Four potholes to economic recovery

15 March 2012 Gareth Stokes : gareth@fanews.co.za Every quarter we attend market updates hosted by dozens of South Africas top investment managers. Over the past 14 days weve listened to analysts and economists from StanLib, Absa Capital, Investec Asset Managers and Sanlam Private Investments to name a few. The message from each of these financial institutions is to tackle 2012 with caution. They say there is a long way to go before the world shakes off its recent economic malaise. This sentiment was encapsulated in Finance Minister Pravin Gordhans 2012 National Budget speech, where the minister warned: The global environment remains highly uncertain while there are signs of revival in the US economy much of Europe is in recession and significant financial risks cloud the global economic outlook! The minister said the local economy would grow by a mere 2.7% this year, recovering to 3.6% and 4.2% in 2013 and 2014 respectively. But even these modest growth rates are under threat. Sanlam Private Investments director, Alwyn van der Merwe, identified four potential potholes on the road to domestic economic recovery. He was addressing the media at the groups Q1 2012 Economic Update titled Navigating the Vastness of Uncertainty. Each of these potholes derives from one of our major trading partners And South Africa can do little more than watch as the leaders in those economies take steps to remedy the problems. The first pothole A Greek default The European sovereign debt crisis has dominated the financial media since late 2010 and continues unabated While some argue over whether Greece will fold or not, others point out that it has already collapsed. It is only thanks to the imaginative spin doctoring of politicians and central bankers that the default has been engineered without being acknowledged! A quick look at the yields on long-term government bonds in the so-called PIGS (Portugal, Italy, Greece and Spain) confirms that Greece is only the first of many Euro-zone economies with significant problems. It is only a matter of time before the next domino in the chain falls... Europes financial woes have brought into question a system that forces countries to implement similar monetary and economic policy regardless of their situation. There is a strong possibility the events of the past two to three years could lead to a break-up of the European Union or at the very least a rethink of certain macroeconomic practices. It is not all bad news Van der Merwe is upbeat about the proactive steps taken by new European Central Bank (ECB) president, Mario Draghi. The ECB put in place a 1 trillion lifeline to the regions banks recently. But despite this unprecedented liquidity uncertainty remains. While we can debate a Euro-zone meltdown, recession is a given. And thats bad news for South Africa, because Europe remains our second largest trading partner. The second pothole Middle Eastern instability With all the talk about US and Euro-zone debt, ongoing tensions in the Middle East are all but forgotten. Van der Merwe said there are major concerns over the political vacuums created in the region in the wake of the Arab spring uprising. Another area of concern is the influence of countries such as Russia, China and Iran in the region exacerbating the East versus West tensions of old. Why should South Africa care about Middle East instability? You can find the answer to this question at your local petrol station Trouble in the Middle East reflects in higher Brent Crude prices, which in turn hit the pockets of motorists worldwide. Local motorists are already docking up almost R11/litre for petrol and with oil hovering near $130/barrel they will soon be paying more! The third pothole Debt and elections in the US Although China is growing in leaps and bounds, the US remains the major economic hub of the world (for now). This region is struggling with a mountain of debt, totalling 100% of GDP and growing. The US debt problem is a legacy of two separate presidencies. First Republican George W Bush (2001 to 2009) cut taxes too aggressively And then Democrat Barack Obama (2009 till present) increased benefits without reining in other expenditures. The net effect is that the average US household now receives more in benefit than they pay in taxes, with the difference funded from new debt! There are some signs that the US is bottoming out, said Van der Merwe. But we expect plenty of political and economic rhetoric *through 2012+ due to it being an election year

The fourth pothole A hard landing in China The monster among the economic potholes is a hard landing in China Economists define a hard landing for the emerging market superpower as GDP growth slumping to between 4% and 6%. A soft landing currently the consensus view is for growth to fall to only 7.5%. It is difficult to imagine the hard landing scenario playing out, because China has posted GDP growth in excess of 9% for more than a decade already But if China stutters South Africa will feel the pain. First, because our commodity-rich economy is underpinned by higher commodity prices, largely thanks to Chinese demand. And second, because China is our main trading partner. Trade with the region surged 77% in 2011 alone! There is little South Africa can do to address the four potholes identified in todays newsletter. The best policy will be to get our house in order and ensure that once the global economic outlook improves, our economy is ready to fire on all cylinders.