Past binges make it hard to balance nation’s books
SOUTH Africa’s current account deficit is our key macroeconomic vulnerability. A large deficit means national spending is greater than national income, or that domestic savings are far less than required to fund investment. Foreign savings are required to fund the gap.
This funding has come largely from volatile sources such as portfolio flows, which include the purchase by foreigners of domestic shares and bonds. The result has been an increase in foreign ownership of shares and bonds. In contrast, foreign direct investment, a stickier form of funding, has lagged the more volatile funding sources.
South Africa’s current account deficit has been persistently large. In 2013 it was 5.9% of GDP, or R208billion. It has narrowed steadily, coming in at R174-billion, or 4.3% of GDP, last year. A large current account deficit coupled with volatile sources of funding renders the economy vulnerable to changing global investor confidence.
Changing perceptions of global monetary policy, China’s growth prospects, associated movements in commodity prices as well as domestic economic and political developments have made portfolio flows to South Africa volatile. This has heightened volatility in the rand due to the large external deficit that must be funded. This in turn has put domestic inflation under pressure, inviting interest rate increases.
In the past, current account adjustment has required two things: first, an easing in domestic spending growth, which tends to constrain imports; second, a rise in domestic production and exports.
There is evidence of partial progress. Domestic spending and import growth are responding as they should, but the export volume response has been disappointing. There are some bright spots in exports such as tourism. The weak rand and recent stability in commodity prices support export values and mitigate poor volume growth. Nevertheless, the major stumbling block to external adjustment is capital flight.
In the first quarter of the year, real growth in domestic spending fell. A decline in household spending and a steep contraction in fixed investment spending were to blame. Domestic spending is responding to higher interest rates, government belttightening and tighter credit criteria. Low business confidence is holding back fixed investment, particularly in the private sector.
The contraction in domestic spending has had the desired effect on imports. Import volumes, which decelerated over 2015, contracted in the first quarter compared to that period last year. The value of imports advanced at a slower pace, mainly due to lower imports of consumer goods. In contrast, higher global prices for certain South African-produced commodities and a weak rand boosted the value of exports. As a result, the trade deficit declined to R38-billion in the first quarter.
South African Revenue Service data show the cumulative trade deficit almost halved in the first four months of 2016 relative to last year. Our trade in services also improved during the quarter, narrowing the net services deficit. This is due to tourism, which is benefiting from a weak rand and easier visa rules.
However, despite a narrower trade and services deficit, the overall current account deficit deteriorated to 5% of GDP in the first quarter. This was due to a significant deterioration in the net income deficit, which increased by R24-billion in the first quarter. The larger shortfall in the net income account is due to a further increase in net dividend payments. In the first quarter, dividend receipts from domestically owned foreign assets continued to decline, coupled with a jump in dividend payments to foreigners.
In sum, the real economy is adjusting as it should. Slower domestic demand growth is leading to the expected decline in the trade deficit. However, income flows are preventing a meaningful current account compression. Unfortunately, the foreign funding we have binged on is coming back to haunt us. This is uncharted territory.
Nxedlana is FNB’s chief economist