South Africa: Downward Revisions to GDP Growth

Michael Kafe and Andrea Masia, Morgan Stanley, Johannesburg.
This article appeared in the July 2008 issue of Current Economics with permission of the author.

Key Concepts: Economic Growth | GDP Growth | GDP Forecast |
Key Economies: South Africa | Euro Zone | Asia |

It is becoming increasingly clear to us that European and Asian growth is likely to slow in 2009/10, and our global economics team has turned a lot less sanguine about their respective regions’ growth prospects than was the case at the beginning of the year. We take advantage of the changing mood to revisit our South African GDP outlook for the coming

Forecasts for 2008,
% change
Morgan Stanley 3.8 11.7 -21.0
Consensus1 3.9 9.6 -21.9
1 Source: Consensus Forecasts, July 2008

three years. Since the second quarter of 2007, we have persistently held a sharply below-consensus view on growth for the next three years. This remains the case, except for 2008, where aggressive revisions to analyst estimates put the consensus GDP estimate below our existing forecast of 4%. In this piece, we downgrade 2008 GDP growth to 3.8% and scale back our forecasts to 3% for 2009 and 4% for 2010.

Although we believe that weaker global growth and tighter money locally will no doubt hurt South Africa’s growth prospects, we are of the opinion that the trough in the growth cycle will be in 2009, and not 2008. What’s more, contrary to recent speculation, we believe that the probability of a recession in South Africa in 2008 is an unlikely tail event.

The Global Backdrop

Despite the continued turbulence in global financial markets, global growth has surprised on the upside, particularly in the US as the Fed embarked on a decisive move to ease monetary policy conditions, in conjunction with a fiscally stimulating package from the Treasury.

Even so, our US economics team maintains its bearish outlook on GDP growth prospects. In its view, the combination of tight financial conditions, higher energy quotes, higher global inflation and weaker global growth will soon promote a mild downturn in the US economy. Rather than averting recession entirely, they believe that the combined monetary and fiscal stimulatory program of action may have simply pushed out the timing of an inevitable economic contraction to the fourth quarter of 2008 and the first quarter of 2009. Our US GDP forecasts have therefore been tweaked marginally higher for 2008 but adjusted downwards for 2009, from 1.2% and 0.9% to 1.5% and 0.7%, respectively.

Similarly, our European colleagues have taken a dimmer view on their growth outlook, and have revised their GDP forecasts for 2008 and 2009 from 1.6% and 1.4% to 1.5% and 1.0%, respectively.

Exhibit 1. A Major Shift in the European Growth Landscape Exhibit 2. Downward Revisions to the Growth Outlook
European GDP Growth GDP Growth Outlook for South Africa
Source: Eurostat data, Morgan Stanley Research;
e=Morgan Stanley Research estimates
Source: Statistics South Africa, Morgan Stanley Research

More recently, our European economist, Elga Bartsch, pointed out that the margin by which Germany has outperformed the Euro area appears to be melting away. After a full-year GDP growth rate of 2.3% in 2008, which would put our estimate of Germany’s growth pace at some 50% above the Euro area as a whole, she now expects German GDP growth to gravitate towards the Euro area’s 1% in 2009. The latter is less than half of the Euro region’s trend growth rate.

In Asia, our ASEAN regional expert, Chetan Ahya, is of the view that, while stronger-than-expected global growth combined with a relatively slow monetary policy response to emerging inflation risks will lift first half GDP growth above expectations, subsequent tightening of monetary conditions should combine with tougher external conditions to ensure that GDP growth comes in at no more than 5.1% (y-o-y) in 2009, versus his initial estimate of 5.9%. However, our Chinese economists expect Chinese GDP growth to remain at 10% this year, before falling marginally to 9.5% in 2009.

Domestic Implications

With global prospects for 2009 looking dimmer, and bearing in mind that only some 14% of South Africa’s exports make their way to the US, while as much as 28% and 33% are destined for Asia and Europe, respectively, we believe that it is only reasonable to acknowledge that weaker growth offshore is likely to impact negatively on South Africa’s exports, and as a corollary, its GDP growth, ceteris paribus. For 2008, however, we maintain a forecast of 3.8%, which is largely driven by our contrarian view that expectations of severe power outages this year are likely to be disappointed. We believe, instead, that short-term relief measures implemented by Eskom (the South African state-owned electricity utility), such as the de-mothballing of existing plants and other demand-side management measures, will provide adequate relief in 2008.

Exhibit 3. We Reinstate our Bet Against Consensus
Consensus GDP Forecast for South Africa
Source: Statistics South Africa, Morgan Stanley Research

Primary Sector GDP

At the primary GDP level, we maintain our outlook that agricultural GDP will remain well supported, as high international food prices have incentivized local farmers to increase planting acreages. Such higher prices have also helped place local food producers in a favorable position to compete with imports from their subsidized developed market competitors. For example, the most recent data from the Department of Agriculture released at the beginning of July show that maize crop estimates for the 2008/09 marketing season are now close to 10% higher than previously thought (see Exhibit 4, below).

For mining production, we expect volumes to remain weak, although they are likely to recover from the surprising first quarter 22.1% (q-o-q)1 contraction, thanks to better and more stable power supply than was the case in the January-March quarter. On the whole, we look for a modest recovery of some 6% (q-o-q) in the remaining three quarters of the year. This should still translate into a negative annual growth rate of 3.4%, however.

Exhibit 4. Upward Revisions to Agricultural Crop Estimates
Agricultural Crop Forecasts
Source: South African Department of Agriculture, Morgan stanley Research  

Secondary Sector GDP

At the secondary level, manufacturing production continues to report unconvincing rates of output growth on a monthly basis, strengthening our conviction that the manufacturing sector is set to experience significant challenges over the next several quarters, particularly as policy rates remain high and manufacturing margin compression intensifies. Although the sector will no doubt benefit from expected South African rand weakness, we believe that this will be insufficient to offset the significantly higher cost of money.

We expect electricity production to recover from the technical recession experienced over the last two quarters to post an average annual growth rate of around 2% in 2009 and 2010. Finally, we have priced in a marked deceleration in construction activity from the second half of 2008 through the first half of 2009. As close to three-quarters of total fixed capital formation originates from private enterprise, we believe that higher policy rates will exert a much more dampening impact on construction activity than may be presently discounted.2

Tertiary Sector GDP

We expect tertiary sector GDP to slow meaningfully, from rates of 5.7% (y-o-y) in 2007, through 4.3% (y-o-y) and 3.1% (y-o-y) in 2008 and 2009, respectively, before recovering somewhat to 4.1% (y-o-y) in 2010.

The slowdown here should be led primarily by a deceleration in the financial services and real estate sectors, as well as transport, storage & communication. General government services should remain rather rigid around current growth rates of around 3.5% (y-o-y), in contrast to the wholesale and retail sector, which we see decelerating to its slowest pace since 2001 on the back of tighter monetary conditions and a crowding-out of discretionary purchases by higher oil prices.

1 All q-o-q GDP growth rates are seasonally adjusted and annualized.
2 Using 2007 GDP numbers, the distribution of fixed capital formation was general government (12.4%), public corporations (13.2%) and private business enterprise (74.3%).

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