2010: The year of disparity

2010: The year of disparity 20102011 Annabel Bishop, 26th August 2010

Topics • Are we on the road to economic recovery? • Where to for the rand? • Will the problems in Europe affect SA? 20102011

Overview: 2010, the year of disparity 2010 is shaping up to be a year of marked disparities. Not only is growth likely to be markedly stronger in the first half than the second, both domestically and globally, but consumer spending substantially stronger in the upper income bands than the lower. Growth is now waning on the turn in the inventory cycle (and fading impact of the World Cup in SA), but household spending is not likely to provide a counter-balance due to high private sector debt and related servicing costs, along with austerity measures and higher taxes in many developed economies. Economic growth will remain below trend until at least 2012; South Africa’s first quarter 4.6% qqsaa outcome not materialising as a full year reading over this period. SA’s rapid rise in unemployment is in stark contrast to growth expected around 3.0% this year. That is, until one realises that expected growth this year of 3.0% y/y is calculated off a recession (2009 recorded -1.8% y/y). Removing this distortion 2010, is really a year of very weak growth (slightly over 1.0% y/y). Surviving companies are typically cash flush, remaining in survival mode and not employing or investing until the recovery proves sustainable and high degree of uncertainty diminishes. Firms continue to reduce costs and remain cautious with operating surpluses. Further interest rate cuts would alter this outcome, not least by reducing the attraction to hold cash, spurring firms into investing and hiring. The rand has been relentlessly trying to penetrate the key resistance level of R7.20/USD, and so the SARB and the National Treasury remain accumulators of hard currency. We expect a 50bp cut in interest rates at the September MPC meeting, which would mitigate against rand strength. However, the MPC may still prove stubborn, which will leave only one more opportunity to cut this year - in November.

The rand, which had traded in an increasingly narrow band since April this year, strengthened dramatically after the July MPC meeting. Post MPC

Short positions taken against the rand prior to the MPC meeting in expectation of an interest rate cut were closed, exacerbating rand strength. SA’s … Post MPC

… relatively high interest rates and negative real interest rates in the US, pushed the rand dramatically stronger on the carry trade. The ANC’s mooted tax ...

… on short-runcapital inflowsis aimed at reducing foreign purchases of equities and bonds (portfolio inflows) to limit rand strength. However, such a ... Post MPC

… tax would target only R22.6bn worth of equity inflows into SA against a backdrop of a turnover in the rand of R16.2trillion since the start of the year...

… seeking to control 0.1% of the movement in the rand. If the tax was imposed on foreign purchases of bonds and equities (tax on net portfolio flows) …

…the negative impact on investor sentiment would likely adversely affect foreign purchases of domestic bonds, a risk government likely wishes to avoid…

… as it would raise funding costs of its substantial borrowing requirement over the medium- term. This planned rise in borrowing is currently sustainable … Net debt is total (gross) debt less government’s financial assets (cash, deposits, loans, holdings of traded equities etc)

… given SA’s very low debt levels …

… and likely economic growth path. SA’s increase in debt is also necessaryto meet capital spendingneeds.Indeed, SA’s planned strong expenditureon…

… infrastructure and human capital will ultimately sustain growth of 6-7%. SA’s on a better long-term growth path than most advanced economies....

… whose high debt levels means higher taxes and austerity measures (reduced spending on infrastructure and human capital). Debt of all spheres of government (national, provincial, municipal), including that incurred in on lending to government owned entities (such as Eskom) or even the private sector

The European sovereign debt crisis upset global financial markets …

increasing the delay in U.S. and most advanced economies monetary policy rate normalization, ...

… further supporting rand (and other EM currencies) strength. Brazil Singapore

Ongoing weakness in the US (and other advanced economies) is raising fears of a double dip recession as fiscal stimulus and the inventory effect fade.

Household spending is unlikely to provide a counter-balance due to high private sector debt and servicing costs, along with austerity measures and higher taxes in many developed economies.

We do not expect a recession in global production (the feared double dip as consumer spend follows suit on escalating unemployment), China’s dip in industrial production is rather a return to its long-run average rate.

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Carry trade

2010: The year of disparity