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Recession alert intensifies
|By Cees Bruggemans, Chief Economist FNB|
|25 August 2008|
With annualized GDP growth jumping steeply from 2.1% in 1Q2008 back to a more respectful 4.9% in 2Q2008, one would think that all thoughts of recession could now be safely banished.
But we aren’t out of the woods yet.
A closer reading of the published data gives reason for concern as to what could still be experienced later this year, but especially early next year.
It has been widely reported that earlier subsidence in annualized GDP growth, from 5.1% in 4Q2007 to 2.1% in 1Q2008 was mostly due to the loss of output in mining and manufacturing on the back of Eskom electricity outages.
With Eskom restoring its electricity supply at least partially in 2Q2008, a bounce back in annualized GDP growth was to be expected. To this we must still add the gathering agricultural windfall currently being enjoyed.
Thus 2Q2008 has recorded 4.9% annualized GDP growth.
Even so, most reporting made mention of dark forebodings, as things elsewhere in the economy didn’t look hot, and could still deteriorate further, offering much less promise for the growth performance in 2H2008 and 1H2009.
Just how justified these forebodings really are is borne out by further analysis of the growth data so far, and by projecting a few straightforward assumptions through coming quarters.
First a few comments about the GDP growth data to date.
If agriculture is experiencing a temporary windfall of magnificent proportions due to exceptional good rainfall last summer, and especially mining and manufacturing suffered electricity (and Easter holiday) distortions during 1Q2008 (depressing growth) and 2Q2008 (boosting it), let us first consider what happened throughout this period in the 75% of the economy not related to these disturbed sectors.
When analyzing the components of “total GDP at basic prices” as per StatsSA, we encounter a rather unsettling reality.
GDP excluding agriculture, mining and manufacturing (75% of GDP) grew an annualized 5.2% in 4Q2007 and a still very respectable 4.4% in 1Q2008, but then slowed down further to 1.8% in 2Q2008.
This was hardly a stellar performance and was the real news, rather than the distorting growth impact of the three aforementioned disturbed sectors.
Sustained strong growth performances in 2Q2008 were still recorded by construction (+10.6% annualized), transport and communication (+4.1% annualized) and private services (+3.9% annualised).
But these strong growth sectors represented only one-quarter of the sub-universe we are dealing with here. The remaining three-quarters had its share of dogs, considerably toning down the overall growth performance.
Notable underperformers were retail, wholesale, motor and hotel trades (-2.2% annualized decline), general government services (+1.1% annualized) and financial and business services (+2.3% annualised).
So what comes next?
How do we project forward, using what assumptions?
The many forces restraining our growth momentum this year have hardly moderated as yet. Inflation is still to peak, if shortly. The SARB has gone on hold for the third time in this tightening cycle, which mustn’t be confused with starting a cutting sequence. And asset prices are still unsettled, with nominal house prices projected to decline, probably through mid-2009, and the JSE highly volatile.
We may hope that inflation will be racing down shortly, gradually restoring some of the real buying power to many households currently still being lost.
And we may hope the SARB will start cutting interest rates eventually, but we should recognize the SARB isn’t a fashion leader, but rather a follower if not a laggard in this field, apparently mostly due to justified concerns about inflation risks for us in the greater world.
That some of us, especially the stock market, can look through these events and discount likely coming changes in conditions is fortuitous, but the real economy takes longer to respond. Like the SARB, the real economy is more inclined to respond to the reality, rather than the promise, of inflation falling credibly, interest rates being cut sustainably and asset prices rising once again.
Until these tipping moments occur, the economy can expect to still lose growth momentum, effectively already baked into the cake by events to date and apparently still playing out. The transmission channels include household replacement behaviour, banking and retail credit criteria and lending conditions, business inventory management, private investment intentions, electricity constraints and the manner in which foreign recessionary conditions affect our trade.
When looking at 3Q2008, what can we reasonably assume and what remains dubious?
Sticking for the moment with the 75% of GDP excluding agriculture, mining and manufacturing, the following seem reasonable assumptions:
-? construction, transport and communication, and personal services by and large maintain their annualized growth performances as per 2Q2008
-? general government (effectively its pace of hiring labour) recovers to +3% annualized growth
-? retail, wholesale, motor and hotel trades show slightly more decline at -3% annualized, while financial and business services slow further to +1% annualized.
These numbers can be tweaked any number of ways, but the sum total needn’t be too different from what is here assumed. GDP growth in 3Q2008 for the non-disturbed 75% part of the economy could be +1.5% annualized. This would represent a further easing from the +1.8% annualized achieved in 2Q2008.
Thus in an underlying sense the GDP growth trend would still be down on these assumptions. Now we should agonise a bit more about manufacturing and mining.
Have these two sectors by now fully restored their output in line with Eskom electricity availability? If so, no more growth boosting can be expected on this score in coming quarters.
But other things still worry. Commodity prices sunk abruptly from mid-July. Gold went below $800 before bouncing, with more sinking a possibility. Platinum has lost nearly $900 from its peak earlier this year. Yet mining costs have robustly increased and will still increase robustly.
The margin squeeze is especially notable at marginal gold producers. These tend to adjust production lower when this happens in favour of mining less costly reserves first. It could spell a drop in output.
In any case, prior to the electricity disruption mining output wasn’t growing that much. And any new capacities will presumably be infrastructure-constrained, at least for a while longer. New projects may take their time coming on stream.
As to manufacturing, Easter was probably a distorting influence, injecting more working days into 2Q2008 and withholding these from 1Q2008. The same benefit will not be there in 3Q2008. Indeed, we already have lost man-days due to strike action in 3Q2008. Even more worryingly, going by BER surveys, how many sectors have involuntary increased inventories, in the trades but also at manufacturing level, and will these be worked off first, at the expense of output?
With the trades in decline, order levels under pressure and export conditions hardly hot as our main trading partners slip into recession it would be a small miracle if manufacturing were to show any growth in 3Q2008.
In other words, the Investec Purchasing Managers Index may have given us a very early signal of what’s really cooking in manufacturing, undistorted by electricity or Easter.
But let’s not go overboard and assume declines in both mining and manufacturing output for 3Q2008 just as yet. One can reassess these evolving conditions when 3Q2008 has shown its true colours, allowing us to start contemplating 4Q2008 and 1Q2009.
If for now we assume nil annualized growth or decline for mining and manufacturing in 3Q2008, how does GDP excluding agriculture perform?
This useful measure, excluding the volatile agriculture booms and busts, yet reflecting 98% of the economy, grew by 5.1% annualized in 4Q2007, slowed to 1.5% annualized in 1Q2008, rebounded to 4.7% annualized in 2Q2008, and looks set to slow yet more significantly in 3Q2008 to 1.2% annualized on the assumptions made so far.
But this isn’t recession yet, for that condition requires at least two quarters of declining GDP (annualized), a fall in employment, a decline in industrial output and/or a fall in real incomes (going by modern practice).
But it would seem as if inflation will only be running down seriously from next year, interest rates may only be cut into 2009 by a cautious SARB, asset prices (especially houses) may take their time recovering, commodity prices may remain under pressure and foreign trade conditions won’t improve soon. If so, that could keep GDP excluding agriculture slowing down for a while, even into 1H2009.
This is where the really interesting thing still awaits us, as agriculture will not repeat windfall acceleration into 2009. If anything, mere normalization of rainfall patterns would restore agricultural output levels that imply some growth decline in this sector, even sizeable.
For overall real GDP annualized, this could just make 1Q2009 and 2Q2009 disappointing growth performances.
Do we remain on recession watch for now? It seems so.
Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics
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