Gill Marcus: Perspectives on recent global economic developments
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the
US Chamber of Commerce in South Africa, Johannesburg, 23 August 2011.
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Good morning and thank you for the invitation to address this meeting of the US Chamber of
Commerce in South Africa. We meet at a challenging time, with the global economy moving
perilously close towards a precipice, as the financial crisis moves into its fifth year. Recent
developments underline just how central the role of the US economy in the global economy
remains. The current global outlook is therefore highly dependent on the health of the US
economy, which is also important from a local perspective as the US is one of South Africa's
main trading partners, with a positive trade balance in South Africa's favour. In 2010, almost
9 per cent of our total exports, totaling R52 billion, went to the US, while around 7 per cent of
our imports, valued at R42 billion were sourced in the US.
A number of recent developments have resulted in a high degree of market turbulence in
recent weeks. These include the realisation that the outlook for US growth is not as
favourable as previously believed, the damaging US debt ceiling debate and the consequent
ratings downgrade of US debt, and the further deterioration of the European sovereign debt
crisis which has now spread from the periphery to the core, and potentially to the European
banking system.
What started in 2007 as a banking crisis related to the US housing market has turned into a
sovereign debt crisis, and recent events in the US and Europe illustrate how quickly the crisis
can mutate. At the heart of the problem is a lack of strong unified and credible leadership,
leading to a loss of confidence and trust in this leadership and potentially in the system as a
whole. Behind the statistics are real people who find their lives in turmoil and livelihoods and
future ambitions at risk. And in these circumstances those presenting easy answers to what
are very complex and difficult issues can readily gain support.
Given the backdrop against which we are meeting, it would be appropriate to make some
comments about the current global developments and their possible implications for Africa in
general and South Africa in particular. It would also be useful to draw out some of the
lessons for Africa from the problems being faced by the Eurozone.
What we are witnessing currently is not a new crisis, nor is it part of a normal economic
cycle. We can learn a lot from the work of Reinhart and Rogoff who have shown that unlike
normal economic cycles or recessions, financial crises are protracted affairs. According to
their research, conventional recessions involve a relatively quick return to normalcy, and
generally the economy makes up the lost output and resumes its pre-recession growth trend
within a year. A recession involving a financial crisis involves not only loss of output and
employment but applies to debt, credit and the deleveraging, which takes much longer to
work through. Their work shows that the aftermath of severe financial crises share three
main characteristics: that asset market collapses are deep and prolonged; that such crises
are associated with profound declines in output and employment, with the latter being
particularly protracted; and the real value of government debt tends to explode, on average
almost doubling over a short period. This debt increase is apart from possible banking bailout
costs, and is a result of an inevitable collapse in tax revenues as well as countercyclical
expenditure policies. Their findings also not only show that banking crises do not discriminate
between emerging markets and developed markets - leading them to label such crises as
equal opportunity menaces - but developed countries generally take much longer to recover
than emerging markets, possibly due to greater wage flexibility in (some) emerging markets.
Normal cyclical downturns are often reinforced by tight monetary policies in response to an
overheating economy and inflationary pressures, and the downturn can be effectively
moderated by a reversal of the monetary policy stance. Unfortunately we are not in a normal
cyclical downturn, and the crisis cannot be solved through monetary policy alone.
Households in the advanced economies are still in the process of deleveraging and repairing
their impaired balance sheets, and monetary policy can only help to a certain extent. In the
context of low and falling house prices, declining equity prices and stubbornly high
unemployment, rebuilding of household balance sheets may take a protracted period.
The problem facing the US currently is this uncertainty relating to the self-sustainability of
private sector consumption expenditure. At the start of the crisis, the gap left by the
consumer, usually the main driver of growth, was filled in part by increased government
expenditure. By the beginning of 2010 the recovery appeared to be underway and the
consensus view was that by mid-2010, the US economy would be on a self-sustaining
recovery path, and the focus then was on exit strategies or normalization of both monetary
and fiscal policies. By mid-2010 it had become apparent that this positive outlook was
misplaced, and an additional fiscal stimulus, in the form of the extension of the Bush-era tax
cuts followed, along with a further round of quantitative easing. The result of this, however,
was a further build-up of public leverage.
There were concerns, however, that the impact of this additional stimulus would disappear by
the middle of this year, and that consumption expenditure would not yet be on a
selfsustaining path. The slowdown in the US economy in the first half of the year was widely
interpreted as a temporary soft patch, attributed in the main to supply chain issues relating to
the disasters in Japan. There is now a more general recognition that the US economic
recovery is weaker than anticipated, and fears of a possible return to recession have replaced
the earlier confidence. This is particularly the case after the significant downward revision of
US growth performance in the first quarter of 2011 from 1,8 per cent to 0,4 per cent. The
announcement by the FOMC that the policy rate in the US is likely to remain accommodative
until mid-2013 is more a statement about the weak outlook for the US economy, and the
structural nature of this weakness, rather than a commitment about interest rates.
Unfortunately the outlook is no better in the UK and the Eurozone. For some time the focus
has been primarily on the sovereign debt problems of the peripheral European economies.
As suggested by Reinhart and Rogoff, there has indeed been a spiraling of indebtedness of
many Eurozone economies. For example, the debt to GDP ratio in Spain is expected to have
increased from 40 per cent in 2008 to an estimated 75 per cent in 2012, while that of Greece
from 105 per cent to 166 per cent over the same period. Fears of default abound as the
different European countries failed to make the difficult decisions about burden sharing
between countries and the private sector. Policy pronouncements and packages have not
been fully followed through, or have generally disappointed the market in their failure to fully
deal with the problems. Countries such as Greece have been forced into austerity
programmes which are likely to be either politically unsustainable, or if they do manage to
achieve the proposed expenditure reductions, may result in declines in real growth rates
which would then reinforce the negative debt dynamics. The recent announcement by the
Greek Finance Minister that Greece is expected to contract at a worse-than-expected
4,5 per cent or above in 2011 is a case in point. Debt sustainability is, after all, partly a
function of both the cost of servicing the debt as well as the real growth rate of the economy.
As the markets reassessed the ability of a number of countries to consolidate their fiscal
positions, the spreads on sovereign debt increased, which in turn undermined the
sustainability criteria.
The failure of the Eurozone economies to deal decisively with the issue has resulted in a
spill-over to the broader region, with the focus leap-frogging firstly Spain and then both Spain
and Italy, and on to France, where the markets are now questioning the sustainability of the
country's AAA rating. The interconnected nature of these economies is reinforced by the
exposure of the banks in France and Germany in particular to the debt of the peripheral
European economies. The IMF estimates that the European banks' exposure to the
European periphery constitutes around 10 per cent of Europe's GDP and about 80 per cent
of the capital of European banks.
In effect we have seen a banking crisis turning into a sovereign debt crisis, which in turn has
the potential to undermine the banking sector recovery in Europe. In recent weeks there
have been reports of US money market funds reducing their exposures to European banks.
Bank equity prices have come under pressure, and interbank rates have also widened
somewhat. Banking systems rely on confidence, and a collapse of confidence relating to
counter-party risk can easily cause a liquidity crisis to translate into a solvency crisis with
negative feedback effects to the real sector of the economy. For this reason it is important for
central banks to stand ready to support their banking systems by providing appropriate
liquidity support if and when required. Fortunately, central banks are probably better
prepared for such actions than was the case in 2008.
As the financial crisis gathered momentum in 2008, a feature that was widely recognised was
the synchronised nature of the downturn. Current developments are disturbingly similar, with
evidence of a synchronised downturn in many of the advanced economy. It is unclear at this
stage if a reversion to recessionary conditions is likely, but at best the advanced economies
appear to be in a stalled state. Even Germany, which until recently had been the powerhouse
of Europe, only managed growth of 0,1 per cent in the second quarter of this year, while the
Eurozone as a whole averaged 0,2 per cent. Growth in the UK is also expected to be
0,2 per cent, and 4 per cent below the pre-crisis peak. This raises serious concerns for two
main reasons. First, there will inevitably be an impact on growth in the rest of the world.
In 2008 the hopes of decoupling by emerging markets proved to be vain ones, and while
there does appear to be an increased amount of intraregional trade, in Asia in particular, it is
almost inevitable that the rest of the world will not escape unscathed. Second, a general
growth slowdown will exacerbate the debt dynamics in many of these countries, and may
indeed reinforce these negative dynamics if further fiscal stimulus is provided.
So what can be done? The cumulative nature of this crisis means that many parts of the
world have reached this stage having sold off most of the family silver. In 2008, the
coordinated response by many countries resulted in fiscal and monetary policy reactions
which are simply not possible this time round. The response at this stage has been limited as
governments generally face fiscal consolidation, and their room for manoeuver appears to be
constrained.
In most of the advanced economies, monetary policy remains extraordinarily
accommodative. As interest rates in many of these countries are close to the zero bound, the
scope for further reductions is limited apart from further quantitative easing and actions to
provide liquidity or support to dysfunctional segments of the financial markets. There is no
doubt that the burden of the policy response will fall disproportionately on monetary policy,
but it is unclear if such actions will be effective in providing additional stimulus as opposed to
simply facilitating the functioning of markets.
The lack of fiscal space creates a real policy dilemma. On the one hand countries require a
fiscal stimulus to try and counteract the slowdown, while on the other hand the inevitable
further build-up of debt means that sustainability issues become paramount. So there is the
conflict between short term exigencies and longer term sustainability issues. Ultimately the
policy focus has to be on growth, which will help with fiscal sustainability, rather than on debt
reduction in the short run. There needs to be a clear distinction between short and medium
term needs, with a clear commitment to medium and long term fiscal sustainability. The focus
should also be on fiscal initiatives that have a durable growth-enhancing capacity and
structural reform, and not simply fiscal impulses for their own sake.
Unfortunately this is easier said than done. In order to avoid a replay of 2008, there needs to
be a cohesive understanding of the situation, and a unity of purpose at the global and
national levels. An effective response requires confidence and trust in leadership, and this
appears to be lacking. The fractious nature of political processes seems to be making it
difficult to have the level of coordinated and purposeful responses that the crisis demands.
This is well illustrated by the debt-ceiling debacle in the United States, where some factions
were willing to take the country and indeed the world over the brink. Similarly, the inability of
the leadership on the Eurozone economies to agree on a credible and durable solution for
the region has undermined support not only for the leadership but for the whole Eurozone
project.
Until now, there have been piecemeal responses to the European crisis, which have merely
delayed the need for a credible solution. There are no easy or painless solutions, but the
longer they are delayed, the more difficult and painful the outcome will be. It is not just the
markets that have lost confidence, it is the ordinary people who are bearing the brunt of the
consequences of the crisis. These social and the social consequences are becoming
increasingly apparent and disturbing with a growing structural unemployment problem,
particularly amongst the youth in some countries, and in a number of instances, increased
civil unrest.
The South African economy will not be immune to these developments. The economy has
made a fragile and uneven recovery from the recession, but the future growth prospects will
be affected significantly by global developments. Favourable growth outcomes were
achieved in the final quarter of 2010 and the first quarter of 2011, when annualised growth
rates of 4,5 per cent and 4,8 per cent respectively were recorded. However the second
quarter performance had been disappointing, with both the manufacturing and mining sectors
likely to have subtracted from growth. The main driver of growth over the past quarters has
been growth in household consumption expenditure, which has averaged around 5 per cent
since late 2009. However, for some time the Monetary Policy Committee of the Bank has
questioned the sustainability of this consumption growth given the slow pace of employment
growth, high levels of consumer indebtedness, low levels of bank credit extension as well as
negative wealth effects emanating mainly from the weak housing market. Recent retail sales
developments indicate that there may be some slowdown in the growth of household
consumption expenditure.
A worrying feature of the domestic recovery has been the slow growth of gross fixed capital
formation, particularly by the private sector. This may be due in part to the relatively low
levels of capacity utilisation in manufacturing, and the unfavourable export climate, due in
part to slow growth in Europe, and declining competitiveness due to a relatively strong
exchange rate and high rates of domestic input cost increases (including wages and
electricity). South Africa's export recovery has not been as robust as that in other emerging
markets, and much of the increase in export values has been due to higher global commodity
prices. The main destination for South Africa's manufactured goods remains Europe and the
United States, so a prolonged slowdown in these regions will have negative implications for
the country's exports. Should a more generalised slowdown transpire, we could see a
decline in commodity prices as well.
The low interest rate environment in the advanced economies has resulted in elevated levels
of capital flows to emerging markets, in search of higher yields, with consequences for both
the level and volatility of the rand exchange rate. There has, however, been a change in the
pattern of these flows, which are now predominantly into bond markets rather than into equity
markets. In South Africa, for example, since the beginning of 2011, non-residents have been
net purchasers of bonds to the value of R51 billion, but have been net sellers of equities to
the value of R8 billion. Given the prospects for a protracted period of low interest rates in the
advanced economies, these flows are expected to continue, although are likely to become
more volatile and uncertain during episodes of heightened risk aversion.
Monetary policy has remained relatively accommodative in response to these developments.
The policy rate, at 5,5 per cent, is at its lowest levels in 30 years, and the real policy rate is
around zero. Inflation has been within the target range since March 2010, but is currently on
an upward trend, mainly as a result of food and energy price pressures, with few obvious
signs of excess demand pressures. In the event of a significant global downturn, monetary
policy will react appropriately.
The policy room available on the fiscal side is more limited, as there is now less fiscal space
than was the case at the onset of the crisis. In 2008 South African was running a small
budget surplus and the debt/GDP ratio stood at 27 per cent. Since the crisis, government
spending levels have been elevated in historical terms, and although the deficit before
borrowing has declined from a high of 6,6 per cent in 2009/10 to an estimated 5,3 per cent
for the current fiscal year, the debt/GDP ratio has increased to 40,3 per cent, one of the
largest percentage increases when compared to other countries over the same period.
A domestic growth slowdown would reduce tax revenues, and there are limits to which the
debt/GDP ratio can expand without bringing its sustainability into question. Any further fiscal
stimuli would therefore need to ensure a focus on growth-enhancing expenditure.
The weakness in South Africa's traditional trading partners underlines the need to seek new
markets for manufactured exports in Asia, and more particularly in Africa. According to the
IMF, African economies, with the notable exception of South Africa, displayed remarkable
resilience during the crisis. Although most countries experienced lower growth, mainly a
result of lower global commodity prices, in general they managed to avoid recession. Unlike
South Africa, the trade channel was less important because of the predominance of
intraregional trade, and the stronger trade links with Asia. Since then, most sub-Saharan
African countries have returned pre-crisis growth rates, in line with those in developing Asia.
The IMF estimates growth in SSA to average 5,5 per cent in 2011 and 6 per cent in 2012. In
addition to the above, a further reason for these positive outcomes is a recovery in
commodity prices as well as improved policy environments
Recent developments in Europe have important lessons for future moves towards economic
integration in Africa. Following the European experience in its 40 year move towards
monetary integration, it became conventional wisdom that the appropriate sequencing was
for full trade integration to precede monetary integration. Africa still has a multiplicity of, and
in some instances overlapping regional trade blocs, and has some way to go to full trade
integration. At the same time, African monetary integration initiatives are still going ahead in
various forums, for example initiatives by SADC and the AU, with different and overlapping
timetables, and with inordinate haste in some instances. Unfortunately the thinking behind
these initiatives ignores the criteria for optimal currency areas, and focuses primarily on
macroeconomic convergence criteria.
An important lesson of the European crisis is that macroeconomic convergence is not
enough. It is not sufficient for countries to comply with the initial conditions. It is now clear
that necessary conditions include the need for institutions to ensure that these initial
conditions are maintained. It is one thing to require countries to achieve certain debt ratios
and fiscal deficit ceilings, for example, but are there appropriate mechanisms for ensuring
that these guidelines or limits are adhered to?
While the need for harmonised fiscal policies was recognised by the architects of the
Eurozone, the issue was dealt with through the Stability and Growth Pact, which has turned
out to be a loose, often ignored and unenforceable agreement that countries would abide by
certain fiscal guidelines. We have seen the implications of the lack of a centralised fiscal
authority, or fiscal counterpart to the ECB. Reaching agreement on, and implementing
monetary policy is difficult enough. Fiscal policy is far more complex and political, as it
involves policy levers that have more pervasive distributional impacts. It involves for
example, decisions relating to tax policies, expenditure policies, and deciding on politically
sensitive social and economic priorities. But ignoring the need for such an institution can lead
to the difficulties currently being faced by the Eurozone.
That is not to say that regional integration should no longer be a goal in Africa. If anything,
the importance of trade diversification has been reinforced by the crisis, and further trade
integration in Africa should be pursued more purposefully. But the excessive focus on
monetary integration is misplaced and premature. South Africa's trade links to the advanced
economies makes it particularly vulnerable to slowdowns in those regions, and more
attention should be given to encouraging regional trade and investment flows.
In conclusion, we are living in difficult times. The global economy is on the brink of falling
back into what could be a prolonged recession unless purposeful and coordinated action is
taken. There are no easy or automatic solutions, but to date policy responses have been
incomplete and irresolute. This has led to a loss of confidence and a lack of trust. It is not just
the markets that have lost confidence, it is the ordinary people behind the statistics. And as
austerity programmes bite further, we are likely to see more scenes similar to those that were
recently played out in London and Athens. The challenge for leadership is to rebuild this trust
and confidence. It can't be through more talk. There has to be action, but the room for action
is limited. Any measures taken are likely to entail significant financial commitments, and
these need to be big enough to put a stake in the ground. Such costs should not be looked at
in isolation, but in relation to the costs already incurred, and the costs of not resolving the
crisis. There is a long, painful path ahead for all of us.
Unless there is a cohesive understanding of who does what, and what is likely to succeed,
then we will not rebuild confidence. Not only can it be done, it has to be done.
Thank you.