The South African economy may come out of recession during the third quarter of 2009, Old Mutual Investment Group SA said on Tuesday.

Senior economist Johann Els said third quarter gross domestic product (GDP) data was likely to show economic growth of around two percent.

Following contractions of -6.4 percent quarter-on-quarter in the first quarter and -3.0 percent quarter-on-quarter in the second quarter of this year, the local economy was starting to show "solid signs of recovery" following the consolidation of economic growth in the rest of the world, Els said.

"Although consumer demand remains weak, the strong government demand, improved exports and the inventory cycle are all supportive of growth," Els said in a statement.

He said key indicators such as manufacturing output and new orders were rising, while electricity production and cement sales were higher, as were commercial vehicle sales.

Consumer not experiencing the recovery

"Even corporate credit extension has seen some small growth after two quarters of decline," Els said.

However, the South African consumer had yet to experience the recovery, as shown by the -7 percent year-on-year fall in retail sales in August, the -8.8 percent drop in car sales in September and the contraction of 0.9 percent in consumer credit over the third quarter of the year, Els pointed out.

He said other factors supporting the recovery included the improving current account, which had moved from a deficit of over eight percent of GDP in 2008 to around three percent of GDP currently, and the stronger rand, which had helped keep inflation in check.

Looking beyond the third quarter, Els forecast a relatively slow recovery, with average GDP growth of about 2.5 percent year-on-year for 2010, accelerating to around four percent year-on-year growth in the following two years.

Inflation rate is stubbornly high

Els said that relative to other economies emerging from the recession, South Africa's forecast 2.5 percent growth rate lagged those of most of south-east Asia (at between four percent and six percent), as well as China (nine percent) and India (6.5 percent).

"It is roughly in line with the likes of Argentina, Australia, New Zealand, the US and Turkey."

However, South Africa compared poorly in terms of its expected 2010 government budget deficit of around -6 percent of GDP, which was higher than most countries apart from Malaysia, the US, Spain and Iceland (the latter two at more than -10 percent of GDP).

"South Africa's inflation rate is also seen to be stubbornly higher than most," he said, projecting average consumer price inflation (CPI) at 5.5 percent year-on-year for 2010.

Only Russia (10 percent), Pakistan (seven percent), Argentina (6.2 percent) and India (six percent) were higher.

SARB unlikely to reduce rates further

"With CPI likely to remain at the upper end of the SARB's three percent to six percent year-on-year target range for the foreseeable future, the SA Reserve Bank (SARB) is unlikely to reduce interest rates any further, with the repo rate remaining at its current level of seven percent for the next 18 months or so."

Els said the SARB was likely to cut rates further only if inflation drivers (like food and oil prices) improved substantially and the real economy did not improve substantially.

"Or they could be forced to reduce more, despite the poor inflation outlook, if the economy proves to be weaker than expected, in combination with a strong rand."

Apart from the risk of a too-strong rand, the other key downside risk going forward, Els cautioned, was the failure of consumer demand to recover.

"Watch out for indicators such as capital spending, employment, household incomes and spending, as well as the SARB's outlook assessments," he said.

A much lower risk was the possibility of a stronger-than-expected demand recovery.

"This would warrant sooner-than-expected interest rate hikes from the SARB, which would put a clamp on the emerging growth cycle," Els said.