In the second quarter of this year, SA ran a deficit on the current account of the balance of payments equal to 6.4% of gross domestic product (GDP). This would translate to an annual deficit of R200bn if sustained for a full year. In rand terms, this is the largest current account deficit yet. As a share of GDP, it has been exceeded only in 2007 and 2008. But the current account deficit this year reflects much greater structural economic weaknesses than were present in 2007-08. Then, the deficits occurred when the economy was growing by more than 5% a year, the fastest in several decades. Now we are seeing very large deficits at a time of anaemic growth.
Current account deficits occur when countries spend more than they produce. As is the case when a household spends more than it earns, they must borrow to fund the difference. A country’s current account deficit must be funded by foreigners.
A current account deficit may occur because a country is investing a large share of its GDP in future productive capacity. Borrowing from abroad to fund such investment need not be a bad thing. In 2007-08 investment in SA was rising rapidly. It briefly exceeded 24% of GDP. But investment today is far below the 25% of GDP needed to sustain economic growth above 6% a year. It is sitting at just more than 19% of GDP.
The largest factor behind the increased current account deficit in the second quarter was a fall in domestic savings from 15.2% to 14.1% of GDP. This was down from an already miserable 16.4% last year.
Several commentators argue the second-quarter deficit was driven by an unusual combination of circumstances, including exceptionally high oil imports and dividend outflows. They note, moreover, that we were able easily to attract the foreign capital inflows required to fund the unusually large deficit. So why should we be worried?
First, our exports are under pressure from weaker global commodity prices. The signs are that global prices could fall further, with China in particular reducing demand. So we may see further falls in export earnings, a trend that will accelerate with the mounting losses in platinum and gold production as a result of labour unrest on our mines. It should be remembered, too, that the capital inflows we attract to fund our deficits are mainly foreign portfolio investments. Foreigners purchased R33bn of bonds in the second quarter and were modest buyers of our shares. We know that such inflows are volatile and easily reversible. Such reversals happen quickly and lead to a sharp weakening of the rand, with knock-on increases in the cost of important imports such as oil.
Foreign investment is coming to SA, not for any particular pulling power of our own. It is simply that investors lack better alternatives. In the context of exceptionally low global interest rates, our bonds offering 5.5% are the best they can get. This will change when global interest rates start to rise. A renewed global financial crisis is a further risk to such flows.
More worrying, persistent current account deficits mean inexorably rising levels of foreign debt, which increases the amounts we must pay foreigners in interest and dividends each quarter. These outflows, which are measured as part of the current account, create a structural deficit that now persists even at times of poor economic growth and low investment. We are faced with a more or less permanent drag on our income flows.
SA is rather like an individual trying to sustain a lifestyle beyond his earnings by borrowing. This is possible only so long as the individual has access to greater and greater amounts of credit. But the longer he lives beyond his means, the larger the share of income that must go in interest payments to fund growing levels of debt. Every month, new borrowings must be secured to cover repayments on old borrowings long spent. Borrowing becomes a perpetual need just to sustain current consumption levels. Eventually access to credit is exhausted, and spending falls. If this happens at the same time when past debts are called in, the effect on spending is catastrophic.
So it is with the current account of the balance of payments. If SA is ever forced by lack of capital inflows to suddenly reduce expenditure back in line with what we earn, the forced reduction in domestic spending will be very painful. If we are simultaneously required to repay just some of our past borrowings, the effect will be far harsher.
We can protect ourselves from such pain only by encouraging increased exports and savings and higher shares of foreign direct investment. Preventing further sharp falls in mining output is especially important. This is especially urgent at a time of global economic and financial weakness, which already negatively affect existing export earnings and threaten future capital inflows. Failure to recognise this places even our modest economic recovery at grave risk.
•Professor Gavin Keeton is with the economics department at Rhodes University.
This article was published on Business Day.