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Thursday, January 1, 2009
Turn in the cycle

After two years of deepening hardship, in which interest rates have been increased ten times, with prime rising to 15.5%, we are finally coming to a turning of the financial cycle, having enjoyed the first cut to 15% 12th December 2008.

“Other shock absorbers have already been operational for some time,” notes Cees Bruggemans, Chief Economist FNB, “protecting the economy from the worst fallout of recent events. The rand weakened by 10% in 1H2008, and a further 30% in 2H2008, shielding many producers, especially miners, farmers, manufacturers, but also some service providers (tourism) and building contractors from adverse business conditions.”
The ultimate giveback was oil, collapsing in four months from $150 to $50, one of the more bizarre and rather unexpected developments of 2H2008. This oil gift assisted in protecting the country from the impact of falling export prices. Oil is now trading around $41.
The Finance Minister furthermore continued government spending even as his tax revenue started to suffer from the slowing economy, indeed spending more on public salaries (pushed higher by inflation) and infrastructure.
Thus despite private sector slowing last year, the public sector remained an important growth anchor. But with inflation finally peaking over 13% in 3Q2008, the die looks cast for a plunging inflation rate in 2009, with interest rates following at least a part of the way. It’s sitting at about 12,1% currently.
With oil and food prices easing, and overdue statistical changes, the CPI inflation rate is set to plunge towards 6% by mid-2009. And this despite the weakened Rand and its implications for higher imported inflation.
Observes Bruggemans, “As the SARB acquires greater confidence regarding the upside risks governing the inflation prospect, especially regarding second-round salary effects and the global financial crisis implications for the rand, the more willing it should eventually become to start easing interest rates.”
He believes prime could fall to as low as 13% by mid-2009, and possibly somewhat lower by end-2009, depending on actual developments.” Such interest rate easing is likely to assist in stemming the inventory and private fixed investment cutbacks, if with a lag. Also importantly, it may influence replacement decisions by households regarding important consumption purchases such as cars, furniture and other household appliances and necessities.”
With the risk of higher interest rates waning as we move deeper into a rate-cutting cycle, and the debt servicing burden of households reducing as nominal incomes keep growing even as interest rates decline, households should become more confident to take on longer term commitments.
“In the course of this year, especially by 2H2009, we may have some hope of the economy gradually reviving once again,” he adds. “If so, it will likely do so in tandem with the world economy which by then is also expected to be growing again.”
Such global growth will be very much a function of a successful ending to the present financial crisis, the very aggressive interest rate easing we can observe around the world in progress today, and the equally aggressive fiscal boosting, especially in China and America but not limited thereto.
Meanwhile, there has been an awful lot of cordless bungee jumping going on late last year: Car sales down 30%; Motor dealers 30% fewer; Real estate agents falling by 50%; Steel output to fall by 30%; Stock market down by 45%; Oil price down by 65%; Platinum price down by 65%; the rand down by 40%; and business confidence down by more than a half.
These are big numbers. They don’t remain ring-fenced. Their impact goes wider.
Credit growth is coming off quickly now. At 16.5% it is already half way down from the 30% cyclical peak, but likely reaching single-digit growth during 1H2009.
The only three things doing well at present are maize, infrastructure and public servants. But that doesn’t even add up to 20% of the economy. The remaining four-fifths are underwater or apparently getting there.
“Yes, we do have impressive shock absorbers,” he notes. “Oil down by 65% means the country pays much less for its energy. But this gain barely matches the export losses faced by the precious metal miners, at least in dollar terms.
“And, yes, the rand’s 40% decline is shielding our miners and creating opportunities for import replacement for some of our struggling manufacturers, but it wont save all of them. Global industrial production is falling heavily now, unleashing intense competitive struggles, which will also wash ashore here.”
The steel story is one indication, with 30% less steel to be produced this year. But also fewer cars, with domestic sales still shrinking, and export of cars also likely to be off by 15%-20%.
Consumers have been cutting spending since mid-year 2008, suggesting we are now six months into recession. And there is a problem in private fixed investment. By type of asset, residential fixed investment is most under pressure, from affordability issues (interest rates), supply-side problems (electricity connectivity, municipal services) to tightening bank credit criteria. Building plans passed are falling in real terms, as are buildings completed. The rate of decline since late last year is considerable.
Non-residential building activity in the retail, office, industrial and warehousing space could be next as present projects reach completion. Together these two sectors represent 20% of total fixed investment. They are expected to show substantial decline in activity levels this year. That should have knock on effects for building merchants and manufacturers of building materials.
Commercial vehicle sales are also declining in recent months, indicative of a new reticence out there. These three items together are usually a good leading indicator for manufacturing investment in plant, machinery and equipment. Expect more pullbacks as people expect a slower economy and lower capacity utilisation.
Another disappointment may be looming in mining, where this time around it is falling commodity prices that cut prospects, with not even a weaker rand being able to prevent more cutbacks. Mining output to date is running over 7% down on 2007.

Copyright © Insurance Times and Investments® Vol:22.1 1st January, 2009
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