International Economic and Steel Environment
The world economy is growing slower than expected, markets for the sector’s exports have also grown slower and commodity prices are lower. Export earnings in dollar terms are down, but declining oil prices are positive for lower inflation.
South Africa is struggling with a balance of payments deficit and the metals and engineering sector contributes substantially to that deficit because of its own imports, but also imports replacing domestically-manufactured goods. It struggles to compete internationally owing to cost pressures and production disruptions (labour and electricity), despite a steadily-depreciating currency.
The latest Organisation for Economic Cooperation and Development (OECD) and International Monetary Fund (IMF) economic prospects concluded that global economic recovery will remain sluggish, with moderate recovery in the UK and the US. The Chinese economy is also steadily slowing down.
The slowdown in emerging economies and risks to their outlook seem to be centred on a few characteristics. World Bank studies since 2013 have confirmed this view:
- The Chinese and Indian economies are huge markets for commodity-rich countries; any slowdown in growth in those markets hurts global exports (South Africa’s included). Slow economic growth in Africa means lower exports from SA to the continent, which makes about 20% of South Africa’s export market, as a second-round effect.
- The huge oil price declines have put oil exporters’ growth prospects in jeopardy. This is particularly so in Africa. Although the lower price of crude oil has a positive impact on SA’s trade balance and inflation, lower African growth means lower exports.
- Commodity and metal price declines will also harm SA and African exports, mining expansions and demand for M&E products.
- Accommodative actions by central banks in the developed world, with the exception of the USA, cushioned continued capital market and exchange rate disruptions in emerging markets during 2014. However, the potential impact of further monetary policy tightening in the US, through strengthening of the dollar, has been compared to a wrecking ball that could play havoc with capital flight out of countries with large external and budgetary deficits.
The SA Reserve Bank has called the prospects “decidedly uncomfortable” and warned about the impact of labour market instability – and now electricity constraints – on SA production and the exports, particularly in mining, the auto manufacturing and M&E sectors.
There is more uncertainty about current and prospective GDP growth rates for the world economy than a year ago. Although demand for the sector’s products has recovered since the financial crisis in 2008, demand growth has levelled off in unison with overall world economic growth. SA seems to have lost substantial ground in international markets during the upheaval in the aftermath of the crisis and has not been able to regain market share.
Domestic Economic and Steel Environment
The South African market represents on average about 40% of total production/sales of the M&E sector. The value of this market in 2014 is estimated to have been in the order of R190 billion. The domestic market for the metals and engineering sector depends largely on intermediate products supplied to mining (10%), construction (10%), machinery and equipment manufacturers (45%) and the auto sector (8%). Of the R190 billion SA market supplied by domestic companies, 90% were intermediary products or gross fixed capital formation in the SA economy.
The South African economic growth for 2014 is estimated to have been around 1,4%. Overall gross fixed capital formation (GFCF) is expected to have grown by 3,3% during 2014. The outlook for economic growth in 2015 is around 2,5% (if not lower, depending on the electricity situation) and investment more or less the same as 2014. Expectations are that both will improve further in 2016.
Of more direct interest to the metals and engineering sector is the outlook for infrastructure expenditure (a recent report by Nedbank showed that announced projects halved since 2013), mining sector investment prospects (which have not fully recovered after the strikes last year and are hampered by low commodity prices) and the performance of the auto manufacturing sector (with mixed prospects). Imports remain a large part of supply to the SA economy.
The Position of the Metals & Engineering Sector
Last year (2014) was disappointing, despite the fact that a better performance was expected, when compared to 2013, because of prospects for domestic and international economic recovery at the beginning of the year. Neither materialised fully and the month-long M&E strike (on top of the five-month mining sector disruptions) weighed heavily on the sector. It is estimated to have contracted by nearly 2%, producing R488 billion or R117 billion of value add during 2014. This means that its production levels are still between 25% and 30% below the peak during 2007. Employment declined, capacity utilisation remained below optimum and profitability declined.
Without demand – or the prospects of growth in demand – and idle production capacity, profits do not materialise and no investments take place. This seemed to have been the M&E conundrum at the beginning of 2015.
The Policy Environment
There has been an overload of mixed and negative signals around the country’s development challenges. Of late, the National Development Plan and the elaboration of action plans in the Medium-Term Strategic Framework have become rallying points that promise more harmony. This is to be welcomed, although the “execution deficit” or perceived deficit remains a stumbling block.
“Uncertainty” has been rising since 2005 (high growth phase and ASGISA), and since then neither elections nor new blueprints led to any significant improvement. This is an ominous sign and calls for renewed efforts to rebuild confidence. The concern is that, if not arrested, the inner contradictions and ambiguity in policy may become destructive.
Any policy response must recognise the complexity of the sector and the fact that it is highly exposed to international markets and import competition. The sector has the same domestic constraints as all other sectors, but it seems to be losing its competitiveness. The support for higher value-added products internationally seems to be overwhelming SA producers. The strategy to tax upstream (commodity and basic metal) producers to compensate for international subsidies of imported products lower down the production pipeline is not viable. The former are competitive and earning foreign exchange, while the latter are not.
The metals and engineering sector has experienced slow and unstable growth since the financial crisis in 2007. The recent demand and production disruptions through various strikes have exacerbated already alarming trends, resulting in the sector contracting during 2014.
Industrial policy is caught between threats (international competition) and constraints (domestic infrastructure and logistics). These constraints are often under-estimated as physical restrictions on business. Without secure electricity supply, production cannot expand. Therefore, the impact of policies often has the effect of compensating for these constraints, instead of stimulating performance in the sector.
2015 and Prospects for 2016
The domestic economy is expected to grow by less than 2,5% during 2015 and closer to 3% in 2016. Fixed investment is expected to grow just over 3% in 2015 and by 4% in 2016.
The SARB leading indicator has been moving sideways for some time, which is in line with previous expansion periods. The Bureau for Economic Research (BER) general confidence index shows the same patterns, also for quite a few quarters. Both of these indicate slow growth for the future, which could be exacerbated by further policy uncertainty, labour unrest and the electricity constraint.
The two general manufacturing confidence indicators show ambivalence. Actual and expected manufacturing confidence showed declines. The business activity sub-index show growth in the fourth quarter of 2014, but the December number declined strongly, indicating the first signs of the impact of the electricity constraints on the M&E sector.
Prospects for international market growth depend a lot on economic recovery in Asia (40%), EU (35%) and Africa (22%) and North America (14%) of the market. Purchasing managers’ index indicators for all these regions, except the US and the UK, have been moving sideways or declined recently. Only the US growth performance seems to be sustainable, although Asian (Chinese) growth out-performs the rest, but at a slower pace than in the past.
Not surprisingly, growth in the demand for steel and related products has been moderating recently and is expected to be about 2%, with much lower prices and heavily-contested markets.
International Trade dynamics
The sector recorded an overall improvement in its trade balance with the rest of the world in 2014. It meant that the sector’s trade deficit with the rest of the world shrunk.
Imports became more expensive (in rand terms), caused by the exchange rate depreciation. However, imported products became cheaper (in dollar terms), also due to lower international commodity prices. The price effect (higher rand cost for imports) and lower import volume demand within SA (due to sluggish growth) had the net result of imports not growing as much as they did in the years preceding 2014.
Africa continued to be a strong export market for the metals and engineering sector during 2014, particularly Southern African Development Community and West Africa. However, Africa’s growth is likely to slow down due to continued sluggish commodity demand internationally, significantly lower oil revenues and the drastic curtailment of investment in new ventures by companies and probably governments.
Despite some respite in terms of the trade balances not deteriorating as much as before, the sector as a whole is still overwhelmed by imports, primarily from Eastern Asia and Europe. Generally this is due to low international competitiveness, which cannot be solved by a continually-depreciating exchange rate. The more complex production becomes and the greater the share of domestic input cost (labour, electricity, transport, etc.), the less competitive the industries become. This is reflected in the sector’s long-term trade balance trend.
The medium- to longer-term impact of instability of domestic production (industrial relations, electricity etc.) disruptions and, therefore, security of supply to international customers has not been discounted yet and should be of added concern for the future.
Electricity constraint and its impact on South Africa’s economic growth
There is very little doubt that reliable energy supply is of vital importance to the growth of any country’s economy. Unstable electricity supply brings business operations to a standstill and hampers long-term economic growth.
South Africa has, over the years, experienced frequent energy supply shortages. In addition, uncertainty about the security of its supply going forward as well as constant reports of delays in solving supply challenges are bound not only to impact negatively on South Africa’s already ailing economy, but also to change how the country is perceived as an investment destination.
On average, energy costs in the metals and engineering sector account for about 8% of intermediary input costs. It, therefore, stands to reason that, without reliable energy supply, the sector cannot grow. It is very unfortunate that even right now the sector cannot operate at full capacity as a result, among other things, of energy constraints.
Actual or realized economic growth in the South African economy has fallen substantially below its potential. While energy provision should support our growth ambitions, there appears to be a real danger of the two gradually drifting apart.
South Africa is now seriously in danger of falling below a 2,5% average in this decade. This is mostly owing to the fact that although the economy had grown faster in the past decade (2000/2010) than recorded during the seventies, South Africa missed the last super cycle and completely under-estimated the economy’s accelerated energy demand over this period.
As a country, we need to tackle this challenge with a single-minded determination as though we were going to war. Without a sufficient and secure supply of energy – and, in this case, electricity – it is not possible for South Africa to be globally competitive.