June 7, 2018
Kevin Lings, STANLIB Chief Economist
Most of the major developed and emerging economies grew relatively strongly in the first quarter of 2018. The growth reflected reasonably low interest rates, elevated levels of business and consumer confidence, and a sustained pick-up in industrial production and global trade.
In its recent World Economic Outlook the IMF raised its forecast for growth in the world economy for 2018 and 2019 to 3.9%. This is 0.2 percentage points above its forecast in October 2017. The upgrade could make 2018 the strongest year since 2011, when the economy was rebounding from the financial crisis.
World trade volumes
Still, there are fears that a potential trade war between the world’s two largest economies could start to disrupt global growth. There is also the risk of the US tightening monetary policy over the next 18 months faster than expected. Together these factors are increasing financial market volatility and providing an element of uncertainty in the global macroeconomic outlook.
US rate hikes respond to solid performance
In the final quarter of 2017 US GDP grew by a very respectable 2.9% quarter-on-quarter. This compares with growth of 3.2% in the third quarter and 2.3% for 2017 as a whole. US GDP is forecast to grow by around 2.6% in 2018. This is above the 2.2% average growth rate for the past eight years and well above population growth. The GDP per person was estimated at a record high of US$60 427 at the end of last year, up almost 30% from the low reached in the 2009 global financial market crisis.
Household consumption remains a key area of strength, along with investment in machinery and equipment, which has gained momentum in recent months. In total, household spending contributed a substantial 2.8 percentage points to the quarterly GDP growth rate, while fixed investment in machinery and equipment added a further 0.6 of a percentage point. On the downside, net exports subtracted 1.1 percentage points, reflecting mainly a pick-up in imports.
Encouragingly, a wide range of US leading-indicator models and their components continue to predict that economic activity should remain robust in the months ahead, and may even gain momentum in the near term. This improvement in outlook is partly due to President Trump’s tax changes that became effective from the beginning of 2018.
US house prices increased further in January 2018. Over the past year, house prices are up a respectable 6.4% year on year, increasing by 51.3% since the low in early 2012. Having risen in 67 out of the last 71 months, US house prices are now at a record high. The previous peak was recorded in April 2006, just before the crash in the US sub-prime mortgage market which precipitated the global financial crisis.
US house prices
In March 2018, the US unemployment rate remained unchanged at 4.1% for the sixth consecutive month. Employment has increased by an average of 211 000 jobs per month over the past six months. The level of US employment is an impressive 9.8 million above the 2007 peak before the global financial crisis, which means that the economy has created more than 18 million jobs since the crisis ended in 2009.
The growth in the labour market coupled with solid business activity, strong confidence indicators, and Trump’s tax stimulus package should encourage the Federal Reserve to continue with interest rate hikes. The pace of the increases remains highly dependent on the outlook for inflation, which has recorded a modest upward trend in recent months, but with risk to the upside. The Federal Reserve will be mindful that a significant and relatively rapid increase in interest rates could start to dampen economic activity, bringing an end to one of the longest economic upswings in US history.
Euro-area managing to sustain growth
In the fourth quarter of 2017, euro-area GDP rose by a disappointing 2.4% quarter-onquarter after growing just under 3% in the preceding six months. For 2017 as whole, the euro area expanded by 2.5%, up from 1.8% in 2016. This is the highest growth the region has recorded in nine years.
Despite the decline in performance towards the end of 2017, most forward-looking indicators for the euro area suggest the region should able to sustain a growth rate of around 2% over the next 12 months. One area of concern is that most economic indicators appear to have peaked. Without additional fiscal or monetary stimulus, the union is expected to lose momentum slowly into 2019,
especially if confidence is undermined by the Brexit trade negotiations combined with a looming trade war between the US and China.
Given the solid GDP growth performance and some upward drift in consumer inflation over the next year, it is expected the European Central Bank will announce the end of quantitative easing before the end of 2018 and that interest rates could start to rise in 2019. In the meantime, monetary policy in the euro area remains highly accommodative.
Over the longer term, Europe’s progress is being impeded by a number of key structural issues. The need for social payment reforms, relatively high levels of government debt, an ageing population and a range of social pressures including increased migration are undermining the union. Ultimately, it will need to strengthen if the region is to prosper.
Exports help to fuel growth in sub-Saharan Africa
During 2018, GDP growth in sub-Saharan Africa is forecast at 3.3%, which is up from 2.6% in 2017, but still well below the 15-year average of 5.6%, measured from 2000 to 2015. The major economies of SA, Nigeria, Angola and Kenya are all expected to improve, although at a modest pace that will barely exceed the growth in population.
Most economies in the region are still highly dependent on rising commodity prices to sustain economic growth. It is critical that these countries actively start to diversify away from a dependence on commodity exports. They need to expand their manufacturing and service sectors while broadening the tax base.
Generally, fiscal balances have deteriorated over the past year as government expenditure rose faster than expected. This led to a meaningful increase in debt, pushing up the debt-to-GDP ratio and resulting in credit rating downgrades for a number of countries in the region. A key concern is that a large portion of the new debt issues have been denominated in dollars, increasing the credit risks if currencies depreciate.
Encouragingly, many countries in sub-Saharan Africa have managed to generate favourable external balances over the past year led by an improvement in exports. This has helped to stabilise most of the major currencies in the region with inflation moving back inside target ranges, especially in southern and East Africa. Inflation in West Africa is still above target but is expected to moderate over the coming months. As inflation rates moderate, many central banks in the region have scope to reduce interest rates even more following the substantial cuts of last year.
Political changes improve SA’s economic outlook
In the final quarter of 2017 South African GDP rebounded, with growth of 3.1% quarter-on-quarter. Despite this improved performance, the economy only grew by 1.3% in 2017 because the year started badly. The economy has averaged growth of only 1.1% over the past three years, which is well below the rate of growth rate required to lift employment meaningfully. Over this time, there has been a systematic deterioration in both consumer and business confidence, much of which was due to the uncertain political environment.
South Africa GDP annual growth rate
Fortunately, the first quarter of 2018 has seen a fundamental improvement in political stability. There has also been a welcome change in the Government’s approach to managing the national
budget and key state-owned entities (SOEs), such as Eskom. The Government still needs to demonstrate success in reforming a broader range of SOEs. Other significant challenges remain,
such as ongoing policy uncertainty about the mining charter and land redistribution, and a lack of private sector capital expenditure, including maintenance capex. A co-ordination of policy efforts across key government departments will be required to lift SA’s growth rate above 3% on a sustained basis – a much larger effort than is currently evident.
Still, the improvement in political stability was acknowledged in Moody’s recent decision to leave SA’s international long-term credit rating unchanged at Baa3 (investment grade). Moody’s has also changed the outlook from negative to stable, reflecting their view that the previous weakening of the country’s institutions will gradually reverse under a more transparent and predictable policy framework. They also suggest that if the recovery of the country’s institutions were sustained, it would gradually support a corresponding recovery in our economy and stabilise fiscal strength. Compared with the concerns they expressed during most of 2017, this is an impressive turnaround.
However, Moody’s did caution that the authority and capacity of the incoming Government administration remains to be fully tested. It said the divisions within the ANC, and more broadly within society, will present policymakers with diverse and sometimes conflicting priorities which will create uncertainty.
For now, it remains unclear how the new Government will pursue its land transformation objectives or what impact that will have on agricultural production and security. Moody’s stressed that how the Government acts on the land issue will provide important insights into its plans to balance nearerterm objectives of sustaining confidence and promoting investment against longer-term objectives of addressing unemployment, inequality and poverty.
It is worth remembering that despite recent political developments, Moody’s is the only major credit rating agency to assign South Africa an investment grade rating for both its long-term foreign debt as well as its long-term domestic debt.
Sovereign credit ratings of South Africa
For the seventh consecutive quarter, South Africa was able to sustain a trade surplus in the fourth quarter of 2017, although the surplus narrowed from R92 billion in Q3 (2% of GDP) to R74 billion in Q4 (1.5% of GDP). The surplus decrease was largely due to increased imports outpacing the increase in exports. On a trend basis, SA’s trade balance has systematically narrowed from a deficit of -3.1% of GDP in the third quarter of 2013 to regular surpluses over recent periods.
Despite this recent narrowing of the trade surplus, SA is expected to hold onto recent export gains. This will be helped by improved world growth, a noticeable uplift in world trade and some
improvement in commodity prices. Improved electricity supply and labour-market stability is extremely welcome and is starting to help SA’s industrial sectors at a critical time. It is crucial for South Africa’s export performance that fears of a possible trade war between the US and China do not escalate to include a broader range of countries.
In February, SA’s headline inflation fell to 4%, while core consumer inflation remained unchanged at 4.1%, having fallen more than expected in prior months. This is the lowest level of core consumer inflation since December 2011. In general, the inflation rate remains under control and is expected to stay inside the target range of 3% to 6% over the coming year, with a slight upward
bias. This supports the view that the South African Reserve Bank (SARB) can keep interest rates relatively low in order to support the current economic revival.
The SARB decided to cut interest rates by 25 basis points to 6.5% at its Monetary Policy Committee (MPC) meeting in March. The SARB previously adjusted interest rates in July 2017,
again cutting rates by 25 basis points. According to the Bank, the interest decision was not unanimous, with four members voting for a cut and three members arguing that rates should remain unchanged. In making its decision, the committee highlighted the improved outlook for inflation due to the stronger exchange rate, which partially offset the recent increase in the VAT rate. The tone of the Bank’s statement suggests that further rate cuts appear less likely unless there is a significant downward surprise in inflation.