The growth outlook is as clear as mud

The year has barely commenced and GDP growth forecasts are being revised lower. Why is growth weakening?

Load-shedding dims SA growth
Electricity load-shedding, which hit SA GDP in the last quarter of 2019, triggering a recession, is usually one of the first culprits identified, although the modest gain in mining GDP in the quarter is an interesting development. Historically, this industry has been sensitive to electricity outages. But, seemingly, mines have adapted to cope better with relatively low intensity electricity load shedding.

In the end, though, the 1.4% fall in GDP in the last quarter of 2019 surprised already subdued consensus expectations, leading to downward revisions of growth forecasts for the year ahead.

But, whereas we have a reasonable handle on the impact of electricity outages on GDP growth, the same cannot be said for the spread of the coronavirus (COVID-19).

It’s reasonable to expect panic to be followed by economic recovery
If previous severe acute respiratory syndrome (SARS) outbreaks are a reliable a guide, the near-term hit to global growth should be followed by a V-shaped recovery. This would have a limited impact on global economic activity and the South African economy for the year overall.

The global manufacturing and service purchasing managers’ data for February 2020 confirms a material slowdown in growth is unfolding. As yet, it’s not as sharp as during the global financial crisis. But it is severe, led by exceptionally weak data in China.

Does available data suggest a V-shaped recovery is plausible? On the plus side the reported rate of COVID-19 infections in China has slowed to close to 0%, while the number of active cases in the country is around half the cumulative number of infections recorded. Further, anecdotal evidence and some (although by no means all) high frequency data releases suggest China’s economy is slowly preparing to return to production.

However, as the virus has continued to spread globally over the past week the possibility has emerged that the impact on the world economy may be more prolonged and deeper than initially thought. Perhaps the recovery will be U-shaped, rather than V-shaped, in which case global growth is expected to be up to 1% lower in 2020 than would have been the case. But, either way the economy is expected to recover in the second half of 2020.

Our flexible exchange rate may absorb some of the shock of a base case scenario
If so, in this base case scenario, the impact on South Africa is expected to be negative, but partially contained as we rely on the flexible rand exchange rate to act as a shock-absorber, supported by monetary policy easing. The problem is South Africa’s current potential growth rate is so low and its unemployment situation so dire, that even a small hit to economic activity is keenly felt. Also, likely further worsening of South Africa’s already unsustainable fiscal position could constrain the extent to which the Reserve Bank responds.

The “what-if?” scenario
Economists are at a disadvantage, though, when analysing epidemiological events. There are many moving parts and estimates of the damage to the economy are open to adjustment as new information becomes available. To start, it is not known whether infection rates will increase again once production commences in China.

Also, even though the incidence of COVID-19 infections outside China is currently highly concentrated in three countries (Iran, South Korea and Italy), the prevalence of COVID-19 is increasing elsewhere. Indeed, the number of countries reporting infections have trebled since early February 2020 and the rate of global infections is increasing. The risk of transmission through the world, possibly along the lines of annual influenza outbreaks, may be higher than we think. If this is the case, the risk is that COVID-19 spreads through the northern hemisphere in the months ahead, before permeating to the southern hemisphere as we head towards the winter season here.

Irrespective of the development of the virus, SA growth will be constrained
Assuming individuals accept this and go about their daily work and home lives as per usual to pay the bills, then “normalization” of economic activity and human interaction is likely in the months ahead, in which case the global economy still rebounds in this year with limited damage. Note, though, even in this scenario, South Africa’s economic growth, constrained by structural deficiencies, is expected to be low. At least, inflation should remain contained allowing some scope for the Reserve Bank to cut its policy interest rate.

On the other hand, if the nascent clamp-down on transport, tourism, trade and events intensifies as the virus and associated news spread; and if more and more consumers in more and more countries seek to limit human contact and reduce discretionary consumer spending, the negative impact will probably be prolonged. If so, chances are the impact of the virus on economic activity does not unfold in a neat, predictable fashion. One would expect further downward revisions to growth forecasts, a stronger disinflationary impulse, monetary policy easing (the US Federal Reserve has already cut its target range by 50bps in response to the virus) and, probably, fiscal loosening.