2018

1. Foreword

The Steel and Engineering Industries Federation of Southern Africa (SEIFSA) is the undisputed voice of the metals and engineering sector in South Africa and the region. Its knowledge and understanding of the sector is unequalled.

Formed in 1943, SEIFSA is 75 years old this year. Over the years, the Federation has seen the metals and engineering sector go through great times and – especially in recent years – challenging times. Not only has it kept pace with developments in the sector, but often it has  been a crucial – and sometimes indispensable – part of those developments and a reliable voice of the sector.

Long known for and strongly associated with collective bargaining, SEIFSA offers various products and services of great importance to companies in the metals and engineering sector, including those in other economic sectors with close links to this part of the economy. It boasts four Divisions led by respected experts in their respective fields – Economics and Commercial; Industrial Relations and Legal Services; Human Capital and Skills Development; as well as Safety, Health, Environment and Quality. These services range from consulting through to training, both public and in-house.

Our revered Economics and Commercial (EC) Division is a repository of much of the information on the sector’s economic performance over the years. For more than half a century, the EC Division has published the unique and indispensable SEIFSA Price and Index Pages (PIPS). Over the past two decades, the Division has also conducted traning for those keen to benefit from our training in Contract Price Adjustments (CPA).

To mark our 75th anniversary, this year we publish our biggest and most authoritative State of the Metals and Engineering Sector 2018 to 2019, which has much more information than any of its predecessors. Compiled by Dr Michael Ade and Ms Marique Kruger, this publication is brimming with invaluable information on the sector’s historical and expected future performance.

I have not the least doubt that all who closely monitor the fortunes of the broad metals and engineering sector and its sub-sectors in Southern Africa, and those with even a passing interest in it and its related sectors, will find this Report invaluable. I commend this Report highly to all who are keen to understand a very important – and strategic – part of the broad manufacturing sector and thank Dr Ade and Ms Kruger for their labour of love.

Both Michael Ade and Marique Kruger are available for consultations with stakeholders interested in deepening their understanding of the metals and engineering sector and its sub-industries. They can be reached at Michael.ade@seifsa.co.za and marique@seifsa.co.za by those companies keen to invite them to help during their strategic planning sessions, for consultations on any aspect of the sector or to book  CPA training.

In conclusion, I wish you, an important stakeholder in the metals and engineering sector, everything of the very best in 2018.

Kaizer M. Nyatsumba
Chief Executive Officer
29 January 2018

2. Executive summary

Global economic growth remained fairly robust in 2017, aided by a rebound in investment and trade, against the backdrop of benign financing conditions, generally accommodative policies, improved confidence and the dissipating impact of the earlier commodity price collapse. There is a general sense of optimism because global growth is expected to be sustained over the next couple of years and even accelerate somewhat in emerging market and developing countries (EMDEs), driven by a rebound in commodity exporters (World Bank, 2018).

However, there remain important downside risks, including disorderly financial market movements, adverse effects of borrowing costs, escalating trade protectionism or rising geo-political risk which could also negatively affect confidence, trade and overall economic activity. However, although global trade strengthened significantly in 2017, driven largely by a recovery in manufacturing and investment growth, the momentum is expected to diminish in 2018-2020, as the upturn in China continues to decelerate.

Global trade is also expected to be constrained by structural factors, including the slower pace of global value chain integration and trade liberalization.  Although the newly-introduced protectionist measures in 2017 stabilized in the largest economies and declined in the rest of the world, the shock of these measures continues to reverberate around the world, with anti-dumping duties and other tariffs accounting for close to half of the recently introduced protectionist measures. Exporters of iron and steel, electrical energy and metal products remained disproportionately affected by trade restrictions.

The US Federal Reserve Bank continued to normalise monetary policy in 2017, raising interest rates and starting to gradually reduce the size of its balance sheet. Recently- legislated corporate and personal income tax cuts are expected to provide a lift to activity (especially investment) in the medium term.  These dynamics are determinants of the pattern of investment and global capital flow to the Rand.

The appreciation of the Euro during 2017 is likely to further delay a pick-up in inflation in 2018 as it puts downward pressure on import prices. This is likely to impact on trade activities and operating profits in the M&E sector, given that Europe is its third largest exports destination. The Bank of Japan left policy rates unchanged in 2017, given its low inflation (below 1%), and continued to calibrate its bond purchases to stabilise long-term bond yields around zero.

Commodity prices recovered in 2017 and are expected to gain momentum in 2018, thereby strengthening exports and improving growth prospects for commodity exporters in emerging markets (along with enhanced capital inflows). Yet, it is unclear how long the positive outlook will continue, given the volatility in commodity prices.

The year 2017 was generally better when compared to the preceding year. The economy grew by 0.8% and potential output was lowered to 1.1%.

Gross fixed capital formation remained negative, with private enterprises and SOCs contributing to this contraction. However, general government is expected to provide the one source of positive investment growth for 2018, still supported by ongoing road rehabilitation projects by provinces and local governments. There is also the possibility that the fiscal consolidation path to be pursued in the February 2018 budget may stifle some investment projects from the government sector.

Growth is forecast at 1.1% in 2018 and 1.7% in 2019, against the backdrop of improved commodity prices. The robust pace of expansion in emerging markets with a number of commodity importers is expected to continue. Risks to the outlook have become more balanced in some regions, but continue to tilt down in all emerging market regions.

Global goods trade has gathered momentum since mid-2016, following two years of pronounced weakness. A cyclical rebound in investment contributed to strong growth of trade in machinery, electronics and semi-conductors. Import demand from both advanced economies and emerging markets has improved.  Export growth also accelerated in most emerging markets. This should translate into some continued exports for South African products, bringing in much-needed foreign currency.

The recent downgrade of South Africa’s sovereign currency ratings to “junk” status by Fitch and Standard and Poor have the propensity of increasing borrowing costs and the general cost of doing business. This will further negatively affect the investment demand curve in the M&E sector, which has been declining over a number of years, as proxied by the low levels of fixed investment.

The continued survival of the sector depends, as far as the domestic economy is concerned, crucially on the health and growth of the sectors which are drivers of its demand, namely mining, construction and the automotive sector. All of these efforts have potential medium- to longer-term benefits for the sector.

Higher protection of the sector against import penetration and domestic demand redirection to domestic suppliers hold good potential, but can only be a short-term solution. Rejuvenation over the medium to longer term will depend on the recovery of the mining, construction and automotive sectors as well as the alleviation of structural constraints (domestic infrastructure and logistics).

Most importantly, the international competitiveness of the M&E sector will have to improve for the sector to regain its position as preferred suppliers domestically and in international markets.  This is imperative given the optimism in the domestic economy and increasingly improving global economic prospects.

As one of the inputs that companies have a relative degree of control over, labour can be measured, observed, influenced, contained and, in times of difficulties, disposed of by employers who often shed jobs (not as a last resort) in order to minimise costs. However, the difficulty with this purview is that output may be compromised in the process, due to the existing linkage between labour and production. The strong correlation between production and employment affirms this point.

Investment into the sector has also been relatively low. Although the labour dynamics of the M&E sector are not the sole cause of low investment flows into the sector (given the poor levels of investment into the broader economy), they are an important contributory factor. More consideration should be given to productivity, especially labour and total factor productivity.

The horizon for the M&E labour market seems calm and there would appear to be no anticipation of disruptions to production from disgruntled employees. Stakeholders need to carefully manage the existing trade-offs between unit labour cost and productivity and arrest the widening gap in the medium to long term, while improving production. This is important, given the spill-over benefits to employment and jobs underpinned by the strong relationship between these two variables.

The international trade performance of the M&E sector improved significantly in 2017. Exports of the sector grew by 9,7% and imports expanded by 5.8% in 2017 when compared to those in 2016. Even though a trade deficit was still recorded in 2017, there was an improvement in the deficit compared to that of 2016 and improvement was also recorded in the terms of trade.

The trade deficit receded further in 2017, with the sector exporting R237 billion’s worth of output and importing R358 billion’s worth of products, resulting in a trade deficit of R121 billion. The sector’s terms of trade also improved in 2017, while import saturation reduced simultaneously. The composition of the export and import baskets remained relatively the same as in 2016. The improvement in the trade deficit was a function of exchange rate movement, especially during the second half of 2017, with South Africa benefitting from improving global trade volumes which gathered momentum since mid-2016.  The M&E sector specifically benefitted from a cyclical growth of trade in machinery, electronics and semi-conductors.

The M&E regional trade baskets have remained unchanged. Africa is still the highest export destination, followed by Asia. Africa also accounts for the best trade balance (R80 billion), including the SADC and SACU shares of R35 billion and R31 billion respectively.  The SADC and the SACU regions continue to be the largest export destinations. Also import saturation reduced in 2017 (albeit not enough to trigger a trade surplus) when compared to 2016, judging by the better trade deficit in 2017.

Prior to 2017, the M&E sector had been in decline for three consecutive years. This had resulted in production declines, under-utilisation of production capacity, employment losses, unprecedented low-profit margins and near-stagnation in investment. Despite the up-tick in production recorded in 2017, the aforementioned challenges significantly contributed in reducing the sector’s competitiveness, leading to a loss of international and domestic market share.

Despite the current potential to improve on margins being fragile, all indications are that the M&E sector will record another increase in growth during 2018. This will have continued positive implications for employment and investment in the sector.

Our forecast is for the entire M&E sector to expand modestly by 1.1% in 2018.  However, the various sub-sectors will register varied levels of growth, with some expanding and others contracting in 2018. These forecasts will be tracked during the year and updates on the actual situation provided in our quarterly reviews.

The results align greatly with the outlook for an increasing but mild domestic growth. Despite improving perceptions (both political and business), the real gross domestic growth for 2018 is forecast at a moderate 1.1%, improving by just 0.3% from 2017.  Gross fixed capital formation is only expected to improve by 0.2 percentage points in 2018 relative to 2017 and accelerate by an additional 0.5 percentage points in 2019. The reasonable contribution of both variables corroborates our modest forecast results for 2018.

2017

1. Foreword

The Steel and Engineering Industries Federation of Southern Africa (SEIFSA) is the undisputed voice of the metals and engineering sector in South Africa and the region. Its knowledge and understanding of the sector is unequalled.

Long known for and strongly associated with collective bargaining, SEIFSA offers numerous products and services of great importance to companies in the metals and engineering sector, including those in other sectors of the economy. It boasts four Divisions led by respected experts in their respective areas – Economics and Commercial; Industrial Relations and Legal Services; Human Capital and Skills Development; as well as Safety, Health, Environment and Quality. Their services range from consulting through to training (public and in-house).

Seventy-four (74) years old this year, SEIFSA has seen the metals and engineering sector go through great times and challenging times over the years. Not only has it kept pace with developments in the sector during this period, but often it has been a crucial – and sometimes indispensable – part of those developments.

Our revered Economics and Commercial (EC) Division is a repository of much of the information on the sector’s economic performance over the years. For more than fifty (50) years the EC Division has published the unique SEIFSA Price and Index Pages (PIPS), which many established companies have found indispensable. It has also routinely conducted training in Contract Price Adjustments, which has been in growing demand over the past two decades.

The EC Division is, therefore, one of our most important business units within SEIFSA. We have also been very lucky to have in that Division a great, enthusiastic team led by the affable Tafadzwa (“Taffie”) Chibanguza, our Senior Economist. He and Junior Economist Roberta Noise – who worked for Statistics South Africa before joining us – did a fantastic job in expertly compiling this invaluable State of the Metals and Engineering Sector 2017 to 2018 Report.

I have no doubt that all who monitor or follow the fortunes of the broad metals and engineering sector and sub-sectors in Southern Africa, and those with even a passing interest in it and its related sectors, will find this Report most useful. It will certainly help them to understand the sector much better and to anticipate possible future trends. Perhaps more importantly, it will also help them to understand better the state of manufacturing in South Africa and, in the process, the South African economy itself.

I commend this Report most highly to all who have the best interests of the metals and engineering sector at heart. Of necessity, these must include sector employers, our labour partners, as well as policy makers and researchers. It is a well-researched, authoritative analysis that is without peers. Our Economics and Commercial team has outdone itself.

Both Tafadzwa Chibanguza and Roberta Noise are available to help stakeholders interested in deepening their understanding of the sector and its sub-industries for their strategic planning sessions, or to consult with companies seeking to enrich their understanding of their areas of business. They can be reached on the addresses taffie@seifsa.co.za and roberta@seifsa.co.za. I cannot commend them highly enough.

Kaizer M. Nyatsumba
Chief Executive Officer
27 January 2017

2. Executive summary

There is a general sense of optimism in the world 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.

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.

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. Sentiment towards emerging markets looks promising, given advanced economy uncertainty. Hopefully this should translate into some continued rand strength.

We have previously highlighted that the metals and engineering sector is currently going through a deep structural adjustment. This structural adjustment  extended through to 2016, which was a particularly difficult year both for 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 increased marginally when compared to 2015 but,  measured on its long- run trend, the index has been on a downward trajectory since 2014.

We highlight statistically that employment 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 in this report to  the risks of further job losses in the sector.

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!

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.

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%.

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 prognosis is for the metals and engineering sector to expand by 1.4% in 2017. This 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.

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.

2016

1. Introduction

For some time now, the metals and engineering sector – and, with it, the whole manufacturing sector – has been on the back foot. At a time when the world is much more integrated, South Africa’s metals and engineering sector has shrunk, thanks to a deluge of imports predominantly from Asia and, to a significant extent, the European Union.

Owing to a host of factors, among them rising domestic input and administered costs, over the past few years our sector has lost its international competitiveness and imports have substituted for some domestic production. That is much more apparent in the year under review, during which metals and engineering sector exports from South Africa have shrunk, at a time when the Rand was at its weakest, and foreign imports have soared.

In 2015 total exports from the sector were R234 billion and total imports R376 billion, resulting in a trade deficit of R142 billion.

This indicates a sector under siege. If nothing is done to counter this alarming deterioration, there is a good chance that the situation can only get worse and more jobs will be lost. Clearly, it is paramount that all relevant stakeholders – the Government, business and labour – work together to arrest this trend and reverse it as a matter of extreme urgency. The metals and engineering sector is one of the most strategic in any economy, our own included.

The only encouraging news from this authoritative, in-depth look at the state of the metals and engineering sector in 2015 and the forecast for 2016 and beyond is the growing importance of Africa, as an export destination, for South African exporters. With the continent attending to its infrastructure development, Africa’s importance as a market for the sector is likely to grow even more in the years to come.

I commend this Report highly to all who are interested in the welfare of the metals and engineering sector in South Africa, be they players in the sector, policy makers or labour. It is a well-researched, authoritative analysis of the sector that is certainly without peers. The SEIFSA Economics and Commercial team, whose understanding of the sector is unequalled, has outdone itself in this report.

The team is available to help stakeholders interested in understanding the sector or any one of its sub-sectors, for their strategic planning sessions, or to consult with companies seeking to enrich their understanding of their area of business. They can be reached on the addresses henk@seifsa.co.za and taffie@seifsa.co.za.

Kaizer M. Nyatsumba
Chief Executive Officer

2. Executive summary

The metals and engineering sector experienced a truly annus horribilis during 2015. At the time of writing:

production has dropped by 3%, the third consecutive year of decline;

employment numbers have dropped by 1,8% or 7000 people;

profit margins have been under severe strain, with many companies making losses; and

capacity utilization is at 75%, against a benchmark of 85%, and investment in the sector has stagnated (-16%) and imports surged.

The sector went into recession in the middle of 2014. These depressed levels of activity have been consistent for seven years, with renewed declines since the middle of 2014. The financial crisis of 2008/9 was a totally unexpected event and “game changer”, and the small domestic metal sector revival around the World Cup activities (2009/10) was short-lived. The aftermath of the labour, electricity and international demand disruptions during 2014 seemed to have deepened the crisis during 2015. The conclusion is that the sector is experiencing a structural change, and not only a cyclical decline.

The export market represents around 40% of total demand for products of the metals and engineering sector. The sector’s trade balance deteriorated significantly during 2015, completely reversing the improvement achieved in 2014. Between 2013/2014, the trade balance improved by 12% in nominal terms and 36% in real terms, but deteriorated by 38.2% in nominal terms and 35.3% in real terms between 2014 and 2015. In 2015 total exports were R234 billion and total imports R376 billion, resulting in a trade deficit of R142 billion.

One of the reasons for the structural trade deficit recorded is the composition of the total export basket (52% to 55% biased towards upstream and semi-processed products) and the import composition (72% to 75% biased towards high-value completed machinery and equipment). The situation was worsened by falling commodity prices, which were a key reason for the structural deterioration (-9,9%) in the sector’s terms of trade (ratio of export to import prices).

It was quite clear in 2015 that the sector’s exports are not sensitive or did not respond to a weakening exchange rate due to domestic rigidities. The African market remains an important export market for the metals and engineering sector, accounting for 38% of total exports in 2015. The Southern African Development Community (excluding the Southern African Customs Union) and the Southern African Customs Union (excluding South Africa) make up 86% of exports into Africa, with West and East Africa making up 10% of total exports.

World economic growth was even weaker during 2015 than expected at the end of 2014. There is overwhelming evidence that lacklustre international growth will continue for at least two to three years, after which improvement could be expected. This is due to the continued structural changes taking place in the Chinese economy, accompanied by huge volatility in stock and currency markets spilling over into all international markets.

The fact is that the commodity super cycle came to an end in 2011 and the down phase has been in progress since. All indications are that at least another five years of subdued growth can be expected, resulting in mining investment decisions on expansions and exploration being drastically curtailed.

There are renewed concerns about the vigour (depressed profits, growth weakness and low labour uptake) of US economic recovery, although cautious actions by the Federal Reserve might be a stabilising factor in an increasingly unstable world economy. Generally, emerging market growth slowed down much more during 2015 (the third year in succession) than anticipated, and in an unprecedented number of countries. According to the World Bank, this is the worst performance in 30 years.

Prospects for and trends in world manufacturing production (the source of demand for SA products) are quite disconcerting and regionally dispersed. The USA, the UK, China, India, Russia, Brazil, Indonesia and Malaysia all showed contractions towards the end of 2015, while the EU and Japan expanded. Global production of steel has recovered since the financial crisis of 2008, but the tempo of growth has tapered off over the last three years, with the problem of huge over-capacity amongst world steel producers remaining. World steel exports have grown strongly, in the process swamping markets. This unleashed a barrage of protection measures from importing countries worldwide, of which SA was one of the last to raise tariffs.

The South African economy grew by an estimated 1,4% during 2015.  Gross fixed capital formation is estimated to have grown by a meagre 1,5% during 2015, with private sector investment contracting. The outlook for economic growth in 2016 is dismal, at around 1% and 1,5% during 2017. There is a possibility that, if the downside risks accumulate, the country could go into a recession during 2016 and struggle to reach 2% by 2018.

The sector is dependent mostly on mining, construction and the auto sectors for domestic demand growth. All four are driven by the same five big variables: global growth, commodity prices, their competitiveness vis-à-vis imports and policy certainty.

International capital flows and confidence in SA’s domestic economic policy direction will continue to have a major impact on the cost of obtaining international finance in future. Markets indicate that it would just be a matter of time before SA’s credit rating is downgraded to sub-investment status. The adverse trends and shocks on the economy resulted in overall confidence (net balances) deteriorating to below an index number of 40 (50 being neutral). It has become abundantly clear that SA’s political and policy direction has a major impact on the performance of the economy.

Apart from policy uncertainty, low growth and unstable international conditions, Government finances face four major risks:

Domestic economic growth is below potential and makes further debt financing problematic;

the Government’s salary bill cannot be contained, thus crowding out capital expenditure and leaving no space for fiscal stimulation;

institutions run by the state (ESKOM, SAA, PRASA, the SA Post Office, etc.) are in an ever-increasing need of support by the Government; and

the unstable labour market environment disrupts production, in the process further jeopardising export success.

The metals and engineering sector faces significant domestic input cost increases, chiefly labour (8% to 10% increase), administered prices (8% increase) and a weakening exchange rate. The inflation rates recorded in both the production price indices (final and intermediate) significantly undercompensates for the price pressures experienced by companies in the metals and engineering sector, suggesting a very difficult operating environment, one in which companies are unable to pass input costs onto the market.

While falling prices have benefits to buyers of the sector’s products, they are of great concern for the sector because factory gate prices equate to selling prices and eventually translate to profit margins. This complete divergence between selling prices and costs threatens the very survival of the metals and engineering sector. The situation is expected to continue throughout 2016, with possible disastrous effects for the sector’s sustainability.

Prospects of growth in international demand are very low. The outlook for both domestic economic growth and gross fixed capital investment in the economy is also weak. All indications are that the metals and engineering sector will record another decline during 2016, with a lower turning point only expected during 2017. This will have continued negative implications for employment and investment in the sector.