Huge Improvement in Trade Deficit Portends Sub 6% Current Account Deficit
Nov 01, 2006
Michael Kafe (Johannesburg)
South Africa’s trade balance for September came in at -R0.2 billion today. This beat market expectations of a R4 billion deficit and our own optimistic forecast of -R3.5 billion hands down. The key drivers were a sharp decline in oil and manufactured imports, as well as what appears to be a late-cycle pick-up in commodity exports.
Falling oil and manufactured goods pare imports...
The overall import bill fell from R41.2 billion in August to R37.8 billion in September. A major component of the R3.4 billion decline in imports was a R0.9 billion fall in the oil import bill. As we have mentioned in earlier pieces, we think that the huge jump in oil imports during the second quarter and the better part of the third quarter was a result of the rise in oil prices as well as an increase in (refined) oil import volumes ahead of scheduled maintenance at two major refineries. It is our belief that the oil stockpiling is largely out of the way now, given that maintenance work was scheduled for October. The September import data certainly support such a view: On average, international oil prices fell 15% in September, while the currency weakened by some 7%, suggesting that the oil import bill should decline by some 8% if volumes were unchanged. The whopping 17% decline in September oil imports therefore suggests that volumes must have fallen in September.
The trade data also show that machinery imports, mechanical appliances, electrical equipment, etc. were down by R0.6 billion in September, while imports of vehicles, aircraft and transport equipment also fell R0.5 billion on the month. There was an additional decline of R0.7 billion in specially classified original equipment components/parts for motor vehicles. These declines are all in line with our prognosis that the huge jump in August manufactured producer inflation would likely force consumers to cut back on imports of durables and semi-durables in coming months. But one swallow does not make a summer, and it is difficult to make any firm conclusions on a single data point. Nevertheless, we think that any further declines in this category in the October trade data that will be released at the end of November will likely provoke some deep thoughts at the SARB’s December 6-7 MPC meeting, with the possibility of a no-rate-hike decision rising fast.
...while precious metals lift export proceeds
With regards to exports, reported revenues rose R1.7 billion in September, despite a R0.9 billion fall in base metals and a R0.4 billion decline in the volatile vegetable exports category. This was thanks largely to a whopping R1.8 billion increase in the exports of precious stones, precious metals and jewels. We suspect that this has to do with a long-awaited increase in throughput at mining refineries, particularly in the platinum sector, which has started showing fledgling signs of improvements in fixed capital formation and capacity rebuild. The increase of R1.8 billion is equivalent to a 20% rise in receipts. This more than offsets the 4% decline in platinum prices and the 5% decline in gold prices in September. Surely, the currency’s 7% depreciation would have helped too. Separately, the data show that vehicle exports were also up R0.6 billion in September.
Looking forward, we think that the October trade number will be critical for monetary policy — particularly if it turns out to be a surplus. Clearly the September data were influenced by both price and volume dynamics. Oil prices played a major role in the import bill, while commodity export volumes were a key driver of exports. In October, we expect volume dynamics to dominate, given that the 7% decline in oil prices was fully offset by an 8-8.5% decline in gold and platinum prices.
With respect to oil volumes, we do not think that the fire that hit a diesel desulphurization unit in one of the country’s four major refineries last week will have any meaningful impact on October oil imports: The extent of damage is still not clear, but reports so far suggest that, although the damage may have been minor, there could well be the need for a brief step-up in import volumes while repair work is done. But crucially, the October oil bill — which is the last one that the SARB will walk into the December MPC meeting with — will not be impacted, since the accident only happened at the end of the month (October 28). In any case, the SARB also knows that any subsequent bump-up in oil imports that is related to this refinery’s repair will be temporary. We also look for further moderation in the manufactured import bill as the weaker currency and the move to tighter money helps eliminate the marginal deficit consumer of these durable and semi-durable goods that now account for more than half of the country’s import bill.
On the export side, it is too early to tell if our impressions about capacity rebuild in the mining sector are indeed true. At this stage, we can only speculate, based on anecdotes and what has been a significant depreciation in the currency and a meaningful rise in commodity prices. But if we are right, then throughput is likely to stay high in coming months, even if commodity prices fall, because capacity considerations are usually focused on the long term. Besides, if exporters feel that they have already missed the cyclical peak in commodities, and that prices will drift lower from here, the rational thing to do would be to try to push through as much volume as possible right now, while prices are still relatively high.
So what does all this mean for the current account?
We were expecting a 3Q current account deficit of some 5.9% of GDP. After today’s number, we revise our forecast to 5.8% of GDP. We are reluctant to cut back more aggressively because we think that the slack in the trade balance would have been taken up by a huge increase in dividend outflows on the net invisible line of the current account balance. Also remember that the SARB adjusts both the denominator and the numerator of this ratio for their respective intrinsic seasonality, and the adjustment process will no doubt affect the outcome too. So one needs to be aware that the forecast risk here is high.
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Current Account Surplus Widens on the Back of Trade Balance
Nov 01, 2006
Deyi Tan (Singapore) and Chetan Ahya (Singapore)
Current account surplus expands further. The current account balance climbed to a record US$1,175 million in September (versus US$813 million in August). This is the fourth successive surplus on a monthly basis and is the highest since December 2004. The current account surplus widening came on the back of a strong trade balance, as export growth remained in double-digit territory (+14.5% YoY versus +17.0% YoY in August) while import growth dipped into single-digit territory (+9.1% YoY versus +11.2% YoY in August). On the other hand, the net services and transfers balance, which usually sees a deterioration in September, decelerated to -US$227 million (versus US$541 million in August).
Exports sustained on the back of machinery and food segments. In terms of the export breakdown, on a custom basis (Bht terms), machinery (+6.8% YoY versus +6.7%) and food exports (+12.2% YoY versus -0.8%) grew at a healthy pace, adding 3.0%-pt and 1.3%-pt to the headline, respectively. In terms of export destinations, exports to EU15 were robust (+13.8% YoY in September) while those to Japan and the US contracted sharply (-1.4% YoY and -3.3% YoY, respectively).
Capital imports remained weak. On the import front, consumer goods imports (custom basis, Bht terms) remained stable at 6.1% YoY (versus +6.8% YoY in August). However, capital goods (-5.9% YoY versus -9.9% in August) and raw materials & intermediates imports (+0.2% YoY versus +2.9% in August) remained in contraction/deceleration in September, likely indicative of the impact of the unstable political situation on investment.
Current account forecast. The Bank of Thailand recently revised its current account surplus forecast upwards to between US$1.5 billion and US$3.5 billion. Comparatively, our 2006 current account forecast stands at US$4.0 billion.
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RBI Adopts Wait-and-See Policy Stance
Nov 01, 2006
Chetan Ahya (Mumbai) and Mihir Sheth (Mumbai)
Reverse repo unchanged, repo hiked by 25bp
In its mid-term review of monetary policy, the Reserve Bank of India (RBI) left the reverse repo rate unchanged at 6% and announced a 25bp hike in the repo rate to 7.25%. The reverse repo is the rate at which the RBI absorbs excess liquidity. The reverse repo rate had become the key short-term policy rate since 2002, in line with the sharp rise in forex reserves. The repo rate is the rate at which the RBI injects liquidity into the money market. As and when excess liquidity winds down, the relevance of the repo rate increases.
Trend in excess liquidity is the key
Excess liquidity stock levels have been driven largely by capital inflows, apart from the domestic liquidity absorption rate. Since F2003, rising capital flows (40% of which are portfolio equity flows) had caused a huge increase in forex reserves, resulting in excess liquidity. Foreign capital inflows not absorbed (excess liquidity) by the domestic economy were sterilized by the central bank in the form of short-term paper issued in the money market (reverse repo and monetary stabilization bonds) to control money supply.
A sharp slowdown in foreign exchange reserves accretion (due to lower inflows of portfolio equity investments or otherwise) results in a decline in excess liquidity. This would mean that the RBI would have to start injecting liquidity into the system instead of absorbing excess liquidity. In effect, the relevant short-term policy rate would then become the repo rate instead of the reverse repo rate. Hence, for the money market, short-term rates would effectively transition to 7.25% as the floor rate.
What does the RBI’s policy move mean for the interest rate outlook?
If the excess liquidity stock is high, at above US$20 billion, the reverse repo rate (the rate at which the RBI absorbs liquidity) is the relevant rate. In that environment, the short-term market rate will remain close to the reverse repo rate and hence ward off pressures on the banking system to raise its lending rates.
However, the bad news is that the excess liquidity stock is declining and the risk of the repo rate coming into play is rising. In that context, the move to hike the repo rate by 25bp has raised the risk of a sharper indirect rate hike in the future. Indeed, the recent decline in excess liquidity stock has already pushed the 91-day T-bill rate to 6.7% (significantly higher than the reverse rate of 6%). A similar (albeit temporary) shock was felt by the market in January-February 2006, when excess liquidity had shrunk to US$12.5 billion. If the current declining liquidity trend continues, short rates will effectively transition to the repo rate of 7.25%, raising the cost of borrowing.
Monetary policy — wait-and-see stance with a pro-growth bias
The RBI’s July monetary policy statement had led us to believe that its bias was increasingly titling towards maintaining stability, even if that implied paying the necessary price of lower growth. However, today’s policy statement seems to have shifted the bias back towards a pro-growth with a ‘wait-and-see’ stance. We believe that three factors have permitted and/or driven this stance:
a) Conducive global conditions: A change in market expectations regarding the peak of the Fed rate cycle has clearly raised market hopes of a possible pause in policy rates. Since the last monetary policy announcement by the RBI in July, the US interest outlook appears to have changed. The Fed has skipped rate hikes in two consecutive meetings and the fed funds futures, which were discounting a 5.4% rate in December 2006 at the time of the last monetary policy announcement by RBI, are now discounting a rate of 5.25%. Many other central banks have also paused after steadily hiking rates over the last two years. This trend has reduced the pressure from global factors on the RBI to hike rates.
b) Waiting for past measures to work their way through: Over the past few months, credit growth has started decelerating, as a result of: (i) the lagged impact of the steady rise in real interest rates increasing supply constraints on banks’ balance sheets (i.e., low deposit growth); and (ii) the RBI’s measures to control aggressive credit by increasing risk weights for banks lending to certain sectors. Indeed, there has historically been a significant lag in the trend in bank credit growth compared with the real 10-year yield trend as financial intermediaries tend to be slow to reflect this trend in lending rates. The central bank has chosen to pause and gauge the impact of the above-mentioned factors over the next few months. We believe that the RBI is wary of getting over-cautious in its efforts to dampen credit growth, lest it result in a sharper-than-expected slowdown.
c) Limited utility of reverse repo as a policy tool: The final factor that has driven this decision is the limited utility of the reverse repo rate as a monetary policy tool. There are two reasons for this. First, a higher reverse repo rate would imply higher sterilization costs for excess liquidity. Second, and more importantly, higher rates (i.e., a higher return on excess liquidity) would have then attracted more arbitrage money and, in turn, may have defeated the purpose of reverse repo as a policy tool.
Risks of pro-growth policy bias
While our base case scenario assumes that there will be a soft landing in credit growth and debt-funded GDP growth, the underlying macro-stability risks have increased as a result of the pro-growth bias in the monetary policy announcement. There are five key reasons for this:
1: The mix of incremental credit disbursement remains biased towards funding consumption and less productive sectors. Additionally, the cost of credit is just beginning to rise and the banks’ credit risk pricing curve remains relatively flat.
2: Although credit growth will likely slow due to the lagged effect of past measures, the pace of the slowdown could be slower than estimated.
3: The stretched banking sector balance sheet has been a key source of concern for the RBI. Although credit growth has moderated to 29.3% from its peak of 33%, it remains significantly higher than deposit growth of 19.7%.
4: The low interest-funded credit consumption is resulting in a deterioration in the current account deficit, which in turn is offsetting the capital inflows into the country and weighing on the accretion of forex reserves.
5: The dependence on less-stable foreign capital flows (and rising forex reserves) to fund credit growth is already high. These less stable capital flows into EM/India have invariably gone through cycles, driven by rates and risk appetite in the developed world. We believe that any slowdown (not necessarily outflow) in capital inflows due to a change in the global environment could result in a decline in excess liquidity and result in a disruptive rise in interest rates.
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