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 Evidence for a recession in SA is overwhelming
Evidence for a recession in SA is overwhelming

Evidence for a recession in SA is overwhelming

ECONOMIC NEWS - Jun 30th 2016, 16:39

SA’s first-quarter GDP release — a 1.2% contraction — was a shocker. 

There evidently remains great hesitancy regarding mention of the dreaded "R" word. There is, also, an ingrained instinct to assume things will improve in future.

Closer inspection, on the contrary, shows that the current domestic economic recession has been shaping up for a while. It has two dimensions, one cyclical and one structural. The evidence is quite overwhelming.

First, is it necessary to emphasise that the business cycle is alive and well. Typically, observers become convinced during periods of unrelenting booming economic conditions (witness the 2003-07 period) or perpetual gloom (witness SA’s growth performance over the period since 2012) that the business cycle has been suspended.

Furthermore, in times of intense structural change — as the world is experiencing — it becomes difficult to discern between the cyclical and structural elements of change. The doyens of business cycle theory, Arthur Burns and Wesley Mitchell, warned more than 70 years ago regarding the "unceasing round" of the business cycle that has "belied repeated prophecies of a ‘new era of prosperity’ and outlived repeated forebodings of ‘chronic depression’".

The 2008-09 global recession is a stark reminder of the profound truth contained in this quote, as it not only interrupted the 2003-07 expansion, but terminated the longer-term so-called Great Moderation (that is, the conviction of the secular reduction of inflation and business cycle instability).

SA’s Reserve Bank has already identified an upper turning point in the current — third post-apartheid (trough-to-trough) — business cycle (November 2013).

It is true that no two business cycles are the same and the current one has peculiar features.

One outstanding feature of the current business cycle is the fact that its expansion came to an end without the typical cyclical pressures of (demand-pull) inflation and/or current account imbalances, inviting tightening monetary policies, for instance. While inflation concerns were present, those were related to supply-side factors such as the weakening exchange rate and food and energy price increases. This explains the (pro-cyclical) tightening of monetary policy since the onset of the current recession (January 2014). Furthermore, current account concerns have been present, but the deficit has been comfortably financed by foreign savings (with the interest rate hikes serving as insurance against the probability of these net capital inflows reversing).

A second peculiarity of the business cycle has been the fact that its demise was largely supply-side driven. The lethal combination of electricity supply constraints, serious labour market strife (in the mining and manufacturing sectors in particular) and widespread economic policy uncertainty, which affected business sentiment — already unnerved in our post-2009 global economic condition of weak demand conditions — led to heavy retrenchments in these sectors. These supply-side constraints spilt over into income constraints, which caused the eventual slowdown in the consumer sector, which, in turn, has been the driver of the business cycle expansion. As the Reserve Bank puts it, "the weak global economy, domestic structural constraints and later also slowing domestic consumer demand all contributed to the demise of the upward phase in the business cycle".

Another feature of the business cycle expansion has been its consumption-driven nature. While this is nothing new for SA, what is striking, has been the poor business confidence levels and the associated absence of fixed investment spending as the usual driver of the cycle.

The consumption leg of the cycle was boosted by aggressive pro-cyclical fiscal policy (read: expansion of public sector employment and wage increases), which was always going to be unsustainable. In the absence of private-sector expansion and, worse, retrenchments due to the noted supply-side constraints, the consumption-driven growth came to an end. In fact, the resilience of the consumer – even 7-8 quarters into the economic downturn has been equally striking.

Unfortunately, the two-pronged step-down in retailer business confidence from the middle of last year, currently confirms that the consumer is finally capitulating, more widely switching to belt-tightening mode.

Herein lies the danger of the current downward cyclical momentum of the economy. If these forces are allowed to linger, the downward momentum may unleash, at least this is what our business cycle history is telling us.

Up to the end of last year, the economic downturn, which shaped up from the end of 2013, displayed strong so-called growth cycle features, with growth remaining positive and merely dipping below its longer term trend. The first-quarter GDP release awakens us to the likelihood of a recession in the classic business cycle definition, that is a sustained absolute contraction in real GDP or broad economic activity. We have witnessed previous one-off quarterly declines in real GDP (due to electricity outages and intermittent labour strife) in the current business cycle; however, this time around the underlying business cycle movement is different as the resilience of the consumer sector is no more.

Even assuming a rebound in mining output during the second quarter, the broader economy is on the verge of developing an outright downward momentum – real non-mining GDP growth averaged a mere 0.5% over the past two calendar quarters. Without decisive policy action, we are likely to witness further contraction in real GDP.

Broad consumer spending accounts for two-thirds of aggregate spending in the economy. While the electricity supply constraint has been relieved by the sluggish economy and an improvement in operational efficiencies (affording the closure of maintenance backlogs) businesses tend to go into cost-cutting mode when faced with weak demand and margin pressures. This, in turn, fuels the contraction in incomes, which completes the downward spiral in economic activity.

Whereas the supply side of the economy – the manufacturing sector in particular – should have the buoyancy to respond to the weakening domestic market conditions and the weaker currency by replacing imports and pushing exports in order to augment the income stream, this is no more. SA’s manufacturing sector is in major trouble – not only is it effectively in a classic recession, but it embodies and mirrors the broader economy’s structural challenges; import-intensive assembly operations (if not internal distribution) have been replacing full manufacturing. As a result, this sector has lost its buoyancy in times of currency weakness, that is, it is failing to generate a countervailing GDP lift in the recessionary domestic market conditions.

The weak external demand conditions add insult to injury. It is difficult to become excited about the positive April manufacturing indicators.

SA’s historic progress has come to a delicate crossroads. If not dealt with decisively, the current recessionary economic conditions have the potential to plunge the country into deep crisis. Imaginative policy action is required as a matter of utmost urgency.

Navigating the current cyclical downturn is an important prerequisite (read: monetary policy should, for starters, be eased).

More important is the decisive implementation of the required structural economic reforms, no matter which political parties triumph at the local government polls on August 3. 

Read more about: business | currency | brexit | south africa | economy

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