The more things change, the more they stay the same

By Arthur Kamp – Chief economist at Sanlam Investments

Pressure on corporate profits and households is intensifying as the economy adjusts to lower commodity export prices and higher interest rates. This is a scenario we have seen many times before.

The fortunes of the South African economy remain closely aligned to the commodity price cycle. In 2021, a surge in commodity export prices resulted in a 40% jump in total mineral sales to R856 billion from R613 billion in 2020, despite a -10.5% fall in total mining production in those two years. The bounce in sales boosted domestic income, including profits and wages, underpinning a stronger post-pandemic economic recovery than initially projected.

However, SA’s terms of trade index (an index of export prices relative to import prices), which peaked in Q2 2021, by Q4 2022 had decreased by -18.9%, reflecting lower commodity export prices. At the same time, the Reserve Bank has hiked its policy interest rate by 475 basis points to 8.25% since November 2021. Monetary policy is now in restrictive territory. These are significant developments, which expose the South African economy to unfavourable outcomes, exacerbated by periodic load shedding.

The downturn in SA’s terms of trade is reflected in the current account deficit. The country needs to invest to upgrade its infrastructure and grow the economy. However, it has insufficient savings to fund this expansion. In turn, if the country’s investment ratio exceeds its savings ratio, the difference is, by definition, reflected in a current account deficit.

This in itself is not a problem, provided the deficit is funded by foreign capital inflows – in other words, that foreign savings can supplement domestic savings to fund investment. Unfortunately, net foreign capital inflows into SA have been declining as a proportion of GDP for years. In 2022, total net foreign inflows recorded on the financial account amounted to R67 billion, or just 1% of GDP.

This set of circumstances is directly relevant for South African households. Improving terms of trade increase the purchasing power of consumers and often lead to currency appreciation, which lowers inflation and interest rates, including household borrowing costs. Currently, however, the reverse is happening.

The dearth of foreign capital inflows, reflected in a weak rand exchange rate, exacerbates the situation. To the extent that foreign capital inflows are insufficient, the current account balance must narrow. A weaker rand helps to achieve this by making exports cheaper and imports more expensive.

However, persistent rand depreciation tends to be inflationary. Hence, tighter macroeconomic policy is required to reduce domestic demand and imports to improve the current account balance. SA’s dire socio-economic conditions preclude material fiscal consolidation. The onus rests on monetary policy to drive the necessary adjustment through interest rate hikes by the Reserve Bank.

The Quarterly Employment Statistics released by Statistics SA in late June 2023 show a 21 000 fall in formal, non-agricultural employment in Q1 2023. In the recovery phase following the pandemic, employment creation has increasingly shifted towards part-time work. This is clearly illustrated by the first quarter data, which shows part-time employment increased by 42 000 while full-time employment decreased by 63 000.

In turn, uncertainty in the job market weighs on consumer confidence. In addition to the increasing costs of debt servicing, this can be expected to constrain private sector credit extension to households. Households have consistently deleveraged since the global financial crisis. In 2008, for example, household debt amounted to 75.8% of personal disposable income. By Q1 2023, this ratio had declined to 62.1% of personal disposable income. Despite this deleveraging, debt servicing costs, which had decreased to 6.7% of personal disposable income by Q1 2022 from 8.9% of personal disposable income in 2016, increased to 8.4% of personal disposable income in Q1 2023. We expect this ratio will increase further to a level close to the 10.6% of personal disposable income recorded in 2009. This can be expected to weigh on the finances of middle to higher-income households in particular.

Household credit increased by 7% in the year to April 2023. Looking ahead, household credit extension is likely to be constrained, or even to slow, at current prices.

At the same time, consumer price inflation rose by 6.3% in the year to May 2023. Although petrol prices were only 3.5% higher than a year ago, food price inflation was especially high at 12%. Food prices are very significant for lower income households. While the overall inflation rate for the highest income band surveyed by Statistics SA was 5.9%, the inflation rate for the lowest income band surveyed was substantially higher, at 9.9%.

At the same time, total worker compensation increased by 3.8% in current prices in the year to Q1 2023, implying a sharp fall in spending power in real terms in the quarter, in view of the fact that consumer price inflation averaged 7% in the quarter.

Can things improve? Yes, it is reasonable to argue the outlook for 2024 is better than for 2023. History suggests the rand should recover ground in response to the Reserve Bank’s interest rate hikes, which should anchor inflation expectations at an acceptably low level. Also, developments in food price inflation at producer level, along with base effects, suggest food price inflation should slow markedly next year. We expect headline consumer price inflation will average 5.1% in 2024, ending the year at 4.9%. In turn, this should support disinflation, which should encourage Reserve Bank interest rate cuts by next year.

At the same time, lower inflation can be expected to boost real compensation growth and overall household expenditure.

In essence, we expect a repeat of the usual cycle we have seen many times historically. The more things change, the more they remain the same.

It also seems reasonable to expect a significant improvement in electricity supply by 2024, as new capacity, supported by embedded generation and renewables-related energy production, comes on stream. If SA can effectively address its infrastructure spending constraints, it would go a long way towards lifting the country’s potential growth rate to help create jobs.

What is the risk? Ultimately, expectations of an improved outlook for 2024 and the medium term assumes SA can attract sufficient foreign capital inflows to fund the current account deficit implied by increasing fixed investment spending. The country has no choice but to invest in and improve its infrastructure. To the extent that it cannot attract sufficient foreign savings to help fund this spending, the greater the pressure will be on households’ consumption spending.