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Economic Outlook
Dr Cees Bruggemans
9 May 2007
The outlook for the economy remains highly encouraging. Having acquired a GDP growth momentum of 5% these past three years, the economy is likely to continue at this speed, if not slightly better during 2007-2008.
The main growth impulse is coming from fixed investment, with real outlays growing at 13% and possibly still accelerating, in the process alleviating bottleneck constraints on further growth.
Also supportive is real government consumption and household consumption, both expected to grow at 5%-6%.
Consumer confidence has an excellent track record of signaling cyclical economic downturns as much as a year in advance, yet the FNB/BER consumer confidence index is at a record high and possibly will still rise further. The RMB/BER business confidence index similarly continues to give very high readings.
Net exports may also add more to GDP growth, as the export performance improves (mining output recovering and a less overvalued Rand favouring manufactures). Import growth should be mildly tempered by the weaker Rand and slowing in household durable consumption (cars especially), even if imports of capital goods are speeded up by fixed investment needs.
The global economy should continue to support our terms of trade (mining export prices rising faster than manufactures import prices), with capital inflows remaining in excess of current account funding needs. This should maintain the Rand within a 6-8:$ band, averaging near 7.00:$, with a firming bias against the Dollar (though possibly mildly weaker on trade-weighted).
This prospect remains highly encouraging for employment growth of 3%-3.5% annually, translating into 0.3 million additions annually to the formal sector's middle class, and a further 0.2 million to the informal sector.
Unemployment, which reached a peak of 40% of the active labour force in 2002, and is currently down to 36%, should continue to decline by some 0.1-0.2 million annually (0.5%-1% of the active labour force).
Although critical skill shortages will be encountered in parts of the formal labour market (for instance building and construction contractors suffer severe skilled labour constraints, and technical professional labour is generally in short supply), the overall labour market condition is likely to remain unconstrained.
Average wage growth should continue in the 6%-7% range (covering a wide range of experiences from well over 10% for some of the heavily unionized labour to less than 5% in other parts of the labour market). After allowing for productivity gains of some 2%, it makes for unit labour cost growth of 4%-5%.
This approximates the underlying long-term inflation trend in the economy, in turn feeding capital market and surveyed inflation expectations of 5%, and centrally positioned in the SARB?s 3%-6% inflation target range.
Headline CPIX is still rising in the short-term and is expected to be near 6% in 2Q2007, but thereafter again averaging closer to 5%-5.5%. CPIX's current elevated condition is due to past oil price pressure coupled to a weaker Rand, and higher food prices on account of global conditions, local drought and the Rand.
The SARB is likely to monitor actual inflation very closely for any evidence of spillover into higher forward-looking inflation expectations.
The SARB can also be expected to be sensitive about the robustness of real domestic demand growth of 6%-7%, supported by credit growth of 15%-20% (post-planned securitizations). Such demand conditions will likely keep the economy near or above its output growth potential of 4.5%-5%. The SARB will not want to see any excessive demand from translating into higher inflation.
Import spillovers, with especially China, India, Korea, Taiwan and Japan functioning as safety valves, should keep a competitive lid on local pricing developments. A fairly firm Rand near 7:$ should also assist in anchoring import prices, suppressing domestic inflation pressure.
The main external threat to this outlook would be from oil disruption, a weaker Rand and higher import prices, while locally the main threat is probably overheating. Be that as it may, until these threats develop more clearly the SARB is likely to continue with its pausing stance, prime settled at 12.5% since December 2006.
It should be noted that real interest rates have risen mildly by 1% over the past year relative to underlying inflation. This represents a robust monetary stance. Macro-stability is further assisted by allowing the fiscal surplus to rise, probably towards 2% of GDP, on account of very lively tax revenue gains.
In such a high growth environment encouraging fast rising consumption expectations, yet with household real purchasing power mildly eroded by higher inflation and interest rates, it is not unnatural to encounter demands for higher wage growth. This will probably be most successful among the more heavily unionized labour in the private sector, even if this comes at the expense of unionized job growth in an increasingly flexible labour market environment.
Original article published at www.fnb.co.za.
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