The current state of and prospects for the business cycle in South Africa

Introduction

According to Mohr (2008, 63) “economic growth (or decline) does not occur smoothly. Periods of rapid growth or expansion are invariably followed by periods of lower growth or decline. The business cycle refers to the fluctuations in the overall level or pace of economic activity.”

Mohr (2008, 63) further defines the business cycle “as the pattern of expansion (recovery) and contraction (recession) in economic activity relative to its long-term trend. One complete cycle, which usually lasts a number of years, consists of four elements: a trough, an upswing or expansion (often called a boom), a peak, and a downswing or contraction (often called a recession).”

One can analyse the current state of and prospects for a business cycle by means of the various business cycle indicators.

Business cycle indicators provide information with regards to the contractions and expansions of a business cycle and are relevant in the sense that it is “identified by comparing the turning points of the cyclical components of individual time series with the reference turning points.” Mohr (2008, 70)

This paper will try to analyse the current prevailing and prospective business cycle situation in South Africa by using the composite business cycle indicators namely, the leading indicator, the coincident indicator and the lagging indicator.

a. Leading Indicator
A variable that tends to precede the reference turning points are identified as a Leading Indicator. The overall Leading Indicator compiled is a composite index comprising of Time series, which tend to shift direction in advance of the business cycle. SARB (2010, http//:www.resbank.co.za)

b. Coincident Indicator
The variables that normally change together with the above mentioned turning points are regarded as Coincident Indicators. The SARB (2010, http://www.resbank.co.za/) described the Coincident Indicator as a composite index comprising of time series, which tend to move in conjunction with the business cycle.

c. Lagging Indicator
In this specific case the change will happen after the reference turning points and therefore be identified as a Lagging Indicator. The Lagging Indicator is a composite index comprising of times series, which tend to shift direction following a change in direction of the business cycle. SARB (2010, http:www.resbank.co.za)


Composite business cycle indicators
Description Apr, 2010 May, 2010 Jun, 2010 Jul, 2010 Aug, 2010 Sep, 2010
Leading indicator 131.5 131.2 129.3 131.0 130.9
Coincident indicator 142.1 143.2 144.9 145.9
Lagging indicator 103.5 103.3 103.3 104.5


The leading indicator recorded a month on month decrease from July 2010 to August 2010 of 0.076%. This was followed by the increase from 129.3 to 131.0 of 1.31% the previous month. There was also a decline between June 2010 and May 201 as well as between April 2010 and May 2010. It is an indication that on the short term the leading indicator moves sideways.

On an annual basis the leading indicator increase from 108.82 to 130.9 with 21.87, which were impressive at 20.29%. This should be compared to the year on year of June that was 18.6%. On the longer term the leading indicator moves upwards and out of the recession that the country was in last year.

The shorter term however suggests that the South African economy does not slow down as much as expected by different analysts. The aggressive growth of the longer term has resulted in the fact that the current indicator has to move off a high base and therefore the sideways move currently (short term).

The coincident indicator changes continuously upward and as can be seen from April 2010 at 142.1 that moved to 143.2 in May 2010, 144.9 in June 2010 and further up to 145.9 in June 2010. The month on month percentage increase is 0.69% from 1.18% the month before. The coincident indicator moves in line with the economy and is a definite indication that there is upward growth momentum, although the leading indicator suggests a slow down in future.

The lagging indicator was reported for 104.5 from 103.3 the month before.

The GDP growth rate of 4.6% in the 1 st quarter decrease to 3.2% at the end of June and that was predicted by the leading indicator. If the leading indicator continues its sideways move we can expect GDP growth to follow the trend, but the data indicate positivism in the long run.

The leading indicator that continues it small up and downward trend on a month to month basis, but no real upward movement might be a contributing factor in influencing the Reserve Bank decission on their last policy meeting for the year on 17 / 18 Nov 2010.

The OECD leading indicators of South Africa have the same trend then the group compiled by the SARB and there is a good correlation between the two sets of data as well as of the overall leading indicator of the OECD.


Leading Indicator Variables

i. New car sales volume in manufacturing
According to the National Association of Automobile Manufacturers of South Africa (NAAMSA), 2010 third quarter “new vehicle sales had lost considerable momentum during the month of September 2010 principally due to strike action in the motor industry which had negatively affected the production of locally manufactured cards and light commercial vehicles. Aggregate industry sales at 41 875 units had registered an improvement of 5 960 vehicles or 16.6% compared to the 35 915 vehicles sold during the corresponding month in 2009. The year-on-year monthly growth figure of 16.6% was down substantially on the year-on-year improvement of 36.9% registered during the previous month of August 2010. Aggregate export sales, as a result of the loss of production due to the widespread industrial action in the automotive sector, had declined in volume terms by 10.3% compared to the corresponding month last year and reflected a massive fall of 36.0% on the previous month of August 2010.

Comment:
Although there is a decline in the short term due to the reasons explained above the longer term indicates an aggressive recovery of the economy. The data shows an excellent correlation with the leading indicator and provide more information why the leading indicator is on a sideways move. The massive strike actions has slow the recovery of the economy considerable, but it is expected that new vehicle sales will pick up speed after December 2010.

This will happen after the market got used to the new carbon emissions tax, which will raise new car prices by 2.5% on average. It is so that the figures of August might be inflated somewhat due to the fact that new vehicles were bought in lieu of the new carbon emission tax and that has resulted that the vehicle sales had to move off a high base, but overall on the long terms there is much positivism.

The causal chain reaction could be depicted as follows:
An increase in consumer spending will result in an increase in investment, a decrease in unemployment and an increase in liquidity.

I do believe that the recent strikes, carbon emission tax and certain public utterances of politicians (nationalisation rumours) had a bigger effect on the leading indicators then what we realise, hence the reason of the sideways move and it is therefore reasonable to expect that we are moving into a growth phase (expansion).

ii. Business Confidence
The SACCI Business Confidence Index (BCI) was released on 7 October 2010 and increased by 0.2 points following the increase of 3.3 points in August 2010.

According to the graph in Fig 1 the BCI has been showing positive upward movements since the start of 2010. The upward trend also picked up as the year unfolded.

Fig 1: SACCI Business Confidence














Source: South African Chamber of Commerce and Industry (http://www.sacci.org.za/) accessed 2010/10/08

Comment
A mixture of signals is observed from the various components, however the overriding factor is that the overall business confidence is in an upward curve and supports the view that the economic growth is in an upward movement.

iii. Residential Building Plans passed – flats, townhouses
According to the SARB (Quarterly Bulletin, September 2010) the construction activity was largely supported by infrastructure-related work programmes during 2009, as the residential building sector experienced a recession and activity in the non-residential sector stalled. Employment in the construction sector decreased at an annualised rate of 6.5% in the first quarter of 2010. The First National Bank (FNB) Building Confidence Index, which reflects overall business confidence in the building industry, rebounded during the third quarter of 2010, notwithstanding the slight improvement the industry remained firmly entrenched in a recession.

Comments
The sector is currently, unfortunately too much largely dependent on government for projects. The accelerated and housing boom after 1994 with government pushing to build more houses for the poor has resulted in the dependence. The dependency was also not helped by the pre-world cup stage where infrastructure development was the norm. It could obviously not go on and the bubble had to burst.

It is my opinion that for this sector to grow government once again needs to have some sort of direction similar the world cup or a threatening of election lost. The latter is obviously not a threat for a long time due to the population’s tendency to still vote by skin colour. Before the world cup everybody worked together with the ultimate aim to be ready for the world cup and the infrastructure development that was put in place was done in a considerably short time. If we do not continue this type of focus we will not progress with our infrastructure and housing shortages.

The shortage in houses and or infrastructure, however are still there and the possibilities to kick start the sector is still intact. The sector however needs to support themselves in terms of market demands and not wait for government investment.

This is also a leading indicator and might be one the reason that growth prospects is somewhat dampened as depicted in the Reserve Bank’s overall leading indicator.
Interest rates are currently the lowest in 30 years and this might be the boost needed for the struggling sector.

The chain reaction for this sector could be the following:
Interest rates decreases → increase consumer spending → unemployment decreases → increase in the building sector

One can argue that the market is currently sending mixed signals, especially with the new car sales and the building sector that is struggling, but I still believe overall that the economy is in an upward movement.

Coincident Indicator Variables

i. Total Formal Non-Agricultural employment
According tot he Quarterly Employment Statistics (QES) survey by Statistics South Africa (Stats SA), formal non-agricultural employment contracted further at a seasonally adjusted and annualised rate of 1,2 % in the first quarter of 2010. Employment numbers in the private sector contracted by 1.9% in the first quarter of 2010 while public-sector employment increased by 1.2 %. Approximately 24 900 jobs were lost in the first quarter of 2010 compared with 127 100 in the corresponding period of 2009.

Comment
There is a decline in the rate of job losses although job losses continued unabatedly during the first quarter of 2010, despite the upward movement of the economy. This synchronises well with the coincident indicator in the sense that economic growth did not picked up speed as yet and we need much more stimuli in the economy in order to start creating jobs in a sustainable basis going forward.

The chain reactions in this sector could be the following:
An increase in unemployment → aggregate decline in consumer spending → decline in aggregate demand → decrease in prices

ii. Remuneration versus Productivity
According to the Reserve Banks (Quarterly Bulletin, September 2010) the year-on-year rate of increases in average salaries and wages per worker started to decelerate in the second quarter of 2009, but remained high despite moderating overall consumer price inflation.

Production suffered due to the strike actions during 2010 and the number of working days lost due to industrial action nationwide increased to 1,25 million in the first half of 2010 from 526 000 in the same period the previous year according to the Wage Settlement Survey by Andrew Levy Employment Publications.

The rate of increase in average nominal remuneration per worker in the formal non-agricultural sector amounted to 11.8 % in 2009 and accelerated to 15.1% in the year for the first quarter of 2010. Despite the widespread losses in the private sector, all subsectors registered double-digit rates or remuneration increases.

The average wages increases is currently far above the Inflation rate, this certainly will have inflationary pressures.

Comment
The big demand for remuneration increases supported by the trade unions and the loss of productive days resulted in a decrease in the overall productivity in comparison to productive value. The wage increases does not go hand in hand with increase in productivity.

The wage increase, however have not resulted in serious inflationary pressure mainly due to the simultaneous and continuing job losses. This seems to cancel each other out.

iii. Value of wholesale, retail and new vehicle sales at constant prices
Wholesale and retail trade is 13.8% of GDP and 20.1% of formal non-agricultural employment. According to the Standard Bank macroeconomic perspectives (2010, 9) real retail sales grew by a stronger-than-expected 7.4% year-on-year in June from 4.5% year-on-year in May 2010. Growth in wholesale trade eased to 2.6% year-on-year in June 2010 from 3.6% year-on-year in May 2010. Despite this slowdown, the sector made headway relative to the first quarter, expanding by 2.7% quarter to quarter in the second quarter from 0.3% quarter to quarter in the first quarter.

The Standard Bank economists further states that “improving wholesale trade, more recently also supported by household goods, supports preliminary evidence that retail demand is firming. Rising manufacturing capacity utilisation signals that the recent improvement in wholesale trade is likely to endure in the second half of the year, albeit remaining limited.”

Comment
The increase in wholesale and retail trade is strongly correlated to the growth in GDP and increase in consumer confidence. As a coincident indicator it moves in line with economic growth and is expected to continue along this path. It is indicative that the post-World Cup pessimism is incorrect.

This variable is a typical coincident indicator and is in concert on the current direction of economic activity and that the economy is in an upward surge, interest rates are low, and sales volumes are moving upwards.

The chain reactions are depicted as below:
Increase in Consumer spending → increase in GDP → increase in aggregate demand → increase in manufacturing

Lagging Indicator Variables

i. Ratio of households use of instalment sale credit to their disposable income
The household sector uses instalment sale and leasing finance to finance their expenditure on vehicles and other durable goods.

According to the Quarterly Bulletin (September 2010, 38) “there has been an improvement in the extension of instalment sale credit and leasing finance. Twelve-month growth in this credit category reached a low of minus 6,1 % in November 2009 before recovering to a still negative rate of 1.5% in July 2010, mainly due to growth in instalment sales. By contrast, leasing finance has shown a steady decline since the implementation of the National Credit Act in June 2007.”

Comment
The interest rates are at a 30 year low and support growth prospects in instalments sales as well as leasing finance. The National Credit Act of June 2007 however is a drawback in terms of granting credit as the focus is much more on affordability then in the time of the Usury Act. This credit act however help the country during the Credit Crises of 2008 and our banks came out of the crises fairly in comparison to banks in other countries.

The upward movement of this variable is however another testimony of the recovering economy in South Africa.

ii. Predominant prime overdraft rate of banks
The Reserve Bank changed the repo rate during 2010 on two occasions. They reduced it with 50 basis points to 6.50%at its March 2010 meeting and with another 50 basis points at its September 2010 meeting to 6.00%. This resulted in the repo rate at it lowest since 1980.

The Prime lending rate of the commercial banks are therefore currently at 9.50% and with inflation outlook that remains fairly favourable one can expect the interest to stay down at this levels for a while.

Comment
The reason why this is a lagging indicator is that it is normally used as a reactive measurement to certain indicators in the economy. A low interest environment however is what the economy currently needs in order to supplement the current upsurge in economic growth. Capital becomes cheaper and investment in businesses will increase, which will result in a decrease in unemployment and that might lead to an increase in household disposable income.

Conclusion
The Composite business cycle indicators all point in the same direction and that is that the South African economy is in a slow upswing and although the leading indicators suggest that it will move sideways in the immediate future, there is good reasons why one can be positive for the longer term. It is also the author’s believe that the recent strikes, rumours about inflation and carbon emission taxes have put a damper on the outcome of the leading indicator.

Consumers and businesses regaining confidence in the economy, hence the increases note in the sales figures. The reduced interest rate environment will push the demand for credit up, but the National Credit Act and the banks current reluctance to revise their lending criteria after the recent shocks will result in the credit market take a bit longer to regain positive growth.

It is however the conclusion that economy is in an upward growth phase.

References

OECD Stat Extracts. Composite Leading Indicators. http://stats.oecd.org/index.aspx?datasetcode=MEI_CLI. (Last accessed on 9 October 2010)

Mohr, P. 2008. Economic Indicators, 3rd Edition. University of South Africa Press

NAAMSA, 2010. NAAMSA Media Release: Comment on the September 2010 New Vehicle Sales Statistics, http://www.naamsa.co.org/ accessed 7 October 2010.

South African Chamber of Commerce and Industry, 2010. Business Confidence Index, September 2010, http//www.sacci.org/index accessed 8 October 2010.

South African Reserve Bank, 2010. Quarterly Bulletin September 2010. http://www.reservebank.co.za/ accessed 11 November 2010.

South African Reserve Bank, 2010. Release of Selected Monthly Data, September 2010. http://www.resbank.co.za/ accessed 11 November 2010.

Statistics South Africa, 2010. Quarterly Employment Statistics (QES), September 2010. http://www.stassa.gov.za/ accessed 8 October 2010.

Standard Bank, 2010. Economics South Africa: Macroeconomic perspectives, September 2010. http://www.standardbank.com/ accessed 8 October 2010.