6% will remain out of reach
Foreign economists find SA economic policies wanting
This year wasn’t just going to be a red letter one for South Africa because of the Soccer World Cup. It was also the year when, according to SA’s growth plans, the economy would be growing by 6%/year and unemployment would be halved to 14%. Now we’ll be lucky to get 3% growth this year after a recession last year; and unemployment is at around 25%. Obviously, that isn’t all SA’s fault: after all, the world experienced its worst recession in more than 70 years and SA couldn’t escape that. But there’s evidence SA isn’t recovering as fast as some countries, most notably in Asia and South America, and that much of the blame for that can be laid at the door of weak or incoherent economic policies.
The trouble with SA’s economic policy is that people are so thankful the ANC didn’t take the socialist route that they don’t pick the policies apart enough. But economists overseas have done so and have been highly critical of SA. Both the Organisation for Economic Development and Co-operation (OECD – the “rich countries” club) and the Harvard Panel of economists have looked at SA’s economic policies and found them wanting.
Taking aim at SA’s economic policies is an easy thing to do. Policy on the rand is incoherent and fraught with conflict; fiscal policy has seen Government spend massively on salaries while cutting back on infrastructure spending; previous SA Reserve Bank Governor Tito Mboweni made some big mistakes; industrial policy isn’t working; and the policy to create “decent jobs” has unfortunate repercussions. It’s a mess. Which suggests that 6% growth rate will remain out of reach.
Both the OECD and the Harvard Panel of experts on SA have recommended a weaker currency for this country. The response from SA’s key policymakers has been far too vague – a problem for any exporter or importer trying to determine planning.
One question that springs to mind is whether Finance Minister Pravin Gordhan is giving those outside groups (such as the OECD) such a high profile platform to call for a weaker rand because he wants to send the same message to the Reserve Bank.
Though the Harvard Panel’s Ricardo Hausmann had a lower profile than the OECD on a recent visit here, he was still widely reported as saying the rand should be more competitive. His advice to SA was to cut its Budget deficit faster than it’s planning to do – to create space for lower interest rates – if it wanted a more competitive rand and faster economic growth.
Hausmann’s argument has many flaws – not least being that a lower fiscal deficit will necessarily allow for lower interest rates and that, in turn, for a more competitive rand. But the bottom line was still his view that a more competitive rand was needed to stimulate faster economic growth.
The OECD was blunter and received a lot of publicity. It said SA’s authorities should intervene more actively against strength in the rand – which has hit exports – and provide policy signals on both the exchange rate and the likely direction of interest rates.
The question of policy signals about the exchange rate is one fraught with uncertainty. Gordhan, though he gave the OECD the platform to make the call for a weaker rand, responded carefully. He was reported as saying: “We want a competitive and stable exchange rate – we intend to repeat that as many times as necessary... To the extent that it is possible and affordable, we’ll enable the Reserve Bank to buy more reserves.”
The Reserve Bank acknowledged at its last Monetary Policy Committee meeting that the rand was overvalued, though Governor Gill Marcus was careful to leave it up to Deputy Governor Xolile Guma to comment. He said the rand was “misaligned”.
When the Bank buys reserves, the rand weakens due to the central bank’s demand for US dollars. Gordhan’s comment raises an important point: there’s a cost to the taxpayer in intervening on the rand. That cost arises because the Bank sells rand into the market when it intervenes, which is a liquidity inflow into the money market. That inflow puts downward pressure on interest rates and interferes with the operation of monetary policy. The liquidity needs to be drained from the market.
Gordhan can help do so by issuing Government stock. But then he has to pay interest on that Government stock, which is less than the interest earned on the US dollars or euro bought in the market. By emphasising the affordability of the exercise, Gordhan injected a note of caution into Treasury’s readiness to help the Bank. It implies no major exercise in intervening on the rand is on the cards, as Treasury can’t really afford the debt.
A different way to drain liquidity from the money market is for the Reserve Bank to issue its own debentures. But the loss incurred on the interest rate differential between what the Bank pays and what it earns resulted in the Bank incurring an overall loss of R1bn over its past financial year. That’s also for taxpayers’ account.
Moreover, the Bank has found there’s little appetite in the money market for its paper. The Bank has indicated it’s working on a new mechanism to drain liquidity from the money market to counteract the rand flows into the money market arising from intervening in the currency market.
Whatever the difficulties in intervening to weaken the rand,
there’s been some action, as indicated by the latest figures for the Bank’s gold and foreign exchange reserves. Those showed net reserves rose US$261m in June – a small sum, but the first movement after months of no change in the reserves at all. It seems the Bank was active to offset the strengthening effect Soccer World Cup tourism may have had on the rand.
It seems the Bank is reluctant to intervene with too heavy a hand because of the strong pass-through from a weaker rand to inflation. That would certainly be true if the rand had to be pushed to US$1/R10,50 – which is what Cosatu wants. But leading manufacturers have said an exchange rate of US$1/R8,60 would be acceptable. Some action from the Bank could achieve that result, although it would be foolish to set a public target for the rand, as that could invite attack from speculators.
Despite the OECD calling for signals on the exchange rate, it would be wiser to stick to the vague mantra of “a stable and competitive exchange rate” while intervening steadily in the market to build on the minuscule start made in June. That would require the Reserve Bank to change its stance.
When it comes to fiscal policy, SA has been fairly smug about its fiscal ratios, given that the world’s most developed countries are experiencing a fiscal crisis. Most often mentioned is the fact SA’s Budget deficit in 2009/2010 was 6,7% of gross domestic product – around half of that of the United States, Britain and Ireland.
However, the first point that needs to be made about this supposedly healthy Budget deficit is it doesn’t take in the whole public sector, as does the deficits for the countries quoted above. The public sector borrowing requirement (PSBR) was 8,4% of GDP in 2009/2010. That, though not yet shocking, is still high.
But the most important point about the PSBR is it masks how the money is spent. True, public utilities such as Eskom and Transnet are still increasing their infrastructure spending. But figures in the Reserve Bank’s Quarterly Bulletin suggest SA’s taxpayers aren’t getting bang for their buck at other tiers of government.
Reading the bulletin, you’re left with an image of a Government spending massively on military aircraft and salaries while cutting back on infrastructure spending. That despite the fact that for the whole of Government infrastructure spending is something of a mantra.
The lack of infrastructure spending is evident at the three tiers of Government – national, provincial and local – “general government” in the parlance of the bulletin. There’s a shocking contrast between Government consumption spending (which doesn’t create productive capacity in the economy or hard physical assets) and Government infrastructure or capital expenditure. (The bulletin uses the term “gross fixed capital formation”, or GFCF.)
Government consumption expenditure rose by a massive 7,3% in real terms in first quarter 2010, while capital expenditure by Government fell by a shocking 8% in real terms. (All figures are quarter-on-quarter, seasonally adjusted and annualised percentage changes, unless otherwise stated.)
The 7,3% increase in Government consumption spending in the first quarter was unusually high. The bulletin reports the big increase in the first quarter primarily reflected the acquisition of two military aircraft, while salary outlays also “edged” higher. But excluding the spending on arms, growth in consumption spending by general government is still high, although it slowed marginally from an annualised rate of 5,2% in fourth quarter 2009 to 5% in first quarter 2010.
Arms buying is influencing SA’s consumption figures. (Though they’re hard assets – and one would expect them to be classified as capex – the international norm is to classify them as consumption spending, because they don’t add to the productive capacity of the economy.) The question that springs to mind is: Why is SA buying
military aircraft? The money could be put to better use in those 55% of municipalities where sewerage facilities have been found to be inadequate.
SA’s municipal sewerage infrastructure backlog is R23bn and the decline in Government GFCF suggests that it isn’t being tackled. In addition, electricity distribution infrastructure has a backlog of R27bn – also being neglected. The need to address both those issues is urgent. These backlogs aren’t being tackled while Government is cutting back on infrastructure spending. Government is also cutting back on spending on schools, houses and hospitals.
In some places, electricity distribution infrastructure is literally falling apart, because municipalities are reluctant to invest in electricity distribution due to the threat of losing the income from electricity tariffs. The problem is that Government has – for years – planned to put all SA’s distribution assets into six regional electricity distributors (Reds), which would bill customers directly and municipalities wouldn’t be involved. Despite promises they’d be compensated for lost revenue, municipalities have clung on to the electricity distribution function while at the same time not investing in infrastructure. It’s no wonder Government capex is falling.
You get some idea why there wasn’t enough money for capex when you see what the increases in public servants’ pay have been. The bulletin reports in the year to fourth quarter 2009 there was a 19,4% increase in the average remuneration/ worker in the public sector. The bulletin doesn’t give a breakdown between the broader public sector, such as Transnet and Eskom, and those financed by taxpayers’ money.
However, the increase for taxpayers must have been big, as the bulletin says the surge in public sector remuneration was due to “one-off pay adjustments made in accordance with the occupationspecific dispensation and included an element of back pay. The intention of this dispensation is to improve Government’s ability to attract and retain appropriately skilled employees through improved remuneration.”
But Government also pays well at the
Why is SA buying military aircraft? The money could be put to better use in those 55% of municipalities where sewerage facilities have been found to be inadequate... Government is also cutting back on spending on schools, houses and hospitals
low end of the scale. The bottom line is that the strain on SA’s fiscus is tremendous and the spending that has suffered the most as a result has been infrastructure spending.
The OECD and the Harvard Panel were both critical of SA’s fiscal policy, saying it should have been more counter-cyclical. That means former Finance Minister Trevor Manuel should have saved more in the fat years. The OECD warns against a big increase in spending on social grants, saying it takes away the incentive for people to find work.
Monetary policy currently seems to be on the right track, although Reserve Bank Governor Marcus surprised the markets with a 0,5 percentage point cut in the repo rate to 6,5% in March. It’s usually not good for central banks to surprise the markets and she hadn’t done enough to prepare people for a cut. But the 5,5 percentage point cut in interest rates since December 2008 is the right medicine for an economy struggling to get out of the doldrums.
However, before those cuts, Marcus’s predecessor – Tito Mboweni – put the economy through severe strain by raising interest rates by 5,5 percentage points. True, inflation did peak at 13,6% – more than double the 3% to 6% target – but the main drivers were exogenous shocks, such as food and fuel and not consumption.
Mboweni committed overkill in the upward cycle of interest rates, just as he committed overkill in the downward cycle. He should never have cut interest rates in 2004 and 2005, which created an “easy money” psychology, causing South Africans to spend on credit as if there were no tomorrow and creating the need for dramatic action later. Hopefully, Mboweni’s successor won’t make the same mistake and will be ready to raise interest rates when the time comes.
SA’s industrial policy action plan (IPAP) isn’t working as envisaged and we can level a lot of criticism at what was envisaged. One of the major problems with the plan is it took years to be finalised, as new Minister of Trade and Industry Rob Davies revised the work done by his predecessor, Mandisi Mphalwa. The final document was unveiled in February this year.
There’s currently a spat between the Department of Trade & Industry (DTI) and the Treasury over one of Davies’s plans. Whatever you think of the merits of this specific part of Davies’s plan, the wrangling with other ministers is fast closing the window of opportunity to implement it. Davies had suggested taking advantage of the public sector’s R846bn infrastructure spending plan (mainly Eskom and Transnet) by giving local suppliers an advantage over foreign suppliers. The details of the plan are that the “pointscoring” system used to decide tenders should give SA’s suppliers the opportunity to come in with a new, lower-priced bid if the only reason they’re beaten by a supplier overseas is on price. The key issue is that if manufacturing is kept in SA it will create jobs.
It’s true many analysts will argue that idea is a serious intervention in the market mechanism, which could push up costs as foreigners give up bidding. There’s also the possibility it isn’t widely feasible, because SA’s capital goods industry has been allowed to dwindle alarmingly. Still, the plan has some merit as a short-term band-aid to create jobs by using public sector spending.
But it has to be pointed out it’s by no
means a new idea thought up by Davies. It’s a plan that’s been bandied about for years, starting with former DTI Minister Alec Erwin. Much time has elapsed and massive public spending has already occurred without the plan being implemented. The window of opportunity is beginning to close.
Trouble is, the Treasury disagrees vehemently with the plan. Although Gordhan hasn’t spoken out publicly, business people have revealed Treasury has concerns about the constitutionality of the “pointmatching” proposal. The constitutionality Treasury is concerned about apparently refers to “fairness” in the tender process.
At end-April, Davies answered a question in Parliament that indicated the pointmatching system dispute with Treasury hadn’t been settled. Things have gone quiet since. Trouble is, the more time is wasted, the more spending is either deferred or goes ahead without the South African component.
That’s but one aspect of IPAP that isn’t happening. The plan also foresaw enhanced access for manufacturers to concessional industrial financing. Though that’s part of the Industrial Development Corporation’s (IDC) remit, there’s little evidence its actions in that regard are boosting manufacturing.
The most glaring problem with IPAP is the eye-popping range of sectors it covers. The whole idea behind industrial policy is for Government to pick “winning” sectors. That’s why it’s a controversial policy, because it should in theory be left up to the market and not Government intervention.
But the IPAP says Government plans to intervene in sectors, including metals fabrication, capital and transport equipment, green and energy-saving industries, agroprocessing, automotives and components, plastics, pharmaceuticals and chemicals, clothing, textiles, footwear and leather, biofuels, forestry, paper, pulp, furniture, cultural industries and tourism and business process services (call centres). Finally, it will place “long-term” focus on nuclear technology, advanced materials and aerospace.
There seems to have been a reluctance to narrow the focus and the question that arises is: Where will the finance to help those industries all come from? The IDC and the Treasury combined won’t have the capacity. Gordhan has been non-committal about finance for programmes not already in place.
Everyone agrees SA’s biggest problem is unemployment. One of the recent imaginative suggestions by Gordhan to begin addressing SA’s unemployment problem – a wage subsidy for young people – has got bogged down in ideological haggling and is unlikely to fly. It’s one of the issues addressed in the OECD report.
PRAVIN GORDHAN AND ROB DAVIES The treasury disagrees vehemently with one of Davies’s plans although Gordhan
hasn’t spoken out publicly