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
CPIX inflation, %oya, avgJPMorganReuters consensusMTBPSReal GDP growth, %oyaJPMorganReuters consensusMTBPSCurrent account balance, %of GDPJPMorganReuters consensusMTBPSPrime lending rate, %, eopJPMorganReuters consensusPrime lending rate, %, eopJPMorganReuters consensus
2002 2003
10.0%9.7%9.6%
2.5%2.5%2.6%
0.0%0.1%0.1%
18.0%17.0%
10.8010.80
8.7%7.4%7.2%
2.5%2.8%3.5%
-0.2%-0.2%-0.3%
17.0%15.3%
11.5011.50
Source: JPMorgan, Reuters, MTBPS
4
2001 2002 2003 2004 2001 2002 2003 20042005
Real growth in demandFinal 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 atcurrent prices (Rbillion) 969.1 1,057.0 1,153.9 1,250.5 975.0 1,093.0 1,214.2 1,325.0
1,439.0CPI 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%
Government macroeconomic forecasts
2002 Budget 2002 Medium Term Budget Statement
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
-8
-6
-4
-2
0
2
4
6
8
90 91 92 93 94 95 96 97 98 99 00 01 02 03
%q/q, saar
Source: SARB, JPMorgan estimates
Forecast
GDP Growth
HCE Growth
SA GDP vs HCE Growth
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
Finance
Business
Labour
Average
2002
Source: Bureau for Economic Research, University of Stellenbosch
2003
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)
2004
6.2 (6.0)
7.5 (7.9)
7.3 (7.4)
7.0 (7.1)
Percent
3rd Quarter 2002 (2nd Quarter in parentheses)
9
23456789
10111213
1998 1999 2000 2001 2002 2003
%oya%oya
Forecast
Targetrange
Source: StatsSA, JPMorgan estimates
Inflation - Close To Peaking But Underlying Picture Less Favourable
CPIX forecast 2002 y/e : 12.1% (10.0% ave) 2003 y/e : 6.6% (8.7% ave)
(Metropolitan & other urban areas)
Peak of 12.2%oyain November
SA CPIX Inflation
10
Food price inflation remains the major cause for concern
0
5
10
15
20
25
2000 2001 2002
0
6
12
18
24
30
%oya%oya
CPIX Food Inflation
PPI Food Inflation
SA CPIX vs PPI Food Inflation
Source: StatsSA
%oya%oya
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
4
5
6
7
8
9
10
11
12
13
2000 2001 2002Source: StatsSA
Goods
Services
%oya
CPIX goods vs services inflation
Although inflation was initially driven by exogenous shocks, it has become very widespread
12
Further petrol price increases remain a major risk
-60
-30
0
30
60
90
120
150
180
98 99 00 01 02
-12
-6
0
6
12
18
24
30
36%oya%oya
Source: Bloomberg, I-Net, StatsSA
Gauteng Petrol PriceRand Oil Price
%oya
CPIX Transport
JPMorgan forecasts Brent to average $25.7/bbl in 2002 and $26.6/bbl in 2003 – but risks are on the upside
13
A further key risk is more pass-through from rand depreciation
-3
0
3
6
9
12
15
18
90 91 92 93 94 95 96 97 98 99 00 01 02 03
2.0
3.5
5.0
6.5
8.0
9.5
11.0
12.5
CPIX
Overall PPI
%oya
Source: StatsSA, Bloomberg, JPMorgan estimates
R/$
Rand/US$
Forecast
PPI and CPIX Inflation vs Rand/$
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
-9
-6
-3
0
3
6
9
12
15
1996 1997 1998 1999 2000 2001 2002
3
4
5
6
7
8
9
10
11
12
13
R billion
Both bond and equity portfolio flows turned negative in 02H2.
Total Portfolio Flows vs Rand/US$:Rate
Source: I-Net
Rand/US$(inverted scale)
R/$
Portfolio Flows
Much of the strength earlier this year was propped up by portfolio flows, which have turned
15
And outflows have picked up as expected
-56
-48
-40
-32
-24
-16
-8
0
8
92 93 94 95 96 97 98 99 00 01 02
Services Account
Net Dividend Outflows
R billion
After falling in 02Q1, outflows have picked up again now that the Myburgh Commission is out of the way
SA Services Account vs Net Dividend Payments
Source: SARB
16
Strong trade performance has supported the rand, but fading with subdued global growth
-4
-2
0
2
4
6
8
10
1998 1999 2000 2001 2002Source: SARS
SA Trade Balance
R billion
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
United States
Euro area
Japan
United Kingdom
Canada
Current Mar 03Dec 02
Source: JPMorgan
Jun 03
1.75
3.25
0.00
4.00
2.75
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
Dec 03
2.00
3.25
0.00
4.75
3.50
Percent of total
18
In South Africa, one more 100bp rate hike forecast for November
2
5
8
11
14
17
20
23
26
95 96 97 98 99 00 01 02 03
Nominal
Real (using CPIX Inflation)
Forecast
And Morgan looks for a 100bp rate cut in 03H2 once inflation is clearly falling towards the target range.
Source: SARB, JPMorgan estimates
%%
Prime Lending Rate
19
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)
2003(f)2002(f)
2.5
2.4
2.6
4.5
-2.0
-0.2
8.7
6.6
17.0
11.10
11.50
2.5
3.0
2.8
5.5
0.0
0.0
10.0
12.1
18.0
12.20
10.80
JPMorgan AnnualSA Economic Forecasts
Source: JPMorgan estimates
20
Budget deficit target FY2002/03 and 2003/04 unnecessarily 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
South Africa: Medium-term budget policy statement: Main Points
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
Yield - 10-year govt bond
CPI, avg 2002
Budget deficit, % of GDP, ESA meth.
Public debt, % of GDP
Czech
Source: JPMorgan
Poland
4.2
2.1
6.4
20.0
6.0
1.9
4.4
48.0
Hungary
7.1
5.3
8.7
53.0
24
SA official budget projections
2002 Budget 2002 Medium Term Budget Statement
R million 2002/03 2003/04 2004/05 2002/03 2003/04 2004/052005/06
National Revenue Fund (main budget)
Revenue 265,217 288,708 313,211 273,281 302,102 330,338358,323
Expenditure
Interest on debt 47,503 49,845 52,434 47,236 51,463 54,59957,853
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 4,0008,000
Allocated expenditure1 237,106 256,386 273,128 244,517 275,955 299,825322,247
Total 287,909 311,231 334,561 291,753 329,418 358,424388,100
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 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 7.07.0
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 2.02.5
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 1.11.2
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.
Outcome
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
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
Difficulties with inflation targeting for an emerging economy
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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