Manufacturing key to recovery

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Strong PMI readings suggest that manufacturing will lead growth in the first quarter of 2010.

Whilst production for January disappointed, we expect South Africa's manufacturing to remain the main impetus to growth in the first quarter. Manufacturing data, released earlier this week, showed output fell 0.6% m/m after rebounding strongly in the closing months of 2009. Nevertheless, the seasonally adjusted Kagiso purchasing managers' index-a forward-looking indicator of manufacturing-jumped to 60.4 in February from 53.6 in January. The latest reading marks the fourth consecutive month that the index has exceeded the growth-neutral level of 50. The largest improvement was in new sales orders, which rose strongly in February and had been inching upward in the prior three months. The inventories component of the index also rose strongly, indicating near-term demand is growing, and inventory replenishment will buoy GDP in the first quarter. The employment subindex was also encouraging, remaining above 50 for the second straight month, suggesting factory employment will likely edge higher in the first quarter.

After lagging the rebound in global manufacturing for several months, South Africa's PMI now exceeds the global index, the first such occurrence since February 2009. The global and U.S. PMIs entered expansionary territory in August, the euro zone followed in September, and South Africa's PMI did not indicate expansion until November. At its widest difference in August, the South African PMI was 14 points below the global index.

Strong PMI readings for January and February suggest that the factory sector will lead growth in the opening quarter of 2010. Manufacturing was a key driver of South Africa's recovery in the second half of 2009, having contributed 1.1 percentage points to quarterly growth in the third quarter and 1.5 percentage points in the fourth quarter. If the PMI improves in March, the factory sector will be on track to exceed its third and fourth quarter performances.

Despite improving business confidence and the upswing in production, risks to the outlook are still tilted to the downside. A concern is that the boost from the inventory swing may be temporary. Given South African manufacturers' dependence on external demand, if the global recovery falters or domestic conditions do not improve to pick up the slack, production may retrench to better align with sales and demand. Consumer demand is unlikely to recuperate until employment and income improve in the second half of the year. The strong rand also threatens to dampen the strength of the rebound.

*This article was first published by Moody's Economy.com