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South African Economic Outlook and the MTBPS

Presentation by Robin Marshall, Managing Director, Economic Research, & Taryn Rebeck, SA Economist JP Morgan November, 2002. South African Economic Outlook and the MTBPS. Key Points.

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South African Economic Outlook and the MTBPS

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  1. Presentation by Robin Marshall, Managing Director, Economic Research, & Taryn Rebeck, SA Economist JP Morgan November, 2002 South African Economic Outlook and the MTBPS

  2. Key Points • JPMorgan expects weaker growth in 2003 than official budget forecasts given recent monetary tightening & a likely slowdown in consumption • A tight budget suggests 1.6% deficit is easily achievable but disappointing that govt. has not taken opportunity to reduce tax burden further • Further inflation overshooting of official forecasts likely but suspending inflation targeting more damaging • SARB policy regime close to best practice, but more frequent meetings, employment stabilization clause & more statistical data on transmission mechanism needed

  3. Key Macro Forecasts 2002 2003 CPIX inflation, %oya, avg JPMorgan Reuters consensus MTBPS Real GDP growth, %oya JPMorgan Reuters consensus MTBPS Current account balance, %of GDP JPMorgan Reuters consensus MTBPS Prime lending rate, %, eop JPMorgan Reuters consensus Prime lending rate, %, eop JPMorgan Reuters consensus 10.0% 9.7% 9.6% 2.5% 2.5% 2.6% 0.0% 0.1% 0.1% 18.0% 17.0% 10.80 10.80 8.7% 7.4% 7.2% 2.5% 2.8% 3.5% -0.2% -0.2% -0.3% 17.0% 15.3% 11.50 11.50 Source: JPMorgan, Reuters, MTBPS

  4. Government macroeconomic forecasts 2002 Budget 2002 Medium Term Budget Statement 2001 2002 2003 2004 2001 2002 2003 2004 2005 Real growth in demand Final household consumption 2.7% 2.5% 2.8% 3.1% 2.8% 3.1% 2.9% 3.3% 3.6% Final government consumption 1.4% 2.3% 2.6% 2.7% 1.4% 2.5% 3.6% 3.6% 3.8% Gross fixed capital formation 3.2% 4.5% 5.5% 7.1% 3.3% 6.0% 5.7% 6.2% 6.8% Gross domestic expenditure 1.4% 2.2% 3.0% 3.4% 1.8% 3.1% 3.2% 3.5% 3.8% Exports 2.1% 2.6% 6.6% 6.7% 2.4% 3.2% 6.4% 6.6% 6.7% Imports -1.2% 2.4% 6.1% 6.3% 0.4% 5.6% 6.1% 6.5% 6.9% Real GDP growth 2.2% 2.3% 3.3% 3.6% 2.2% 2.6% 3.5% 3.7% 3.9% GDP inflation 6.9% 6.6% 5.7% 4.6% 7.5% 9.2% 7.4% 5.3% 4.5% Gross domestic product at current prices (Rbillion) 969.1 1,057.0 1,153.9 1,250.5 975.0 1,093.0 1,214.2 1,325.0 1,439.0 CPI inflation CPIX (Metropolitan and urban areas) 6.6% 6.9% 5.8% 4.7% 6.6% 9.6% 7.2% 5.5% 4.9% Balance of payments Current account balance (% of GDP) 0.0% -0.5% -0.5% -0.7% -0.2% 0.1% -0.3% -0.6% -1.1% Source: SARB

  5. Main uncertainties about growth forecasts • 2003 Growth forecast looks optimistic given likely slowdown in household consumption in response to recent monetary tightening, lower income growth and higher inflation • Overall increase projected in domestic demand for 2003 looks odd given 400 bp of tightening to date in 2002 & 12-15 month lag in monetary policy impact – demand indicators are already showing signs of slowdown (retail & auto sales) • Official forecast of 6.4% export growth in 2003 looks difficult to achieve during subdued global growth recovery • Other traditional lead indicators of GDP growth – like inverted yield curve – suggest growth will slow modestly in 2003 • JPM believes that a larger fiscal stimulus could have been made in budget statement

  6. Growth – Stable with relatively subdued domestic demand SA GDP vs HCE Growth %q/q, saar GDP Growth HCE Growth Forecast Source: SARB, JPMorgan estimates

  7. Main uncertainties about inflation forecast • Inflation forecasts for 2002/3 look optimistic, given evidence of 2nd round effects in wages and broad-based increase in 2002 • Combination of declining inflation and stronger GDP growth next year is possible but unlikely • Given scale of inflation overshoot in 2002, and to prevent deterioration in inflation expectations, SARB is likely to tighten a further 100 bp in November

  8. BER survey of CPIX inflation expectations 3rd Quarter 2002 (2nd Quarter in parentheses) 2004 2002 2003 Percent 6.2 (6.0) 7.5 (7.9) 7.3 (7.4) 7.0 (7.1) Finance Business Labour Average 9.2 (8.5) 8.3 (8.4) 7.9 (7.6) 8.5 (8.2) 7.1 (7.0) 7.9 (8.2) 7.9 (7.4) 7.6 (7.5) Source: Bureau for Economic Research, University of Stellenbosch

  9. Inflation - Close To Peaking But Underlying Picture Less Favourable SA CPIX Inflation Peak of 12.2%oya in November %oya Target range (Metropolitan & other urban areas) Forecast Source: StatsSA, JPMorgan estimates • CPIX forecast 2002 y/e : 12.1% (10.0% ave) 2003 y/e : 6.6% (8.7% ave)

  10. Food price inflation remains the major cause for concern SA CPIX vs PPI Food Inflation %oya %oya PPI Food Inflation CPIX Food Inflation Source: StatsSA • Food price inflation has been increasing steadily at both the producer and consumer level in the past year – JPMorgan does not expect it to unwind just yet

  11. Also Note Current inflation is broad-based CPIX goods vs services inflation %oya Goods Services Source: StatsSA • Although inflation was initially driven by exogenous shocks, it has become very widespread

  12. Further petrol price increases remain a major risk %oya %oya Gauteng Petrol Price Rand Oil Price CPIX Transport Source: Bloomberg, I-Net, StatsSA • JPMorgan forecasts Brent to average $25.7/bbl in 2002 and $26.6/bbl in 2003 – but risks are on the upside

  13. A further key risk is more pass-through from rand depreciation PPI and CPIX Inflation vs Rand/$ %oya R/$ Forecast Rand/US$ Overall PPI CPIX Source: StatsSA, Bloomberg, JPMorgan estimates • Both directly (although behavior of corporate margins makes the extent difficult to predict) & through second-round effects via deterioration in inflation expectations and wage settlements.

  14. Much of the strength earlier this year was propped up by portfolio flows, which have turned Total Portfolio Flows vs Rand/US$:Rate R billion R/$ Rand/US$ (inverted scale) Portfolio Flows Source: I-Net • Both bond and equity portfolio flows turned negative in 02H2.

  15. And outflows have picked up as expected SA Services Account vs Net Dividend Payments R billion Source: SARB • After falling in 02Q1, outflows have picked up again now that the Myburgh Commission is out of the way

  16. Strong trade performance has supported the rand, but fading with subdued global growth SA Trade Balance R billion Source: SARS • South Africa has posted trade surpluses of R2.9 billion on average in the ten months year to date thanks to a weak currency, but export performance is starting to come off due to an uncertain global outlook.

  17. Interest rates – globally rates appear to be on hold for now Dec 03 Current Dec 02 Mar 03 Jun 03 Percent of total 2.00 3.25 0.00 4.75 3.50 United States Euro area Japan United Kingdom Canada 1.25 2.75 0.00 4.00 2.75 1.50 2.75 0.00 4.00 2.75 1.75 2.75 0.00 4.25 3.00 1.75 3.25 0.00 4.00 2.75 Source: JPMorgan

  18. In South Africa, one more 100bp rate hike forecast for November Prime Lending Rate % Nominal Real (using CPIX Inflation) Forecast Source: SARB, JPMorgan estimates • And Morgan looks for a 100bp rate cut in 03H2 once inflation is clearly falling towards the target range.

  19. JPMorgan AnnualSA Economic Forecasts 2002(f) 2003(f) GDP Growth (%oya) HCE Growth (%oya) GCE Growth (%oya) GDFI Growth (%oya) Current Account (R billion) Current Account (% of GDP) CPIX Inflation (average, %oya) CPIX Inflation (eop, %oya) Prime Lending Rate (eop, %) R153 Yield (eop, %) Rand/$ Exchange Rate (eop) 2.5 3.0 2.8 5.5 0.0 0.0 10.0 12.1 18.0 12.20 10.80 2.5 2.4 2.6 4.5 -2.0 -0.2 8.7 6.6 17.0 11.10 11.50 Source: JPMorgan estimates

  20. South Africa: Medium-term budget policy statement: Main Points • Budget deficit target FY2002/03 and 2003/04unnecessarily tight at 1.6% and 2.2% of GDP, given infrastructure spending and tax reform needs • Statement suggests a modest fiscal tightening… • …given government caution on revenue assumptions, which makes another undershoot likely • Very low debt/GDP ratio and debt service costs gives government more scope to ease fiscal policy further

  21. Government cautious again on revenue projections • Government revenue collection assumptions are very conservative for 2002/03; growth in government revenue is forecast to be 10.1% for the year • Revenue growth so far this fiscal year is 17.5% • Very strong growth in corporate tax revenue (especially mining ) • Strong retail sales have helped VAT collection • Continuing improvement in efficiency of tax collection • JPMorgan expects revenue growth close to 13% for full fiscal year 2002/3

  22. Government expenditure control remains tight…perhaps unnecessarily so • Year to date government expenditures up 12%… • …. expenditure over-runs modest and due to impact of higher inflation especially on public sector wages • Overall Government target for FY2002/03 looks excessively prudent • JPM’s weaker growth forecast for 2003 suggests govt. has more scope to increase public expenditure

  23. International comparison of fiscal positions Hungary Czech Poland 7.1 5.3 8.7 53.0 Yield - 10-year govt bond CPI, avg 2002 Budget deficit, % of GDP, ESA meth. Public debt, % of GDP 4.2 2.1 6.4 20.0 6.0 1.9 4.4 48.0 Source: JPMorgan

  24. SA official budget projections 2002 Budget 2002 Medium Term Budget Statement R million 2002/03 2003/04 2004/05 2002/03 2003/04 2004/05 2005/06 National Revenue Fund (main budget) Revenue 265,217 288,708 313,211 273,281 302,102 330,338 358,323 Expenditure Interest on debt 47,503 49,845 52,434 47,236 51,463 54,599 57,853 Percentage of GDP 4.4% 4.2% 4.1% 4.2% 4.1% 4.0% 3.9% Contingency reserve 3,300 5,000 9,000 – 2,000 4,000 8,000 Allocated expenditure1 237,106 256,386 273,128 244,517 275,955 299,825 322,247 Total 287,909 311,231 334,561 291,753 329,418 358,424 388,100 Percentage increase 9.6% 8.1% 7.5% 11.1% 12.9% 8.8% 8.3% Surplus (+) / Deficit (-) -22,692 -22,523 -21,350 -18,472 -27,316 -28,085 -29,777 Percentage of GDP -2.1% -1.9% -1.7% -1.6% -2.2% -2.1% -2.0% 1. Includes transfers to provinces and local government, the National Skills Fund and sectoral skills development funds. Source: JPMorgan.

  25. Official SA budget projections Budget Outcome Revised Medium Term estimates R billion 2001/02 2001/02 2002/03 2003/04 2004/05 2005/06 Main budget deficit 14.4 22.7 18.5 27.3 28.1 29.8 Extraordinary payments 2.1 1.6 8.6 7.0 7.0 7.0 Extraordinary receipts -4.7 -12.0 -12.0 -5.0 -5.0 -3.0 Main budget borrowing 11.8 12.3 15.1 29.3 30.1 33.8 Other government borrowing1 -5.3 3.1 3.1 1.5 2.0 2.5 General government borrowing 6.5 15.3 18.1 30.8 32.1 36.3 percentage of GDP 0.7% 1.4% 1.6% 2.5% 2.4% 2.5% Plus: Non-financial public enterprises -2.3 -0.5 -0.5 0.3 1.1 1.2 Public sector borrowing requirement 4.2 14.9 17.7 31.1 33.2 37.5 percentage of GDP 0.4% 1.3% 1.6% 2.5% 2.5% 2.6% 1. Social security funds, provinces, extra-budgetary institutions and local government. Source: JPMorgan.

  26. International experience with inflation targeting • International experience suggests - • monetary policy should be carried out by independent central bank, even if choice of inflation target rests with govt./Finance • credibility gains from announcing and implementing inflation targeting (lower borrowing costs, reduced inflation expectations) • implementation of targeting should be stable & predictable, but policy responses also involve judgment • optimum central bank implementation depends on structure of economy, nature of shocks and welfare judgments • successful inflation-targeting regimes generally employment-friendly, enhancing political credibility by minimizing output losses in achieving inflation target • open economies, subject to international capital flows and shocks, can still benefit from successful inflation targeting (UK)

  27. Difficulties with inflation targeting for an emerging economy • Inflation targeting means inflation forecast targeting due to lags in impact of policy (SARB estimates lags at 12-15 months) • Inflation forecasting must be accurate, reflecting stable structural relationships • Thus for a Taylor rule, or variation, to work, where interest rates are set to minimize deviations of inflation from target and output from trend, these relationships should be stable • Smaller, open economies may be subject to de-stabilizing shocks from international capital flows & exchange rate moves, with uncertain inflation consequences

  28. South Africa’s evolving monetary policy framework Years Monetary policy framework 1960-1981 Liquid asset ratio-based system with quantitative controls over interest rates and credit 1981-1985 Mixed system during transition 1986-1998 Cost of cash reserves-based system with pre-announced monetary targets (M3) 1998-1999 Daily tenders of liquidity through repurchase transactions (repo system), plus pre-announced M3 targets and informal targets for core inflation 2000 Formal inflation targeting Source: JPMorgan, SARB

  29. South African experience with inflation-targeting • Much of South African policy regime conforms with industry best practice, but 2002 experience suggests - • more frequent meetings desirable to reduce risk of “ getting behind inflation curve “ (inflation data monthly) • uncertainty over inflation forecasting due to structural change in economy • more information required on transmission mechanism & inflation pass-through from rand to improve accuracy • a secondary objective for stabilizing employment; current escape clauses deal only with shocks • missing targets in 2002/3 not a mortal blow to regime.. only repeated target misses & evidence of unstable inflation expectations would justify suspension • difficult to specify longer term path for target until SARB becomes more confident about transmission mechanism

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