation has not been an issue in China, remaining subdued in 2021. Some acceleration in inflation is expected in 2022 amid higher consumption spending and services demand. However, the spread of the Omicron variant in China remains a downside risk and could continue to weigh on non-food inflation in early 2022.

Moderating inflationary pressures provide authorities with additional room to continue to ease both monetary and fiscal policy. The People’s Bank of China (PBoC) implemented an unexpected cut to its one-year medium-term lending facility in January 2022. Further easing from the central bank is expected in 2022, with additional support provided by the fiscal authorities. Overall, however, government should remain committed to implementing structural reforms to ensure a lower rate but a higher quality of growth in the long term.

SA is still waiting for a sustainable uplift in economic growth and employment

In the third quarter of 2021, SA’s GDP declined by -1.5% quarter-on-quarter, seasonally adjusted but non-annualised. (It was 1.1% in Q2 and 0.9% in Q1 2021.) The decline in activity was concentrated in retail, manufacturing and mining, although agriculture, transport and construction activity also slumped. The weakness can be mainly attributed to a combination of looting/unrest in July 2021, electricity outages and pronounced job losses. It is also important to recognise that business and household confidence remains weak, while government policy implementation remains unconvincing.

For 2020 as a whole, the South African economy declined by -6.4%, and it is expected to grow by around 4.7% in 2021. After the latest decline in GDP, the economy is still 3% below the level of GDP that prevailed in the first quarter of 2020, and 3.4% below its 2018 peak. At the same time, total employment remains a staggering 2.1 million below its level prior to the onset of Covid-19 and 2.25 million less than the peak achieved at the end of 2018.

SA’s economic performance surprised on the upside in the first half of 2021, buoyed by better export receipts due to higher international commodity prices, as well as an uplift in retail activity helped by an easing of lockdown restrictions. Unfortunately, this positive sentiment all changed with the shock unrest/looting in July 2021, which was then compounded by the third wave of Covid-19 and the return of electricity outages. At the same time, the agricultural sector declined, partly due to base effects, while the lack of fixed investment activity further dented the construction sector. The South African economy has clearly lost momentum since the middle of 2021, despite the ongoing revival of world economic activity and numerous promises by government that policy implementation would be dramatically improved.   

Critically, GDP is forecast to grow by only around 2.1% in 2022, assuming that:

• the latest Covid-19 variant can be mostly contained in early 2022
• the vaccine rollout improves meaningfully
• interest rates hikes remain modest
• there is an improvement in international tourism during the second half of 2022 (although off a very low base)
• electricity and water outages remain broadly manageable and become less disruptive during the year
• government is able to avoid any significant tax increases in February 2022 (with the exception of excise duties and the fuel levy/Road Accident Fund)
• Operation Vulindlela gains some momentum.

Unfortunately, a growth rate of 2% is still well below the rate required to inspire an increase in private sector fixed investment and widespread job creation.

SA: looking forward

The traditional policy measures typically implemented to revitalise economic growth under current circumstances are restricted in SA, especially fiscal and monetary policy. Government cannot afford to cut taxes extensively to boost household consumption and corporate investment, given the extreme fiscal constraints. Equally, the government does not have the scope to meaningfully increase its own spending, given its current debt trajectory. This means that government’s growth initiative (as outlined in the Reconstruction and Recovery Plan) needs to move ahead rapidly in trying to initiate a wide range of private/public infrastructure partnerships to stimulate growth and employment. This includes deregulating economic activity and continuing to make it easier to do business. At the same time, the South African Reserve Bank has clearly signalled that interest rates can be expected to move higher during 2022.

Ultimately, the success of the government’s growth and employment agenda in 2022 and beyond will be determined, not by the quality of the policy document but by its ability to make progress in implementing real reforms that encourage the business sector. Closing the gap between SA’s current trend growth rate and a modest target of 3% to 4% on a sustained basis will require a significantly larger implementation effort than is currently evident, including the co-ordination of economic policy across key government departments and actively partnering with the private sector.

SA’s inflation is on the rise, moving up from a recent low of 2.9% in February 2021 to well above 5% at the end of 2021. It is expected to remain above 5% during the first few months of 2022, but then slowly start to moderate to a year-end level of around 4.5%. This forecast assumes that the oil price remains around $80/bbl over the next few months, but then eases back to around $70/bbl in 2022, and that food inflation starts to slow to below 5% in late 2022. Global food inflation remains elevated, while persistent global supply disruptions have exerted upward price pressures in many sectors of the global economy – and are clearly a risk to SA’s inflation outlook.

The recent upward trend in inflation encouraged the South African Reserve Bank to increase the repo rate (repurchase rate) by 25 bps to 3.75% at its Monetary Policy Committee (MPC) meeting in November 2021. The decision was not unanimous, with three members of the MPC preferring an increase in rates and two members voting for rates to remain unchanged.

Critically, the Reserve Bank highlighted the upside risks to domestic inflation, both over the short and medium term. At the same time, the MPC highlighted the downside risks to growth, including renewed electricity outages and some softening of precious metal prices.

The interest rate decision in November 2021 was entirely appropriate and consistent with the Reserve Bank wanting to ensure that inflation is anchored around the midpoint of the inflation target. By controlling the upward pressure in inflation, the bank ultimately limits the longer-term damage that higher inflation would inflict on SA’s overall economic performance. As expected, the MPC also stressed that, although the repo rate is going up, interest rates remain highly accommodative by historical standards – which is a fair point.