The first four months of 2011 delivered some nasty surprises for the world economy, including: a surge in political turmoil in North Africa and the Middle East that sent oil prices soaring; sharply higher global food prices aggravated by extreme weather conditions in many countries; a disastrous earthquake in Japan that led to a massive disruption to the production of vehicles and electronic equipment; and the re-emergence of financial tensions in the Euro-area, which could ultimately see a number of countries in the Euro-area having to formally restructure their national debt.
These ‘nasty surprises’ (which are discussed briefly below) have combined to undermine the strength of the global recovery, leading to the current downward revisions to world growth estimates. At the same time, they have complicated the outlook for monetary and fiscal policy across the globe, as countries try to balance the competing objectives of high growth and low inflation. They have also led to increased financial market volatility and uncertainty.
The Libyan civil war and the turmoil in other MENA countries, including Syria, sent oil prices soaring. During December 2010 the international oil price averaged $92 per barrel, but spiked to a high of over $127 per barrel in early April, a rise of over 38%. This has, naturally, led to higher inflation in most developed economies including the United States, United Kingdom and the Euro-area, but also in many emerging markets such as China, India and South Africa.
In fact, using a survey of the latest consumer inflation rate in 74 countries, it is clear that global inflation is on the rise. Out of the 74 countries examined, more than 60 have shown an increase in their annual rate of inflation over the past year. While this is certainly not a definitive indication of rising global inflation; given that some countries are coming off a very low base of inflation in 2010, it does appear to confirm a general upward bias. Furthermore, while underlying or core inflation in most countries remains well contained, there are signs of the start of an upward bias in this measure of inflation as well. Capacity utilisation levels are rising, and monetary conditions remain extremely loose in most economies. Under these circumstances, the risk of a broad based increase in underlying global inflation is clearly rising.
International food prices have also risen dramatically since the middle of 2010, aggravated by severe weather disruptions in many countries, most notably Russia and Australia. According to The Economist food prices index, prices are up a staggering 42%y/y over the past year, in Dollar terms. Furthermore, the rise in international food prices has also been extremely broad-based, with almost every category of food up sharply. This has already led to higher food inflation in numerous countries and is expected to impact SA more forcefully over the coming 12 months. Consequently, we expect South Africa’s food inflation rate to reach 10% year-on-year by year-end.
Japan is still reeling from one of its largest earthquakes on record. Besides the massive human tragedy, the event led to the closure of many electronic and vehicle production plants, a disruption to the supply of key motor and electronic components to factories around the world and a sharp fall-off in confidence levels within Japan. According to data released recently by the Japan Automobile Dealers Association, vehicle sales plunged by 51% year-on-year in April 2011. This is the largest annual decline in sales recorded since the data series started in 1968, and follows a decline of 37% year-on-year in March. Also, April is the lowest level of vehicle sales, in volume terms, that Japan has recorded since at least 1968.
This sharp decline in production, together with the fall-off in many other areas of business and consumer activity, including retail sales, will severely impact both the Q1 2011 and especially the Q2 2011 estimates of Japan’s GDP performance. The Japanese economy was weakening in the months prior to the earthquake and has probably re-entered recession conditions in the past 6 weeks.
Greece, Ireland and most recently Portugal, have all received significant financial assistance from the European Central Bank and International Monetary Fund. Unfortunately their financial difficulties have continued and they will most probably require further financial assistance in the coming months. At the heart of the problem, national debt levels are extremely high, while economic growth rates remain depressed. The higher the level of government debt, the worse the debt service burden. If left unattended, this can reach a point where the government falls into a debt trap.
Using a simple matrix that combines the absolute level of government debt with the level of non-resident holding of government debt, it is possible to establish a very crude measure of fiscal vulnerability. Using this methodology, the ten countries that currently have the highest level of fiscal vulnerability are: Greece, Belgium, Austria, Ireland, Italy, Portugal, France, Hungary, Finland, Netherlands, and Germany.
Interestingly, while Japan is the most indebted government in the world, the extremely low level of non-resident holdings of their debt reduces the vulnerability under the current economic environment. Also Spain is not on the most vulnerable list simply because their absolute level of debt is actually still fairly manageable at 60.1% of GDP.
It is fascinating to see that the countries that have the highest degree of fiscal vulnerability are mostly all developed economies, while the least vulnerable are mostly all emerging market economies. South Africa features exceptionally well in almost all measures of fiscal vulnerability.
More positively, the economic recovery in the United States, which remains the world’s largest economy, has broadened and become more consistent over the past six months. While the US is officially out of recession, it does not mean that the economic recovery is without risk. Rather, there are a number of key structural economic concerns, including a weak housing market and high public sector debt, that suggest that the US will struggle to return to its historical average growth rates, but equally the economy appears to have successfully navigated the worst of the credit crisis and has avoided a double-dip recession.
We continue to closely monitor all of the main-stream leading economic models for the US (see charts attached), and while all of them have shown some deterioration in the past couple of months (and hence are signaling a loss of growth momentum), none of them are indicating a return to recessionary conditions. These leading indicators include: the Conference Board Leading Economic Indicator, the Chicago Federal Reserve National Activity Index, the Federal Reserve’s Yield Gap Model, and the ECRI Leading Indicator (weekly). The consensus growth forecast for the US economy has been revised down in the past few months, but remains respectable at 2.7% for 2011.
Germany, which is the largest economy within the Euro-area, has performed particularly well, helped by an improved export performance. The value of German exports rose an all-time record high in March 2011. Consequently, manufacturing sentiment has risen at a rapid pace, with demand for capital goods reaching a record high recently. In April, the IMF revised up their 2011 and 2012 growth projections for Germany.
Developing Asia, which includes China and India, has also continued to convincingly outperform the other regions of the world.
A number of other emerging economies have also maintained a consistently strong performance, including Sub-Saharan Africa. During 2010, Sub-Saharan Africa grew by around 5% and in 2011 it is expected to expand by around 5.5%, rising to 5.9% in 2012. This reflects sustained strength in domestic demand in many of the region’s economies as well as a rising global demand for commodities.
The latest growth estimates for South Africa suggest that economic activity is expanding within all major sectors of the economy. This includes mining, manufacturing, retail trade and finance. In 2010 the South African economy grew by an estimated 2.8%, which is a healthy improvement relative to a decline of 1.7% in 2009; but unfortunately still not sufficient to close the output gap and result in a sustained increase in employment. The growth forecast for 2011 is currently 3.5%, which is similar to the Reserve Bank’s own forecast of 3.6%.
As we have noted over the past few months, the annual rate of change in the SA leading indicator has slowed noticeably since the middle of 2010, and it is expected to slow further in the coming months. This is partly due to the exceptionally high base that was established in the early part of 2010, but also due to a general moderation in the main global leading economic indicators, as well as a lack of investment spending and job creation locally.
Overall, the SA leading indicator suggests that the economy should still show reasonable, but somewhat unexciting GDP growth in 2011; and that while there has been a loss of momentum in the pace of the economic recovery (which is already factored into the current forecast), the models are NOT suggesting a return to recessionary conditions.
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