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GDP Contraction, But Decline Not A Game Changer

South Africa’s Gross Domestic Product (GDP) declined by 0.7% quarter-on-quarter on a seasonally adjusted basis (q/q sa). This was broadly in line with the consensus forecast, but was a “positive” surprise relative to concerns about a deeper slump. The economy faced numerous headwinds in the second quarter: severe floods in KwaZulu-Natal during April interrupted production, transport, and trade; load shedding started escalating; and global growth moderated in part due to the war in Ukraine and due to lockdowns associated with China’s zero-Covid strategy.

Global activity data seems to be holding up so far in the third quarter, which lessens the risk of a sequential contraction locally. A modest rebound should ensure that calendar year growth prints at 2.0% – 2.5%. Even if we have no growth in 2H22, full-year GDP would still come in at an above-potential 1.6%.

Services carrying the economy

The detail underlying the production side of GDP confirmed that the primary and secondary sectors felt the strain as mining, manufacturing, and agriculture dropped sharply. The latter was somewhat surprising in light of another solid grain harvest. In addition to floods and load-shedding, manufacturing was hampered by refinery shutdowns, which, alongside Eskom’s demand for diesel, boosted chemical and petroleum imports, which detracted from growth.

Transport, storage and communication, as well as financial, real estate, and business services expanded in Q2, in keeping with the low volatility in the non-cyclical sectors. General government – which largely reflects real salaries and wages paid – contracted because of the high base associated with the census in Q1.

Spending remains resilient

The demand-side showed more resilience, with evidence of recovering inbound tourism, some capex demand for machinery, as well as restocking in the trade sector. The latter could be a positive signal that we may be facing easing supply chain strain, but it could also be a symptom of slowing consumer demand. Either way, higher inventories would generally limit inflationary pressures down the line. Consumption held up in the face of lower real income growth, but the bias shifted towards services over goods. This indicates that the Covid-19 DIY boom may be petering out, while also reflecting the nascent recovery in tourism.

A recession is unlikely

For now, this contraction is expected to be once-off, but the details reveal limited expansion in capacity. Construction remains under pressure, and unit labour cost growth has reaccelerated in the face of falling productivity. This means that the economy’s potential remains constrained, which could limit the disinflationary pressure from the output gap. To be sure, the South African Reserve Bank (SARB) does not believe the output gap to be too negative and this release was an upside surprise relative to the Reserve Bank’s forecast. Even so, this release on its own is unlikely to lead to a more hawkish response given that inflation has most likely peaked and global evidence of easing input cost pressures.

High state spending may keep the SARB hawkish despite the tight economy

Much depends on the US Federal Reserve’s (Fed’s) policy path, the rand’s response (it did lose about 1% in the hours following the print, but this reflects dollar strength rather than SA-specific factors), and ongoing domestic fiscal prudence.

Newsflow this week that Cabinet may consider a “relief package” to assist South Africans in the face of surging costs comes at a time when the worst of the inflation surge is already in the base. Given other government spending pressures – the wage bill, Eskom bailouts, and demands for a universal basic income grant – it will become difficult to ensure that new programmes are temporary and deficit neutral. Additional fiscal laxity may very well force the SARB to maintain a more hawkish stance.