South Africa: barely into cyclical recovery

One couldn’t possibly be too careful. Three years into recovery and the European crisis hanging over us like a Sword of Damocles, with media reports this month of bankers calling the bottom of their credit impairment cycle as their book growth is starting to create renewed increases in portfolio provisions, some are looking out for the next recession while others may just want to turn cautious naturally.

 

And yet the real economy is anything but ready for a cyclical slowing, carrying as much resource slack as it does, even if it is mainly the own supply constraints that create important headwinds for growth.

Cyclically speaking, we may be underperforming but should be looking for an exceptional long expansion, given the resource scope for doing so, provided of course the many supply constraints don’t pull us under (and Europe, China and/or the US don’t blow up these next 12-24 months).

Three economic sectors, namely mining, manufacturing and the building trades, between them generate some 25% of GDP and probably 80% of cyclical volatility.

Mining and the building trades are still at rock bottom activity levels while manufacturing has so far retraced only half its 2009 recession losses.

Also examine formal labour force levels and the property market, especially vacancies, as much residential as non-residential (meaning offices, industrial, retail).

What you get isn’t a recovered economy ready to start overheating once again shortly.

If anything, what you get is an economy barely off the recession floor, and that three years after the last recession ended.

In manufacturing, capacity utilisation is barely 80% and apparently unwilling to budge. In historic terms, that’s just off the average recession floor and a long way to go to overheated heights, with absolutely no booster in sight shortly capable of moving it off its lowly perch.

In mining, things are especially dire, with output earlier this year hitting 50 year lows. Special factors were evident, especially the labour-torn platinum sector, but that wasn’t the full story. Mining just hasn’t come off the floor this decade despite a global commodity supercycle, with infrastructure constraints, labour and government regulatory intervention most to blame.

The building trades remain at recessionary lows, with every possible statistical metric confirming it, a likely function of property market and banking overindulgence in the 2004-2008 boom years, and subsequently laid low by oversupply, lacking demand and a changed credit culture following the global experiences since 2007 and our own national credit act.

The formally deployed labour force is barely off the recessionary floor of three years ago, yet with many new annual cohorts having entered the labour market since.

South Africa currently only employs 9.3m formal labour, with slack in the system of some 0.5m to 1m that could be absorbed if there were enough activity.

Output may have grown by 3% annually since mid-2009, but after accounting for productivity gains (unit per labour produced) there hasn’t been much of an uptake in active production factors.

If anything, resource slack remains of historically large proportions, with the economy effectively still stuck near recessionary lows in terms of resource use (though not output levels).

These resource utilisation levels still have to rise a good deal before we can say that cyclically the economy is getting quite advanced and it is time to get cautious about credit and import overheating.

As things stand, the economy remains underheated and stuck in a close-to-recessionary rut.

The reason for this sad state of affairs is manifold. There are the many supply side constraints holding output growth back, meaning electricity, rail export capacity, credit, technical manpower in the public sector, labour militancy in the private sector.

A slow economy makes private businesses cautious in their investment and hiring commitments. And global crises, whether the European imbroglio, the US fiscal cliff looming or the Chinese enigma, they all make people cautious about what comes next.

Cautious boardrooms translate into restrained investment spending, self-reinforcing limited demand and more management caution.

The mantra seems to be that at the best of times it is advisable to be cautious for ere long some unexpected event may catch you out.

We have seen it before that the cycle can catch out the credit providers, either because they weren’t cautious enough as the cycle took off (and they missed the takeoff) or because they were overcautious (and missed to notice that the cycle failed to have a proper ignition, lingering aimlessly for some years because it was missing a proper booster).

Business cycles with their property cycles missing are always sad affairs, as the past 100 years have taught us.

We may eventually encounter a serious new takeoff in infrastructure as a new investment wave bunches large new projects together in close proximity, potentially later this decade.

Nothing else is close on the horizon offering the same lift-off strength. If anything, the global audience remains petrified of any new downsides, emanating from shock treatment in Europe, China and/or the US (and PLEASE not simultaneously).

Yet all this global downside potential may be overstated. Greece may not leave the Euro and a European banking union seems to be forming.

The US may encounter an outsized fiscal adjustment (“jump off a cliff”) later this year, but the Fed is unlikely to remain idle under such circumstances, providing yet more monetary accommodation, with the US economy still having private momentum as well.

China has engineered a gradual slowing and has started to throw the policy tiller once again in favour of expansion, if not quite so aggressively as in 2008, but enough to stabilise her growth dynamics.

The geopolitically restive Middle East and the slowing world economy seem to be conspiring to get the oil price down, and to fluctuate for a while below $100, supporting the global economy.

This isn’t quite the dire downside potential breathless media reporting makes it out to be. Growth may be slow, for sure, but it isn’t another late 2008 panic, with everyone globally cutting their order levels by 30%.

Even so, catastrophic crisis potential is evident and should make anyone cautious, as the SARB Governor keeps reminding in nearly every speech.

As things stand, our supply shortcomings are holding us back, our exposure to slow global growth via restrained exports is keeping us back, cautious boardrooms hold back our private fixed investment expansion and new job hiring and our next wave of public sector infrastructure expansion may be slow out of the gate later this decade.

This translates into lingering severe resource slack, or as economists put it, a continuing large output gap which refuses to close quickly (seeing that we are counting from as far back as 2008).

In plain English, we are still in the immature phase of the new cyclical expansion. The banking industry may have seen its debt impairment ratios normalise, but this is at most a moment for reflection rather than the start of renewed caution.

This economy is stuck in low growth gear, with lots of resource slack remaining, and this situation seems unlikely to change soon, likely not before mid-decade (three years away) and possibly only much later in the second half (five or more years away), if a European or US or Chinese bus doesn’t hit us before then, as the super-cautious among us keep promising.

So this may remain a moment, after debt impairment has finally normalised and even undershot cyclical averages, to remain accommodating because so much has changed (in the credit culture), so much has changed in the economy (with so many constraints holding us back) and so much has changed in the world at large (holding so many of us back fearfully) that we are going to struggle to get to full potential and overheating credit cycles any time this decade.

It may therefore be early days, not only cyclically but also structurally, to start getting overly cautious.

We aren’t close to being in the right frame of mind, never mind actual conditions in the economy being there.

Ask your customers, retail as much as commercial. They should be able to paint you very realistic pictures as to where we really are in this new cycle.

It is therefore also not a time to be asking about interest rate increases soon, unless a devastating global crisis destabilises the Rand to such an extent that it gives us another massive inflation wave, requiring nominal rates to rise.

Short of such a catastrophe, interest rates could remain at current low levels for a long while, years even, with the potential of renewed downside through 2013 if inflation were to moderate enough.

This will remain a function of oil, domestic resource slack, the Rand, administered price hikes and organised labour demands, today a particularly volatile mixture that may yet yield us still many surprises.             
         
Cees Bruggemans
Chief Economist FNB

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