X P Guma: The South African economy and financial markets - outlook,
risks and policy responses
Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the South
Africa Economic Conference "Business Unusual", Johannesburg, 4 September 2008.
* * *
1. Introduction
Our meeting here today occurs during a period of considerable uncertainty: financial
turbulence in the major industrialised economies being the proximate cause of international
uncertainty; with a variety of factors impacting upon the short-term indicators of domestic
economic performance. It is, therefore, appropriate, I think, to attempt to place recent
economic developments in some perspective as this may go some way towards piercing the
veil of gloom which appears to have descended over this and other economies. And, for this
reason, I thank the organisers of this Conference for according to me the opportunity to
participate in these discussions.
2. Overview of key economic indicators: South Africa
In order to assess the South African economy's performance over the medium-term, I have
chosen to divide the period from 1990 to 2007 broadly into five-year segments, as indicated
in Tables 1A and 1B: namely, the periods 1990-1994; 1995-1999; 2000-2004 and finally, the
most recent period 2005-2007.
As these Tables show, real gross domestic product grew at progressively increasing rates
throughout this period: from an average rate of 0.2 per cent during 1990-1994 to an average
rate of 5.2 per cent during the most recent period. The strongest sectoral growth occurred in
the secondary and tertiary sectors, with growth reaching levels, on average, of 5.8 per cent
and 5.7 per cent, respectively, over the period 2005-2007.
The economy has become more open with the sum of exports (X) and imports (M) as a
percentage of gross domestic product (GDP) increasing progressively, from 40.6 per cent on
average, between 1990 and 1994 to 61.6 per cent on average during the period 2005-2007.
And inflation, as measured by the Consumer Price Index (CPI), had decreased progressively
from an average annual rate of 12.5 per cent in the early period, to an average rate of 5.1 per
cent during 2005-2007.1
Developments in the financial markets have, in general, been consistent with those
described above regarding the real sectors of the economy. Stated briefly, the assets of the
banking sector have increased substantially; from a nominal value of R281 billion on
average, between 1990 and 1994 to an average of R2 100 billion on average between 2005
and 2007. The average market capitalisation of the bond market has increased, in nominal
terms, from an average of R374 billion between 1995 and 1999 to an average of R860 billion
between 2005 and 2007. And the average market capitalisation on the JSE Limited has
increased from an average of R920 billion during the first of our time periods to an average
nominal value of R5 697 billion in the last period.
Moreover, as has been noted elsewhere2, growth in South Africa's securitisation market has
remained relatively healthy since its emergence in 2000. However, this market is subject to
cyclical variation to a far greater extent than are others.
In the fairy tale from which the description "Goldilocks" is derived, experimentation by the
heroine leads to temporary bliss: not all the plates of porridge were of a temperature that was
just right. But one was. And that plate was licked clean - finished, exhausted of its contents.
So too, some would have us believe, with the South African economy: it could, apparently,
have been described as approximating a Goldilocks economy, with most of the key ratios
being "just right"; neither too strong nor too weak; neither too hot nor too cold. Just right or on
the way to being just right. Until March 2007.
As explained by Dr M Mnyande3, Chief Economist of the South African Reserve Bank (the
Bank), the first sign of a possible turning point in the business cycle indicator, which is
calculated by the Bank, is usually when the composite leading business cycle indicator
changes direction clearly for a period of at least six months. And, in March 2007, the leading
indicator reached its most recent peak, whereafter it has been following a downward trend. It
was also in March 2007 that CPIX, the measure of the rate of inflation that is of interest to the
monetary authorities was last within the target range of 6 to 3 per cent which is specified as
being the inflation target. Then, global food and fuel price shocks intensified, employment
growth abated, real value added in manufacturing contracted as production was hampered
by strike activity in the motor industry and slowing demand, inter alia. Household debt started
to edge higher, the deficit on the current account of the balance of payments widened to 8.1
per cent of gross domestic product in the third quarter of 2007 - the highest ratio since the
9.2 per cent registered in the first quarter of 1982. And then in January 2008 power cuts
disrupted output and exports, taking the public by surprise. Or stated in such a way as to
complete the analogy, at some time during or around March 2007 Goldilocks jumped up and
ran away ... and has not yet returned.
3. The International financial environment
According to the Quarterly Review of the Bank for International Settlements (BIS) issued on
1 September 2008;
"... During the period from end-May to late August 2008, global financial markets
adjusted to growing signs of a broad-based cyclical deterioration.
While markets continued to display signs of fragility, worries about the economic
outlook and related uncertainties gained prominence, weighing on valuations across
asset classes.
Credit markets came under renewed pressure over the period, as spreads widened
to reflect the implications of the ongoing cyclical adjustment for loss expectations
and financial sector balance sheets. This was despite retreating oil and commodity
prices, government action in support of the US housing market and continued
recapitalisation efforts by banks and other financial firms. Equity markets reflected
similar concerns, as valuations adjusted to reflect disappointing earnings data,
including in the financial and other cyclical sectors. Against this background,
pressures in interbank money markets persisted, prompting further central bank
action to ease financial sector access to funding." (p.2)
The origins of this turbulence, turmoil and distress in the international financial markets are
well known and need not detain us unduly.4 As summarised in the Annual Report 2007 of the
Bank Supervision Department of the Bank, the episode began with credit concerns in the
United States (US) sub-prime mortgage market, in 2007; and developed into concerns in
global credit markets as the extent of exposures and potential losses from the sub-prime
market were not known.
Then,
"... The ongoing boom in the US housing market attracted clients who
would not normally have qualified for loans. Loans granted to these clients
are commonly known as "sub-prime mortgage loans". In some instances
the sub-prime loans were offered at initial low "teaser" rates, which reset to
higher rates after a few years. As these loans began to reset and the
housing market began to cool off during 2006 (i.e., growth in house prices
decreased), these clients found themselves unable to meet the higher
payment obligations and were not able to refinance their loans. It was
during this period that non-performing sub-prime mortgage loans increased
rapidly."
"Concurrent with the granting of sub-prime mortgage loans, certain
institutions securitised their mortgage loans. Numerous methods and
instruments were developed to facilitate this process, and the instruments
became increasingly complex. Instruments such as mortgage-backed
securities and collaterised debt obligations offered tranches of risk, ranging
from high-risk equity tranches to low-risk senior tranches. As a result, a
wide range of banks and investors faced significant exposure, directly and
indirectly, to the US sub-prime mortgage market." (p.3)
At the time of writing, the impact of the US sub-prime crisis on the prospects for the
international economy are difficult to assess: not least because of the rate at which the
losses which have been incurred by major financial institutions are being reported. However,
from media reports, it would appear that Bloomberg's calculations of write downs by and
credit losses of banks related to the sub-prime crisis, at approximately US$400 billion,
provide a plausible threshold. These estimates are reproduced in Table 2, below.
What is clear is that prolonged financial-market turmoil in the major industrialised economies
of the world would impact adversely on economic and financial stability generally, making
prospects for a resumption of robust and sustained economic growth in South Africa more
uncertain. So too with an attenuation of the processes currently underway to reduce the
imbalances which are extant in the global economy through unchanged or increased
protectionism, reluctance to permit currencies to appreciate (or depreciate) in accordance
with economic fundamentals.
In short, prospects for the international economy are served poorly by a generalised failure
by policy makers to acknowledge, by praxis, a simple fact: namely, that a globalising
economy is, was and will remain a closed system. Its imbalances cannot, as yet, be exported
(or transported) elsewhere.
4. Some considerations regarding policy
My discussion of policy will be brief for two reasons. First, because the bulk of the effort of
this Conference will be devoted to this matter: and second, because the subtitle of the
Conference is: "Business Unusual".
According to President Thabo Mbeki, to whom authorship of this phrase is ascribed,
"Business Unusual" does not refer "... to any changes in our established policies..."; rather it
refers to "... the speedy, efficient and effective implementation of these policies and
programmes, so that the lives of our people should change for the better, sooner rather than
later." So, to use the idiom of the contemporary policy analyst, we can assume that the policy
thing has been parameterised: in the form of the RDP (1994); GEAR (1996); the Growth and
Development Summit (2003) and the Asgisa (2005).
My only caution is that in proceeding, sight should not be lost of the fine balance that needs
to be maintained between the state and the market as the primary allocator of resources.
For, as Schumpeter observed5, when the state is pre-eminent and its shortcomings are
highly visible, economists and others seem to swoon over the charm of the market. But when
the market is in the ascendancy and its drawbacks are evident, then the state may be
idealised. Both extremes should be resisted.
5. Conclusion
Let me conclude by making the following observations. First, fairy tales have a useful
function to perform in entertaining children - but are of dubious value in enhancing
discussions of economics. Goldilocks and her kindred spirits should, please, be allowed to go
away from the pages of economic analysis.
Second, any notion that the South African economy is soon to enter a recession6 must be
rejected, firmly. The current growth rate of the economy may be somewhat lower than had
come to be expected but is still strongly positive and will remain so. The so-called "tsunami"
of adverse economic outcomes in the period subsequent to March 2007 will lose momentum
as inflation abates, the balance between aggregate saving and investment improves, the
process of financial deepening intensifies and better use is made of the potential for capture
of resource rents in the current commodity cycle.
Third, whilst South Africa has been spared, along with many other emerging markets, the
worst of the financial market turmoil, the authorities have not become complacent.
Adherence to a clearly articulated macro-economic framework, which includes an explicit
inflation-target, provides the first line of defence - in particular, against capital flight. A
second line is drawn by ensuring adherence to international best standards on laws,
regulations, practices and policies in the financial sector; monitoring proven financial
soundness indicators for early warning of potential problems. And a third line is drawn by the
Financial Sector Contingency Forum - which I currently chair. This is a forum which
facilitates inter-agency coordination and preparedness for addressing crises.
Finally, I think that South Africa should continue to participate fully in international fora in
order to make the case for multi-lateral adjustments in the interests of systemic stability in
our closed system. Continued myopia by national governments will, likely, prolong the
adjustment process which needs to be completed if the current turbulence in financial
markets is to be resolved.
And on that note, I end: thank you for your attention.
References:
1. Bernanke, B.S. (2007) "Housing Finance and Monetary Policy", Speech at the Federal
Reserve Bank of Kansas Economic Symposium, Jackson Hole, Wyoming: 31 August.
2. BIS (2008) Quarterly Review, Basel.
3. IMF (2008) Global Financial Stability Report, Washington D.C.
4. Klitgaard, R. (1991) Adjusting to Reality: Beyond "State versus Market in Economic
Development, San Francisco, I CE G.
5. Mminele, A.D. (2008) "Benefits and Risks of New Instruments: Derivatives and
Securitisation; the case of South Africa", Berlin, 4 July 2008. Conference on Financial
Innovation and Emerging Markets.
6. Mnyande, M. (2008) "Keynote address at the 4th Convention of the South African Institute
of Black Property Practitioners (SAIBPP), Helderfontein Conference Centre", July 31.
7. Schumpeter, J.A. (1949) "English Economists and the State-Managed Economy", Journal
of Political Economy, 57, no. 5.
8. South African Reserve Bank (2008) Annual Report 2007: Bank Supervision Department,
Pretoria.
BIS Review 106/2008
BIS Review 106/2008
BIS Review 106/2008