A settling global economy over the past month has strengthened the case against a global recession, but it's too early to get the champagne out, warns David Mayfield.
Over the past few weeks, a thawing of financial markets has begun. But recovery is not yet guaranteed, and some notable worries have yet to be resolved. There is still some balance sheet de-leveraging to come. House prices continue to be vulnerable. And some real economic insecurities remain - particularly in employment. The long-term trend shows emerging markets becoming increasingly relevant to the world economy. The evidence for this can be seen in global inflation rates, and in emerging markets’ relative resilience to the weakness of more mature economies and of financial market flows. These, in turn, are collectively weakening the longer-term influence of mature economies in international financial institutions.
In the latest South African Reserve Bank's Financial Stability Review, for the fourth quarter of 2007, the high level of household debt is noted as a potential source of vulnerability. Higher debt servicing costs are compounded by rising interest rates, slowing income growth and the low level of households' savings. These, together with slower growth in households' net wealth and financial assets, may adversely affect credit quality in the future. What’s more, over the past four years households have become increasingly reliant on mortgage equity extraction to fund their spending on consumption, so that this is no longer an alternative source of funding.
Even though households spend approximately 11% of their income paying off debt, the Reserve Bank is worried by the slowing growth of their financial asset holdings. This, along with moderation in house prices, means a decline in households' net wealth. In conjunction with reduced debt affordability, deterioration in households' net wealth will weigh on their consumption patterns in 2008 and, by extension, on economic growth.
A degree of financial market stability and confidence has been restored over recent weeks. Nevertheless, and perhaps more worryingly, real economies in developed countries are precariously poised. In particular, employment and housing concerns in these economies, coupled with the possibility of prolonged higher inflation, are depressing consumer confidence and cutting into purchasing power. This is an opportune moment to reflect on the cyclical and structural dynamics that are revealing themselves and what they teach us.
Consumer surveys in the US, UK, the Eurozone and other mature economies all suggest slower growth in consumer spending in the near to medium term. More importantly, from a structural perspective, over the next few years we are likely to witness a catch-up in emerging markets' share of consumer spending relative to both their own GDP and to consumption in industrial economies.
In South Africa, renewed interest rate tightening and high household indebtedness mean that bad debts are likely to increase this year, heightening potential credit risk. Faced with deflating growth both in their financial safety net and in the value of their homes, credit-constrained households have limited equity available for distressed borrowing or funding of consumption. As a result, mortgage equity withdrawal is expected to wane and to become a drag on economic growth this year.