6% will re­main out of reach

For­eign econ­o­mists find SA eco­nomic poli­cies want­ing

Finweek English Edition - - FRONT PAGE - By Greta Steyn

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

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