ECONOMIC REVIEW

THE ECONOMIC RECOVERY GATHERED PACE IN 2010, HELPED BY THE INJECTION PROVIDED BY THE HOSTING OF THE 2010 FIFA WORLD CUP, LOW INTEREST RATES AND BETTER PERFORMANCE BY KEY TRADING PARTNERS. EXTRAORDINARILY LOW INTEREST RATES AND LIQUIDITY PROVISION BY CENTRAL BANKS IN MAJOR ECONOMIES LED TO SIGNIFICANT CAPITAL INFLOWS ON THE BALANCE OF PAYMENTS, BOOSTING EQUITY PRICES AND PUSHING SHORT- AND LONG-TERM INTEREST RATES DOWN.

The production side of the economy bounced back strongly after the massive contractions experienced in 2009. However, a strong rand and structural issues in certain industries restricted improvements, with momentum slowing in the second half of the year.

International overview
The global economic climate improved in 2010, with growth in both the emerging and the developed world surprising on the upside. Chinese economic strength helped demand for commodities and capital goods, shoring up growth in other emerging economies as well as in key industrialised countries. The main contribution from developed economies was the provision of liquidity and low interest rates. This provided plentiful and cheap capital to more quickly growing economies and pushed up asset prices. However, poor employment growth for this stage of the cycle, weak credit growth and fiscal troubles in peripheral Europe and elsewhere suggested that underlying problems remain in developed countries. In contrast, in many emerging economies credit and asset bubbles as well as inflationary fears started to emerge.

Local overview
The effects of these international developments on South Africa were mixed. Exports were helped by improved demand and rising prices, leading to a significant narrowing in the current account of the balance of payments. Capital inflows accelerated, with foreign purchases of securities rising to record levels. This strengthened the rand to three-year highs and helped push inflation into the lower end of the South African Reserve Bank’s 3% to 6% target range. Interest rates therefore declined, with prime falling to a 36-year low of 9%. Unfortunately, the firmer currency also put pressure on more marginal producers, particularly in import-replacing sectors.

Domestic spending trends diverged in 2010. Consumer spending strengthened as above-inflation wage increases, attractive prices and lower debt service costs improved the purchasing power of households. However, employment only started to recover late in the year, making this recovery less broad-based, with spending on durable and semi-durables outpacing that on services and non-durables. In contrast, fixed investment spending continued to contract despite a flurry of activity ahead of the 2010 FIFA World Cup and continued expansion in the energy and transport sectors. Sufficient spare capacity and uncertainty over the strength and sustainability of the local and global upswings kept spending and future plans in check in the private sector.

Debate on environmental issues intensified during the year, with looming energy shortfalls and concerns over deteriorating water quality and supply underlying the need for increased and appropriate spending on infrastructure as well as more responsible usage. South Africa is hosting the United Nations COP-17 (Conference of the Parties) on climate change this year, which will increase the local focus on the nature of growth and its sustainability over the medium to long term.

Banking sector overview
The macroconditions for the banking sector improved. Insolvencies started easing in the second half of 2009 and this trend intensified in 2010. In contrast, liquidations peaked in mid-2010 only. Impairments typically respond with a lag to these indicators and official statistics suggest that, at the aggregate level, modest improvements started towards the middle of 2010. Credit extension also began recovering in the early part of the year after contracting in 2009. However, by year-end the rise was still muted despite low interest rates and improving spending patterns. Increased regulatory requirements and policy uncertainty, the recent negative default history in certain categories of loans and still highly indebted households all contributed to the sub-par patterns.

Outlook
The economic upswing should strengthen in 2011 as the effect of improving global demand, low interest rates and better confidence feeds into consumer spending and capital formation. However, South Africa is a small, open economy and much will depend on whether the world can avoid further dislocation in financial markets and whether growth will settle into a more normal pattern.

The key dangers are that fiscal consolidation in the developed world proves too contractionary, rising commodity prices hurt consumers and trigger aggressive monetary tightening, and that asset and credit bubbles in key emerging markets implode as liquidity is withdrawn.

Locally, improvements in infrastructure provision and a more conducive regulatory and policy environment would help to reduce the medium-term constraints on economic growth.