First, construction and manufacturing are fairly well represented in the JSE Small Cap universe. Economic activity in these industries tends to be more cyclical than, say, services industries. But, despite the business cycle upswing, construction and manufacturing real GDP increased just 2.4% and 1.7% respectively in the year to 2012 – reflecting a weak residential housing market and a moderate advance in total domestic and external demand compared with the previous business cycle upswing.
Second, weak earnings momentum in small businesses simply reflects the lacklustre performance of the total economy. The current business cycle upswing clearly lacks the dynamism of the growth environment leading up to 2007.
Key export commodity prices have declined since last year and the country’s terms of trade have seemingly peaked against the backdrop of tepid global economic growth. This is constraining domestic income growth.
And, third, despite the lowest Reserve Bank policy rate since the early 1980s, the advance in credit extension to private business is constrained. At the current low level of interest rates the demand for credit should be firm. However, supply of credit appears to be constrained. At the current low level of real interest rates Banks probably do not feel adequately rewarded for taking on the risk of lending to small businesses that tend to have unpredictable earnings profiles. Further, the requirements of Basel III, including prescriptions on banks’ liquidity ratios, are aimed at constraining bank lending.
What can be done to lift small business earnings momentum? After all, they are the bedrock of innovation and hence GDP and employment growth.
My colleague, Vanessa van Vuuren who is Portfolio Manager for the SIM Small Cap Fund, notes small businesses have been through a process of rationalisation during the recession. This should translate into improved earnings performance if economic growth is sustained.
Ultimately, though, small business development is only possible through continued productivity enhancement. Incidentally, this should not include debasement of the currency, which only boosts price competitiveness temporarily. For reference, my estimates indicate the Rand is fairly valued at around USDZAR8.40.
Rather, successful completion of government’s infrastructure spending programme would be a good starting point.
Further, government’s Manufacturing Competitiveness Enhancement Programme, which aims to bolster productivity and competitiveness by offering incentives in labour intensive industries, excluding those already benefiting from incentives (motor vehicles, clothing, textiles, leather and footwear) should help too. The March 2012 National Treasury Budget Review indicates investment in fixed capital, product development, standards accreditation, process redesign and feasibility and marketing studies qualify for the incentive (p. 20). In total, the Treasury allocated R5.7bn to the Programme, administered by the Department of Trade and Industry, over the next three fiscal years, including 2012/13.
But, incentives can only go so far and are unlikely to address the lethargy that besets the domestic business environment, including small businesses.
It is disappointing South Africa fairs so poorly in global entrepreneurship rankings, lagging numerous emerging market countries such as Argentina, Peru, China, Brazil, Hungary and Uganda by a long way. If anything, this suggests we need a quantum leap in skills development to promote the establishment of Small & Medium Enterprises,.Article written by Arthur Kamp, Investment Economist, Sanlam Investment Management