THE NATIONAL income accounts for the second quarter offer naught for comfort about the economy. Growth in spending by households, firms and the government is slowing and may well shrink further in the quarters to come.
Estimates of expenditure released by the SA Reserve Bank yesterday reveal that growth in final demand for goods and services adjusted for higher prices slowed to a miserable 1.3 percent annual rate in the second quarter from a still weak 2.9 percent annual rate last year. Growth in spending by households that accounts for over 60 percent of gross domestic product (GDP) slowed to a 1.5 percent annual rate.
Growth in spending on plant and equipment also slowed to a 0.5 percent crawl as private businesses reduced rather than extended productive capacity. Private formal businesses not only reduced their capital stock, they also employed still fewer workers in the second quarter of this year.
The only growth in spending and employment came from the government sector, almost all funded by the hard-pressed taxpayer.
All central government spending excluding interest payments and on budget was 8.8 percent up in the second quarter (interest expenses were only 3.8 percent higher) while taxes on income profits and capital gains were 9.2 percent higher in the second quarter. VAT collected from domestic consumers was 12 percent higher and 1.6 percent above budget. Total central government revenue came in 7.3 percent higher and below budget mostly because revenue from imports declined.
Without a recovery in the willingness of households to spend more, the economy will not grow at anything like the rate that could justify additional fixed capital expenditure or a larger formal workforce. Decisions by firms to invest in people or capacity are derived from the state of demand for their goods and services, which are predominantly exercised by households rather than government agencies.
The country suffers a short-term lack of demand that has to be resolved if the economy is to pick up momentum. The danger is that demand will remain subdued for an extended period, prolonging the failure of the economy to fulfil even its modest and economic policy-constrained supply side potential of, at best, 4 percent GDP growth.
The inflation that the Reserve Bank has been so intent to counter with higher rates, despite the weak economy, is very largely beyond the influence of interest rates as is the exchange rate or administered prices that have driven inflation higher. But interest rates do affect the willingness to spend and borrow.
Not enough encouragement for the economy has come recently from the housing market or the banks. Bank lending to companies has picked up, augmented by loans made to fund wind turbines that supply expensive electricity that households will have to pay for, while bank lending to households fell away. Mortgage lending by banks is declining in inflation-adjusted terms despite the average house now being worth a helpful 10 percent more than a year before.
It may be asked what the effect of mortgage rates of half their current levels might have had on these important metrics and the economy. The demise of African Bank will undoubtedly make it harder for the average family to raise credit.
The current state of the economy would surely have justified much lower borrowing costs. But there is higher inflation despite weak demand because the Reserve Bank decided to defend its anti-inflationary credentials and push interest rates in the other direction this year.
It is regrettable that the bank has committed itself to an inflation target that is highly vulnerable to exchange rate trends over which interest rates have no predictable influence.
But interest rates do significantly affect the demand for goods and services and the state of the economy, much more than they influence the consumer price index. Inflation targeting only makes good sense if controlling inflation is a realistic objective of monetary policy. Without a predictable exchange rate – the behaviour of the rand is highly unpredictable and dependent on global risk appetite – it is not possible to either predict inflation in South Africa with any degree of certainty or to control it with interest rates.
Low inflation is helpful, but not if it comes at the expense of economic growth depressed by too little spending.
The ability of households to spend is being pressured by higher prices linked to a weaker rand and to rising administered prices. These trends are accompanied by the weaker labour market, making it difficult for even those who retain their jobs in the private sector to achieve the inflation adjustments to nominal wages.
There is furthermore no good evidence to support the Reserve Bank notion that more inflation expected leads to more inflation. South African expectations remain consistently high and stable and above 6 percent, despite the central bank’s apparent willingness to sacrifice the economy to prove its inflation-fighting credentials.
These unfortunately remain suspect, despite efforts to show otherwise. The inflation expected over the next 10 years remains well above the target range for inflation, at close to 7 percent. These highly pessimistic expectations of inflation are implied by the difference between the long-dated bonds and inflation-protected bonds.
Where will the spark that lights up the economy come from? Just as the damage has come from higher prices and interest rates, relief can only come from a reversal of these price trends.
The light at the end of the tunnel would have to be a stronger rand or a stable rand exchange rate that brings down inflation and interest rates.
Furthermore, it would help if the government, local governments and Eskom did not look to higher prices for electricity and other services as their preferred funding mechanism, given the state of the economy.
Raising what are in practice expenditure tax rates in the form of higher charges for electricity and utilities including road use taxes of one kind or another to fund government spending is a particularly bad idea right now.
It would make much more sense to fund capital expenditure undertaken by government agencies including Eskom with as much debt as possible, spreading the interest rate burden on to future generations who will benefit from the additional infrastructure.
It would make even better sense to sell off some of the government-owned infrastructure to private operators who would manage the assets better and help to reduce budget deficits and the incentive to raise tax rates.
How likely then is a stronger or at worst a stable rand? How likely is it that the government will worry less about its balance sheet and much more about the immediate state of the economy?
There is a good chance that the value of the rand can remain where it is or even appreciate. Any strength in the global economy and in emerging equity and bond markets would help.
Any improvement in labour relations leading to less disruption of production would help GDP and the rand. The prospect of faster South African growth would help attract capital from abroad and support the rand. It is possible to recognise sources of light at the end of what has been a long, dark tunnel. Let us hope they are not snuffed out by poor government and Reserve Bank decision-making.
Brian Kantor is an investment strategist at Investec Wealth and Investment.