The SA Consumer – always a spender!
By Gina Schoeman
Economist - Macquarie

hings are changing for the SA consumer this year.

On one side, household expenditure will be supported by lower inflation, rate cuts and some debt consolidation that took place in 2009 (as seen in the reduction in insolvencies).

Because such improvements typify a cash-bias, spending should occur on easy-on-the-pocket items (such as services, non-durable goods and relatively inexpensive semi-durable goods).

On the other side, significant job loss in 2009 (950k) had a widespread negative impact on discretionary spend due to both a downfall in consumer confidence, a pickup in savings/debt consolidation and limited access to credit (which is impossible without a salary and was exacerbated by the pullback in lending by the local banks).

These factors tend to hit spending on durable and pricey semi-durable goods the hardest. Of course, the future of consumer spending depends mostly on one thing: consumer affordability or, its economic equivalent, household income.

Employment – the impact of job loss and job gains

Looking at the composition of the labour force in South Africa, the pie charts below show that by end-2008 the employed workforce totalled 13.8 million, the unemployed amounted to 3.8 million and the not economically active (NEA) population added up to 13.2 million. Overall the potential labour force totalled 30.9 million individuals.

This leaves the employed accounting for 44% of the labour force in the country while the NEA account for 43% and the unemployed 13% (Figure 2).

Splitting the above-mentioned categories by income, Figure 3 shows that the employed population commands 81% of total income, while the NEA and the unemployed make up 15% and 4%, respectively. While employed income represents wages and salaries, incomes of the unemployed and NEA are made up of a variety of grants, UIF payments and other social benefits, which are still proceeds that enable spending.

The bottom line is that this breakdown of the labour force by income highlights the harsh extent of income inequality in South Africa. Put simply, the number of all individuals (employed, unemployed and NEA) that earn less than R100k per annum comprise a massive 91% of the total labour force. This immediately highlights the importance of employment in generating household income and consequently, growth in consumer spending.

In 2009 the numbers changed dramatically.

According to the official Labour Force Survey data, 870,000 jobs lost thanks to the global recession meant that by end-2009 the employed workforce had dropped from 13.8m to 13.0m.

In conjunction with this, the number of unemployed individuals rose by almost 300,000 (from 3.9m to 4.2m) while a massive 947,000 additional individuals were classified as NEA, which increased this category from 13.2m to 14.1m. This led the overall labour force down to 17.1m in 2009 from 17.7m in 2008 (Figure 4).

The impact of this job loss was a slowing of nominal disposable income from 12.5% YoY in 2008 to 4.5% YoY in 2009. Taking into account consumer inflation of 7.3%, real income growth contracted by 2.8% in 2009.

Taking our analysis through to 2010, we believe that an economic recovery, driven by the labour-intensive production side of the economy (manufacturing, mining, transport and exports), will leave the employed labour force growing by around 3.0% YoY after declining by 6.3% YoY in 2009. This adds 380,000 jobs to the employed work force this year (Figure 5).

Although this would mean a 1.6% decline in unemployed persons in 2010 (from a 7.5% increase in 2009), this still does not completely offset the 870,000 job losses from last year. Remember that in a recession, companies ‘cut the fat’ in an attempt to improve their bottom line.

Employing our estimates of 380,000 jobs to be created in 2010, nominal income growth should grow by around 7.0% YoY (Figure 6). If CPI is to average 5.0% in 2010 as we expect, real income growth rises by at least 2.0% YoY in 2010.

Contrasting the downfall in jobs and income in 2009, the largest recovery in nominal income is expected to be measured in the R50–300k income bands at 10-12% (Figure 6), or 5-7% in real terms.

In line with our view that the economy will be buoyed by inventory adjustment, a recovery in exports and government spending this year, sectors like construction, manufacturing, services and transport will be important catalysts to employment. This is a positive for incomes as these sectors (like manufacturing and services) employ a large number of individuals with annual incomes around the R50–150k level per year (Figure 7).

Inflation

Thanks largely to base effects, a strong currency since 2Q09 and recessionary conditions through most of 2009, headline CPI has retreated to within the 3–6% target range, measuring 5.7% YoY in February.

Figure 8 shows the correlation of each category within the consumer inflation basket against the ZARUSD (we make use of the pre-2009 inflation basket as there is insufficient history available on the latest CPI basket).

Figure 9 goes on to illustrate how long it takes for changes in the ZARUSD to impact the various components of the basket.

On the whole, the currency impact for headline CPI is at its strongest 10 months down the line, with still-considerable influence up to a lag of 15 months. This appreciation together with fierce inventory rundown throughout last year leaves us estimating a speedy retreat in CPI in 1H10 (especially given that restocking is now taking place at stronger rand levels).

A contentious issue for inflation this year is the recently announced electricity tariff increases of 24.8%, 25.8% and 25.9% over the next three years. These are the average standard tariff increases for the years FY10/11, FY11/12 and FY12/13 and take the average standard price to 41.57c/kWh, 52.30c/kWh and 65.85c/kWh, respectively.

That said, our calculations show that households will end up with notably smaller increases.
Within Nersa’s media statement was an important point: those municipal distributors who implemented a 34% increase in FY09/10 (a guideline increase provided by Treasury when the timeline of the Nersa announcement did not match that of the municipalities’ implementation dates) are now only authorised to implement increases of 15.3%, 16.0% and 16.2% over the next three years, starting 1 July 2010.

On top of this, in some cases municipal distributors also failed to keep to the 67:33 ratio between actual electricity power costs and non-electricity power costs. While the 70% portion of municipal electricity costs are meant to rise by the agreed tariff increase, the remaining 30% portion is split between maintenance and distribution (which Nersa tells us typically rises by 10–15%) and labour (which National Treasury recommends increases in line with headline CPI).

In 2009 some municipalities hiked the entire cost by 34% and so, the above-mentioned smaller increases (15.3%, 16.0% and 16.2%) were decided on to clawback the excess tariff increases from last year.

According to Nersa the six major metros in South Africa make up 80% of electricity consumption. Furthermore, the regulator has stated that only 1 of the 6 metros put through a 34% tariff increase last year and will thus pass through only ~16% increases over the next three years. More so, 80% of the small municipalities making up the 20% of electricity consumption will also be increasing tariffs by only ~16%.

According to our calculations, this means that around 29% of electricity consumption will be facing far lower tariffs of ~16% over the next three years while the remaining 71% will face the 24.8% increase as stated by Nersa.

Using these lower municipal guideline tariff increases together with the standard municipal tariff increase, we apply the 67:33 split and show that the end result is an average tariff increase of around 18% over the next three years, which is certainly lower than the 25% priced into much of consensus and the SA Reserve Bank’s inflation forecast this year.

Considering the implications on the CPI basket, one must remember that while the electricity and other fuels component command a weight of 1.87%, after stripping out ‘other fuels’ (0.19%), the weight of electricity alone reduces to 1.68%.

Given that the electricity component of the CPI basket recorded 26.3% inflation in July/August 2009, an increase of only 18.1% YoY in July/August 2010 means noteworthy disinflationary risk to the overall CPI basket.

In our view, the contribution of electricity prices to CPI will be a mere 0.3ppts in 2010 –certainly not as substantial as contributions/deductions brought about from sharp movements in the currency.
We remind our readers of the reweighting/rebasing methodology change of the CPI basket at the start of 2009 and the substitution bias that crept in. We therefore make note that the effective weight of the electricity component will rise to around 3.1% by 2011, suggesting that it is inappropriate to use the official 1.68% weight to calculate the contribution of electricity tariff increases to headline CPI in FY11/12 and FY12/13.

Given this higher effective weighting, we forecast a contribution to consumer inflation of 0.5ppts and 0.54ppts, respectively, for years FY11/12 and FY12/13.

According to our calculations, lower-than-expected electricity tariffs will be the key reason for the consumer inflation trajectory to surprise markets to the downside this year.

Of course second-round and third-round effects will occur.

Second-round effects will occur when a portion of the 24.8% wholesale electricity tariff increase will be passed through to goods or a service, which of course has the effect of pushing up the cost of living 9–18 months down the line. Third-round effects occur in the form of higher wage settlements to compensate for this higher cost of living and should kick in 16–24 months after the tariff increase. In South Africa’s case, however, strong labour union power means that electricity tariffs are already influencing this year’s wage bargaining rounds and so, third-round effects could easily occur sooner.

Even though the contribution from electricity is small, given that the SARB’s inflation outlook hovers around the 6% target ceiling until the end of their forecast period in 4Q11, we believe that the Bank’s inflation profile should prove to soften by around 0.2ppts by the time they meet again in March 2010 thanks to lower-than-expected electricity inflation alone.

That said, we think it is too late for the Bank to respond via additional rate cuts. Instead, we maintain a view that rates will remain on hold from here on throughout 2010. This would be hugely accommodating to the consumer’s pocket.

Finally, a hopeful spot this year for consumers is food inflation, which is proving to be far more contained than originally anticipated. Although we had been pricing in close-to-zero food inflation by end-2009, moving up to an average 5% for 2010 overall, the higher-than-expected carryover of global stocks looks to be keeping prices in check. As a result, we believe that food inflation will hit a low point of 0.5% in 2Q10, enjoying sub-5% inflation until at least 3Q10 and averaging below 5.0% for the year as a whole.

Taken as a whole, we forecast an average 5.0% for consumer inflation in 2010, with a low point of 4.4% in May 2010. It must be mentioned that the risks lie to the downside if the rand maintains current levels.

For 2011 we see some upside pressures return to the basket as inventory adjustment restores domestic demand to a respectable growth trajectory, which should leave CPI rising to 5.5% YoY on average.

Real disposable income

Inflation matters because it determines real disposable income growth, which in turn, sculpts consumer spending.

As the National Accounts data shows, thanks largely to job loss, real income growth fell by 2.8% in 2009 and our above-mentioned calculations show that low- to middle-income household balance sheets felt the most pain.

If jobs are to be added back into the economy and inflation slows quickly; the combination of these two factors should boost real income growth in 2010. Our estimation is for 380,000 jobs created together with a softer inflation trajectory of 5.0% for 2010 will boost real income growth by around 2.0% in 2010.

Debt, debt-servicing & interest rates

Growth in household debt plunged lower in 2009. After growing by 14.5% in 2008, household debt slowed to 3.0% in 2009. As a percentage of GDP household debt shifted down to 47.0% in 4Q09 from its peak of 50.8% in 1Q08; even though rates declined by 500bps, job insecurity dissuaded individuals from accumulating additional debt while actual job loss didn’t allow for a great deal of consolidation.

We have already revealed our view that real income growth of 2.0% is possible and that inflation will slow to 5.0%. Add to this our position that debt accumulation will only pick up speed in 2H10 (once the banks start lending more willingly) and the ratio of household debt to income for the year as a whole should decline slightly. For 2010 we are pencilling in a debt-to-disposable income ratio of around 78.9%.

But debt comes at a cost. And the blend of debt accumulation and interest rates determines the obligatory debt-servicing that must take place across households. Through 2009 the debt servicing-to-income ratio improved greatly, decreasing from 12.2% in 2008 to 9.5% in 2009 thanks to a cumulative 500bps in rate cuts – the benefit of which is now showing up in declining insolvencies. This is important as, like the ability of inflation to eat away real income growth, debt-servicing costs eat away consumer purchasing power.

As far as rates go, we believe that the economy will surprise to the upside this year (thanks to stronger-than-expected consumer spending and rebounding inventories); while Reuters consensus estimates look for GDP to average 2.9% in 2010, we think a range of 3.2-3.5% is reasonable.

Even though 2010 inflation may prove lower-than-expected, we think upside risk to growth forecasts will be a key reason for why the SARB keeps rates on hold from here on, which of course supports lower debt-servicing costs. Given that the SARB tackles the expected inflation rate 12–18 months down the line, the inflation trajectory for 2012 will look to be rising (we’re expecting around 7.2% on average) particularly if the rand is showing signs of weakness. This leaves us expecting rate hikes to start up by2Q11 with a total 300bps priced into the next hiking cycle over 2Q11-2Q12. (Figure 15).

Finally, we look at the debt-to-income and debt-servicing-to-income ratios against the various income bands.

It is immediately obvious that levels are considerably low in the R0–100k income range while still manageable in the R100–300k range. Our analysis in preceding sections has shown that it is these income bands that are likely to grow the strongest in 2010. As a result, consumer spending in households commanding annual incomes under R300k should benefit in 2010.

Credit

A final step in dissecting consumer affordability and where spending will occur in 2010 is the ability of consumers to access credit as this creates a powerful purchasing power tool in the economy.

Much like the rest of the world, credit growth in South Africa in 2009 practically dried. We believe this occurred for three main reasons: (1) the big local banks pulled back on lending; (2) job loss (accessing credit under the NCA is difficult without a salary); and (3) job insecurity caused distaste for debt accumulation.

A popular rule of thumb is that credit growth is a function of the sum of real GDP and inflation (or, that credit growth should broadly follow nominal GDP growth). This makes sense as banks are typically willing to take on balance-sheet risk if the economy is growing strongly.

The graph below (Figure 17) shows that while this theory loosely held across 15 years to 2004, the exuberance of lending that kicked off in 2004 (exacerbated by the absence of the NCA) saw credit growth outgrow the economy by as much as 15ppts.

By 3Q08 the banks took their cue from leading indicators signalling that growth was faltering. The brakes were applied and private-sector credit extension came in practically in line with its rule of thumb.

Employing our forecasts for inflation and GDP for 4Q09 and 1Q10, a question mark arises: why is credit growth not turning alongside improving domestic economic conditions (Figure 17)?
To see if this may be because of a still-weak consumer, we apply the same exercise to household credit and consumer spending growth. The graph above (Figure 18) shows that even conservative expectations for consumer spending growth implies that household credit should at least be at a turning point. The fact that it is not turning leads us to suspect that banks remain relatively cautious in regards to lending.

Considering its major components, Figure 19 shows that mortgage advances account for around 50% of overall PSCE, suggesting that the state of the housing market and home loan divisions at the banks is critical to estimating a recovery in overall PSCE.

2010 kicked off with mortgage advance growth increase by 3.1% YoY. While this may seem encouraging to overall credit growth, it must be kept in mind that this speaks to outstanding mortgage loan values only. If the 2009 recession and subsequent deterioration to household balance sheets held back capital repayments, the mortgage advance category may appear healthier than it truly is.

Showing this, 3Q09 new mortgage loan payouts were only running at 23% of their peak in 3Q07. This adds the risk that there may still be some decline in outstanding mortgage growth to come, once capital repayments start up again.

Another important consideration when looking at overall mortgage advances is the fact that residential mortgages make up around 70% of this while commercial mortgages account for around 25% (farm mortgages make up the remaining 5%). Most recently, commercial mortgage advances grew by 5.2% YoY in December 2009, which is slightly higher than the 2.9% YoY measured in residential mortgage advance growth for the same month.

This is at odds with the fact that the other loans & advances category – which portrays much of corporate credit take-up in the form of overdrafts, credit cards and non-mortgage loans – remains deep in the red at -5.7% YoY in January 2010. While this may simply be the result of fewer employees and cut-backs on corporate spending given the 2009 recession, it adds downside risk to a hearty recovery in overall corporate credit growth for most of this year.

All things considered, the state of private-sector credit extension brings us to an important point in our hypothesis: can recovering household cash positions (thanks to job growth and lower inflation) breathe life back into consumer spending if credit growth remains relatively muted (especially for the first half of 2010)?

Income & consumer spending

Translating this all into consumer spending we employ non-durable goods and services as a proxy for cash spending and durable and semi-durable goods as a yardstick for credit purchases (Figure 21). The inverse relationship between this ratio and private-sector credit growth is startling and implies that up to end-2009 the proportion of cash purchases outstripped credit spending 1.3 times. Illustrating our concept further, we track M1 money supply against private-sector credit extension and real retail sales. This visual certainly suggests that the slight improvement being measured in the retail sector at present is mostly being driven by cash purchases figure 22).
Akin to the global opinion that ‘jobless’ growth will occur in 2010, our calculations suggest a ‘credit-less’ recovery in consumer spending is likely.

So why is income so important? Reminiscent of economic theory, we remind our audience that consumption is typically the difference between disposable income and savings: C = Yd – S. In an economy with a negative household savings rate, the equation becomes something very close to C = Yd as shown in Figure 23. One cannot ignore the gap forming from 2005 onwards and we put this down to the credit boom, which took place during the period, allowing consumers to spend more than what they earn (which adjusts the theoretical consumption equation to C = Yd + PSCE).

That said, the correlation between real income and real consumer spending is still practically 100% and we consider this the best estimate for consumer spending growth in the economy. If one can determine disposable income growth, consumer spending growth will follow.

Given our analysis, we are confident that real income growth will rebound to 2.0% this year (after falling by 2.8% in 2009); this means that even with only moderate levels of credit extension (sub-10%) the consumer should be able to spend more.

More specifically, cash spending in 1H10 should be sufficient to push retail sales back into positive territory in 2Q10. Thereafter, although credit availability will become more necessary we believe the banks will be lending more willingly.

This view brings us to our forecast that for 2010 overall consumer spending will average at least 2.1% growth YoY.

This outperforms market expectations, especially National Treasury’s forecast that consumer spending will only grow by 0.9% YoY in 2010 – no doubt this will be revised up in October when the Medium-Term Budget Estimates are presented.