Economic Thoughts: Birth Pangs 2016

The year wasn’t supposed to start like this. One darn thing after another. Not so much crisis stations as having to manage the unexpected, with fallout of course registering in Rand and JSE stock market.


The Big Thing, feared for well over a year, didn’t turn out to be the Fed. It managed liftoff last month, but ever since events have conspired to keep the Fed grounded from here onward (at least temporarily). Disorderliness has resulted, but it primarily came from elsewhere, the Chinese economy repositioning (sinking global commodity prices and EM currencies), the Chinese handling of its financial liberalization (mangled), the changing oil dynamic (Iran coming out of sanctions, Saudi and others maximizing supply), drought hitting us badly and Zuma and friends mangling SA credibility through personnel changes and policy emphasis (Rand weakening further, reaching 17:$).


And for our next act? Eh, more of the same, at least for awhile?


The Chinese, oil producers and the Fed aren’t quite finished with their respective dramas. The drought will have to show us its final bill. As to Zuma and friends, there is damage control with the one hand but negating it with the other (giving left engine more forward thrust, while reversing thrust on right engine, giving a very twisty kind of flight path).


How to read this?


America is not in trouble. Her data may be more slow-coach than expected by the Fed, probably delaying the next rate hike, market betting on September. That isn’t necessarily the end of the world. Talk of recession way overdone.


China is much more of a struggle, as much in the real sector as the financial one. Her industry sectors are going through a major rationalization process, suffering severe overcapacity with growth slow, changing their commodity appetite while overseas suppliers are much slower in adjusting, them into the bargain shielded by massive currency depreciations. The result is sliding global commodity prices, some of which have yet to bottom, and may then not bounce quickly, suggesting an L-shaped landing.


The global commodity rationalization will likely be a drawnout process, not least as too many countries are monocultures or specifically commodity-based, with no second acts. It is a structural indigestion, rather localised, that will not change the direction of the world but may create a few large backwaters (like rust belts in old industrial heartlands around the world).


The Chinese are trying, in stages, to move away from a controlled, planned economy towards at least in part a market-directed economy. This process, however, is like an obstacle course, with erstwhile planners reluctantly giving up controls and interference, inviting hiccups as markets imperfectly take over. Currency and stock market cases in point.


Liberalisation reform is to be welcomed, but its Chinese imperfections reminding of early 1960s Europe. The costs of making the change are upsetting but not necessarily changing the direction of the world economy. Yet another indigestion being worked off.


Oil is yet another example of a temporary disruption. Demand has waned, while supply has been boosted, by innovative frackers, market share defenders and now Iran returning to full export potential as sanctions lift. This is creating short-term downward pressures on global prices, offering a major price undershoot. This impacts negatively on energy investment (notably in the US) and positively on consumer spending worldwide (at least potentially, but so far no cigar).


Though rains have belatedly turned up in our interior this past week, the drought is not broken and the impact on agricultural output substantial.


The Zuma effect is unlikely to be transitory as the broader policy framework shows no evidence of a change in direction. Finance minister Gordhan has yet to show what he intends to orchestrate this year, together with SARB, if anything.


This is not quite the same thing as saying the recent uncontrolled Rand rout will continue. Certainly global effects could keep pummeling the Rand, but the Zuma effect is for now possibly discounted, a Rand step-up so to speak having been achieved, until new policy twists are unearthed.


What does all this hold for SA in 2016?


Growth is likely to be eroded further by external headwinds (commodity price pressures) and domestically by the drought impact, a lack of public delivery and ongoing business reticence (a reflection of clashing paradigms). GDP straddling the 0% line (at best +0.5%, at worst -0.5%).


Headline inflation will be spiky most of the year in a 6%-7% range due mostly to commodity effects (energy and food) and Rand driven. Core inflation should be nearer 5.5%.


Such an inflation environment will make SARB wary indeed, with China good for fresh global strains, though Fed liftoff impact may be more subdued (indeed wane….), and the ECB may engage in more policy easing, making for a welter of confusing global market influences.


The semi-indexed SA pricing reality, and global unsettledness, will keep SARB vigilant regarding dragging of inflation expectation anchors, but the very weak SA economy, and the limited extent of any inflation outbursts may limit the extent to which SARB is prepared to impose higher risk premiums. SA interest rates will probably rise further, with prime currently 9.75%, but the extent is likely to be limited these next two years to 11%-12%.


The Rand has further weakness potential this year, driven both by global forces and domestic perceptions, worsening the Rand undershoot from fair value near 10:$. Whereas the Rand could reach 20:$, its moves against other trading partner currencies may be much more subdued, as many of these in turn also further weaken against the Dollar. Thus our overall trade-weighted situation will differ materially from the Rand-Dollar experience, also its impact on our inflation and trade (export and import).