The SA economy in Q2 2015 was not as it appeared – after taking an inventory
According to the first readings of gross domestic output (GDP), in real terms for Q2 2015, the SA economy performed very poorly. It is estimated by Stats SA to have shrunk by 1.3% on a seasonally adjusted annual rate in the quarter.
(All figures are taken from the Quarterly Bulletin of the SA Reserve Bank, September 2015.)
On a second reading for the second quarter of figures provided by the SA Reserve Bank, which include estimates of the demand side of the economy, the outcomes, on the face of it things. seem even worse. Gross Domestic Expenditure (GDE) is estimated to have declined by as much as a 7.2% rate in the quarter. The outcomes were not nearly as dire as might be inferred from either the GDP or GDE estimates. Final demand, the sum of spending by households, firms and the government sector, actually grew by about 1%. That final demands continued to grow at a very modest pace is consistent with our own measures of economic activity. What turned final demands into very weak GDE growth rates was a dramatic decline in inventories. Inventories in Q1 grew by R8.8bn on a seasonally adjusted annual rate. In Q2 they declined by the equivalent rate of over R38bn. This decline in inventories was enough to reduce real GDP in the quarter by as much as 6.2%.
Much of the action is attributable to the large seasonal adjustment factor interpolated to the estimates of inventories, the consistency of which may well be questioned. It is normally the case that the second and third quarters are periods when inventories are built up and the fourth and first quarters are normally associated with a general run down in inventories. But as the Reserve Bank comments, inventory events in Q2 were anything but normal in the mining and oil sectors. To quote the Economic Review of the Reserve Bank for Q2 2015:
Following a modest build-up in inventories in the first quarter of 2015, real inventory levels declined significantly at an annualised pace of R38,9 billion (at 2010 prices) in the second quarter. The rundown of real inventories in the second quarter of 2015 was mainly due to the destocking in the mining and manufacturing sectors, partly reflecting subdued business confidence levels and a decline in import volumes.
In the mining sector, inventory levels at platinum mines in particular contracted during the period on account of a significant increase in the exports of platinum in order to fulfil offshore export obligations. The rundown of inventories in the manufacturing sector partly reflected lower crude oil import volumes due to scheduled maintenance shutdowns at major oil refineries over the period. Consistent with a slower pace of increase in retail trade sales, the level of real inventories in the commerce sector rose in the second quarter. Industrial and commercial inventories as a percentage of the non-agricultural GDP remained unchanged at 13,8 per cent in the first and second quarters of 2015.
Inventories can run down because firms lacking confidence in future sales plan for a reduction in goods held on the shelves or in warehouses. They may also run down in an unplanned way because firms are surprised by the actual sales they were able to make. The planned reduction in inventories can represent bad news for the economy as orders decline. The unplanned reduction can mean better news should firms attempt to rebuild inventories. Similarly, a planned increase in inventories can reflect a more confident outlook for sales to come. An unplanned build-up of inventories may also reflect unexpectedly poor current sales volumes, and so fewer orders to come in the quarters ahead. Making the distinction between planned and unplanned inventory accumulation will be all important for any forecast of economic growth. In the case of the SA economy in Q2, it seems clear from the Reserve Bank statement that the run down in inventories in Q2 was for largely idiosyncratic reasons, making the application of seasonal adjustments particularly subject to error.
Judged by the estimated growth in final demand, the economy did not deteriorate in Q2 as the statistics on the pure face of it may suggest. In our judgment of the National Income Accounts released for Q2, the economy continues on its unsatisfactorily slow growth path as other indicators of the economic activity, included our own Hard Number Index, have revealed. The economy is growing slowly and not shrinking, nor is it about to do so. There is moreover at least one silver lining to be found in the latest statistics. As much as inventories subtracted from the growth rate, net exports added as much, due to the growth in export volumes and the stagnation of import volumes. The trade balance went into surplus and the current account deficit declined thanks to the weaker rand and the relative absence of strike action.
Another development this year, essential to lessening the tax burden on the productive part of South Africa, and so increasing potential growth, is the further decline in public sector employment in Q1 noted by the Reserve Bank. Lower tax rates and less spent on employment benefits for a bloated public sector, also lower interest rates, will help stimulate a recovery in the all-important household spending that is essential for faster, sustained growth over the longer run.
A combination of export growth and a stronger trade balance combined with a smaller budget deficit, accompanying fewer expensive public officials, of the kind revealed in Q2 2015, is some of the right stuff necessary to recalibrate the SA economy in the collective mind of the global capital market from a fragile to a resilient economy.