South Africa is searching for higher economic growth in a global environment increasingly shaped by rising nationalism, higher levels of trade protection and a fall-off in the effectiveness of monetary policy.

1. stanlib.com
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The economic
outlook for 2017
By Kevin Lings
STANLIB Chief
Economist
South Africa is
searching for
higher economic
growth in a global
environment
increasingly
shaped by rising
nationalism, higher
levels of trade
protection and
a fall-off in the
effectiveness of
monetary policy.
The surprise victory of
Donald Trump in the
8 November 2016 US
Presidential election,
coupled with the
unexpected Brexit vote
on 23 June 2016 and the
rising support for France’s
National Front, which is
a socially conservative,
nationalist political party in
favour of France exiting the
European Union, highlights
the widespread surge in
right-wing politics.
This shift in global politics is
centered around demands
for more self-determination
including additional trade
protection as a means of
safeguarding local industry,
as well as reduced levels of
immigration. Unfortunately,
this trend could intensify
in 2017 as a large number
of European countries
are scheduled to hold
elections including Austria,
Netherlands, France, and
Germany.
There is a concern that
the current shift in global
political sentiment, including
Donald Trump’s stated
intention to revise or scrap
important trade agreements,
could lead to an escalation
of global trade wars,
accentuating the current
sharp slowdown in global
trade. A fall-off in global
trade tends to limit global
economic growth through
the curtailment of global
manufacturing activity.
According to the
International Monetary
Fund (IMF), world growth
is projected to slow
fractionally from 3.2% in
2015 to 3.1% in 2016 before
recovering modestly to
3.4% in 2017. Importantly,
given recent global political
events, risks to global
growth are weighted to the
downside. Furthermore,
the 2017 forecast is still
slightly below the long-term
average growth rate of 3.5%.
The IMF recently described
the world growth outlook
as “stable, but somewhat
unexciting”.
However, while Trump’s
victory has raised serious
concerns about a further
rise in global trade
World growth
is projected to
slow fractionally
from 3.2% in
2015 to 3.1%
in 2016 before
recovering
modestly to
3.4% in 2017.
World GDP growth forecast
0,0
1,0
2,0
3,0
4,0
5,0
6,0
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
%y/y
Source: STANLIB, Bloomberg

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protection, it has also
sparked a renewed focus on
infrastructural development
as a means of lifting growth.
This was probably the most
promising component of
Trump’s election campaign
that has the potential to
lift the United States’ (US)
economic growth back
above its long-term average.
In order for this to happen,
the infrastructure spending
has to be accompanied by
other policy initiatives that
meaningfully help to lift
business confidence and
fixed investment spending.
The US desperately needs
to improve private sector
investment activity as well
as its level of productivity
growth, which has fallen well
below its long-term average
in recent years.
United States
In the third quarter of 2016,
US GDP grew by a much
improved 2.9% quarter-
on-quarter, annualised.
This compares with revised
growth of 1.4% in the
second quarter of the
year, and 0.8% during the
first quarter. For 2015 as
a whole, the US economy
grew by 2.6%, up slightly
from 2.4% in 2014 and 1.7%
in 2013. The US economy
is expected to have grown
by only 1.6% in 2016, before
improving to 2.0% in 2017.
A key area of strength
in the US economy
remains consumer
spending. Although
the contribution from
household consumption
slowed somewhat in the
third quarter, the sector
still added a respectable
1.5 percentage points to
growth. At the same time,
consumer confidence
is back to the level that
prevailed before the global
financial market crisis,
employment is 6.5 million
above the pre-crisis level,
and household wealth is
comfortably at a record
high supported by a steady
rise in house prices as well
as financial wealth.
In contrast, US industrial
activity remains in recession
declining by an average
of -1.4% over the past
twelve months. This has
been aggravated by a
sharp slowdown in fixed
investment spending as well
as productivity growth.
While US economic growth
is unlikely to slow sharply
over the coming quarters
despite the increased
uncertainty associated with
the election of Donald
Trump, growth is equally
unlikely to accelerate
sustainably without a
more robust increase
in productivity. Instead,
the US economy appears
range-bound at around 2%
growth, with some risk to
the downside in 2017. This
will not change unless there
is a noticeable pick-up in
fixed investment activity.
The election of Donald
Trump suggests that US
economic, trade and
foreign policy priorities are
likely to undergo significant
change as the incoming
Republican administration
seeks to address voter
concerns and honour their
election promise. It also
seems fair to conclude
that there is a high degree
of uncertainty about the
shape and timing of those
changes in policy.
Despite this uncertainty,
many financial market
participants have, rather
hastily, assumed that the
incoming administration
will look to boost growth
through the use of
expansionary fiscal policy,
including increased spending
on infrastructure and
extensive tax cuts. This is
despite concerns about
the sustainability of US
government debt. In 2015,
the US fiscal deficit was
estimated at 2.5% of GDP,
rising to around 3.2% of GDP
in 2016. This suggests that
the US government may have
some room to increase the
deficit to stimulate growth.
There is however a limit to
how much and how long this
can go on before adverse
debt dynamics become an
issue. Large and persistent
budget deficits will eventually
raise the level of government
debt held by the public.
Without reforming various
entitlement programmes
that were introduced under
the Obama administration,
the US is projected to see a
ballooning of government
debt. The ratio of total US
general government debt
to GDP, as calculated by
the IMF, was estimated at
more than 106% of GDP in
2016. That is exceedingly
high by historical and global
standards.
At the same time, many
market participants appear
to be ignoring the possibility
that an escalation of US
trade protection would
most likely act as a drag on
world trade, which could
quickly become a further
headwind for global growth.
It seems likely that both
these factors will play a vital
role in shaping the world
economic outlook in 2017.
Irrespective of whether
the economic debate in
2017 is mostly focused on
the positive impact of an
infrastructure led fiscal
expansion programme
or the negative effect of
heightened trade wars with,
for example, Mexico and
China, it seems clear that
US interest rates are likely
to drift higher in 2017,
possibly by as much as
United States GDP growth forecast
%y/y
-3
-2
-1
0
1
2
3
4
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: STANLIB, Bloomberg

3. 75bps. In addition, higher US
interest rates in the context
of a policy mix of tighter
monetary policy and looser
fiscal policy would tend to
strengthen the US dollar.
The expectation of higher
US interest rates in 2017
partly reflects the current
upward bias in US consumer
inflation to around 2,0%,
as well as the steady rise
in US wage growth and
the anticipation that the
government’s budget will
become more expansionary.
It also reflects a growing
recognition that the highly
accommodative monetary
policy in the US and other
major economies has
systematically become
less effective in boosting
economic growth and
has distorted risk-taking.
Furthermore, if the US
economy were to lose
momentum the Federal
Reserve would have little
scope to re-stimulate the
economy without resorting
to extremely unorthodox
and risky policy measures.
Europe and the
Brexit vote
As mentioned above, key
members of the European
Union are facing important
elections in 2017 at a time
when Europe is struggling to
adjust to the Syrian refugee
crisis in an environment of
below average economic
growth and above average
unemployment. Populist
right-wing political parties
across Europe are gaining
momentum and the trend
appears to be strengthening.
In essence, voters are
rejecting mainstream
political parties in favour
of outsider candidates that
offer an alternative to the
existing establishment.
While economic growth
in the Euro-area remains
relatively lackluster, the
ability for the region to
switch from relying on
monetary policy to stimulate
economic growth to making
greater use of fiscal stimulus
in 2017 varies greatly from
country to country. A few
countries such as Germany
enjoy positive debt dynamics
and so could increase their
fiscal deficit somewhat
without materially impacting
their government debt
ratios. Ironically, Germany
may not actually require
much fiscal stimulus given
its current economic
performance.
Contrary to popular
perceptions, Italy, Europe’s
third biggest economy after
Germany and France, could
also provide some additional
fiscal stimulus given that it
has systematically reduced
its fiscal deficit down
to around 2.6% of GDP.
However, agreeing on the
type of fiscal stimulus could
prove problematic given that
the government remains
fragmented.
Whilst many other European
countries, such as the UK and
France, could also benefit
from a dose of fiscal stimulus,
they currently run large fiscal
deficits with an already high
government debt ratio. This
will undoubtedly constrain
their ability to relax the fiscal
policy stance.
Overall, the Euro-area is
forecast to grow by about
1.5% in 2017. This is down
from 1.7% in 2016 and well
below the long-term average
of almost 2.0%. One of
the key factors negatively
impacting the region is the
uncertainty associated with
Brexit, but also the risk that
one or two other countries
in the region try to follow
the UK in voting to leave
the union. If this included
a country such as France, it
would signal the break-up of
the European Union.
The financial market’s
initial reaction to the shock
Brexit vote on 23 June 2016
was, according to the IMF
“reassuringly orderly”. This
was probably premised
on the notion that the
exit would be in name
only and that most of the
current trade and access
arrangements between the
United Kingdom and the
European Union would
remain largely unchanged.
However, at a Conservative
Party conference in late 2016,
Theresa May announced that
she will invoke Article 50
of the EU Treaty by the end
of March 2017, triggering
a two year countdown
that will culminate in the
United Kingdom leaving
the European Union.
Importantly, she stressed
that “exit means exit”.
This change in expectations
around the nature and
impact of Brexit has since
been accentuated by a
clearer understanding of the
process to exit and that a
Euro-area GDP growth forecast
-6
-5
-4
-3
-2
-1
0
1
2
3
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
%y/y
Source: STANLIB, Bloomberg
stanlib.comSTANLIB is an authorised financial service provider.

4. new deal with the European
Union will take many years
to be concluded and ratified
by all member states within
the European Union. This
implies that the United
Kingdom will first have to
negotiate a “transition”
arrangement within the next
two years, before trying
to negotiate a final exit
agreement. Without this
transition agreement, there
would quickly emerge a large
number of important legal
disputes. It is also very clear
that the United Kingdom is
a long way from detailing
the type of deal they are
likely to pursue and that
the complexity of the exit is
immense.
Many of the European
Union member countries
are unlikely to approach
the Brexit negotiation
favourably, while some
of the discussions could
become relatively hostile
and antagonistic in 2017. It
would appear that in order
for the United Kingdom to
get a “good” exit deal (which
implies securing maximum
access to Europe’s single
market), they are going
to have to be flexible on
immigration; but that is at
the core of why so many
citizens voted for the exit.
Hopefully, while the Brexit
negotiations are under-way
the United Kingdom can
look to strengthen its trade
relationships with other key
countries, including China,
but this is unlikely to fully
compensate for the loss of
easy access to the European
Union.
South Africa
Since the global financial
market crisis in 2009, the
rate of economic growth in
South Africa has averaged a
mere 1.6%. This has clearly
not been robust enough
to lead to widespread job
creation. In fact, over the
past year the South African
economy added a mere
5 000 jobs, while the official
rate of unemployment has
moved to its highest level
in at least thirteen years at
27.1% in the third quarter
of 2016. The high rate of
unemployment explains
most of the social tension
and anguish experienced in
South Africa on a daily basis,
especially among the youth.
This lack of economic
growth reflects a
combination of factors
including a sluggish global
economic backdrop, low
business and consumer
confidence, rising social
tensions and a dearth
of private sector fixed
investment activity that
has been aggravated by
significant policy uncertainty
and political turmoil.
Despite these constraints,
South Africa’s economic
growth rate is still expected
to improve modestly in 2017
to around 1.2%, which is
up from an estimated 0.3%
in 2016. This improvement
in economic activity,
albeit modest, reflects a
combination of factors
including a much improved
agricultural season after a
disastrous drought in 2016,
a moderate but sustained
uptick in commodity prices,
a further improvement
in exports due to rand
weakness, a decline in
import intensity, and
ongoing labour market
stability. All of this should
be further supported by
a noticeable slowdown in
consumer inflation, which
will provide some relief to
the household sector. Under
these circumstances the
South African Reserve Bank
could consider a moderate
cut in interest rates during
the second half of 2017.
Unfortunately, this slightly
more favourable growth
outlook for 2017 is not
without risk. These include
still low consumer and
business confidence which
will take time to revive,
increasing signs of consumer
distress, ongoing cost-
cutting by many corporates
which could start to include
more retrenchments, and
a deep recession in private
sector fixed investment.
Furthermore, the South
African finance minister
indicated in the October
2016 medium term budget
policy statement that
taxes are going to increase
sharply in the February 2017
national budget.
The detailed proposals for
these tax increases will
be outlined in next year’s
budget, but presumably
Sub-Saharan Africa GDP growth forecast
0
1
2
3
4
5
6
7
8
08
09
10
11
12
13
14
15
16
17
%y/y
South Africa GDP growth forecast
-2
-1
0
1
2
3
4
08
09
10
11
12
13
14
15
16
17
%y/y
Source: STANLIB, Bloomberg
stanlib.comSTANLIB is an authorised financial service provider.

5. they will flow from some
of the recommendations of
the Davis Tax Committee
as well as tax measures
already announced, such as
the sugar tax. Government
aims to collect an additional
R28 billion in tax during the
2017/2018 tax year, which is
up R13 billion from what was
announced in the February
2016 Budget. In addition, the
Minister indicated that tax
revenue will have to rise by
a total R43 billion over the
next two years.
Part of the reason for
higher taxes is the sluggish
economic growth that has
led to sustained tax revenue
under-collection. However,
the scheduled tax hikes
also reflect the fact that the
government is aiming to
spend an additional R17.6
billion on tertiary education
over the next three years in
order to cover fee increases
for poorer students, as
well as make more money
available for study loans.
Unfortunately, tertiary
education has been under-
funded in South Africa for
many years, which has clearly
contributed to the recent
widespread student protests.
The combination of lower
projected tax revenue, and
reduced economic growth
means South Africa’s
projected budget deficit
for the next three years has
been revised higher. More
specifically, the fiscal deficit
is projected to remain above
3.0% of GDP for the next
two years. While this fiscal
slippage is a concern, the
National Treasury has been
applauded for endeavouring
to maintain fiscal discipline
under very difficult
economic conditions.
A key risk to South Africa’s
ongoing fiscal stability is
the increase in state debt
cost. While the interest
cost on state debt remains
manageable at around 10%
of total expenditure, it is
now consistently the fastest
growing component of
government expenditure.
In fact, nominal growth in
interest and rent on land is
expected to average 10.1%
over the next three years.
Under these circumstances,
a significant rise in bond
yields, due to credit rating
adjustments, would put
South Africa’s fiscal position
under increasing strain.
Given the current state
of government finances,
including higher levels
of debt and a weakening
tax base, as well as the
increasing demands for
financial support from
state owned enterprises, it
seems clear that the public
sector is unable to provide
a significant additional
economic stimulus in
the form of government
spending in order to boost
the economy. Instead,
they will need to focus on
maintaining fiscal discipline
while pursuing targeted
fiscal programmes.
This implies that South
Africa's economic policy
officials need to find a way
to lift business confidence
and encourage the private
sector to play a bigger role
in growing the economy.
Realistically, this is most
likely to be achieved by
an implementation of
economic infrastructure
development through the
increased use of private/
public partnerships.
Achieving this will
require the full backing
of cabinet, supported by
sound economic policy.
Ultimately, the current
political turmoil in South
Africa is likely to prove
decisive in how the balance
of risks to the economy
unfolds in 2017, especially
as the ANC starts to focus
on their elective conference
in December 2017.
Since the global
financial market
crisis in 2009,
the rate of
economic
growth
in South
African
has averaged
a mere 1.6%.
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