SA may be heading towards stagflation

Ian Cruickshanks, chief economist at the IRR, and Michelle Pingo deAbreu, an independent economist, have warned that GDP growth in South Africa risks declining below 2% in 2014. This will have a severe impact on government revenue, infrastructure development, job creation, and may channel government spending into non-productive areas.

Mining production (5% of GDP) in March contracted 4.7% y/y as the platinum mines saw production fall due to the broad sector strike, leading to corporate revenue loss estimated around R19.2bn. This is having a severe impact on exports where platinum has sunk to being a non-contributor after being South Africa's most valuable export in the previous two years. The ripple impact on mining support industries has led to broad business closures on the platinum belt. Employees have lost earnings estimated at R8.5bn, leading to a severe contraction in retail spending.

Declining business and consumer confidence has limited new project development, stunting corporate profitability and halting job creation while slowing consumer spending.

The manufacturing sector (15% of GDP) has also been limited, 0.7% y/y growth in March after 1.5% y/y in February, by power cuts as Eskom's maintenance projects hit snags. The manufacturing sector's purchasing managers' index registered below break-even level 50 in March and April confirming a likely contraction in that sector in the short term. Vehicle manufacturers, the largest contributor to the manufacturing sector, showed a contraction in sales of 10.5% y/y in April after a marginal 0.1% y/y increase in March. Vehicle export sales will be further negatively impacted by the decision of BMW to switch the manufacture of their new 3 series model from South Africa due to unstable labour relations and inadequate power supply from Eskom.

Retail sales which grew just 1.0% y/y in March after 2.3% y/y in February are likely to be further limited by lower consumer spending, impacted by low confidence, weak household finances, high debt levels (74% of disposable income in 2013/Q4), tighter credit standards (private sector credit extension 8.8% y/y in March vs long term mean of 14% y/y), rising inflation and spreading unemployment.

As consumer spending exceeds 60% of total economic activity in South Africa, this decline will have a broad and significant impact. Consumer price inflation has slowed to some extent as insufficient demand has inhibited the expected pass through impact of rand depreciation. This has led to restricted margins hampering corporate profitability. Consequently business confidence has declined restricting capital expenditure and corporate profit growth. This risks leading to delays in national infrastructure development, limiting job creation, exacerbated by government revenue being switched to social grants rather than fixed investment.

Higher global food prices (+13.1% year-to-date) are likely to underpin higher domestic food inflation (CPI food price index 7.2% y/y in March after 5.6% y/y in February). Consumer strain will be exacerbated by administered prices up 7.6% y/y in March with expected winter electricity pricing risking even higher power tariffs. Average wage settlements increasing by 7.9% in 2014/Q1 will only partially offset increasing price impacts.

Rand depreciation has forced up the cost of imported goods, raising producer input prices, rendering South African exporters' less price competitive. The Rand's recent temporary recovery will be beneficial to exporters in the short term, while the expected longer term depreciating trend is likely to maintain South Africa's high capital import costs, hampering price competitiveness.

The IMF has downgraded their global growth outlook to an optimistic 3.6% y/y in 2014 after 3% y/y in 2013, with their outlook for South Africa still at 2.3% y/y.

Low growth prospects are likely to limit corporate profitability, restricting tax payments and government revenue, lessening the ability to deliver much needed large infrastructure development, risking a higher budget deficit as rising demand for social grants exceeds revenue growth. This could increase government's borrowing ratio to GDP, threatening a national credit downgrade. Foreign portfolio inflows will slow with South Africa's current credit ratings only 2 notches above junk status, which is unacceptable for the majority of global asset managers.

These factors reinforce our view for South Africa's economic growth to be limited to less than 2% this year, as domestic inefficiencies and slowing global economic prospects lead to downside risks.

Issued by the Institute of Race Relations, May 26 2014

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