The MTBPS and the SA economy Facing down the challenges Chris Hart Economic Strategy Unit Absa Capital October 2006

The SA economy

BoP Interest Rates Trade Balance GDP Demand PPI $/R CPI The Business Cycle

Inflation: Under pressure due to rand and oil Pressure expected to ease by the end of the year

5 S.A.: lower inflation, higher growth The first time since the early 1970’s. The favourable shift in the risk-reward profile will help to attract investors over the longer term. However, over the next year, the growth/inflation profile may slip back below the line should the rand not start to recover in the short term.

Economic growth shift Investment boom Consumption boom Strong profit generation, strong economic growth and interest rate stability are expected to drive the economy. The commodity boom and the infrastructure rollout will be further drivers of the economy. Consumers, business and government all have considerable capacity to increase credit levels. The growth cycle does not appear to have reached the stage of diminishing returns, which still suggests that there are a number of years before exhaustion of the current phase. Developments in the property market and credit extension provide some evidence of this shift taking place

The rand: Current drivers

8 Longer-term recovery prospects USDCommodities Precious metals Macroeconomic management Growth

The region

Sub Saharan Africa has developed into a growth region, which holds numerous opportunities in contrast to a few years ago where this was the worst neighbourhood in the world. Sub Saharan Africa Commodity boom End of cold war Demise of Apartheid Improvement of governance Integration with the continent Now starting to benefit

Summary of Prospects: Economic growth: could exceed expectations Economic conditions shift Refugees and entrepreneurs Southern Africa

The SA economic challenges

Debt levels are not a problem in absolute and relative terms. The trend in Household debt is a problem but not one that interest rates alone can resolve Debt levels Household Debt ~70% of income Public Debt ~35% of GDP External Debt >20% of GDP Trend: downwards Trend: upwards

Kinds of debt Consumption Produces liabilities Investment Produces income.

Economic imbalances Current account deficit Credit-led consumption expenditure High demand levels can be expected in an economy undergoing structural transformation. Balance to the economy will be restored when supply matches demand. This can be achieved by suppressing demand to match supply or by boosting supply to meet demand. Suppressing demand to match supply is the low growth option and will only prove to be a band-aid solution – the demand will manifest itself sooner or later. The long term solution (and high growth option) is to boost supply in order to meet demand. This would involve a combination and coordination of official and private sector initiatives that make sense but could prove to be politically difficult.

Major economic challenges Poverty & unemployment Savings Capacity Lack of savings is a major constraint on sustainable growth. Places too much reliance on FDI and credit. Constrained but too narrow. Needs massive expansion to reduce joblessness Most important blemish of SA’s economy

Supply side focus

The Current a/c and household expenditure Household expenditure: high but not ‘wild’ While the SARB has been warning households to moderate expenditure and demand for credit, household demand growth does not appear to be at alarming levels. However, gross fixed capital formation has been accelerating, which would be one of the culprits behind the current account deficit.

Fiscal measures: Shift the tax burden onto consumption and away from savings & investment Lower the overall tax burden back to below 25% of GDP Raise VAT, lower income taxes but design the shift so that it transforms into savings Shift a greater portion of income into pension provision through tax incentives Lower the CGT burden Monetary measures: Aim to align real interest rates with major trading partners Selectively apply reserve requirements for different debt categories Selectively accommodate different debt categories Coordinate with the National Treasury but retain independence Aim for a strong currency

Regulatory measures: Scrap exchange controls Abolish the dept of home affairs Red tape Apply a policing/complaints policy wrt regulatory requirements Revisit the skills export policy Infant industry regulatory exemption/dilution support measures BEE and AA Concentrate on regulatory failures rather than on market failures Social measures: Social grants Corporate Gini coefficient Land reform

The MTBPS: Meeting the challenges

Life expectancy: income does matter

Typical B/S of Lower Skilled Workers Age: Assets Pension Bond Net The shortened lifespan of the average South African is a major economic drag. If anti- retrovirals or improved health care can extend the economically active lifespan by 10 years, the difference to families is substantial. The social bottom line report could include an approximation of the economic value added of an HIV program.

Social impact Economic cost GDP growth Investor response Economic viability Budget Need Tax Social spending spiral

25 Growing the economy Social spending Cost or contributor Financial center Needs investment and policy support WTO Trade South South cooperation Industrial Projects Meeting consumption needs Region SADEC, borders and 2010  Coega  Gautrain  Energy  Capital Equipment  Exchange Controls  Tax competitiveness  Energy  Capital Equipment

Questions and summary Contact Details:

The global context

CRB commodities index – strong performance expected after the global slowdown Could come under some pressure over the next two to three quarters due to slowing global economy but primary upward trend could last for a further 15 years or more.

Bank of Japan Raise interest rates Tighten liquidity The Bank of Japan has been one of the biggest sources of global liquidity. Recent indications are that deflation will be officially over by the second half of 2006 and this will signal the end of the zero interest rate policy. The first step in tightening monetary policy has been to tightening liquidity and the first of a series of tentative hikes has already been effected. This development has negative implications for global bond and equity markets. Tighter liquidity conditions would also provide a headwind for all deficit countries that have ‘benefited’ from the carry trade.

USD bear market – 2005 just a correction in a 10-year trend Reserves rebalancing, lower growth and a turn in the interest rate cycle to contribute to dollar weakness. Uncertainty over policy direction of the FED and mixed economic signals could result in further dollar losses with the euro possibly moving back to the 1,35 level reached at the end of This could happen over the next two to three months. A move below the 80 level on the $ index could be a crisis trigger.

Currency stress – precious metal price divergence from other commodities and the euro. Growing investment demand, a drop in new mine supplies and increasing Central Bank interest to buy have been contributing factors. The divergence between gold and the euro will continue due to protracted problems in the US and Eurozone. Gold is rising primarily for monetary reasons.