2008 :

Global Markets – 3rd quarter 2008 : The widening income disparity in South Africa is a cause for concern

The Business Day recently published an article, based on research that had been done by the Bureau for Market Research at Unisa, which reported that “income disparities in SA have widened in the past two years, boosted by more rapid growth in high-income earners…”

According to the research, the 2008 annual income statistics for working adults in South Africa are as follows:

The above data suggests that 1.42% of working South Africans earn annual salaries of R501 000 or more, with only 0.60% earning in excess of R751 000. If we include the next category (R301 000 – R500 000), then less than 4% of South Africans earn more than R301 000 per year (which translates into a monthly income of R25 000 or more). It is sobering to note from the above figures that more than 75% of South Africans earn an annual income of R50 000 or less. With more than three quarters of the South African working population earning less than R4 166 per month, it is little wonder that households are really battling to make ends meet in the current environment of high inflation, high interest rates and ever rising debt levels.

According to Unisa’s Professor Van Aardt, the Gini coefficient for South Africa has risen from 0.63% in 2006 to 0.65% in 2008. “A zero coefficient implies all households have the same amount of wealth, while 1.0 would mean one household has everything.” The research reflects that there were fewer wealthy people in South Africa in 1994 – at that time, South Africa’s Gini coefficient is estimated at having been 0.57%. It also highlights that, while “the people who have gained the most in SA are skilled black people, “ it confirms that “income inequality is rising more rapidly among black South Africans.” Professor Van Aardt has raised his concern about this fact, and has indicated that, while economic empowerment policies have benefited some South Africans, “these tools” have been “blunt instruments” for many unskilled South Africans. He is concerned that “this trend is likely to continue” because many unskilled employees do “not have access to institutions to improve their skills”. Compounding this was the fact that “foreign direct investment into SA was too low to generate the kind of growth which would create jobs for low-skilled workers” and that “there was very low growth in self-employment, which created huge dependency on job creation.” According to Professor Van Aardt, “a lot of people are waiting for employment and that’s not the answer. We need to change mindsets and that is not happening in SA.”

Source: Business Day, Bureau for Market Research and Unisa.

REGIONAL COMMENTARY UNITED STATES OF AMERICA

The Federal Reserve kept interest rates on hold at 2% during the quarter under review, amidst the turmoil in the financial markets. The primary reasons for keeping rates on hold are concerns about declining growth and rising inflation. The policymakers have stated that the current outlook for inflation is “uncertain” and that they expect growth to “remain weak for some time.” According to a recent BBC article, “experts say uncertainty over how severe and prolonged the economic slowdown will be is making the Fed cautious about any shift in policy. The continued slump in the housing market and its impact on consumer confidence has made any imminent rate rise unlikely despite signs of increasing inflationary pressures.”

The statement released by the Federal Reserve following the latest rates announcement cautioned that “inflation has been high and some indicators of inflation expectations have been elevated.” In addition, “tight credit conditions, the ongoing housing contraction and elevated energy prices are likely to weigh on economic growth over the next few quarters.”

The next move in interest rates is a much debated issue. Some economists are of the opinion that if the oil price continues to decline, the Fed will have room to cut interest rates further.

However, another view is that because the Fed currently appears to be more concerned about inflation than growth (unless there is a significant downturn in the economy) the next move in interest rates could well be up.

Despite the headwinds discussed above, GDP growth for the second quarter came in ahead of expectations at an annualized 1.9%. The support from the stimulus measures introduced by government is clearly evident in this number. The White House has revised their growth forecast to 1.6% (from 2.7%) for 2008 and to 2.2% (from 3%) for next year.

EUROPE

ECB President Jean-Claude Trichet. (Source: BBC)

The European Central Bank (ECB) raised rates by 0.25% at their June meeting. Following this, rates were kept on hold at 4.25% for the remainder of the quarter, amidst growing concerns about slowing economic growth. The region also faces the dilemma of a combination of declining growth and accelerating inflation (largely driven by high food and fuel costs). Another headwind is the rise in unemployment levels within the region, with Spain being the hardest hit at 10.7%.

Eurostat have confirmed that inflation reached a record level of 4.1% in July, which is the highest level reached since this number started being recorded in 1997. This
puts the current inflation level at more than double the target level (2%). Commenting on this latest inflation number, Martin Van Vliet of ING Bank, stated “the further increase in Eurozone inflation in July will intensify the ECB’s already alarming concern about inflation. However, with oil prices off their peak and downward momentum in economic activity gathering pace, dampening inflationary pressures in the medium term, the most likely path for interest rates is to be on hold for the rest of the year.”

UNITED KINGDOM

Interest rates remained on hold at 5% during the quarter under review. Commenting after the rate decision in July, Hetal Mehta (Ernst & Young Item Club’s senior economic advisor), stated “it should not come as a surprise to anyone that, on balance, the bank felt it could do nothing but sit tight this month – a situation that is likely to prevail for a few more months.” However, she is of the opinion that if the oil price continues its decline, the door may well be open for a reduction in rates towards November. Economic advisor for the British Chamber of Commerce, David Kern, has said “the MPC cannot ignore the fact that recession threats have worsened. While the near-term rise in inflation is unavoidable, it is also temporary as weaker growth would clearly push down inflation sharply next year. Limiting the threat of a major recession must be a priority.” According to Howard Archer of Global Insight “the three-way split in the MPC’s voting in July encapsulates the predicament that the Bank of England is in over a deepening and widening economic slowdown, yet elevated and still rising inflation.”

Inflation is currently at 4.4%, which is well above the Bank’s target of 2%. The BoE expect inflation to peak at 5%, before falling back to the target level over the next two years. In the latest report by the BoE, Mervyn King commented on the “difficult and painful adjustment” that the economy was going through, saying “we will come through it, inflation will come down and we will resume a pattern of normal growth.”

Growth for the second quarter came in at 0.2%. The International Monetary Fund have revised their growth forecasts for the region to 1.4% for 2008 and 1.1% for 2009. Government, however, have not made any changes to their 2% growth forecast for both 2008 and 2009.

JAPAN

Interest rates, which remained unchanged during the quarter, have remained at the current level of 0.50% since February 2007. At its latest meeting, the Bank of Japan (BoJ) revised its forecast for growth for the one year to March 2009 to 1.2% (from 1.5%). According to a statement released by the BoJ “economic growth is slowing further reflecting weaker growth in business fixed investment and private consumption against the backdrop of high energy and material prices. With regard to risk factors, global financial markets remain unstable and there are downside risks to the US and the world economy.” A large percentage of exports from Japan are to the US, which makes Japan particularly vulnerable to the current economic slowdown in the US.

Commenting on the slowdown in growth, Daniel Citrin from the International Monetary Fund stated “we do see the economy growing to a virtual standstill in the second quarter of the year and rather weak growth in the second half of the year before beginning to recover next year.” However, Takeshi Minami, chief economist at the Norinchukin Research Institute, is not as optimistic about the output data from the region, stating that the data “is quite bad and suggests the Japanese economy is likely slipping into a recession. Firm demand from overseas economies has been supporting production but as exports weakened in June, we can no longer count on it.” The latest data from the region indicates that, following an expansion of 0.80% between January and March, the economy shrank by 0.60% over the period April to June. Takahide Kiuchi, chief economist from Nomura Securities has said “this data gives the impression that the economy has entered a recession and I think it is in recession.” It is concerning to note that a recent survey established that consumer confidence levels fell to 26 year lows for the quarter to June.

SOUTH AFRICA

The Prime Lending Rate and the Repo Rate were increased to 15.5% and 12%, respectively during the quarter under review. Some economists are of the opinion that we may have reached the top of the current interest rate cycle (provided the oil price remains stable or continues to decline) and that, while interest rates aren’t expected to come down in the short term, the next move in rates is likely to be down.

The latest CPIX inflation figure came in at 13%, which was in line with the market forecast. Investec released a statement in July again questioning the accuracy of this number. Investec “calculate that inflation is currently overstated by more than two percentage points, because the current data no longer accurately reflects the spending patterns of South African consumers.” Their view is that “there is no question that monetary policy has been based on the official published inflation rate. Every single forecast by the Reserve Bank has been based on these inflation numbers. Rate increases this year would have been less likely had the MPC been aware that the real inflation number in South Africa was significantly lower.” Should Investec’s view be correct, the ramifications are far reaching, as “every single pricing decision rests on the inflation rate, whether it is wage negotiations, long-term contracts or the price increases retailers push through to the customer.” Stats SA have responded by saying that there is no error in their calculations and that “the difference between Stats SA’s official inflation rate and Investec’s estimates arises from the reweighting and rebasing of the CPI to be implemented in 2009.” Investec have concluded that “whatever the reaction of the MPC to the current dilemma, the room for manoeuvre into next year will be a lot more. This means that we can expect rate cuts far earlier than might have seemed possible before StatsSA released the details of the revision.” Chief economist for Old Mutual Investment Group, Rian le Roux, has indicated that rates may well fall faster than expected in 2009. He warns, however, that “we are not out of the woods yet as far as inflation is concerned” as he expects CPIX inflation to peak at 13.5% by the end of 2008.

Goolam Ballim, chief economist for Standard Bank, expects 2008 year-on-year GDP growth to weaken to 3%, from 5.1% achieved in 2007. He has forecast that growth in 2009 should improve to 3.2%, with slightly better growth (4%) expected in 2010.

OIL AND GOLD

After rising sharply during the quarter under review (to levels in excess of $147 a barrel), the oil price ended the quarter at $113.99 a barrel. A combination of weaker demand (based on slowing global growth) and a stronger US Dollar have triggered the downward shift in the oil price. While this is good news for now, a recent report entitled “The Coming Oil Supply Crunch” by Professor Paul Stevens warns that the world may yet face a “supply crunch” in relation to oil within the next decade. This is based on the view that, notwithstanding the fact that there are enough oil reserves, governments and companies are not investing enough “to ensure production.” A BBC article commenting on the report, states “Prof Stevens warned that investment in new oil supplies has been inadequate as oil firms prefer to return profits to shareholders rather than reinvest it. Furthermore, oil producing cartel Opec has failed to meet plans to expand its capacity since 2005.” According to Professor Stevens, “in reality, the only possibility of avoiding such a crunch appears to be if a major recession reduces demand – and even then such an outcome may only postpone the problem.”

The gold price retreated to $837.30 an ounce from $885.80 an ounce during the quarter, driven largely by declining demand, a stronger US Dollar and profit taking.

CONCLUSION

Global markets experienced yet another difficult quarter, plagued by the dangerous cocktail of rising inflation and declining growth. A combination of the credit and housing crises that began in the US a year ago and the sharp volatility in the oil price appear to be the main culprits. Despite the massive slowdown in the US market, certain market commentators believe that a lot of the bad news is already out and they are now beginning to see small pockets of good news emerging from this region. Consequently, their concerns now appear to be shifting to the Eurozone and UK economies. A key difference between these regions and the US is that both still have relatively high interest rates, leaving their central banks less room to manoeuvre when it comes to curbing inflation, without stifling growth completely. Needless to say, most central banks (including our own) are walking a tightrope of trying to curb inflation without stalling growth – a very difficult and unenviable task.