Resist calls for lower rates and bigger fiscal deficits

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THE National Union of Metalworkers of South Africa (Numsa) resolved in August on "rolling mass action in the form of a national strike", targeting the "National Treasury and related government departments".

It will be unfortunate if this translates into further labour disruptions at a time when the economy is already weakened by violent or illegal strikes in the transport and mining sectors. Labour unrest has had a negative effect on foreign investor perceptions of South Africa. It has prompted large sales of our shares by foreigners, causing the rand to weaken significantly over the past two weeks.

As a result, Finance Minister Pravin Gordhan and Reserve Bank governor Gill Marcus have warned that South Africa’s international reputation is being severely tarnished. This will have a negative effect on growth and jobs, they caution. And, in a bid to end the strikes, President Jacob Zuma took action this weekend and called a summit of business, labour and government leaders.

The rand could have weakened further had foreigners not continued to buy our bonds after Citigroup’s decision to include South Africa in the countries making up its World Government Bond index. This move obliged global index-weighted bond funds to buy South African bonds even as other foreign investors sold their South African shares. However, this welcome capital inflow will stop once bond holders reach their required weighting of our bonds.

What motivates the proposed Numsa strike? A number of sector-specific grievances are part of the story. But Numsa is also highlighting its repeated opposition to what it terms a "toxic combination of inflation targeting, high interest rates" and the "religious maintenance of the failed macro-economic policy, so-called Gear". Is the claim that inflation targeting leads to high interest rates valid? South Africa’s prime overdraft rate is at its lowest level in 30 years.

After allowing for inflation, real three-month interest rates are zero. SA’s interest rates have been more stable and on average lower since inflation targeting was introduced. While interest rates in South Africa may appear somewhat higher than in other countries, it is invariably because those countries have much lower inflation than we do. After allowing for inflation, South Africa’s interest rates are not high compared with our global peers. The claim that inflation targeting has led to high interest rates is a myth.

Numsa’s opposition to the "so-called Gear" policies mainly reflects its belief that government deficits since 1986 have been too low. This, too, is surprising at a time when the budget deficit is already a whopping 5.2% of gross domestic product (GDP) this year. The deficit is projected to fall to 3.6% of GDP by 2014-15, although there is growing scepticism that this will actually be achieved.

The belief that higher budget deficits are a good thing is misplaced. It ignores the effect of rising debt in curbing future government spending. By 2014-15, South Africa’s cumulative budget deficit since the start of the slowdown in 2007 will have added R960bn to existing government debt. Even at today’s low interest rates, interest charges on this new debt alone will be about R74bn a year.

According to the Treasury, total government debt by 2014-15 will be 40% of GDP. This will be almost 1.6 times what the government will receive in tax revenue. Government debt relative to its income will then be exactly double the level of household debt to income in South Africa today.

We are all concerned about the excessive debts ordinary people have incurred. Are we really happy to let government debt grow to twice this level? By 2014-15, interest charges on government debt will be R109bn a year, which is 11% of all tax revenue. R1 of every R9 of tax collected will be used to pay interest.

Alternatively, almost half of the tax paid by companies will be needed to meet interest charges. Just think how this will reduce what can go to state spending elsewhere.

Higher deficits and rising government debt during economic downturns are accepted parts of countercyclical fiscal policy.

It makes little sense for the government to raise taxes or cut spending when an economy is already weak. But then the government must run budget surpluses when the economy is growing faster. These surpluses are needed to reduce the debt and interest incurred during the previous downswing.

Gordhan has repeatedly reminded us of this. But it is certain that attempts to run such surpluses in future will attract the ire of the African National Congress’s alliance partners. Convinced of the inherent virtues of high government spending, these critics ignore the restrictions that rising debt and interest payments place on noninterest government spending.

Inflation targeting and the reduction in government debt before 2007 served South Africa well. Interest rates are lower in both nominal and after-inflation terms. Reduced debt and interest burdens then freed up resources in the national budget for increased spending on social security grants and infrastructural investment.

These gains are now threatened at a time of economic weakness. Firm leadership is required to resist siren calls for much lower interest rates and even bigger deficits.

  • Gavin Keeton is with the economics department at Rhodes University.This article was published on