State of the Metals and Engineering Sector 2017 to 2018
This article is an extrapolated summary of the State of the Metals and Engineering Sector 2017 to 2018 Report. The current report is the fourth such report in as many years. The full report is available from SEIFSA.
GLOBAL ECONOMIC ENVIRONMENT
There is a general sense of optimism in the global economy as we enter 2017.
The high degree of uncertainty surrounding the economic policies of the new administration in the United States of America (USA) is expected to persist for some time, creating a challenging and volatile environment for emerging markets. The prospect of rising protectionism and its implications for world trade are also a concern. The impact of Brexit, how the separation will be managed, and if any more countries will leave the Union also pose a potential risk to global economic stability.
Prospects for a resumption of interest rate hikes in the USA remain and will be a key determinant to the pattern of global capital flows and to the rand. Hopefully this should be mitigated by the very accommodative monetary policy stances in the European Union and Japan.
Activity in advanced economies is expected to expand to 1.8% in 2017, up from 1.6% in 2016.
Emerging market developing economies expanded by an estimated 3.4% in 2016, according to the World Bank. Interestingly, commodity-exporting economies expanded at a markedly lower pace than commodity importers. This suggests resilient domestic demand, low commodity prices and generally accommodative macroeconomic policies in commodity-importing economies. It also suggests that the increase in the commodity prices has not fully translated to the benefit of the commodity exporters, raising questions into the cyclicality or structural probabilities of the commodity price increases. Growth in the emerging economies is expected to expand to 4.2% in 2017.
Table 1: Growth Rates (Global, Advanced and Emerging Economies)
Source: World Bank, Jan 2017
Commodity prices were significantly low at the start of 2016, but the majority of them recovered. This points to possible further momentum in 2017. This has improved growth prospects for commodity-producing emerging markets in particular, along with more favourable capital inflows. However, it is unclear how long these positive developments will continue. Several emerging markets and developing economies face the task of optimising on the recent commodity price increases, even if the surge is short lived.
Graph 1: Global Commodity Price Index
Source: SARB, Dec 2016
SOUTH AFRICAN ECONOMY
2016 was a very difficult year for the South African economy and, by extension, the metals and engineering sector. The economy grew by 0.4% in 2016 and potential output was downgraded to 1.3%. A negative output gap was recorded in 2016. Gross fixed capital formation remained negative, with general government contributing to this contraction as explained by fiscal consolidation.
Economic growth in South Africa is forecast at 1.2% in 2017 and 1.8% in 2018, against the backdrop of improved commodity prices and improving global activity. Sentiment towards emerging markets looks promising, given advanced economy uncertainty. Hopefully this should translate into some continued rand strength.
THE METALS AND ENGINEERING SECTOR
The metals and engineering sector is currently going through a deep structural adjustment, one which begun in 2007/08. This structural adjustment extended through to 2016, which was a particularly difficult year for both the sector and the South African economy in general.
2016 was particularly concerning given the renewed downward trajectory in the production, employment, investment and profit trends. In 2016 capacity utilisation for the overall sector increased marginally when compared to 2015 but, measured on its long- run trend, the index has been on a downward trajectory since 2014.
In 2016, production in the metals and engineering sector contracted by 2%, employment decreased by 1.7% and profit margins deteriorated substantially.
Employment in the sector is currently above its production level by about 3000 jobs, and given the historical characteristics of the labour market in the sector for clearing excess capacity, we draw attention to the prospect of further job losses in the sector into 2017.
There is clear statistical proof that the renewed downward pressure in the production index can be attributed to the production disruptions of 2014 (the five-month platinum mines strike and the month-long metals and engineering strike). The sector has clearly not recovered from these disruptions. More importantly, the disruptions appear to have adversely affected the long-run trends. This is particularly important because the sector will be negotiating a new wage deal in 2017. We highlight this as a definite risk because in the event of an unfortunate outcome (production disruption), a new, deeper downward spiral could be initiated, in the process spelling disaster!
THE LABOUR MARKET IN THE METALS AND ENGINEERING SECTOR
Labour market dynamics are complex, at best. However, labour is one of the costs over which companies have a relative degree of control. It would follow that in an environment where the sector is contracting, cost rationalisation and optimisation would most likely result in attempts to manage this line in the income statement. The strong correlation between production and employment affirms this synopsis.
There is a negative unit labour cost to labour productivity differential in the metals and engineering sector, an unfortunate trend which has held since 2009.
Investment into the sector has also been relatively low for reasons that include a flat economy, flat markets and idle capacity, to name a few. However, the capital labour ratio indicates that there has not yet been a significant drive to mechanise in the sector.
METALS AND ENGINEERING INTERNATIONAL TRADE
The international trade performance of the metals and engineering sector improved markedly when 2016 is compared to 2015, even though a trade deficit was recorded in 2016. Improvement was also recorded in the terms of trade in 2016.
The trade deficit receded in 2016, with the sector exporting R216 billion worth of output and importing R339 billion worth of product, resulting in a trade deficit of R122 billion. The sector’s terms of trade improved by 4.6% in 2016.
Regional trade baskets have remained unchanged, with Africa still counting as the highest export region for the sector. A decline of 9% in Africa’s share to the total export basket was recorded in 2016, which is indicative of the reliance of African economies on commodities and commodity prices, and how it affects their demand for imports (South African exports). In the composition of Africa as an export market, the South African Development Community (SADC) continues to be the largest export destination at 85%.
INPUT COST AND SELLING PRICE INFLATION
The input cost inflation prospects of the metals and engineering sector are to a great degree dependent on exchange rate movement. This is evident in the easing in input cost inflation as the exchange rate strengthened in the last quarter of 2016. This created a positive inflation differential between selling price and input cost inflation for the first time since the beginning of 2015.
Our 2017 prognosis is for the metals and engineering sector to expand by 1.4% on an annualised quarterly average.
This is comparable to the calculation of GDP growth. However, 2016 was a very bad year therefore contributing statistical base effects in computing the result above. When we control for base effects, our model computes the metals and engineering sector expanding by 0.4% in 2017.
This improvement is a function of improving global and domestic growth. Commodity prices are an important link between developed and developing markets and are a channel of wealth distribution. The current commodity price surge contributes favourably to our forecast; however, there is a lot of uncertainty as to whether it is simply a cyclical bounce or a structural one. As at the beginning of 2017, all indications point to a cyclical bounce. This places greater responsibility on policy makers and companies to make the most of the commodity price surge, in what seems to be a fairly short time horizon.
Table 2: M&E and Sub-Industry Forecasts
Source: SEIFSA Calculations
In our prognosis we stress the fact that our forecast is underpinned by an assumption of no production disruptions linked to the 2017 wage negotiations. In the event of strike action ensuing, we would have to revise our forecast model.