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Send  Share  RSS  Twitter  13 Dec 2011

ECONOMY: Five Reasons to Worry About Europe


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At the outset, it is important to stress that I don’t necessarily believe all of the problems that are flagged in this article will occur. Rather they each represent a risk which South African businesses and consumers face and for this reason we need to monitor them carefully says Dr Adrian Saville, CIO of Cannon Asset Managers.

1. Despite the shifting global economic plates, Europe remains South Africa’s largest trading bloc, accounting for about 35% of this country’s trade. Although China is the single most important country from a trade perspective, and India is growing rapidly, as a region Europe still dominates South Africa’s international trade flows.

That our most important trading partner finds itself in deep economic trouble has implications for South Africa’s prospects. As things stand, there is a better-than-even chance that Europe will dip back into a recession in 2012. If this happens, demand for our exports will be constrained.

There are many commentators who advocate that a weaker rand would simply solve this problem, but I have a different argument. Even if the rand weakens and thus lowers the prices of our exports in other countries, if the demand is not there, lower quantities will be sold, so the benefit may not materialise. The October manufacturing data support this: while the rand has slipped by 16% so far this year, manufacturing growth has been a mere 1%. Equally, whilst a weaker rand makes the prices of imports less attractive, if the South African economy is sluggish demand will not switch to domestically manufactured goods, but rather fall away. These arguments are supported by three decades of manufacturing data.

2. Europe is an important destination for South African commodities. If Europe does slide back into a recession, this would have negative implications for the prices realised on many of South Africa’s most important exports. In global terms, the commodity that is probably most at risk of price weakness is oil, but I believe that the platinum price also could come under meaningful pressure. Europe accounts for about a third of global platinum consumption, with the automotive industry being the most significant user of the metal in the region.

We only have to look at our mining production which slipped by 5.6% and a further 4.2% in 2008 and 2009 respectively to see the impact that a recession in metal-consuming countries has on South Africa.

Base metals would be affected to a lesser extent, as they find solid demand in the more resilient dynamic markets such as China and India, which are less likely to witness recessionary conditions.

3. The South African tourism industry remains heavily reliant on the footfall of European tourists.

If the Euro goes into a rearrangement (for example Greece breaks away from the single currency) it would only be done for a country to have a weaker currency, in which case that nation becomes a highly attractive tourist destination, on the doorstep of Europe. This poses a clear threat to the relative attractiveness of South Africa as a tourist destination, especially if one looks at the broader factors which tourists consider when selecting a destination such as distance, cost and travel time. In addition, if Europe is in a recession, there would be fewer European travelers.

4. There is an outside chance that the Euro will ¬ďcollapse¬Ē, although I believe that it will survive, given the enormous vested interested in preventing a collapse. Indeed, at this juncture I would put the probability of a dismantling of the Euro at less than five percent. However, if all options are exhausted, it remains a possibility that the Euro is dismantled or that there will be a rearrangement with at least some countries exiting the common currency, with a core Euro remaining.

This would prove a major disruptor to European trade and the domestic economic environment and it would dramatically elevate the risk of financial contagion. Countries would only abandon the Euro in order to have a devalued currency of their own, not a stronger one. In turn, this outcome presents the clear threat of a currency war, which results in a ¬ďrace to the bottom¬Ē amongst competing nations and provokes a significant price inflation risk.

Under this outcome, we effectively would be taking a step back to the 1970s and 1980s, after the United States ended the convertibility of the US dollar for gold and governments were free to print money. The ugly side of fiat currency is that countries, in effect, are printing worthless money and inciting price inflation. This brings with it many negatives associated with inflation, including currency turbulence and disruptions to economic welfare.

5. The factors listed above would together result in slower economic growth in South Africa. This is an enormous risk for the country as our economy already battles to grow at anything like the rate required to alleviate unemployment. On this point, as recently as last month the Development Bank of Southern Africa (DBSA) said that South Africa's economy needs to grow by at least 10% a year if it is to create our government’s policy target of half a million jobs each year for the next decade.

Current estimates for 2011 economic growth in South Africa are hovering around 3%. If Europe fails to grow in 2012, South Africa’s growth would be drawn closer to 0% than the 10% required. On this score, it is notable that the two recessions we have experienced in the past two decades both have been associated with a recession in Europe. In short, the South African economy is highly correlated with that of Europe, and a European economic slowdown presents a clear threat to our economic welfare.

At the same time, in recognising this troubled relationship we are presented with the opportunity to straddle the shifting economic plates by striving to gain competitiveness and market share, not only in existing markets but also against new competitors. If we turn to African countries such as Angola, Kenya or Nigeria, or South American states like Brazil, Chile and Peru, or Asian ones such as Indonesia, the Philippines and Vietnam, we can see the enormous potential of large, diverse economies which are growing rapidly ¬Ė in some cases extremely rapidly.

To put the point differently, the sheer size and growth of these new, dynamic markets is compelling. For example, over the past ten years, the collective nominal growth of the BRIC economies was close to $10 trillion, more than three times their 2001 size of $3 trillion. Moreover, in the decade ahead, the BRICs will probably create at least another one of their current self, say $12-13 trillion: that's equivalent to 40 times the size of the Greek economy, six size times the size of the Italian economy, or another US economy.

While these risks may not all occur, South Africans need to follow developments in Europe carefully and devise strategies to mitigate any threats, which include harnessing the remarkable growth prospects that are emerging elsewhere.

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