Strong 2Q08 GDP Print
August 20, 2008
By Michael Kafe, CFA & Andrea Masia | South Africa
Supply-side GDP data show that South Africa’s underlying GDP growth could be stronger than currently expected by the market. According to Statistics South Africa, 2Q08 GDP rose 4.9%Q (all quarterly readings are at seasonally adjusted and annualised rates) to deliver a 4.5%Y reading that was close to our estimate of 4.6%Y, but much higher than consensus forecasts of 4.0%Y. The quarterly profile shows a very strong performance in agriculture and a technical rebound in mining and manufacturing. Transport and communications surprised us on the upside, as did personal services. However, these were more than offset by a shocking decline in the wholesale, retail and electricity sectors.
After posting an already strong 17.2%Q reading last quarter, the agricultural sector advanced even further to deliver a 19.6%Q reading in 2Q08, thanks largely to a high harvest of field crops. Indeed, a month ago, we upgraded our agricultural sector GDP estimates for this year, largely due to upward revisions to agricultural crop estimates by the Department of Agriculture (see South Africa: Downward Revisions to GDP Growth, July 11, 2008). Even so, the reading comes with a pleasant upside surprise, as the outturn was higher than our 2Q08 projection of 8.2%Q. In that same research piece, we also took the position that expectations of severe power outages this year were likely to be disappointed. As a result, we priced in a recovery in electricity production and called for a commensurate technical rebound in mining and manufacturing output. The latest reading shows that mining swung from -22%Q to 15.6%Q (broadly in line with our 17% estimate), while manufacturing also swung from -1.0%Q to 14.5%Q (again, only slightly lower than our 17%Q forecast). However, we were wrong on the electricity sector, which posted another negative reading of -1.3%Q, significantly lower than our expectation of a 2.4%Q rebound. According to Statistics South Africa, the further decrease in electricity production in 2Q08, off a significantly low base in 1Q08, was the result of “a decrease in the consumption of electricity”. Although somewhat surprising, this explanation could well be the first tangible evidence yet that Eskom’s demand-side management efforts are indeed yielding positive dividends. We have our reservations, however, and will not be surprised to see a correction in the next quarterly print. The electricity production reading certainly does not tie up with the strong rebound in mining and manufacturing production. The transport, storage and communication sector posted a resilient 4.1%Q reading that was higher than our estimate of 2.8%Q, while personal services came in at 3.9%Q – higher than our 2.8% forecast. According to the report, the strong performance in transport and communications was driven by buoyant land transport activity. We suspect that efforts by Eskom to step up the haulage of coal from its suppliers to the national grid may have combined with a step-up in Transnet’s capital overhaul to lift the reading. Good overall progress on the Gautrain Rapid Rail Link project may have helped too, we think. At 3.9%, personal services were largely unchanged from their 1Q08 reading, and a lot higher than our forecast of a deceleration to 2.8%Q. Statistics South Africa does not provide an explanation for the strong performance of this sector. Offsetting the relatively buoyant readings discussed above was a sharp fall in wholesale and retail activity, which came in at -2.2%Q. We had forecast a positive growth rate of 1.6%Q, given the significant upside bias between the monthly and quarterly readings recently. For example, while the 4Q07 and 1Q08 monthly readings pointed to 0.3%Y and 0.6%Y, Statistics South Africa published annual readings of 4.1%Y and 3.7%Y, respectively. According to the report, decreases in value-add were reported in motor trade, restaurants and general retail. The huge decline in retail trade combined with a weak 1.1%Q print in general government services (Morgan Stanley forecast: 2.8%Q) to more than offset the positive surprises elsewhere, and cap the overall GDP growth rate at no more than 4.9%Q. Looking forward, our GDP forecast for the year as a whole now comes in at 3.7% – still higher than consensus estimates of 3.3%, thanks largely to our view that the electricity shortage will turn out to be a lot less restrictive than was expected earlier in 2008. We would also like to reiterate our view that the trough in the growth cycle will be in 2009, and not 2008. We believe that a rising number of market participants are now migrating towards this view.
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Dark Clouds for the Consumer
August 20, 2008
By Luis Arcentales | New York
The Chilean economy grew at a surprisingly strong 5.0% annual pace in June, consolidating hopes that the economy would begin to show signs of strength in coming months. In fact, once seasonally adjusted, June’s GDP proxy IMACEC posted the strongest monthly gain (+1.4%) in over a year. During 2H08, an easier comparison base combined with some normalization in the energy sector, mining and selected manufacturing activities should boost growth above the modest 3.5% pace seen during 1H08. But we would warn against extrapolating from June’s strength. We fear that further retrenchment by consumers will partly offset the factors that underpin the long-awaited 2H recovery. Chilean consumers are facing severe headwinds, which are unlikely to fade in the coming months, in our view. From soaring inflation to tighter lending standards and slower job creation, this challenging environment has translated into a collapse in consumer confidence. Under these circumstances, a slowdown in sectors linked to consumption is likely to keep overall economic growth subdued, even if the global economy were to remain more resilient than recent data – particularly from Europe and Japan – seem to indicate (see Gerard Minack’s Bouquets to BRICbats, August 13, 2008). Given our expectations for consumer restraint ahead, we are revising our growth forecasts lower, to 3.8% this year (from 4.3%) and to 3.2% in 2009 from 5.3% previously. Credit Squeeze Rapid credit growth has been a major consumer tailwind in recent years, but the tide is quickly turning. Chilean financial institutions are not experiencing the types of structural problems that their US counterparts are currently facing. Still, banks and, to a lesser extent, retailers have turned decisively more cautious on extending credit to consumers, leading to a sharp deceleration in credit growth. Since the introduction of a new methodology in 2008, annual bank credit figures are not comparable; however, based on work by Chile’s central bank and our own estimates, bank credit to the consumer likely grew in the mid-single digits (real) in 1H08, off from nearly 14% in 2007. Meanwhile, retailers continue to extend credit at an aggressive, though decelerating, pace and the first financial reports from 2Q point to further restraint. Indeed, consistent with slower credit growth, surveys of consumers’ intentions to buy durables – from houses to cars and appliances – have collapsed since early 2008. And further credit pullback seems to be in the cards, in our view. Three powerful factors seem to be at work: First, banks have tightened lending standards severely in response to prospects of deteriorating credit quality (see “Chile: Tighter Credit”, EM Economist, July 25, 2008). Indeed, the central bank’s 2Q08 survey of credit conditions showed that 44% (net) of banks making consumer loans had tightened standards. Second, the deteriorating inflation picture has prompted 275bp of cumulative central bank tightening since July 2007, and we suspect that the central bank has more work to do (see “Chile: Another 50bp and More Ahead”, EM Economist, August 15, 2008). The lags from monetary policy are still working their way through the economy. Not surprisingly given the ongoing tightening cycle, consumer credit costs have been trending higher. And unlike the experience of 2004-06 when credit steadily accelerated, today higher interest rates seem to be getting more traction. While during 2004-06 on average some 40% of banks (net) reported improving demand for consumer loans, the figure was just 15% last year, and in 2Q08, a net 41% of banks perceived that the demand for consumer loans had weakened. Lastly, Chile’s has a relatively high level of credit penetration – particularly with higher income groups of the population. This means that the room for further expansion in consumer credit is likely to be more limited, more so given today’s context of poor income growth. It is also a sign of the power of monetary policy likely to be felt in the months ahead. After all, 150bp of the 275bp of tightening took place in the past three months. However, the cautious tone from bank surveys and other credit indicators do not point to a credit bust. By most metrics, the Chilean financial system is in excellent shape. For example, the banking system’s ratio of past-due loans to total loans reached 0.89% in June, a low level by historical standards. Moreover, the proactive way in which banks have tightened lending standards – as well as evidence of growing restraint from retailers – suggests they’ll be better prepared to withstand a worsening macro backdrop, supporting our case for a moderation in consumer credit growth, rather than a bust. Inflation Pain With annual inflation running at the highest level in 14 years (9.5%), inflation angst is high among Chileans, with nearly 70% believing that prices will go up by “a lot” in the next 12 months. And their concern is well justified: in July, electricity bills were 29% above July 2007 levels, food prices were 18% higher, and by mid-August, fuel quotes were still hovering near historically high levels, despite the recent pullback in crude prices. Importantly, there is mounting evidence pointing to broader price pressures beyond just food and energy, suggesting that high inflation – which is hurting discretionary income – is likely to linger for longer. In July, for example, inflation rose 1.1%, with the usual suspects adding meaningful pressure: food accounted for 0.39pp of the 1.1% monthly increase, while energy pushed the transportation and housing groups higher, contributing a further 0.54pp. However, other prices are also trending higher, with inflation ex-food and energy increasing to 5.1% from 4.5% in June. Moreover, the pace of the increases, once seasonally adjusted, is showing a worrisome acceleration to around 6% annualized in the three months ending July. Diffusion indices are also deteriorating, with over 40% of items in the CPI basket, excluding food, posting increases above 3%. Overall, Chile’s inflation dynamic is showing worrisome signs that the energy and food shocks are contaminating other prices. Indeed, in the very hawkish July minutes – released on August 7 – Chile’s central bank highlighted that the “most recent (June) inflation reading began to provide support to the hypothesis of more generalized increases in prices different from food, energy and fuel, indicating that the degree of inflationary contamination was above expectations”. In the statement from the August 14 meeting, the authorities added that July’s bad inflation figure was caused by “increases in the majority of items (in the consumer price basket).” The government has taken several actions to try to offset the pain from rising inflation pressures, such as cuts to gasoline taxes, allocating fresh monies to the Fuel Stabilization Fund and offering diesel-tax rebates to truckers and bonuses to low-income households. Despite these measures and the recent pullback in commodities, we suspect that high inflation is set to remain higher for longer and are thus adjusting our forecast up to 8.1% for year-end 2008 (from 4.7% previously) and to 4.8% for the end of 2009 (from 3.5% previously). Slower Job Growth In addition to high inflation and tighter credit, consumers are facing slower job growth. By most standards, the deterioration in labor markets so far has been modest. In 1H08, the seasonally adjusted rate of unemployment hovered near the highest level since mid-2006, but the upturn has been magnified by a large jump in labor participation, particularly among female workers. Adjusted for the new entrants, Chile’s uptick in unemployment does not look that concerning. But prospects for job growth going forward are deteriorating. The most recent June survey of business confidence (IMCE) showed that the captains of industry are becoming more cautious with their intentions to hire. Indeed, not only did June’s overall index dip below the 50 ‘neutral’ threshold for the first time in its 4.5-year history, but the details also showed a sharp pullback in hiring intentions amid unprecedented pessimism about the economic prospects going forward. The hiring index dipped to 48.9 in June, down 13 points from a year earlier – the second-worst decline among the 14 components of the IMCE. Looking at different sectors, mining – which accounts for less than 2% of total jobs in Chile – was the only sector in positive territory (60.2). Hiring intentions in construction – a sector that accounted for nearly 20% of all new jobs over the past year – plunged 9.9 points to 42.1. This unprecedented swing is consistent with the deterioration in fundamentals for the sector as evidenced by a 30.5% annual decline in authorized building surface in June, reports of bloated housing inventories and pressure on the government to limit expenditures. Manufacturing remained downbeat at 43.2 points, while commerce declined for the third straight month to 50.0. A final headwind for consumers is Chile’s persistent crime problem. To be fair, Chile lacks the incidence of violent crime seen in some other major economies in the region. Still, crime is a rising problem, weighing heavily on consumer sentiment. A survey conducted in April by researchers from Libertad y Desarrollo shows that 61% of participants are fearful of becoming victims of crime, virtually unchanged from April 2007 (58%) and not far from the record-high of 64% last October. Over the same period, the number of households with at least one member that was the victim of crime in the preceding three months rose to 19% from 13%. And Chileans are reported to lack trust in the judiciary: nearly two-thirds of those surveyed (63%) believe that reporting crimes to the authorities is pointless. Mirroring these worrisome findings, a survey by Adimark showed that in July a significant 83% of Chileans disapproved of the government’s response to crime – the poorest mark among the issues surveyed, which included the economy, corruption, education and the environment. Bottom Line Chilean consumers are facing strong headwinds, which are likely to translate into a further pullback in spending and should keep economic growth subdued. Importantly, we suspect that many of the pressures on consumers are likely to persist, testing the resilience of Chilean consumers and keeping consumption growth sluggish into 2009.
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