SOUTH AFRICA ECONOMIC NEWSLETTER JANUARY 20 2006

UNCLAS SECTION 01 OF 03 PRETORIA 000227 SIPDIS SIPDIS DEPT FOR AF/S/MTABLER-STONE; AF/EPS; EB/IFD/OMA USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND TREASURY FOR OAISA/RALYEA/CUSHMAN USTR FOR COLEMAN E.O. 12958: N/A TAGS: ECON EINV EFIN ETRD BEXP KTDB PGOV SF SUBJECT: SOUTH AFRICA ECONOMIC NEWSLETTER JANUARY 20 2006 ISSUE ¶1. Summary. Each week, Embassy Pretoria publishes an economic newsletter based on South African press reports. Comments and analysis do not necessarily reflect the opinion of the U.S. Government. Topics of this week's newsletter are: - Consumer Confidence Up; - Manufacturing Activity Improves; - October Retail Sales Up 7.7%; - Predictions of 2006 Budget Proposals; and - South Africa's 2006 Growth Prospects; End Summary. Consumer Confidence Up -------------- ¶2. Diminishing chances of a rise in interest rates, along with declining fuel prices, led South African consumers to express strong confidence in the final quarter 2005. The First National Bank and Bureau for Economic Research at Stellenbosch University (FNB/BER) consumer confidence index rose to 20 in the fourth quarter, compared to 17 in the third quarter 2005. More people seem confident about their own economic prospects, as income, employment and asset market prices keep rising. Consumers expect that interest rates will remain constant throughout 2006, although more consumers thought that durable goods should not be purchased now and that housing price growth will stagnate. Confidence among whites fell, while black consumer confidence rose for the third consecutive quarter. The confidence of high-income earners rose, while that of low-income earners fell. Source: Business Report and Business Day, January 18. ¶3. Comment. The FNB/BER index is compiled from the results of a survey in which consumers are asked for their outlook for the economy and their own finances in the next year, as well as whether they view the present time as suitable to buy durable goods. End comment. Manufacturing Activity Improves -------------- ¶4. According to the Investec Purchasing Managers Index (PMI),growth in manufacturing improved in December, with PMI reaching 52.5 compared to November's level of 50. The December rise halted a consecutive four month decline, although the index remains well below the peak of 60 reached in July 2005. Analysts fear the recent strength of the rand could still threaten continued job creation in the manufacturing sector as exports decline and competition increases from cheaper imports. At the end of December 2005, the rand closed at R6.32 per dollar, and reached R5.96 on January 17, an eight-month high. PMI's employment index improved in December, although still showing signs of contraction. December's job index reached 48.7 compared to 45 in November. Source: I-Net Bridge, January 18; Business Day, January 17. ¶5. Comment. A reading above 50 signifies expansion in the manufacturing sector, while a number below 50 indicates that manufacturing output is shrinking. Manufacturing accounts for 16.4% of GDP, however, it accounted for almost 22% in 2002. The latest PMI follows figures from Statistics SA showing manufacturing output grew 3.7% in November compared to the previous month's 0.7% growth. End comment. October Retail Sales Up 7.7% -------------- ¶6. In October, South Africa's real retail sales rose by 7.7 % (y/y) compared to September's growth of 5%, according to Statistics South Africa. On a quarterly basis, retail sales rose by 7.0% percent. Stronger growth in consumer demand has driven faster South African growth since 2002, helped by low inflation and interest rates. Retail sales contributed 13.7% to GDP in the third quarter of 2005. Although retail sales are expected to continue to grow strongly in 2006, economists expect the rate of growth to stabilize in the absence of any new interest- rate cuts and as higher inflation slows down the pace of real income growth. Brait economist Colen Garrow said strong retail sales had been supported by both fiscal and PRETORIA 00000227 002 OF 003 monetary policies, with R74 billion ($12 billion using 6 rands per dollar) in tax relief since 1995 and 6.5 percentage points reduction in interest rate since 2003. However, he does not expect these expansionary policies to continue. In addition to the stimulus of tax cuts and lower interest rates, retail sales had benefited from increasing black middle class. The South African Advertising Research Foundation, which measures movements from Living Standard Measures (LSM) 1 (low income) to LSM 10 (high income),had reported significant shifts within the middle income spectrum. These shifts were concentrated around LSM 6-7, where the number of black South Africans had increased by some 683,000 between 2000 and 2004. Source: Reuters and Business Day, January 19. Predictions of 2006 Budget Proposals -------------- ¶7. According to Kevin Lings, the chief economist at Stanlib (South Africa's largest mutual funds company),the February 15 South African budget might announce that exchange controls for individuals would be lifted. In addition, pension funds may also have their offshore limits lifted slightly. Another of Lings' predictions was that the SA Revenue Service might have collected R40 billion ($6.6 billion) more in taxes than was expected. A growing number of financial firms predicted that the government would collect extra revenue. BoE Private Clients estimated a total R60 billion ($10 billion) extra revenue, while Johan Rossouw, the chief economist at Vector Securities, estimated a R32 billion ($5.3 billion) overrun with an outside chance of R50 billion ($8.3 billion). The collection of excess revenue opens the possibility of tax cuts and extra government spending. Lings expects individual tax relief, although he is less certain about reduction in company taxes. He advocates a broad-based policy response to growth obstacles cited recently by a World Bank report surveying 800 South African companies. These companies cited lack of skilled workers, labor regulations, rand volatility and crime as the main obstacles to sustained 6% growth in South Africa. Source: Business Report, January 19. South Africa's 2006 Growth Prospects -------------- ¶8. Domestically, economic growth prospects are optimistic. Uneasiness remains over the extent to which South Africa's future growth prospects depend on global events. The South African economy has outperformed expectations, with GDP growth now seen at about 5% for 2005, and 4%-plus growth expected for 2006. South Africa benefited from the fairly robust performance of the world economy as reflected in strong demand for exports, high international commodity prices and favorable financing conditions. The structural improvements inherent in the emergence of a new black middle class, as well as low inflation expectations, suggest that the economy should be able to sustain substantially higher growth. Globally, economic growth is expected to continue. The U.S. is expected to continue to outperform other developed countries with 3.4% growth in 2006, while China's growth could reach over 8% again. Global economic growth risks could point to constraints in achieving high 2006 South African growth rates. Higher oil prices pose growth and inflationary risks. Global trade imbalances, such as the U.S.'s large current account deficit and low savings rate and the matching surpluses in Asia, may cause increased volatility in currencies, increases in interest rates and a slowdown in growth. According to Nedbank's chief economist Dennis Dykes, the key economic vulnerability South Africa faces is the growing current account deficit. As of the third quarter of 2005, the current account deficit had risen to R73 billion or 4.7% of GDP, compared with 3.7% in the second quarter. Merchandise exports, though improving, continue to be less than imports, which have expanded strongly with record high oil prices, the strong rand and the sustained buoyancy of domestic expenditure. If foreign capital cannot finance the deficit, the rand would weaken, and higher inflation and interest rates would appear, stunting growth. Despite the strong likelihood of ongoing pressure on the current account in 2006, JP Morgan economist Marisa Fassler expects the economy to continue to attract strong capital PRETORIA 00000227 003 OF 003 inflows given the favorable GDP growth outlook. The improvement in domestic optimism is also reflected in a Merrill Lynch Fund Managers' survey undertaken in December ¶2005. According to the survey, 46% of fund managers (versus 31% in the November survey) expect the economy to grow a little stronger over the next 12 months. Inflation fears have also eased. Though most managers still expect interest rate hikes in 2006, the timing of these increases has now shifted from the first quarter 2006 to the second quarter. More than 45% expect the repurchase rate to be 8% or higher in the next 12 months (compared with the current 7%),but only 17% expect the first hike to be in the first quarter 2006. About 42% expect an increase in the second quarter. Source: Financial Mail and I-Net Bridge, January 18. TEITELBAUM