Growth is the only way to add jobs and reduce poverty

• Strengthening and maintaining core institutions important for building foundation for the achievement of meaningful socioeconomic transformation

Many highincome economies and middle-income economies that are seeking to transition to highincome economies, employ inflation targeting.

SA is a middle-income economy, which means it can afford welfare payments and other social services that low-income economies struggle to provide from government earnings (tax) alone. These countries, such as Zimbabwe, rely on international donor aid or access to employment in neighbouring countries, among other supports.

In seeking to protect the rand’s value by preventing high inflation the Reserve Bank seeks to maintain macroeconomic drivers fundamental to a stable economic system, as opposed to an economy that is heading to junk status — ultimately a failed state that is unable to make social welfare payments to the poor. Indeed, it is the poor who are most rapidly afflicted by sharply rising prices (the outcome of doing away with inflation targeting), particularly the prices of food and other necessities, as they spend the bulk of their income on these items.

A high-inflation environment in which inflation targeting is abandoned would mean a rapid, probably double-digit, rise in the cost of living, which the poor would not be able to afford.

When the question of economic growth versus inflation targeting is introduced, the answer is somewhat different. Indeed, the US, a highly successful high-income economy, balances a dual mandate of seeking low unemployment (employment creating growth) and low inflation. The US differs from SA in that its unemployment rate is in single digits and, therefore, not comparable to SA’s high rate, officially now close to 30% (27.7%). SA’s unemployment rate contains a large structural element, estimated at up to 22%. Even if interest rates are substantially cut despite high inflation and higher expected inflation — abandoning both inflation targeting and the independence of the Bank — these interest rate cuts would not reduce unemployment to below 22%. Strong, persistent and inclusive economic growth is needed instead. It is the only way radically to reduce unemployment to single digits, eliminating poverty and radically dropping inequality. We estimate reducing unemployment to single digits in SA would take continuous real GDP growth 6% above the current level for at least 10 years, along with a strengthening (not weakening) of SA’s institutions.

Without strong economic growth of this magnitude, driven primarily by the private sector, there will be insufficient incentive to employ the number of individuals needed to drop SA’s unemployment rate sharply to single digits. The government has run out of borrowing capacity and its debt is now in the process of being downgraded to sub-investment grade, with negative outlooks on those key credit ratings that remain investment grade. This means the next move will be a credit rating downgrade. The government can no longer borrow to pay current expenditure as it has done in the past, resulting in a primary deficit. That includes borrowing for public servants’ remuneration. Indeed, the credit rating downgrades risk causing further downgrades and a lower growth environment as business and consumer confidence falls. Already depressed confidence levels have caused the economy to tip into recession after a slow, steady decline in economic growth since 2009.

Business confidence has been depressed since 2009. Why? Initially, as a legacy issue from the global economic crisis, but then, after growth lifted in the global economy, SA followed a different growth trajectory. Key institutional strengths are necessary in any successful economy that improves the standard of living for all its citizens. No country has sustained successful socioeconomic transformation to higher living standards if it eroded key institutional strengths such as central bank independence.

Clearly, it is not the Bank’s role to achieve meaningful socioeconomic transformation.

Not only is it impossible for just one entity to do this, but the key problem in SA is a radical loss of confidence in the macroeconomic outlook. Meaningful socioeconomic transformation can only be achieved by fast, sustainable GDP growth, that can be achieved only by strengthening and maintaining core institutions. These include inflation targeting, central bank independence, judicial independence, private sector property rights (including intellectual property), eliminating corruption and wasteful government expenditure, reducing unnecessary regulation, ensuring transparency and consistency of government policy-making, low costs of crime and violence, strong auditing and reporting standards, efficacy of corporate boards and investor protection.

Crucially, government policies must be balanced with support for robust, broad-based private business sector activity (an environment where risk and return can be priced with nearcertainty) if lasting, meaningful socioeconomic transformation is to occur.

The private business sector is the growth engine of any economy and, with fiscal stimulation having run out of steam in SA as government finances are very constrained, monetary stimulation has come under scrutiny.

However, unlike the robust debate that takes place between the Bank and the private business sector, which generally prefers lower interest rates, public sector threats to the constitutional independence of the Bank are unhelpful. The Bank cannot bring about meaningful socioeconomic transformation on its own. The best it can do is balance regulation of the financial services industry with care to underpin sustainable positive activity and employment, while ensuring a workable inflation environment. Businesses cannot operate successfully in a high-inflation environment, particularly one that is at risk of runaway inflation.

Tinkering with the cornerstones of economic success that are encapsulated by the strengths of the core institutions mentioned above (the global norms for successful economies), historically results in unsustainable socioeconomic transformation — except for the politically connected few. The wheel cannot be reinvented when it comes to the formula for inclusive economic success and socioeconomic transformation.

Rapid growth of the private business sector is the key, as only it has the capacity to absorb all the unemployed in the long term. But business is hamstrung in SA by weak demand and the gradual weakening of core institutions. The latter has depressed the business sector’s confidence to invest and employ and has increased its fear of failing through expanding or overstretching in a weak economic environment. Private sector businesses need to be able to ensure their continued existence, as failure means job loss (increased unemployment), loss of capital and economic hardship for all involved.

Central bank independence and inflation targeting, or low inflation, are key factors underpinning high credit ratings, and are the remaining positives that have been identified for SA by the credit rating agencies.

If SA’s central bank is no longer independent, and is mandated by the government or Parliament to cease inflation targeting and take up a new mandate, SA will very probably lose its remaining key investmentgrade credit ratings, which are already on a negative outlook and in line to fall to subinvestment grade.

A migration from investment to subinvestment grade for a sovereign invariably means higher borrowing costs for that country, particularly when a season of global risk-on wears off. These seasons are never permanent in the financial markets. Pressure is put on the whole maturity spectrum and interest rates in the short end rise too.

While the Bank’s repurchase (repo) rate will not escape this pressure, it will also be under pressure to increase following rand weakness and a resultant rise in inflation.

Scuppering inflation targeting wouldn’t remove the upward pressure on financial market interest rates for a subinvestment-grade sovereign, but it would remove the pressure on the repo rate for hikes from higher inflation.

The advent of a blanket subinvestment-grade sovereign rating for SA would, we estimate, weaken the rand substantially and quickly towards R19/$. Such a radical depreciation of the domestic currency would push up living costs substantially, transforming living costs as food price and transport inflation are influenced by the exchange rate.

Doing away with or diluting the inflation targeting mandate would not stop the negative effect on living standards, and this socioeconomic own goal would hurt the poor most.

THE CREDIT RATING DOWNGRADES RISK CAUSING FURTHER DOWNGRADES AND A LOWER GROWTH ENVIRONMENT PUBLIC SECTOR THREATS TO THE CONSTITUTIONAL INDEPENDENCE OF THE BANK ARE UNHELPFUL