Hardly a week goes by without some fresh depressing news about the current state of the South African economy. The Reserve Bank has twice this year reduced its growth forecast for 2014, from 2.8% at the beginning of the year to 2.1% and most recently to 1.7%. It has also reduced its forecasts for 2015 and 2016. Standard and Poor’s and Fitch have downgraded South Africa’s credit rating and Moody’s has put it on negative watch. The Minister of Finance has warned recently that the period ahead will not be easy.

How should South Africa conduct itself under these circumstances?  We suggest that responses should conform to five maxims.

1. Accept that expansionary monetary policy is not possible in the short run.  The interest rate tightening cycle has already begun.  Further upward pressures on the interest rate are emerging from the international system.  The United States is winding down its quantitative easing programme and most observers are expecting upwards movement in US interest rates to start in 2015.  Two other risks facing emerging markets are:

  • The unwinding of leverage in the Chinese economy.  Everyone knows that China has been spectacularly successful in expanding its manufacturing capacity.  What is less well known is that the financing of this expansion has been less than sound, creating a real, but submerged problem in both the public and private sectors.
  • Slowing credit growth in emerging markets themselves.

Some emerging markets face only one of these problems.  Some face two.  But according to a recent Bloomberg study, only three countries face all three:  Indonesia, Brazil – and ourselves.

2. Accept that expansionary fiscal policy is not possible in the short run.  The Treasury has been concerned about the buildup of public debt for two or three years now and it points to the need for fiscal consolidation.  South Africa has used up its expansionary fiscal space since 2008.  It has no more.  Bear in mind that the issue of whether there should be higher government expenditure financed by higher taxation is a different issue.  To a first approximation, especially when savings rates are low, such a development merely shifts purchasing power from the private to the public sectors.  It is not significantly expansionary per se.  Moreover, recent comments by Judge Dennis Davis confirm a problem encountered by his tax reforming predecessors.  It takes the form of harsh trade-offs between equity and efficiency if the tax share of GDP is to rise.

3. Anchor expectations by levelling with the people.  The last major fiscal consolidation came in 1996.  It was necessary and it was implemented.  The misjudgment came in marketing the policy.  It was considered necessary to sugar coat the pill by promising spectacularly improved outcomes within three of four years.  It took no more than an elementary understanding of economic principles and a passing acquaintance to know at the time that these promises were whoppers.  And so they proved.  Political, you may say, and indeed it was, but bad politics.  The deceit has not been forgotten and it has lowered government credibility for the next round of fiscal consolidation, due now.  Franklin Roosevelt was smarter about communication.  During the course of his presidencies he used fireside chats over the radio to explain circumstances plainly and directly to the American people and what he intended to do about them. They were great morale boosters through the Depression and the war.

4. Keep a firm hand on the tiller by distinguishing clearly between short term business cycle problems and long term growth strategies.  South Africa has long been in need of mood stabilizers to get it through the business cycle.  We know that growth in the first quarter of South Africa was negative.  Should growth in the second quarter also turn out to be negative, South Africa will have been in recession.  Moreover, Statistics South Africa estimated that the growth rate of the population in mid-2013 was just over 1.3% per annum.  So even if we escape a recession, one more downward revision of growth will mean that real average per capita incomes are expected to fall.  Well managed, the drop will be small and reversible.  South Africa escaped exposure to toxic assets a few years ago.  It was one of the advantages of being provincial.  Other countries have faced much more wrenching adjustments.  What is needed now is a steady hand.  Where is it to come from?

5. Manage sovereign and commercial risk carefully.  There seems to be a view out there that the conjuncture has changed.  Twenty years ago, an incumbent government had to be negotiated out of power amid an international swing to greater market orientation.  Now, it is argued, circumstances have changed and old compromises should make way for new, more aggressive policies.  In pursuit of these goals, a raft of new legislation has been passed, is being debated in parliament, and is promised for the future.  The effect has been to raise great uncertainty about the rules of the game.  The deterioration between 2013 and 2014 in the widely respected International Country Risk Guide composite indicator (used in many academic studies as well as by business) was as great in South Africa as it was in Nicolas Maduro’s Venezuela.  Rising risk means a rise in the risk premium - the differential between returns on internationally riskless assets and the required rate of return on loans and equity in South Africa - aggravating recessionary pressures.  Misreading the conjuncture in other times and places has sometimes been catastrophic for both economy and democracy.  Here and now, a misreading will lead us only into the torments of Tantalus.  Hungry, he reached for the grapes overhead, which swung out of his reach.  Thirsty, he bent down to drink from the river, only to see it dry up.

Charles Simkins
Senior Researcher