Gov­ern­ment tam­pers with SARB at its peril

The Star Early Edition - - OPINION & ANALYSIS - Annabel Bishop Annabel Bishop is Investec chief econ­o­mist.

MANY high-in­come economies, and also mid­dle-in­come economies seek­ing to tran­si­tion to high-in­come economies, em­ploy in­fla­tion tar­get­ing. South Africa is a mid­dle-in­come econ­omy and this means it is able to af­ford so­cial-wel­fare pay­ments and other so­cial ser­vices that low-in­come economies typ­i­cally would strug­gle to do on their gov­ern­ment earn­ings (taxes) alone, and so these coun­tries rely on in­ter­na­tional donor aid or ac­cess to em­ploy­ment in neigh­bour­ing coun­tries, among other sup­ports, such as Zim­babwe.

In seek­ing to pro­tect the value of the rand (by pre­vent­ing high in­fla­tion), the SA Re­serve Bank (SARB) is seek­ing to main­tain macroe­co­nomic drivers fun­da­men­tal to a sta­ble eco­nomic sys­tem, and not an econ­omy that is head­ing to junk sta­tus – ul­ti­mately a failed state which is un­able to make so­cial-wel­fare pay­ments to the poor.

In­deed, it is the poor who are most rapidly af­flicted by sharply ris­ing prices (the re­moval of in­fla­tion tar­get­ing), par­tic­u­larly the prices of food and other ne­ces­si­ties as they spend the bulk of their in­come on these items, of­ten go­ing with­out. A high-in­fla­tion en­vi­ron­ment, where in­fla­tion tar­get­ing is aban­doned, would mean a rapid (likely dou­ble digit) rise in the cost of liv­ing, which the poor would not be able to af­ford, and would have to in­creas­ingly go with­out.

When the ques­tion of eco­nomic growth versus in­fla­tion tar­get­ing is in­tro­duced, then the an­swer is some­what dif­fer­ent, and in­deed the US, a highly suc­cess­ful, high-in­come econ­omy, bal­ances a dual man­date of seek­ing both low un­em­ploy­ment (em­ploy­ment cre­at­ing growth) and low in­fla­tion.

How the US dif­fers from South Africa, though, is that its un­em­ploy­ment rate, in low, sin­gle dig­its, is not com­pa­ra­ble to South Africa’s high rate, of­fi­cially now close to 30 per­cent (27.7 per­cent), in that South Africa’s un­em­ploy­ment rate con­tains a large struc­tural el­e­ment (which we es­ti­mate up to 22 per­cent).

This means that even if we cut in­ter­est rates sub­stan­tially, de­spite high, and ex­pected high, in­fla­tion (aban­don both in­fla­tion tar­get­ing and the in­de­pen­dence of the SA Re­serve Bank), these in­ter­est rate cuts would not re­duce un­em­ploy­ment to be­low 22 per­cent. In­stead, what is needed is strong, per­sis­tent and in­clu­sive eco­nomic growth.

In­deed, strong, in­clu­sive eco­nomic growth that con­tin­ues (eco­nomic growth which en­sures the so­cio-eco­nomic well-be­ing of all the coun­tries cit­i­zens) is the only sus­tain­able so­lu­tion to sus­tain­ably and rad­i­cally re­duc­ing un­em­ploy­ment to sin­gle dig­its, elim­i­nat­ing poverty and rad­i­cally drop­ping in­equal­ity.

We es­ti­mate re­duc­ing un­em­ploy­ment to sin­gle dig­its would take con­tin­u­ous real gross do­mes­tic prod­uct (GDP) above 6 per­cent from cur­rent lev­els for at least 10 years, along with strengthening (not weak­en­ing) South Africa’s in­sti­tu­tions.

That is, real GDP growth of above 6 per­cent from cur­rent lev­els ev­ery sin­gle year for at least 10 years driven by the pri­vate busi­ness sec­tor. With­out strong eco­nomic growth of this mag­ni­tude, there will be in­suf­fi­cient in­cen­tive to em­ploy the num­ber of in­di­vid­u­als needed to drop South Africa’s un­em­ploy­ment rate sharply to sin­gle dig­its.

The gov­ern­ment has run out of bor­row­ing ca­pac­ity (if it wishes to re­tain an in­vest­ment grade credit rat­ing), and its debt is in­stead in the process of be­ing down­graded to sub-in­vest­ment grade, with neg­a­tive out­looks on its key credit rat­ings that re­main in­vest­ment grade (neg­a­tive out­looks mean the next move will be a rat­ing down­grade), it can no longer bor­row to pay cur­rent ex­pen­di­ture (which in­cludes public ser­vants’ re­mu­ner­a­tion), as it has done in part, re­sult­ing in a pri­mary deficit.

What is hap­pen­ing now is that the credit rat­ing down­grades risk fur­ther down­grades and a lower growth en­vi­ron­ment as busi­ness and con­sumer con­fi­dence falls.

Al­ready de­pressed con­fi­dence lev­els have seen the South African econ­omy tip into re­ces­sion af­ter a slow, steady de­cline in eco­nomic growth since 2009. Busi­ness con­fi­dence has been de­pressed since 2009.

Why? Ini­tially as a legacy is­sue from the global eco­nomic cri­sis, but then, af­ter the global econ­omy saw growth lift­ing, South Africa fol­lowed a dif­fer­ent growth tra­jec­tory. Key in­sti­tu­tional strengths are nec­es­sary in any suc­cess­ful econ­omy to im­prove the stan­dard of liv­ing for all its cit­i­zens (pro­vide so­cio-eco­nomic trans­for­ma­tion).

No coun­try has sus­tained suc­cess­ful so­cio-eco­nomic trans­for­ma­tion to higher liv­ing stan­dards as key in­sti­tu­tional strengths, such as cen­tral bank in­de­pen­dence, have been eroded.

It is not the role of the re­serve bank to achieve mean­ing­ful so­cio-eco­nomic trans­for­ma­tion. In any case not only is it im­pos­si­ble for just one en­tity to do so, but the key prob­lem is a rad­i­cal loss of con­fi­dence in the macroe­co­nomic out­look.

Mean­ing­ful so­cio-eco­nomic trans­for­ma­tion can only be achieved by fast, sus­tain­able GDP growth, which in turn can only be achieved by strengthening and main­tain­ing core in­sti­tu­tions (such as in­fla­tion tar­get­ing, cen­tral bank in­de­pen­dence, ju­di­cial in­de­pen­dence, pri­vate sec­tor prop­erty rights (in­clud­ing in­tel­lec­tual prop­erty), elim­i­nat­ing corruption and waste­ful gov­ern­ment ex­pen­di­ture, re­duc­ing un­nec­es­sary reg­u­la­tion, en­sur­ing trans­parency and con­sis­tency of gov­ern­ment pol­icy-mak­ing, low costs of crime and vi­o­lence, strong au­dit­ing and re­port­ing stan­dards, ef­fi­cacy of cor­po­rate boards and in­vestor pro­tec­tion. Cru­cially, gov­ern­ment poli­cies need to be bal­anced with sup­port for ro­bust, broad­based pri­vate busi­ness sec­tor ac­tiv­ity (an en­vi­ron­ment where risk and re­turn can be priced with near cer­tainty) if last­ing, mean­ing­ful so­cio-eco­nomic trans­for­ma­tion is to oc­cur.

The pri­vate busi­ness sec­tor has al­ways been the growth engine of any econ­omy, and with fis­cal stim­u­la­tion hav­ing run out of steam, with gov­ern­ment fi­nances now con­strained, mon­e­tary stim­u­la­tion (mon­e­tary pol­icy ac­com­mo­da­tion) has come un­der scru­tiny. How­ever, un­like the ro­bust de­bate which takes place be­tween the re­serve bank and the pri­vate busi­ness sec­tor, public sec­tor threats to the con­sti­tu­tional in­de­pen­dence of the re­serve bank are un­help­ful as it can­not bring about, let alone achieve, mean­ing­ful so­cio-eco­nomic trans­for­ma­tion. The best the re­serve bank can do is bal­ance reg­u­la­tion on the fi­nan­cial ser­vices in­dus­try with care to un­der­pin sus­tain­able pos­i­tive ac­tiv­ity (and em­ploy­ment) in it, while en­sur­ing a work­able in­fla­tion en­vi­ron­ment, as busi­nesses also can­not op­er­ate suc­cess­fully in a high-in­fla­tion en­vi­ron­ment, par­tic­u­larly one that is at risk of run­away in­fla­tion.

Tin­ker­ing with the cor­ner­stones of eco­nomic suc­cess that are en­cap­su­lated by the strengths of core in­sti­tu­tions (the global norms for suc­cess­ful economies), his­tor­i­cally re­sults in un­sus­tain­able so­cio-eco­nomic trans­for­ma­tion, and as a re­sult the so­cio-eco­nomic trans­for­ma­tion proves not to be mean­ing­ful (does not last), ex­cept for the po­lit­i­cally con­nected few.

The wheel can­not be rein­vented suc­cess­fully when it comes to the for­mula for in­clu­sive eco­nomic suc­cess, and so so­cio-eco­nomic trans­for­ma­tion.

Rapid growth of the pri­vate busi­ness sec­tor is the key, as only it has the ca­pac­ity to ab­sorb all the un­em­ployed in the long-term, but it is cur­rently ham­strung in South Africa by weak de­mand and the grad­ual (ac­tual and at­tempted) weak­en­ing of core in­sti­tu­tions. This has de­pressed the busi­ness sec­tor’s con­fi­dence to in­vest and em­ploy, and in­creased its fear of fail­ing through ex­pand­ing and over-stretch­ing in a weak eco­nomic en­vi­ron­ment.

Pri­vate sec­tor busi­nesses need to be able to en­sure their con­tin­ued ex­is­tence as fail­ure means job loss (in­creased un­em­ploy­ment), loss of cap­i­tal and eco­nomic hard­ship for all in­volved.

Cen­tral bank in­de­pen­dence and in­fla­tion tar­get­ing/low in­fla­tion are key un­der­pin­nings to high credit rat­ings, and re­main­ing pos­i­tives which have been iden­ti­fied for South Africa by the credit rat­ing agen­cies. If the re­serve bank is no longer in­de­pen­dent, and is man­dated by Par­lia­ment to cease in­fla­tion tar­get­ing and take up a new man­date, South Africa will very likely lose its re­main­ing key in­vest­ment grade credit rat­ings, which are al­ready on a neg­a­tive out­look (in line to fall into sub-in­vest­ment grade).

A mi­gra­tion from in­vest­ment to sub-in­vest­ment grade for a sov­er­eign in­vari­ably means higher bor­row­ing costs for that coun­try, par­tic­u­larly when a sea­son of global risk wears off (these sea­sons are never per­ma­nent in the fi­nan­cial mar­kets). Pres­sure is put on the whole ma­tu­rity spec­trum and in­ter­est rates in the short term rise too. While the re­serve bank’s re­pur­chase (or repo) rate will not es­cape this pres­sure, it will also be un­der pres­sure to rise fol­low­ing rand weak­ness and a re­sul­tant rise in in­fla­tion.

Scut­tling in­fla­tion tar­get­ing wouldn’t re­move the up­wards pres­sure on fi­nan­cial mar­ket in­ter­est rates for a sub-in­vest­ment grade sov­er­eign, but it would re­move the pres­sure on the repo rate for hikes from higher in­fla­tion.

The ad­vent of a blan­ket sub-in­vest­ment grade sov­er­eign rat­ing would, we es­ti­mate, weaken the rand sub­stan­tially and quickly to­wards the R19 a dol­lar mark. Such rad­i­cal de­pre­ci­a­tion of the do­mes­tic cur­rency would push up liv­ing costs for South Africans sub­stan­tially, trans­form­ing their liv­ing costs as food price in­fla­tion is in­flu­enced by the ex­change rate, as are trans­port costs.

Do­ing away with, or di­lut­ing the in­flat­ing tar­get­ing man­date would not stop the neg­a­tive im­pact on liv­ing stan­dards, and this so­cio-eco­nomic own goal would hurt the poor most.

If the Re­serve Bank is man­dated to cease in­fla­tion tar­get­ing, SA risks los­ing its re­main­ing key in­vest­ment credit rat­ings, al­ready on a neg­a­tive out­look.

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