If government had been relying on a smooth, seamless economic ride to the magical 6% growth level by 2014, it was not counting on the Reserve Bank. The Bank's cumulative 350 basis point increase in interest rates since June 2006 has led economists to revise their growth forecasts for 2008 downwards. The ripple effects will be felt right through to 2014.
There could be more interest rate rises to come next year, now that inflation is widely expected to peak at above 7% in early 2008. By now it has been well established that the two main factors underpinning inflation, namely agricultural prices and the international oil price, are beyond the direct control of monetary policy. But, though interest rates are proving a blunt tool in many respects, the Reserve Bank is concerned with suppressing inflationary expectations and the secondary effects of high food and oil prices.
By adopting a hawkish policy and rhetoric it believes it can dampen demands by trade unions for increased wage settlements and by businesses for higher prices for goods and services.
The end result is that the interest rate rises to date - coupled with more stringent credit regulations contained in the National Credit Act - have already taken the wind out of consumers' sails by making credit-based spending a lot more costly.
The Reuters September Econometer - made up of the forecasts of 16 leading economists - still has growth for 2008 at 4,78%, but the 50 basis point rate hike in October has led some to predict growth as low as 4% next year. This contrasts markedly with earlier optimism by economic policy makers; as recently as February, finance minister Trevor Manuel had budgeted on 5,1% growth.
2007 has proven that cyclicality is still ingrained in the SA economy, says FNB economist Cees Bruggemans. "In retrospect, the year will probably be seen as some kind of watershed in our eight-year, nonstop business expansion," he says. "Inflation, credit growth and the current-account deficit went into unacceptable territory, and price and nonprice action was taken to enforce change."
Adds Brait economist Colen Garrow: "Such tightening highlights a harder landing in the momentum of the economy than previously envisaged." He, like many other economists, feels the latest interest rate rise may have been one too many.
If growth does slip to 4% next year, it would make the government's Accelerated & Shared Growth Initiative for SA (AsgiSA) target of 6% growth by 2014 that much more difficult to achieve. "We have clearly been buffeted by many cross-currents and the question of the moment is whether these buffetings are going to change our growth trajectory," says Bruggemans.
It's still too early to answer that question. The downward cycle could well be over by 2009 - the Reuters Econometer forecasts 5,1% growth that year - and pick up sufficient steam to achieve the 6% growth target. But that will rely on greater structural economic changes on top of the continued growth in the spending power of the emerging black middle class.
Some of the structural foundations to higher economic growth will be provided by surging fixed investment spending. It has taken off in earnest this year and is set to accelerate sharply in 2008 amid a pick-up in spending on 2010 soccer World Cup stadiums and other infrastructure linked to government's R420bn deployment plan.
SA is edging towards its target of spending the equivalent of 25% of GDP on infrastructure projects. In the 2007 June quarter, gross fixed capital formation - a measure of investment in infrastructure - was recorded at just over 20% of GDP.
Fixed investment outlays have a far more beneficial long-term impact on the economy than consumer spending, which has driven economic growth over the past five years. Investment in infrastructure lays the foundation for greater productive capacity in the years ahead. Fixed investment spending is also more resilient to higher interest rates, says Absa Capital economist Jeff Gable. "Large borrowers generally raise finance on cheaper bond markets, so are less susceptible to interest rate hikes," he explains.
Vice versa, adds Gable, the large investment in infrastructure is not necessarily bad for inflation either, though he says the higher import bill could create pressure on the rand. Much of the plant and machinery needed to make the investments is produced offshore, and to purchase them importers have to pay for them in US dollars and euros.
"A weaker rand in itself is not necessarily a bad thing unless it leads to a country importing inflation," Gable says.
The higher import bill will undoubtedly widen the deficit on SA's current account of the balance of payments. The deficit is expected to accelerate to R130bn this year, and the Reuters Econometer predicts it will be R148bn in 2008 and R169bn in 2009.
But despite the higher interest rate and inflation environment, uncertainty about the rand's direction and the return of cyclical growth into the economic equation, many economists are convinced that SA remains on a sound growth path.
Citigroup economist Jean-François Mercier certainly believes the underlying potential growth rate has picked up. "The growth rate is at around 4,5% and will probably accelerate to 5%-5,5% in the early part of the next decade, provided that stable politics and policies sustain the current investment boom," Mercier says.
There are a number of factors that support his assertion.
Firstly, the global economic and financial environment has been favourable and is likely to remain so in coming years.
Commodity prices are on a record run which shows little sign of abating. With gold and platinum at record levels the export revenue from SA's mining sector should keep on rising and boost the country's trade account. This is only partially offset by the higher import bill for crude oil, given that SA meets about 30% of its demand for fuel products from local sources, mostly Sasol.
However, exports could be marginally hurt by the expected global economic slowdown - in October the International Monetary Fund lowered its outlook for world economic growth to 4,75% in 2008 from an expected 5,2% this year. Again, though, much of SA's commodity growth stems from Chinese demand, which shows no sign of abating.
A second fundamental plus for the economy is the sound state of government finances. As has become the norm, Manuel produced a solid R559bn budget for fiscal 2007/2008. Higher than expected tax revenues are again likely to better the budget balance, which Manuel in February put at a R10,8bn surplus before borrowings.
For 2008/2009, government's medium-term estimates forecast revenue of R641bn (2007/2008: R576bn), spending of R619bn (R559bn) and a budget surplus of R16bn, equivalent to 0,8% of GDP.
With a full coffer it has become much easier to finance government's R420bn infrastructure plan.
Mercier believes that AsgiSA will also play its role in underpinning the country's economic performance. Though many of the plan's strategies - greater public investment, improving government capacity, better-quality education systems and a new industrial policy - are only in the initial stages of implementation, Mercier says they will eventually address many of the inefficiencies in the economy.
"Though we are somewhat sceptical about reaching government's goal of 6% growth as early as 2010, we nonetheless believe that potential SA growth is more likely than not to be in a 5%-6% range in the 2010s," Mercier says.
"This could result in average actual growth of somewhat more than 5% in 2009 /2012, beyond the expected cyclical moderation of 2008," he says.
But next year is likely to add challenges to the economy beyond cyclicality. Crucially, it will test investors' faith in the underlying political structures, given that the presidential succession race is expected to have reached a measure of finality by then. Concern about the economic policy direction under a new president could well be mirrored in the course of the rand, or worse, a delay in possible foreign direct investment until policy clarity is evident.
In a much-publicised paper in October Kristin Lindow, vice-president at rating agency Moody's, expressed concern over "the controversial ANC leadership transition". Without stating so directly, she and other foreign investors and economists make much of the closeness of presidential contender Jacob Zuma to the trade union movement.
"No surprises or fundamental deviations from the existing economic policy framework are expected. In order to properly shepherd this policy agenda, however, the next state president will need to command popular legitimacy as well as the loyalty of the ANC and its allies in the SA Communist Party and Cosatu," Lindow writes.
Economists are also calling on government to address other fundamental obstacles to greater investment. Though many of these mirror the challenges outlined in the AsgiSA document, there are concerns that they are not being tackled with the necessary urgency.
Heading the list are skills shortages, which have been exposed by the substantial infrastructure drive and compounded by continued emigration.
Mercier also believes that government should lower corporate taxes to stimulate greater investments. "The case could be made to lower corporate tax rates in coming years, so as to shelter investment plans from the potential impact of higher interest rates and a weaker rand."
