STANLIB ECONOMIC REPORT Increased concerns about a US slowdown by monkey6


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March 2007 GLOBAL
We are still predicting a general slowdown in the US economy rather than a full blown recession. There have, however, been some significantly hawkish comments made recently by Alan Greenspan. ECB recently increased rates by a further 50bps to 3.75%. Further hike expected. Risks to Euro-area inflation remain. The strength of Euro-area real GDP growth in Q4 is indicative of ongoing robust growth in the Euro-area.

Increased concerns about a US slowdown, but Euro-area growth remains robust.
We are still predicting a general slowdown in the US economy rather than a full blown recession. There have, however, been some significantly hawkish comments made recently by the ex Federal Governor Greenspan. As far as Greenspan is concerned there is a 33% chance of the US going into recession. This is reasonable consistent with the Federal Reserve Bank’s own Yield Curve Model. The concern about the US economy centre around the slowdown in the housing market as well as a weakening of industrial production. There are also tentative signs of slowing employment growth as well as a weakening in retail sales.
US existing single-family house price
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SA’s GDP growth for the final quarter of 2006 was impressive at 5.6%q/q. For 2006 as a whole the economy grew by 5.0% and has averaged 5% over the last 3 years. The strong performance has been broad based. The Reserve Bank opted not to hike the Repo Rate in February, after having increased rates by 50bps in December to 9%. On balance STANLIB expects the Reserve Bank to keep interest rates onhold for the remainder of 2007. However, the risks are still clearly to the upside. These is a substantial under-recovery on the petrol price (which was at 74c/l on 3 March). SA recorded another shock trade deficit in January of R11.9bn. Current account remains under pressure. CPIX inflation was slightly higher than expected in January at 5.3%. Inflation is expected to move higher over the coming months. The Minister of Finance presented the National Budget on Wednesday 21 February 2007. It was largely in-line with expectations, with a budget surplus reflected for both 2006/07 as well as the 2007/08 fiscal years

US consumer inflation was recorded higher than expected in January due to an increase in medical costs. There is further upside risk to inflation. In the short-term the risk to US interest rates is clearly still to the high side the Federal Reserve’s ongoing concern about inflation. However, on-balance we still expect that the next move in US interest rates will be lower, albeit only in the second half of the year or early in 2008. The next FOMC meeting is scheduled for 20/21 March. The current Federal Funds Target interest rate is 5.25%.

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ECB increased interest rates further in March In the Euro-area, risks to the medium-term outlook for inflation remain on the upside. These risks relate, in part, to stronger than currently expected wage developments in a context of robust ongoing growth in employment and economic activity.
Euro-area, US and UK official interest rates

averaged growth of 5% a year, government’s interim target of 4.5%.



The key features of the Q4 data was ongoing extremely strong growth in construction, financial activity and retail sales, while the recovery in the mining sector provided a welcome boost. Only the agriculture sector reported a decline in activity. Excluding agriculture, GDP grew by a very robust 6.0%q/q, annualised.
SA GDP annual growth rate




6 5 4



3 2

0 01 02 03 04 05 06 07

1 0

The strength of real GDP growth in the Euro-area in Q4 is indicative of ongoing robust growth in the region. As the same time global economic growth has become more balanced across regions and, while moderating somewhat, remains robust, providing support for Euro-area exports. As far as the ECB is concerned, monetary policy continues to be on the accommodative side, with the key ECB interest rates moderate, money and credit growth vigorous, and liquidity ample.

-1 -2 -3 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

SA’s economic fundamentals remain solid although interest rate risk is to the upside.
SA GDP growth remains robust In Q4 2006 SA GDP grew by an impressive 5.6%q/q, annualised (seasonally adjusted), up from a revised 4.5%q/q in Q3 2006 (previously Q3 GDP was recorded at 4.7%q/q). SA’s Q4 growth rate was above market expectations for growth of 4.8%. For 2006 as a whole, the SA economy grew by 5%. Over the last 3 years the South African economy has

Looking forward, economic activity is expected to slow modestly in the quarters ahead on the back of some moderation in consumer activity (GDP growth for 2007 is currently projected at 4.5%y/y). Fortunately the fixed investment cycle is gathering pace with infrastructure spending expected to gain more and more traction in the years ahead. The 2007 National Budget has added another R34.8 billion to capital and infrastructure spending, taking the total to R416 billion over the next three years! SA CPIX inflation drifting higher In January 2007, headline CPI inflation rose by a large 0.9%m/m, with the annual rate rising to 6.0%y/y from 5.8%y/y in December. This was in-line with market expectations. CPIX inflation also rose by a substantial 1.0%m/m in January, with the annual rate rising to 5.3%y/y from 5.0%y/y in December. CPIX consumer inflation for low income earners is now up at a substantial 6.9%, well above the top-end of the inflation target range.

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Food inflation, at both the producer and consumer level has moved-up sharply during the past 6 months. Fortunately, although the monthly increases remain relatively large, the annual rate of change has moderated a little in the past two months, mostly due to base effects. Nevertheless, there is clearly upward pressure on food prices, especially from certain crops such as maize as well as within the processed food category, which has now moved up steadily from a low of 1.3%y/y in early 2005 to the current level of 6.6%y/y. Surprisingly, clothing and footwear inflation fell further in January, declining by 1.0% in the month and by 9.1% over the past year. While this category has a relatively low weight in the overall CPIX index (4.06%) it has certainly helped to keep CPIX on the low side. In other words, if clothing and footwear inflation was currently 0%, CPIX inflation would be up at 5.7% instead of 5.3%. Clearly, there must be some upside risk to clothing inflation going forward. Medical inflation rose by 4.3%m/m in January, with the annual rate easing to 5.6%y/y from 6.5%y/y in December 2006. The increase in January was due to the scheduled surveys of doctors’ and dentists’ fees, as well as contributions to medical aids, and hospital fees.
SA CPIX forecast
% y/y

For 2006 as a whole CPIX averaged 4.6%y/y, up from 3.9% in 2005 and 4.3% in 2004. For 2007 as a whole, CPIX is now forecast to average 5.4%. SA consumer inflation has been remarkably well contained given the fact that the trade-weighted Rand weakened by 16% in 2006, and that private sector credit grew by more than 25%. This, in part, reflects the benefits of increased globalisation as well as the importance of managing inflation expectations. SA trade balance under pressure In January 2007, South Africa’s trade account recorded another large trade deficit of R11.9bn, compared with a surplus of R388 million in December 2006. The market was expecting a deficit of around R4bn, although there was a very wide dispersion of estimates. During January 2007, exports declined by a substantial 16.7%m/m, while imports rose by a significant 17.2%m/m, pushed higher by a R1.9bn increase in imports of machinery and equipment as well as R1.8bn increase in imports of motor vehicle parts.
SA trade balance
10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11 -12 -13 -14 2000 2001 2002 2003 2004 2005 2006 2006

12 11 10 9 8 7 6 5 4 3 2 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Impressively, CPIX services inflation (33.8% of CPIX basket) is still relatively low at 4.6%y/y, but appears to have started to trend moderately higher.

This is the 12th monthly trade deficit during the past 13 months. While the increase in the deficit in January is partly due to seasonal effects, there is no doubt that the ongoing buoyancy in the domestic economy is reflected in sustained high import demand. As pointed-out recently by the Monetary Policy Committee of the Reserve Bank, the deficit on

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the current account most likely widened significantly in the fourth quarter of 2006. Looking forward, the trade balance is likely to remain under pressure, especially considering the expected steady pick-up in fixed investment spending, which contains a large component of imports. This supports the view that the Rand is likely to remain underpressure, at least on a trade-weighted basis. SA private sector credit should start to ease In January, SA growth in broad money supply (M3) was recorded at 22.5%y/y, down from a revised 23.1%y/y in December. The market was expecting growth of 22%y/y. As pointed-out for a number of months now, overall M3 growth remains exceptionally high, having accelerated substantially from around 12%y/y in March 2005, mostly on the back of a substantial increase in net claims on the domestic private sector (bank credit). The slowdown in M3 growth during January was mainly due to R15bn decline in government deposits. In contrast, claims on the private sector rose by a further R10.8bn.
Growth in private credit (excluding investments)
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in November. At over 27%y/y, private sector credit (excluding investments) is still growing extremely fast. In real terms (adjusting for inflation), the growth in private sector credit (excluding investments) is still growing by around 20%. Overall, the growth in M3 and private sector credit remains exceptionally high, especially taking into account the increase in securitisation issues, which understates total bank credit. This has amounted to a substantial R12.6bn in just five months. Consequently, the Reserve Bank is likely to remain vigilant. There is clear evidence that the robust growth in bank credit does not just relate to asset based finance, but has clearly broadened into all forms of credit including general household consumption (growth in individual credit card debt is now back up to 43%y/y). National Budget relatively unexciting but reflects fiscal discipline The Minister of Finance presented the National Budget on 21 February. Overall the budget was largely in-line with expectations, with the Minister presenting a budget surplus for 2007/08.
SA budget deficit as % of GDP
% Fiscal years

23 20 17 14 11 8 5 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
0 -1 -2 -3 -4 -5 -6 -7 -8 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970 1969 1968 1967 1966 1965 1964 1963 1962 1961

The growth in private sector credit rose by a more modest 0.8%m/m in January and by 24.83%y/y. This slowdown was due to a further decline in the Investment category of private sector credit. Excluding the investments category (which is a more appropriate measure of the trend in credit demand), private sector credit actually rose by 27.11%y/y, compared with 27.63%y/y in December and 27.35%

Government’s medium-term strategic framework comprises the following five key policy objectives: Accelerating the pace of economic growth, and the rate of investment in productive capacity.

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Advancing participation of the marginalised in economic activity through expanded job creation. Maintaining and expanding a progressive social security net, alongside investment in community services and human development. Improving the capacity and effectiveness of the state, including combating crime and promoting service-oriented public administration. Building regional and international partnerships for growth and development. Government’s macro-economic outlook: Government remains extremely optimistic about the SA economy. GDP is forecast to grow by 4.8% in 2007, down slightly from 4.9% in 2006. The expansion is expected to strengthen over the medium term, as exports increase and the growth in investment spending accelerates. Growth is projected to reach 5.1% in 2008 and 5.4% in 2009. Consequently, over the next three the government expects the South African economy to grow by an average of around 5.1% a year. Robust investment growth is anticipated over the next three years as government maintains its focus on the extension and improvement of transportation links, increasing electricity supply and provision of housing close to places of employment. Strong investment spending by the private sector linked to the Gautrain and 2010 FIFA World Cup stadiums is also anticipated. Revenue overrun and budget surplus: In 2006/07 government revenue amounted to a massive R476 billion, which is an astounding R29.5 billion ahead of budget. This follows a revenue overrun of more than R40 billion in 2005/06. The revenue overrun in 2006/07 was relatively broadbased with corporate tax, personal income tax, VAT and customs duty all substantially exceeding budget.

The favourable revenue outcome allowed the government to record a budget surplus of R5.2 billion for the 2006/2007 tax year, equivalent to 0.3% of GDP. This is the first time that South Africa has generated a budget surplus since at least 1960. In addition the government has budgeted for an even large surplus of R10.7 billion (0.6% of GDP) in 2007/08. Key tax changes There were, relatively speaking, very few changes proposed by the Minister. The key changes include: Replacing the STC with a dividend tax, reducing the rate from 12.5% to 10.0% (with effect from 1 October 2007). This will mean a revenue loss of R2 billion during the next tax year.) Personal income tax relief for individuals amounting to R8.4bn (This is relatively modest considering that government granted individuals tax relief of R13.5bn last year). Abolishing the retirement fund tax (which was at 9%). This means a revenue loss of R3 billion for government. Effective 1 March 2007. Treating the sale of shares (equities) held for more than three years as capital gains. Increasing the tax-free interest income monetary thresholds (up from R16500 to R18000 for people under 65 years, and from R24500 to R26000 for people older than 65). This will result in a revenue loss of R470 million for government. Increasing excise duties on tobacco products and alcoholic beverages (revenue gain of R1 480 million). Increasing the general fuel levy and the Road Accident Fund (RAF) levy, resulting in a revenue gain of R950 million.

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Government revenue as % of GDP
% Fiscal years
29 28 27 26 25 24 23 22 01/02 02/03 03/04 04/05 05/06 06/07 07/08

As a result of sound economic policy and prudent management of the national debt portfolio, supported by increasing revenue from strong economic growth, South Africa’s borrowing requirement continues to decline. At the same time the country’s international credit ratings have steadily improved enabling government to borrow at more competitive rates in the global capital markets. Over the next three years, government will in net terms buy back R6.6 billion of debt, compared to net borrowing of R78.6 billion over the preceding four years. Importantly, a lower borrowing requirement reduces government debt issuance in the market, providing the opportunity for state-owned entities and other companies to finance their operations at lower cost. In effect this amounts to crowding-in the private sector as opposed to the typical problem of state debt ‘crowding-out’ the private sector. Lower borrowing requirements and the slower increases in the stock of debt have had a positive impact on state debt cost, which as a percentage of GDP and revenue continues to fall. State debt cost as a percentage of total revenue averaged 19.7% between 1994/95 to 2005/06, declining to 11% in 2006/07.
Debt servicing as % of total spending
% Fiscal years

Expenditure priorities Government is budgeting for real average growth in non-interest expenditure of 7.7% a year over the next three years. This will certainly add to the buoyancy of the economy. Expenditure priorities reflect a significant increase in infrastructural spending. This includes an additional R13.3 billion for the 2010 FIFA World Cup, bringing the total contribution from national government to R17.4 billion – R8.4 billion for stadiums and R9 billion for transport infrastructure. The 2007 Budget adds R34.8 billion to capital and infrastructure spending over the 3-year medium term for transport, community development and the built environment. In total, government has budgeted for infrastructure expenditure of R416 billion over the next three year. There is also a focus on improving the quality and access to health care, school education, welfare services and economic services. It would appear that exchange control will continue to be relaxed on a very gradual basis. This budget included additional relaxation measures, albeit very modest. Fiscal discipline and the bond market

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Where to from here South Africa’s fiscal authorities have established a high degree of credibility over the past ten years. But

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it needs to be recognized that most budgeting processes are essentially an exercise in uncertainty. On many occasions, budget projections have swung by literally billions of Rand within the space of a year or two. It is therefore essential that the fiscal authorities are cautious in making permanent and irrevocable fiscal policy changes after a period of extreme prosperity; especially when one considers the current strength of consumer spending as well as the sustained high real increase in government expenditure. Rather, the current policy of debt reduction has the advantage of preserving the government’s flexibility and leaving the Minister of Finance with options, not merely if projections turn out as he plans, but also if they do not. Equally, debt reduction now leaves the country with significant scope to provide a counter-cyclical response in the event of future negative shocks to the economy.

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