South African economy reaps benefit of weak rand
September 7, 2016, 12:36 pm

Strong data from mining and manufacturing helped boost the South African economy in Q2 [Xinhua]

Final sales are calculated by subtracting the change in inventories from the gross domestic product (GDP), on a quarter-by-quater (q/q) seasonally adjusted annualized (saa) basis.

In other words, net exports contributed 6.7 percentage points to total GDP growth. On a year-on-year (y/y) basis GDP growth recovered to 1.4 per cent in the second quarter after shrinking by 0.9 per cent in the first quarter as exports grew by 3.1 per cent from only a 0.7 per cent rise in the first quarter.

Sanlam Investment Management economist Arthur Kamp warned, however, that the strong growth may not be sustainable.

“In a base case scenario the improving current account balance should help establish a foundation from which the economy can lift a little in 2017, especially if inflation peaks in late 2016 (implying a more benign interest rate outlook), before slowing through next year, which in turn, would boost real personal disposable income,” Kamp said.

“The well documented risk is sustained rand weakness if policy uncertainty causes risk aversion to increase (especially if any sovereign debt rating downgrade is accompanied by expectations of additional ratings downgrades), which could re-ignite inflation expectations and lift inflation forecasts,” he added.

In response the South African Reserve Bank, in Kamp’s view, would have little option in this scenario but to continue increasing its repo rate – or rate at which it lends funds to banks – in response to waning liquidity, despite the noted weakness in domestic final demand.

“That would, ostensibly, place the expected upswing in jeopardy,” he said.

The domestic demand side of the GDP equation remained muted with household final consumption expenditure increasing by only 1.0 per cent on a q/q saa basis in the second quarter and government final consumption expenditure rising by 1.3 per cent.

Poor business confidence meant that gross fixed capital formation decreased by 4.6 percent.

GDP grows

On the productive side, GDP grew by 3.3 per cent q/q saa in the second quarter after a 1.2 per cent q/q saa contraction in the first quarter. The largest contributor to GDP growth was manufacturing, which jumped by 8.1 per cent q/q saa, reaching the highest quarterly growth rate in three years.

This came due to a surge in production of petroleum products, chemicals, rubber, motor vehicles, spare parts and accessories, and other transport equipment as exporters took advantage of the weak rand.

The mining and quarrying industries have recovered in the second quarter with a 11.8 per cent q/q saa gain following a 18.1 per cent q/q saa contraction in the first quarter.

Despite the good growth in these tradable sectors, the surge in export demand meant that there was a R23 billion ($1.64 billion) drawdown of inventories in the second quarter after a R1 billion ($71 million) build-up in the first quarter. Because these stocks have to be replenished, prospects for mining and manufacturing remain good for the remainder of the year.

But Kamp is cautious as he points to the two sectors which underpinned the solid GDP outcome recorded gains off weak bases, implying a slowdown is likely looking ahead.

“The July 2016 and August 2016 manufacturing PMI releases were palpably weak as the business activity index fell from a level of 54.3 in June to 49.5 and 44.8 in July and August respectively,” he says.

At the same time, new orders fell from a level of 54.4 in July 2016 to 42.5 in August.

Kamp further pointed out that domestic final demand remains palpably weak, as well.

“Especially concerning is the continued fall in real fixed investment spending, which declined 4.6 per cent in the second quarter following decreases of 2.8 per cent and 10.0 per cent in the fourth quarter 2015 and first quarter 2016 respectively. The weakness in investment spending was concentrated in machinery and construction works,” Kamp noted.

Third quarter weakness?

Mike Schüssler, an economist at Economists.co.za – a leading private economic research house, also warned that early third quarter data pointed to weakness in the current quarter.

“Yes, the second quarter data is good news, but – and this is the big problem – the economy is already far weaker in the third quarter and we need to also understand that with a population growth at 1.7 per cent we are growing far slower than that on a year-on-year basis,” Schüssler said.

Professor Charles Simkins from the Helen Suzman Foundation – an institution promoting liberal democracy – said the second quarter boost from exports was very welcome, but exchange rates were volatile so the situation could change rapidly.

He pointed to the fact that growth has largely been driven by exports, which increased by 18.1 per cent. The export sector – mining, parts of manufacturing and financial services – has done better than other sectors, he adds.

This is largely due to the depreciation of the rand.

On the converse side, imports declined by 5.1 per cent.

“Both developments have improved the balance of trade, as they should have done,” Simkins told The BRICS Post.

What happens next depends to a considerable extent on movements in the exchange rate. Exchange rates tend to overshoot, and an appreciation of the rand sustained over several months would change the situation again,” he added.

The Rand

Economist Sanisha Packirisamy and Herman van Papendorp, head of asset allocation at specialist investment firm Momentum, said depressed consumer and business confidence indices point to a slowdown in growth in the third quarter of the year as rising inflation, weak hiring intentions and muted credit growth constrain household spending.

They also see that elevated political risks and soft growth in corporate profitability are likely to cap investment growth.

“We expect GDP growth at below half a per cent in 2016, increasing to around a per cent in 2017 as additional electricity capacity comes on stream and as commodity prices inch higher in response to an improvement in global demand and in reaction to a further reduction in commodity supply,” they said.

The Nedbank Economic Unit says the outlook remains murky.

But Kamp believes that with all the risks in the quarters ahead, Tuesday’s data is a positive development for the South African economy.

“Especially considering that the positive flip-side of the weakness in domestic final demand is the better trade account data. This should be accompanied by a far smaller current account deficit relative to GDP in the second quarter,” he said.

“Look out for that number.

Helmo Preuss in Pretoria, South Africa for The BRICS Post