NEWS that the Reserve Bank’s monetary policy committee considered cutting interest rates at its latest meeting is confirmation of the growing weakness of the South African economy. The weakening outlook is highlighted by the downward revision of the Bank’s growth forecast for this year from 2.7% to 2.4%. This is barely sufficient to sustain present employment levels. It is nothing like the 6%-7% annual growth needed for longer than a decade to reduce poverty and unemployment meaningfully.
Despite its lower inflation forecast, the committee felt unable to cut interest rates. This is because it is concerned about the effect on the rand. Lower interest rates, the committee feared, might encourage foreign fund managers to move their funds away from South Africa, battering the rand still further.
The result is policy paralysis. We watch helplessly as already feeble growth weakens further. It should not be like this. The world is awash with financial liquidity following quantitative monetary easing in the US and Japan. That the managers of these funds choose not to invest in South Africa confirms our economic weaknesses and vulnerability to further upsets.
South Africans have become used to periods in which the rand exchange rate suddenly weakens dramatically. It happened in 1996, 1998, 2001 and 2008. In each case, the rand subsequently rebounded, encouraging complacency that such events are just temporary episodes of market overreaction.
But this is to ignore the fact that only one of these precipitate declines in the rand was triggered by domestic factors. This was in 1996 and arose from unfounded fears about then president Nelson Mandela’s health and concerns that we were too reliant on foreign portfolio inflows to fund a rising current account deficit. Compounding this was doubt about the credibility of macroeconomic policy at the time. Once this credibility concern was addressed, with the publication of the Growth, Employment and Redistribution strategy in June 1996, foreign capital inflows resumed and the rand exchange rate strengthened again.
The 1998, 2001 and 2008 falls in the rand were triggered by global events. In 1998, the key factor was fallout from the East Asian economic crisis. In 2001, it was the collapse of the dotcom bubble and the September 11 attacks in the US, while, in 2008, the cause was the global financial crisis.
The rand’s steady decline since 2011 is very different. Its causes are mostly local and weakness is occurring in a global economic context that should favour rand strength. Some may argue rand weakness is the result of declining global commodity prices, a negative factor beyond our control. Yet Australia is also affected by falling commodity prices and its exchange rate is painfully strong.
The real change is that foreign fund managers have substantially reduced their purchases of South African bonds, despite the attractiveness of our interest rates. In the first three months of this year, monthly foreign bond purchases were less than half their average last year. Moreover, foreigners have been moving out of our equities since 2011.
The reason offshore fund managers have lost their appetite for our bonds is their growing concern about our astonishingly high current account deficit of 6.5% of gross domestic product. To fund this, South Africa requires foreign capital inflows of more than R200bn a year — nearly four times the amount coming in from portfolio inflows at present.
This is a big problem that could become even bigger if mining exports are disrupted. And so the extraordinarily high wage demands tabled at the start of wage negotiations in the mining industry were seen as the portent of renewed strikes and lost production. The rand weakened markedly as a result and we seem set for a vicious cycle in which disrupted production will increase our current account deficit even further, which will in turn increase our need for foreign-capital inflows. If foreign investors who previously bought our bonds and equities at that juncture decide to take their money home, we will face the unhappy combination of a big current account deficit at the same time as foreign capital outflows. We are therefore very lucky that global financial conditions remain so favourable. A world of vast liquidity makes large outflows less likely. The fact that the rand’s present weakening occurred gradually over two years also helps.
We are much less likely to experience the dramatic "leads and lags" — when importers all suddenly seek to cover their foreign currency exposure and exporters hold onto their dollars to benefit from the weaker rand — that compounded falls in the rand in the past.
However, in 1996, the government was able to reassure sceptical foreign investors that it had an economic vision for the future. At the moment, we face an absence of economic leadership. South Africa has to convince the world that we have a credible plan for improving growth and employment, as well as for dealing with problems such as those plaguing the mining industry. If we can’t, we run the risk that foreigners will hold back the funds we need. A further sharp fall in the rand will trigger higher inflation, forcing higher interest rates. And our hopes of faster growth will be postponed still further.
Written by: Gavin Keeton
• Keeton is with the economics department at Rhodes University.