Buoyant global trade flows, surging US consumer spending and strong commodity prices present compelling reasons for optimism, both globally and domestically, as the third quarter of the year approaches.
A year after the worst economic blows of COVID-19, data releases are vindicating the optimists who predicted a “V-shaped” recovery. But the picture is not altogether rosy, and careful policy choices will be needed to ensure US and South African economic growth does not fall off a cliff after 2022.
Commodity prices good for SA
Over the ten months to end-March 2021, world trade volumes recovered by 25% to reach a level 3% above the peak recorded in 2018. This is significant because world trade represents about 30% of global GDP. The data reinforces the likelihood that the global economy will grow by 6% this year, significantly above its historical average rate of 3.5%. Strong global trade flows are positive for the South African economy in general, but commodity prices in particular. This is one of the most positive developments in the world economy in the last six to eight months.
However, there is a caveat to these strong flows. The Baltic dry index shows the cost of shipping has touched its highest level in about 10 years, indicating that swelling trade volumes are pushing up prices.
On a year-on-year comparison, commodity prices have gained about 100% up to end-April, which partly reflects base effects and a strong recovery in energy prices. Precious and base metals prices are clearly stronger and this has turned around the profitability of SA’s mining companies, as well as their contribution to tax revenue. This trend is likely to continue, as there is underlying momentum.
SA’s trade balance has benefited as imports have been subdued while the value of exports has appreciated strongly, with the value of precious metals exports almost double that of a year ago. SA also needs to ramp up volumes of commodity exports, but this depends on improvements in rail and port infrastructure. Strong earnings from the export of commodities make it difficult for the rand to weaken, however, when commodity prices revert to longer term trends, the rand will likely also revert to its long-term depreciation trend.
Central bank intervention: healthy or harmful?
The broad recovery shows how effective central bank stimulus measures have been, particularly in the US. Thanks to generous government handouts to the unemployed, US retail sales have recovered rapidly from the lockdown and have surged to a record high. This is critical for the US and world economic recovery, since consumer spending underpins 70% of the US economy and the US imports many consumer items. Apart from boosting retail sales, government cheques have also raised the level of consumer savings. If the US can bring employment back to pre-COVID levels, the economy can continue to grow.
However, this massive stimulus has caused dislocations. The US manufacturing sector has three times as many job openings as it did a year ago, reflecting shortages of appropriate skills, generous unemployment benefits that encourage people to delay returning to work, and people’s fear of infection in the workplace. This creates a risk that as demand for workers is high, wages will rise and the price of goods will increase. If inflation starts to become entrenched, central banks will raise interest rates. Producer inflation in the US has already climbed to about 6% as a result of base effects and increases in the cost of energy and other commodities inputs. That could feed into consumer inflation.
At STANLIB, we believe the US Federal Reserve has effectively entrenched inflation expectations around 2%, but we are watching these trends closely.
Proudly South African
STANLIB expects the South African economy will grow by 4.3% this year and 3.5% next year, which is well above recent trend growth. In 2021 the surge in growth numbers results from effects and in 2022 growth rates will reflect pent-up demand as economic activity normalises. But these growth rates will not bring GDP back to pre-COVID levels.
For South African to experience good growth beyond 2022, four issues need to be tackled effectively, as a matter of urgency.
The first important issue is to combat COVID-19, which depends on a rapid and broad vaccination roll-out. We believe this is possible.
The second issue is for government to demonstrate greater spending discipline, particularly in the current negotiations over a three-wage deal for public servants. Uncontrolled government debt will lead to credit rating downgrades, tax hikes, and other negative outcomes.
Thirdly, SA has to see implementation of public-private partnerships on fixed asset investment, as it is clear that state-owned entities do not have the capacity to make this investment on their own, especially within the electricity sector.
Fourthly, the shocking deterioration in municipal finances has to be addressed. Municipalities are owed over R220 billion, which is probably irrecoverable, and they owe suppliers, many of which are small businesses, almost R70 billion. This matter cannot be ignored for another election cycle, but if it is addressed effectively, it represents a growth opportunity.
Optimism abounds, yet caution prevails. The signs and data are pointing towards a strong short term recovery worldwide and we can be optimistic about sustainable growth for SA. However the risks and dependencies remain evident.