It’s been a challenging time for the metals and engineering industries recovering from the effects of the COVID-19 pandemic, unprecedented inflation, rising fuel prices, devasting floods and persistent loadshedding. All businesses have been impacted by these events. The global economic outlook has deteriorated significantly since Russia invaded Ukraine. Growth forecasts have been revised lower with each iteration while inflation has been revised upwards.
During Q1 2022, inflationary pressures were already building in the global economy, however, this was initially driven by aggregate demand increasing faster than supply chains could respond. The invasion of Ukraine by Russia in February 2022 set the proverbial cat amongst the pigeons in economic and inflation terms.
In the spectrum of leading, coinciding and lagging economic indicators, the metals and engineering sector is classified as coinciding. That is, its performance is indicative of the prevailing economic fundamentals. It is also extremely sensitive to these prevailing global and domestic economic events. To this end, our estimates already point to production in the sector contracting by between -1.1% to -1.3% in Q2 2022, with notable downside risks for the full year’s outlook.
This view is informed by a number themes that are shaping the global and domestic economic fundamentals. These include the aggressive monetary policy tightening in the US, in response to multi-year record inflation outcomes recorded in that country. The on-going Russia-Ukraine war and its implications for the European Union. A concerning development is the weaponizing of gas supply by Russia to Germany, which will have recessionary consequences for Germany, the largest economy in the EU and South Africa’s second largest trading partner. The dominance of Russia and Ukraine in the food inputs and commodity complex is driving inflationary pressure globally, reinforcing the need for central banks around the world to increase interest rates. China’s aggressive zero-covid policy, in which the last round of lockdowns has affected the economic hubs of Shanghai and Beijing have contributed to a slowing global economy.
These themes will continue to dominate the global economic narrative and the slowing of global economic growth. Steel production is highly correlated with economic growth and the early warnings signs of a slowing growth rate are evident in the reduction of iron ore prices, a key ingredient in steel production.
In dollar terms iron ore price have decreased 28.6% year to date 2022 and down 49.3% year-on-year to July 2022. This is despite a reduction in sea-borne supply from Ukraine. Domestically basic iron and steel sales declined by 8.1% year to date, other fabricated metals declined 8.5% and structural steel products declined 1% over the same period.
Compounding the global headwinds are weak domestic fundamentals that are also feeding into the outlook. The energy crisis, which was the worst on record in Q2 2022, is a major constraint and risk to the outlook. Electricity availability is an essential input into the metals and engineering sector. The sector is comprised of energy intensive users of electricity who have to cut production due to electricity curtailment. Whilst the sector also comprises producers that are less energy intensive, load-shedding causes a complete halt to operations.
The state of local government and the lack of service delivery is another major constraint. Companies in the metals and engineering sector are spread across the length and breadth of the country and are adversely affected by service delivery failure at local government level. The inefficiencies of local government breed costs for producers eroding their competitiveness. It goes without saying that, now, more than ever before a national strategy on industrialisation is needed to stabilise and reignite the metals and engineering sector, which must include an aggressive infrastructure programme and a dedicated focus on economic reform rolled-out in partnership with the private sector.
To borrow the adage that a rising tide lifts all boats, means that the inverse is also true. In a less supportive global economic environment with headwinds intensifying, domestic economic policy and reform has to do a lot more heavier lifting to support the economy. With a fragile global environment, a sluggish local economy, an outlook for the remainder of the year and into 2023 remaining uncertain and the prospects of things getting worse before improving now would be a good time to adopt a more frugal outlook.