The current account balancing trick
Improving the savings rate should be a national priority
THE POINT OF FOCUS of the SA Reserve Bank’s Quarterly Bulletin for March 2007 was the announcement of the current account deficit for fourth quarter 2006.
The Bank’s intention was to prepare the market for a poor figure, and market players – especially the foreign exchange market, where short positions in the rand were the order of the day – could therefore position themselves appropriately.
The Bank’s announcement that SA’s current account deficit in the fourth quarter of 2006 had risen to 7,8% of gross domestic product therefore didn’t unsettle the market. In fact, the reaction of the foreign exchange market was a strengthening of the rand from approximately US$1/R7,40 before the announcement to US$1/R7,20 after it. Apparently, the market had therefore discounted an even weaker figure, which resulted in a sigh of relief all round. Or was it simply a case of profit taking – “sell on the rumour, buy on the fact” – as far as the rand was concerned?
The Bank had taken care to urge the market not to respond negatively to these figures, inter alia, by emphasising that exceptionally high oil imports were an important reason for the weakening and, if that were left out of account, the deficit would be less than 5,8% of the GDP.
However, the increase in oil imports in fourth quarter 2006, compared with the third quarter, was four times greater than the fall in the third quarter compared with the second quarter – which raises the question of which portion of the increase in the fourth quarter can in fact be regarded as temporary.
Apart from the fact that a deficit of 5,8% of GDP is still a high figure, I have reservations concerning the Bank’s wisdom in trying to influence the market’s interpretation of data selectively in a specific direction. There are other figures in the balance of payments statistics that also justify comment (for example, the payments to neighbouring states that are members of the Southern African Customs Union, where the financing requirement is debatable), but the Bank has refrained from that. Which raises the question of what the Bank’s agenda is.
You should consider the imports of crude oil and refined products together (the latter in the fourth quarter, as SA’s refineries again became fully operational) and then the deficit of the fourth quarter should have been adjusted upward to allow for the exceptionally low oil imports, to give the full picture.
If you accept the Bank’s argument concerning oil imports, it’s necessary to use the average deficit for the third and fourth quarters – which was 6,8% of GDP – as an indication of the underlying trend. That’s also close to the deficit of 6,4% of GDP recorded for 2006 as a whole. In short, SA’s underlying current account deficit is about 6,5% of GDP.
The statement that the deficit on the current account is financed by the inflow of capital (including unrecorded transactions) is, of course, factually correct but should nevertheless be qualified.
In the first place, 70% of the deficit in the fourth quarter was financed by unrecorded transactions (35% for 2006 as a whole) and not by proven capital inflow. Second, the fact that foreign direct investment made a negative contribution (and for the year as a whole) puts a question mark over the sustainability of the current account deficit.
Third, SA’s overdependence on foreign portfolio investments has again been demonstrated. Though the end of the bull market that began in 2003 is apparently not yet in sight, that day will eventually come and portfolio managers will adjust their strategies accordingly.
All that’s needed to upset the apple cart is for the inflow of portfolio capital to dry up, even if there’s no withdrawal of previous investments.
The fact that the deficits of the recent past have been financed therefore doesn’t lead automatically to the conclusion that future deficits will be financed to the same extent. The Bank in fact admits that SA benefited from excessive liquidity and low returns in developed countries.
That says nothing about the terms at which this financing is available: the fact is that the nominal effective exchange rate of the rand is about 20% weaker than it was a year ago. In other words, foreigners are only prepared to buy SA assets at lower prices than previously. SA’s current account deficit places us in a small group of emerging-market countries that don’t sustain a surplus and that are consequently regarded as more risky. Any weakening in investors’ rating of risky assets will therefore have a negative effect on the rand.
As for the prospects for 2007, the consensus view prior to the publication of the Quarterly Bulletin was that SA’s current account deficit would be about 5,5% of GDP this year. That view can most probably be adjusted upward in view of the new information. As long as the growth in domestic spending exceeds that in domestic production, for whatever reason, SA will find it difficult to reduce the deficit on the current account to a more sustainable level. The immediate prospect – in other words, for the first quarter of 2007 – is in any case not very rosy.
The balance of trade for the first two months of 2007 again provided an unpleasant surprise, with a R13,6bn shortfall. Customs Union payments are also expected to be abnormally high in the current quarter. According to National Treasury, those payments were R19,8bn for the 10 months to end-January 2007 compared with a budgeted total of R25,2bn.
That creates the impression that the payment in the first quarter of 2007 could be as much as R10,3bn, compared with R4,9bn in the fourth quarter of 2006, which could to a large extent neutralise any fall in oil imports (if this should happen).
Therefore, the Bank faces a serious dilemma. Must it wait and see whether the depreciation in the rand’s value will eventually lead to an improvement in the current account deficit? How preventatively should the Bank act to address the risk to the economy arising from the high deficit? Should the Bank be prepared to force the growth rate down to 3,5% or 4% in order to limit imports and improve the current account balance?
But perhaps the real point is simply that SA’s national savings rate is too low, after falling further in 2006 to 13,9% of GDP. It’s cause for concern that savings are at the lowest level since 1949, particularly at a time when the investment rate is showing a welcome acceleration.
An improvement in the savings rate should long since have been a national priority. Without that, it will be impossible to sustain a 6% growth rate, as envisaged by Asgisa.