Gill Marcus: Headwinds from the global crisis - the need for proactive
responses
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the ORT SA
Fundraising Dinner, Sandton, 31 July 2012.
* * *
This evening is a celebration of the work that ORT does in promoting education and training
in South Africa. The focus could not be more appropriate: education and training is key to
giving each and every South African a real chance in life, the ability to break cycles of
poverty, and is an imperative for long term economic growth in this country, which faces huge
legacy challenges in the education system. Sadly, despite significant resources being
allocated to education, many parts of the system remain dysfunctional. A literate and skilled
labour force is necessary to ensure domestic growth, employment opportunities, social
stability and cohesion, and the ability to compete globally.
Unfortunately the global environment in which we find ourselves is extremely difficult and is
likely to remain so for a good number of years. The challenges facing Europe are of a long
term nature, so even if appropriate steps are taken at this stage to deal with some of the
issues that are making the headlines, the best case scenario will still be one of slow growth
for some time to come before the required structural reforms can take place and take effect.
This is supposed to be a light-hearted evening where we can relax, share jokes and enjoy
ourselves. Unfortunately, we cannot ignore what is happening in the world around us,
recognising that behind the numbers, often in the hundreds of billions, that are frequently
referred to stand tens of millions of people whose lives, hopes and dreams have been altered
forever.
Central bankers have the reputation of being the party poopers, the ones who take away the
punch bowl as the party really gets started, as our function is often to guard against excesses
of various kinds. Tonight my role will be no different. We are living through extremely
challenging times, and unless we recognise the gravity of the situation, we will not take the
required steps in time to create a buffer against the risks that we face. At the root of the
problem is the global economy, but underlying problems and the structure of our own
economy and society will shape how the global downturn will impact on us.
The recent data coming out of the world economy makes depressing reading. In the last two
weeks or so alone we learned the following: the UK economy contracted by 0,7 per cent in
the second quarter (an annualised rate of -2,8 per cent), far more than expected, and
remains in recession; the US economy grew at an annualised rate of 1,5 per cent in the
second quarter, about half its potential growth rate, and is in danger of falling over its self-
induced fiscal cliff; German business confidence declined for the third successive month, far
more than expected, to its lowest level in two years; Eurozone business declined to a three
year low in July, while almost half of the members countries are experiencing negative
growth; unemployment in the Eurozone reached new euro-era highs at 11,1 per cent in May,
with youth unemployment in excess of 22 per cent; spreads on Spanish and Italian sovereign
debt have reached new and unsustainable highs; the global PMI is now indicating a global
contraction; and systemically important emerging markets, until recently the main ray of hope
in a dismal world, are also slowing markedly, particularly China, India and Brazil. The litany is
almost endless.
If you were hoping for some countervailing good news, it has been hard to find. Perhaps we
can point to remarks by the ECB Chairman, Mario Draghi, that the ECB would "do what it
takes" to safeguard the euro generated a relief rally in global financial markets late last week.
But we would be fooling ourselves if we think that the problems are over. Verbal intervention
by central banks can have an impact, but the sustainability of these effects will be dependent
on evidence that their words can be backed up with deeds. Until the substance of such
assurances materialise, we are likely to see continued volatility as markets react to good
news, more in hope than anything else, only to be disappointed and to revise their
assessment soon after. The ECB is a central part of the solution, but it cannot act unilaterally
to extend its mandate, and getting agreement on these issues at a political level is far more
complex.
Perhaps some other relatively good news is that the downward revisions in July by the
International Monetary Fund (IMF) to its global growth forecasts were relatively modest- by
0,1 and 0,2 for this year and next year respectively. But we can take cold comfort from the
size of the revision. Of concern is that the downside risks are seen to "loom large", as the
forecasts are predicated on a number of conditions, one of which seems unlikely to be met
very soon: namely that "there is sufficient policy action to allow financial conditions in the
euro area to ease ..." According to the IMF, the situation in the Eurozone will "likely remain
precarious until all policy action needed for a resolution of the crisis has been taken".
There seems to be no near-term or easy solution in sight, as the problems are multifaceted,
and there is no agreement within the euro area as to how to go forward. Indeed there is no
agreement among economists either. And as the situation worsens, negative feedback loops
intensify. The underlying problems involve three distinct but interrelated problems: a
sovereign debt crisis, a systemic banking crisis and a growth crisis, which have combined in
a way that has significantly increased unemployment. But while everyone will agree that
there is a growth crisis, analysts differ as to the causes and therefore the cures for this.
Much of the focus is on the fiscal side, with many seeing the solution being one of fiscal
austerity all round. However, as Paul Krugman and Richard Layard have recently argued in
their "manifesto for common sense", the crisis did not originate in the public sector, but
rather, expanding public sector deficits were a consequence of the bursting of the
unsustainable private sector expenditure bubbles which then contributed to reductions in
output and tax revenues. They argue that the crisis, which originated in the advanced
economies, was fundamentally one of excessive private sector expenditure, driven by
excessive borrowing and lending and over-leveraging by banks. When the bubble burst, the
public sector had to fill the expenditure gap. With the private sector still deleveraging, fiscal
austerity will only intensify the downward growth spiral.
This can be clearly seen from the data of public sector deficits before and after the crisis. In
2007, the overall gross debt/GDP ratio of the euro area was 66,4 per cent. In 2011 it had
risen to 87,4 per cent. If we look at some of the countries that have come under the spotlight
recently, we see pre-crisis debt ratios at relatively modest levels in some cases, but
accelerating significantly thereafter. For example in 2007 the Spanish debt ratio was 36,3 per
cent but in 2011 had grown to 68,5 per cent; the debt ratio of Portugal increased from
68,3 per cent to 107,8 per cent; that of Ireland from 24,8 per cent to 108,2 per cent; that of
Greece from 107,4 per cent to 165,3 per cent and the Italian ratio increased from 103,1 per
cent to 120,1 per cent.
These data illustrate three important points: first, that sovereign debt crises in some countries
did not originate in the public sector; that debt ratios can accelerate very quickly from
seemingly benign and sustainable levels; and that any given level of debt may be seen to be
sustainable, but if the bond markets change their view on this, spreads rise to the extent that
the costs of servicing these deficits can rapidly turn sustainable deficits into unsustainable
ones.
These debt ratios have increased because of widening current fiscal deficits in response to
the crisis, and not necessarily because of previous excessively large deficits. For example, in
2007 Ireland and Spain had fiscal surpluses and the deficit/GDP ratio in Portugal and Italy
were 3,1 per cent and 1,6 per cent respectively. Greece on the other hand already had a
deficit of 6,5 per cent.
At a time of continued private sector and bank deleveraging, excessively deep public sector
austerity is likely to generate and reinforce negative growth and debt dynamics: as growth
falls, the debt to GDP ratio increases, and if debt is reduced too fast, growth will fall even
more.
There is no doubt that some countries have excessive fiscal burdens and unsustainable fiscal
positions. Those countries have to adjust, and take the pain, but a key question is over what
time horizon. Nor does it mean that all countries should be following austerity measures. If
they do, and the austerity measures proposed are excessive, it will only reinforce the global
downturn. The pace of fiscal consolidation has to be more measured, and it is for
governments and the central banks to ensure that their interventions keep the markets in
check. As Krugman and Layard have argued, "at a time when the private sector is engaged
in a collective effort to spend less, public policy should act as a stabilising force, attempting to
sustain spending. At the very least, we should not be making things worse with big cuts in
government spending or big increases in tax rates on ordinary people".
This does not mean that governments should go on a spending spree. More focus should be
placed on the efficiency of government expenditure, to ensure that it is of the type that is
likely to generate growth, and not simply be an irreversible increase of social expenditure.
Furthermore, expenditure that is likely to crowd in private sector investment would be even
more appropriate. But the focus does not need to be only on expenditure. Tax reductions or
tax incentives, appropriately focused on growth-generating activities, for example on small
businesses, would have a similar effect.
The sovereign debt crisis is intertwined with the banking crisis. Banks are major holders of
sovereign debt, and they have seen the value of their holdings declining. At the same time,
many banks had excessive exposures and leverage to the property market, particularly in
Spain, and the property market bubble has since burst. In addition, the stricter global banking
regulations, commonly referred to as Basel III, have imposed higher capital adequacy ratios
on banks, and they are trying to achieve these by selling assets and reducing lending. The
Spanish banking system in particular is under stress and requires a bail-out, which in turn will
put further pressure on the Spanish fiscal position, as was the case in Ireland. One of the
currently intractable issues in the Eurozone is whether the ECB can bail out these banks
directly.
Fiscal austerity and bank deleveraging, while contributing to the negative growth outlook in
Europe, are not the only growth constraints. There is no doubt there is also a structural
element to the Eurozone crisis, in part a result of very different structural features in the
member states. After unification, the German economy underwent an extended period of
restructuring. The economy became more efficient, more productive and competitive,
particularly relative to many of its Eurozone partners. In the face of labour and product
market inflexibility and higher wage growth in many of these countries, current account
deficits were widening and were readily financed at low Eurozone rates of interest, given the
prevailing assumption that all euro area sovereign bonds were the same. As we have seen,
this assumption no longer holds, but the divergences in competitiveness remain.
It has been estimated that most of the peripheral European economies have lost
competitiveness relative to Germany in the order of magnitude of between 20 to 30 per cent
since the introduction of the euro. This is a longer term structural issue that is likely to take a
while to reverse. But it is debatable whether the required increases in productivity, with
associated significant wage and price declines and increased unemployment can occur
without causing major social upheaval and this at a time when government safety nets are
being cut back on. The adjustment will be that much more severe given the lack of an
exchange rate policy lever.
An early resolution to the crisis is unlikely because there is a lack of trust at a number of
levels. There is a lack of trust in the leadership of the Eurozone to take difficult decisions;
there is a lack of trust between countries; there is a lack of trust of the banking system, and
the recent revelations concerning Libor fixing and money laundering reinforce that lack of
trust; and there is a lack of trust between banks, as evidenced in the dysfunctional nature of
the interbank system in Europe. And as austerity measures bite ever deeper, there are limits
to how much the electorate can take. Ultimately, the situation becomes increasingly
economically and politically untenable.
As the Eurozone crisis impacts increasingly on the rest of the world, it again raises the
question that was asked at the beginning of the crisis: can the emerging market economies
decouple from the advanced economies? While there seems to be little doubt that the centre
of gravity of the global economy is shifting eastwards, and the Asian economies as a bloc
may be better able to withstand a renewed global downturn given increased intraregional
trade, a complete decoupling is unlikely. Already a number of institutions have downgraded
their emerging market growth forecasts and we have seen slowdowns in Asia and Latin
America, including China, India and Brazil. In 2010 Brazil recorded an annual growth rate of
7,5 per cent. In 2011 this had moderated to 2,7 per cent, and in the first two quarters of this
year, annualised growth rates of 0,8 per cent were recorded. While Chinese growth of 7,6 per
cent may seem extremely fast to us, we must bear in mind that it is significantly slower than
the levels previously achieved, and further moderation is expected. A recent IMF Survey
viewed the slowdown in China as having been initially self-induced, to correct overheating
asset markets, but more recently is due to the effects of the global slowdown.
The channels of contagion to emerging markets from the slowdown in the advanced
economies are likely to be similar to those experienced in 2008. We have already seen
declining emerging market exports and weaker commodity prices, although what happens in
China will be an important determinant of the outlook for commodity prices. In general it will
be difficult to sustain growth in many emerging markets, particularly those that are non-food
commodity exporters, as well as those that have strong manufactured export markets in the
advanced economies. There is also some evidence that tightness in bank lending in Europe
may be impacting on the cost and availability of trade financing as well, putting further
pressure on trade.
Emerging markets are also being affected by the volatile risk perceptions in global financial
markets and associated capital flows. In 2009/10, emerging markets were faced with strong
capital inflows from advanced economies in search of yield. However, since the
intensification of the Eurozone crisis in August 2011, the so-called risk-off scenarios have
become dominant. During bouts of risk aversion, the overriding concern becomes security
rather than yield, and investors are prepared to pay for such security as seen in the recent
negative bond yields in Germany and the negative interest rates on bank accounts in
Switzerland. As capital has moved to safe havens, a number of emerging market currencies,
including those of Mexico and Brazil, have depreciated significantly. This will not provide a
strong stimulus to export growth if the demand is not forthcoming, but may have inflationary
consequences, which may limit monetary policy flexibility. For this reason some emerging
market economies have intervened to prevent excessive depreciations.
Increased intraregional trade has been an important contributor to the resilience of the Asian
economies. The recent emergence of sub-Saharan Africa as a significant growth region, with
growth rates in excess of 5 per cent in the past 3 years, has been instrumental in helping
cushion South African exports from the global crisis. In 2007, 36 per cent of South Africa's
manufactured exports went to Europe, while 24 per cent went to Africa. In 2011, 29 per cent
went to Europe and 34 per cent to Africa. Apart from direct trade, there has also been
increased penetration of Africa by South African companies, particularly in the retail,
construction and banking sectors, facilitated in part by more generous exchange control
allowances for investment into the continent.
Some of the reasons for the recent resilience of regional growth, highlighted by the IMF,
include the fact that financial systems in Africa are relatively insulated from global financial
developments with banks obtaining funds from domestic deposit bases rather than external
sources; increased infrastructural expenditure; improved macroeconomic policy frameworks
during the 2000s; fiscal policies generally being supportive of growth since 2009, with
average fiscal deficits increasing by three percentage points in that year, with some
consolidation (about 0,5 percentage points) since then; variations in monetary policy stances,
depending on inflationary pressures; and until recently, relatively strong commodity prices.
However, although there is good news coming out of Africa, the continent will also be
impacted by a global downturn, although as was the case in 2008/09, it may be relatively
more insulated than other regions. But we cannot be complacent about it. Although growth in
sub-Saharan Africa is faster than the global average, it is still lower than the pre-crisis level of
around 6,5 per cent. According to the latest IMF Regional Economic Outlook (April 2012),
growth in the region is expected to average 5,4 per cent in 2012 and 5,3 per cent in 2013.
However, it is mainly the oil-exporting countries that are expected
to have higher growth this
year (7,1 per cent up from 6,0 per cent in 2011), as non-oil exporting middle income country
growth is expected to decline from 4,3 per cent to 3,4 per cent in 2012, and low income
countries more or less unchanged. Overall, the risks are seen to be on the downside due to
global developments and their possible impact on commodity prices.
Natural resources and commodity exports remain the main growth driver for sub-Saharan
Africa, and the region is therefore vulnerable to the global downturn through this channel.
The recent increase in global food prices should, however, benefit African food exporters.
Just under half of the 45 countries in sub-Saharan Africa are viewed as significant exporters
of natural resources, and most of the remainder are dependent on agricultural commodity
exports. About half of the region's exports are non-renewable natural resources, but seven
countries are oil exporters and account for more than half the natural resource exports.
Thirteen others have at least a quarter of their export proceeds coming from mining.
Resource exports as a percent of non-resource GDP is 110 per cent in Angola; 68 per cent in
DR Congo; 116 per cent in Gabon; 54 per cent in Nigeria; 38 per cent in Botswana; 52 per
cent in Zambia and 8,6 per cent in South Africa.
The impact of the global downturn on South Africa is already evident. Growth has been
below potential and moderating, with a progressive downward revision of growth forecasts. In
the middle of 2011, the Bank was forecasting a growth rate of 3,9 per cent for 2012 and
4,4 per cent for 2013. The most recent forecasts now show forecasts of 2,7 per cent and
3,8 per cent for these two years, and the MPC viewed the risks to these forecasts to be on
the downside. The value of merchandise exports contracted by 2,4 per cent in the first
quarter of 2012and the terms of trade have deteriorated for two consecutive quarters. The
resulting current account deficit contributed to a weakening of the exchange rate. Capital
flows have been highly volatile in response to changing global investor risk perceptions which
in turn have impacted on the exchange rate. Since August 2011, the exchange rate has
depreciated by around 23 per cent against the US dollar, and the volatility has increased.
Employment growth has been positive but sluggish, and we have yet to get back to pre-crisis
employment levels.
Growth has been driven primarily by consumption expenditure, but even this is expected to
moderate, as seen in the sharp decline in the FNB/BER consumer confidence index in the
second quarter. Investment expenditure has also lagged. There appeared to be a steady
recovery during 2011, but private sector gross fixed capital formation grew by only 1,8 per
cent in 2012. Fortunately some growth is being seen at the public sector level, but the private
sector accounts for around 65 per cent of total fixed capital formation.
In such an environment, South Africa's policy options are constrained. However we cannot
just sit back and hope that the world will somehow turn around. And when it does turn
around, we should be well-positioned to take advantage of the improved situation.
Macroeconomic policies can help to alleviate the cyclical elements of any possible downturn
but both monetary and fiscal policies have less room for manoeuver than was the case in
2008. The recent monetary policy easing should be seen in the context of alleviating some
of the strains in the economy, but we emphasised that monetary policy cannot solve the
underlying problems of the economy, which will still exist even if the global economy recovers
sooner than expected. We need to recognise the structural nature of the challenges facing
the economy, and in addressing them we can reduce our vulnerability to global headwinds.
These include addressing the structural nature of unemployment, and require concerted
policy coordination across government departments, and between government, the private
sector and civil society. It is not my role to provide a comprehensive plan for structural
change in the economy but allow me to mention briefly what I think are a few of the top
priorities.
The continued focus on infrastructure is essential. This is investment in the future as opposed
to current consumption. It is productive, it provides jobs, and it helps alleviate constraints to
growth and to exports. Lack of infrastructure has been an impediment to the mining sector's
ability to get the ore to the ports, and capacity constraints at the ports are also well
documented.
Electricity supply remains a binding constraint on growth. While more capacity is being built,
we need to ensure that further delays do not occur, and that planning for future capacity is
not left till too late.
Incentives need to be given to encourage the growth of small and medium enterprises, while
competition policy should be enhanced to reduce the occurrence of monopolistic pricing and
other anti-competitive pricing policies.
We need to encourage regional trade and integration. The advantages of such diversification
and expansion are obvious. But we must also heed the lessons of the Eurozone and not
focus on monetary union. The focus should be on trade, investment and infrastructure.
Finally, we come full circle from where we began earlier. Skills development and education
are key. Although this is a long term issue where formal schooling is concerned, skills
development is not confined to the formal school or academic environment. We need skilled
artisans, yet we have far too little by way of apprenticeship training. There remain a
significant number of vacancies which, if they were filled, could contribute to economic
growth and job creation. This is particularly true at the provincial and local government level
where we have seen how the lack of technical skills has impacted on the ability to achieve an
adequate level of service delivery in many instances.
None of this is new. All of this has been said before and by many people. The problems of
the global economy should be the impetus for action. We need to find ways to minimise the
negative impact of the prevailing crisis, and be ready to take advantage of the global
recovery when it comes. As we emphasised in our recent monetary
policy statement, a
sustained increase in the potential output of the economy will require a concerted and
coordinated effort from both government and the private sector. Policy consistency and
coordination is essential if we are to achieve a growing economy and significantly reduce
unemployment.
All of you who are here tonight have significant spheres of influence and a role to play in
building cohesion in our society. The future will be what we, all of us, make of it.
Thank you for inviting me to be here with you this evening, and congratulations to all of you
who ensure that ORT touches and changes the lives of so many people.