The South African economy is enjoying strong growth and low inflation for the first time in over 30 years. Peter Leger examines whether this current 'good luck' run is sustainable or whether it will soon run out
Over the past year, confidence in South Africa has been improving, with mounting evidence that the country has good growth potential and greater stability than similar emerging market economies. The South African economy is currently in the 44th quarter of consecutive economic growth, the longest period of growth since the 1960s. Has South Africa's time in the sun finally arrived, or are potential problems looming on the horizon?
The 1960's environment in South Africa was a period of concurrent strong economic growth (averaging around 5.5% pa) and low inflation (averaging 2.5% pa). This phase of prosperity saw cyclical swings in growth, inflation rates and interest rates muted by the positive economic forces at work. In addition, strong spending on infrastructure, increased exports and good capital inflows kept growth bubbling along. If we examine the current environment, a number of key factors point to the country moving into a similar cycle.
a growing economy
The painful process of South African companies re-integrating into the global economy is largely over. Jobs have been shed and efficiencies implemented, and while this caused a great deal of economic pain over the last decade, austerity is starting to pay off. Companies are competing effectively in the global arena, despite some difficult global economic conditions. In some key areas such as platinum production, exports volumes are rising.
On the monetary policy front, the conservatism necessary to force inflation into the target range has done its job. The economy appears to be under control and government now has the luxury of being able to promote a more growth-orientated agenda to stimulate the local economy. Planned expenditure on infrastructure will boost the economy significantly. Local and foreign investors seem to be slowly accepting that South Africa is entering a different economic phase, and the steady flow of good news has boosted confidence further.
The first good news centres around the theme of improved stability and the various factors contributing to this. Despite global geo-political turbulence and economic shocks, South Africa has remained on track in terms of its economic goals. Policymakers are starting to be perceived as in control of the economy, with South Africa far less subject to external shocks and contagion than some other emerging markets. A key factor is that inflation has shown stability within the target range, despite the large increases in the oil price. With the rand trading within a relatively narrow range compared to the wild swings of a few years ago, the impact of the higher oil price has largely been offset by the strong rand. Given this, the oil price is unlikely to have a major impact going forward unless the rand weakens significantly. Further stability is demonstrated by the smooth and peaceful elections earlier this year, despite the ruling party achieving for the first time a greater than two-thirds majority in parliament.
Accelerating growth forms the basis of the second set of good news stories. GDP growth is stronger compared to last year and local production recovered strongly in the first half of 2004, despite a strong rand. In addition we have seen a sharp increase in capital expenditure by government and steady growth in the public sector. In aggregate we see the widespread theme of improved stability, in conjunction with growth stimuli, as a catalyst for economic growth, as it enables businesses to plan more effectively and have the confidence for further investment into the country.
This upward trend in investment spending will provide the capacity necessary to fuel increasing economic growth. An upward trend in employment growth rates, with 60,000 new jobs being created per month, adds to the evidence for an accelerating growth picture.
All this good news has led to consumer and business confidence levels improving dramatically. Local demand growth remains strong, with recent car and retail sales data confirming booming consumer spending. In addition, the production side of the economy has responded positively to strong demand growth. Property prices have continued to boom, with international investors still seeing value in South Africa. Local equities have outperformed many established global markets, and deals such as the proposed Barclays-Absa case show improved international investor sentiment. With the equity market having returned nearly 36% in local terms over the last 12 months, an abundance of good news on the economic front and improving confidence levels, investors are returning to the local equity market.
Will the good luck run out?
However, it is prospective future returns that count, so will the current equity bull run continue, or will investors soon be switching to other opportunities? The macro economic environment looks supportive for economic growth into 2005, which will provide support for some further upside in the local equity market. We believe the valuation of local equities has not completely factored in the optimistic economic outlook, and even after the run we have had, the market is not expensive relative to prospective profits.
Going forward, do the fundamentals support continuing good news, or are there potential shocks on the way? The international environment is still South Africa friendly. Global growth remains intact, and while the oil price surge is a serious concern, it has not had the major impact of historical oil crises due to prevailing low inflation and low global interest rates. Commodity prices are still strong, providing good export revenue streams to our economy. Turning to the local fundamentals, interest rates are down and inflation is under control. We believe rates are likely to remain more stable than the in the 'boom/bust' cycle we saw in the 1980s. The strong rand, although it has a negative effect on exports and the current account, also has positive effects. It is a powerful disinflation force, currently offsetting the inflationary pressure of record oil prices. In addition, it allows production capacity to be overhauled cheaply and provides offshore investors with a signal of confidence in the South African economy.
Factoring in risk
There are however, some risks. South African economic growth is below that of other leading emerging markets, and in an environment where the competition for international capital is fierce, growth will have to improve in order to sustain the positive interest rate and inflation rate situation. Other risk factors include the persistence of the high unemployment rate, despite employment growth, and continued concerns about HIV/AIDS and crime. The rand is also potentially a 'wild card'. While we believe that it has entered a period of greater stability, a sudden sell off could trigger higher interest rates.
Despite some risks, on balance, South Africa appears stronger and better off than any time in the last 30 years. We believe the positives outweigh the potential negatives and believe that South Africans, and those with sufficient foresight to invest in the country, can look forward to a time in the sun.
Local and foreign investors are accepting that South Africa is entering a different economic phase, and the steady flow of good news has boosted confidence further.
This upward trend in investment spending will provide the capacity necessary to fuel increasing economic growth.
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