Export competitiveness in the metals and engineering sector is pivotal for economic growth and synchronised upswing in the world economy. Our review of the State of the Metals and Engineering sector in the first quarter of this year reaffirmed the low-growth scenario, which saw a second consecutive contraction in gross domestic product (GDP), technically catapulting the South African economy into a recession.

However, the latest prediction by the Steel and Engineering Industries Federation of Southern Africa (SEIFSA) captures an adjusted annual economic growth trajectory, highlighting a moderate turnaround in GDP growth this year of 0.8 percent, which is generally congruent with a global positive outlook.

The recovery – albeit slowly – of some economic fundamentals provides some comfort and basis to argue that the South African economy is gradually weathering the depression. Indications are that the trough in the current business cycle may have finally been reached and a rebound is imminent. There is optimism that second-quarter GDP growth figures will provide a mild impetus for slightly robust growth from the second half of 2017 onwards.

This is possible given the generally improving international economic environment, underpinned by moderate recovery of investment and exports.

Moreover, developments in key external markets – such as the SADC, the rest of the African continent, Europe, Asia (particularly China) and the US – for locally manufactured products are important in gradually improving demand conditions, regionally and globally. These should be beneficial to local exporters over the medium to long term.

Also, it is expected that an improvement in the socio-political environment (including a clearer government economic policy stance) and international commodity prices will translate into better business opportunities and improve the financial positions and performances of local companies

M&E sub-sector benefit

This is potentially good news for the manufacturing industry at large and the metals and engineering (M&E) sub-industries in particular. SEIFSA’s first-quarter revised growth outlook for this year specifically simulates the M&E sub-sectors benefiting from these developments and expanding by 0.9 percent in the second quarter, thereby contributing to a revised predicted annual outlook of 1.2 percent. This figure was revised downward from 1.4 percent, due to weaker than anticipated first-quarter results and deterioration of the outlook is 60 percent of the sub-industries.

Although there is confidence for medium-to-long term economic activities in the M&E sub-sectors, the short-term figures are cause for concern.

SEIFSA is of the view that increasing pessimism about current business conditions and poor performance of key economic indicators does not presently bode well for production activity. Both the Absa Purchasing Managers Index (PMI) and the Producer Price Index (PPI) reduced by 4.8 percent and 1 percent, respectively, from May 2017 to June 2017. This was accompanied by a reduction in the Unit Value Index for exported commodities from 2.2 percent in April to -2.8 percent in May 2017.

Additionally, an oscillating rand does not provide confidence to businesses. A weak rand translates to high cost of exchanging currencies, resulting in increasing import costs (including costs of inputs). Input costs are a fundamental component of manufacturing input cost inflation and a trade-off between rising input cost inflation and the reducing PPI (including the PPI of stage of processing) impacts negatively on the margins of companies.

SEIFSA closely monitors these indicators, as their performance at the moment is a cause for concern to the M&E sub-sectors. A consistently poor performance may dampen the outlook and present a basis for further revision of our estimates.

Contemporaneous to the need for improved economic indicators towards economic growth is exports competitiveness in the M&E industry. SEIFSA strongly believes that export competitiveness will ensure that output growth is consistent and sustainable, generally translating to better employment opportunities as companies rally to boost productive capacity in anticipation of higher than expected demand for their products.

Dual approach will benefit

Indeed, an imperative need exists for all companies in the M&E sub-sectors to be both inward looking (that is, sell within South Africa, in addition to intra-company transactions to upstream local companies) and outward looking (that is, sell beyond our borders and reduce dependence on the local economy in order to benefit from an expected economically buoyant aura.

In our first-quarter review of the State of the Metals and Engineering sector, we noted that the M&E production capacity expanded by 0.5 percent in Q1 2017, against our forecast of 1.3 percent. Total exports decreased by 8.4 percent in real terms. Despite a stronger rand in Q1, imports also decreased by 7.9 percent (real), which is indicative of a weak domestic economic environment. The table of export-to-output ratios of the metals and engineering sub-industries shows that 87 percent of demand for plastics, 77.5 percent of that for electrical machinery and 67 percent of that for metal products is derived domestically.

An interesting observation is that sub-industries with the most significant exposure to the domestic economy experienced the most severe contraction in output, while the opposite mostly held for sub-industries with higher export-to-output ratios. In addition, sub-industries contracted the most in Q1 2017, confirming a cyclical output pattern to that of the domestic economy.

A paradigm shift and new strategy is needed in doing business in the M&E sub-industries. Rather than conducting business as usual, a focus on improving export competitiveness is needed in order to enhance profits and act as a buffer during difficult times and sustained economic downswings. Export competitiveness is pivotal if M&E companies want to benefit from expected domestic green shoots (given the current expansionary monetary policy stance) and increasingly optimistic global outlook. It is necessary to ignite and sustain economic growth as South Africa seeks to benefit from the broadest synchronised upswing the world economy has experienced in the last decade.