Thinking on role of state, Reserve Bank needs to be upended
It is paradoxical that just as SA’s public finances are at their weakest since the 1980s, the government must step in to provide economic stimulus, support private firms and substantially expand social welfare spending.
It upends the thinking that has dominated conventional criticism of the Treasury and government since 2012, which has been that it should contain spending, consolidate debt and move towards a smaller role for the government in the economy.
But right now it is only governments that can do what is required, and without them the social and economic consequences are too dire to contemplate.
In a similar way, while conventional thinking — that is, views held by investors and the savings industry, ratings agencies and private sector economists — has been to back the insular approach of the SA Reserve Bank to narrowly target inflation, the mainstream view now is that the Bank should buy government bonds at a large scale with the intention of lowering the government’s cost of borrowing, restoring investor confidence and adding liquidity to the wider capital markets.
This too is something only the central bank can do, and again the consequences of not acting will be dire for the country.
At the time of writing this column a cabinet meeting was under way at which the government’s fiscal response would be discussed.
Of the G20 (Group of 20) countries, SA and India — both without much of a fiscal buffer
— lag far behind the rest. Italy’s and Germany’s responses are more than 30% of their GDP, while SA and India are at about 1%. The outcome of the cabinet meeting will be crucial.
It is also important to make the point now that while SA must respond to the Covid-19 crisis immediately, once we are through it a fiscal plan for consolidation must be provided.
The lockdowns in response to Covid-19 have caused unprecedented economic damage across the globe.
Never has the global economy been this integrated and brought to such a sudden stop.
In SA’s case, the economic effect of the lockdown is a daily loss of about R13bn to GDP, a group of Wits economists headed by Prof Imraan Valodia has estimated.
Of course, everyone knows a continued or successive series of lockdowns is not viable.
Valodia’s group estimates this would shrink GDP by 50%, so a plan for a gradual lifting of the lockdown is essential.
There is no escaping, though, that a lockdown will continue in some variation, which underlines the urgency of monetary and fiscal measures.
When finance minister Tito Mboweni tabled the national budget in February, he projected a main budget shortfall of 6.8% of GDP, or R368bn, in 2020/2021.
The debt to GDP ratio was expected to rise to 71.6% of GDP and showed no sign of consolidating over the medium term.
Based on new GDP forecasts arising from a five-week lockdown, the Stellenbosch Bureau for Economic Research (BER) projects a budget shortfall of 11.1% of GDP, or R558bn, due mainly to lower tax revenue and higher debt service costs.
Add to this, for example, a temporary R500 top-up to social grants for six months, and the deficit is closer to 12%.
To fund the shortfall the government, which issues about R15bn of bonds every week, would need to increase issuance by another R5bn, says the BER.
In the weeks leading to the lockdown bond investors were already in full flight for the door, with bond yields — the return investors realise — spiking to close to 13%.
That is when the Reserve Bank entered the secondary market on a modest scale to buy government bonds itself.
But the Bank stated that it would not target the price of borrowing and intended only to unfreeze the bond market.
Now, with greater issuance and a credit ratings downgrade in the mix and yields still above 11%, the real prospect has emerged that the government could rapidly find itself in a position where it is unable to sustainably raise the money it needs.
It could turn to short-term borrowing or use the cash reserves held at the SA Reserve Bank. It could also access concessional funding such as that offered by the New Development Bank, African Development Bank, World Bank and maybe even the IMF special Covid-19 facility.
It is doubtful, though, that any or all of these will be of the scale required to finance the government continuously for the next 12 months.
The main source of funding is likely still to be weekly bond auctions.
Unless confidence in this market is restored the government will have limited options, none of which is attractive.
Among them are: the route the apartheid government took of prescribed assets; bilateral loans from other countries; or a standby facility from the IMF.
The next move by the Reserve Bank will give us a sense of where we are heading.