Europe’s summer of discontent — and what this means for South Africa

25 Aug 2022

Europe faces the perfect storm: Soaring energy prices, a once in 500-year drought, recession and the likelihood of a protracted war on its doorstep. Fortunately, the direct impact of South Africa’s second-largest trade partner’s misfortunes on the domestic economy looks manageable.

It was only a matter of time before markets began to face up to the full extent of the challenges Europe — particularly Germany — face as the Northern Hemisphere heads towards winter and the prospect rises of a protracted war continuing into 2023.

Acute gas shortages have been looming over the region for some time, as Russian supplies dwindle and could well dry up completely before winter sets in. But over the past week, several forward-looking economic indicators were released that have made the likelihood of a winter recession all but assured.

Add to these the worst drought in 500 years and water levels that have fallen so far that they have revealed so-called hunger stones, rocks put in place on the side of the river centuries ago to mark water levels during previous historic droughts. Marked with the phrase, “If you see me, then weep”, the message encapsulates just how dire the situation is in the eurozone.

Low expectations

On Thursday, a leading indicator for the German economy, the Ifo index, fell for the third month, reflecting business expectations that are close to all-time lows, having only been worse in December 2018 and April 2020, according to ING.

Earlier in the week, the eurozone’s composite PMI for August fell into contractionary territory, below 50 and its second monthly decline.

There was some relief from the stream of negative data in the backward-looking second quarter German growth figure, which, at 1.8% on a year ago, was higher than expected and not the stagnation expected for the three months. The data highlighted that tourism had been a bright spot for the German economy, notwithstanding the travel chaos, with poor performing sectors including construction (-2.4% quarter-on-quarter) and net exports (-0.6%).

Although latest GDP data also showed private consumption surprising to the upside, ING Global Head of Macro Carsten Brzeski says that consumption is unlikely to hold up in the face of the doubling or tripling of energy prices in the months ahead and with consumer confidence at all-time lows.

Not whether, but how severe

“The list of arguments why the German economy is sliding into recession is getting ever longer. The question isn’t about whether there’ll be a recession, but rather how severe and how long it will be.”

Capital Economics says although there has been some easing in the pressure supply chain problems have been putting on prices globally, soaring European gas prices and strong domestic price pressures will keep inflation high.

Latest inflation statistics put euro area annual inflation at 8.9 % in July 2022, up from 8.6 % in June 2022, and likely to move higher on the almost 40% rise in gas prices in August.

Sanlam Investments economist Arthur Kamp also sees inflation as a key concern in the eurozone, given high natural gas prices, supply disruptions and the potential for firmer wage growth.

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“The latter relates to a potentially more fundamental inflation problem. It would be of concern to the ECB if this is accompanied by additional fiscal support for households whose real income is being eroded by high inflation.”

He notes that with consumer confidence dented, pressure on the terms of trade and the ongoing Russia-Ukraine war, the risk remains that there will be lower than expected GDP growth.

The impact on softer growth on government revenues is also cause for concern, says Kamp, with deteriorating fiscal metrics increasing fragmentation risk in the euro area, as reflected in higher bond yields in some euro area countries relative to Germany.

What impact on SA?

As South Africa’s second-largest trading partner, what impact will Europe’s woes likely have on the country during the months ahead? South Africans jetting off to European destinations for the summer had first-hand experience of the scars Covid has left on the travel industry. Staff shortages after retrenchments during the pandemic translated into hundreds of cancelled flights, waiting times of four to five hours and luggage lost in transit for weeks, if not forever.

Kamp says the most immediate economic implications of Europe’s economic decline for SA is the potential impact on trade. Germany, the economy taking the most pain in the region, is SA’s second-biggest trading partner after China and the largest in Europe. It is the destination for almost 10% of our exports and source of around 11.5% of our imports. More broadly, some 15% of SA’s top 10 export destinations go to European countries, namely Germany, Italy and Belgium.

Kamp says SA’s goods exports to Eastern Europe were sharply lower in May 2022 relative to a year earlier. For now, however, exports to Germany recorded double-digit growth in rands over the same period. Exports to Italy, France, the Netherlands and Spain were also robust.

“On balance, though, SA export growth to Europe appears set to slow materially in 2022 relative to 2021.”

On the import front, the impact could be positive.

Kamp says South Africa’s coal export prices are benefiting from increased demand for coal, given Europe’s energy crisis.

“This, all else being equal, benefits our terms of trade and current account balance. In turn, South Africa’s high terms of trade relative to a year ago is one of the key reasons positive real GDP growth is still expected in South Africa this year, albeit moderate.”

Thus, on a balance of probabilities, the eurozone’s perfect economic storm is unlikely to have a significant direct impact on the domestic economy.

But those thinking of enjoying a winter skiing holiday in the Alps may want to reconsider. Not only is it likely to be way more expensive, but chillier indoors and potentially a low-snow season. DM/BM

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Low expectations

Not whether, but how severe

What impact on SA?