Gill Marcus: Perspectives on the global and domestic economic
environment
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the Volkswagen
South Africa Strategic Conversation Dinner, Sandton, 15 March 2012.
* * *
Thank you for the opportunity to lead in the strategic conversation this evening. We have
come through a difficult few years, and the road ahead is likely to be just as challenging.
Right now there seems to be a small breathing space that might allow a better assessment of
where the world is today. We have seen three elements of the global crisis come together,
namely sovereign debt, a banking crisis, and the crisis of weak growth and rising
unemployment, particularly among the young. There is also the increasing recognition that
what is occurring is not simply a very deep economic crisis, but a fundamental shift in the
balance of forces in the world. This is likely to take time to unfold, but significant changes are
taking place, with the growing voice and economic power of emerging markets being heard
more loudly.
The global financial crisis is still with us, although it does appear that some of the worst case
global scenarios may have been avoided or perhaps merely delayed. But even the optimistic
scenarios for Europe are not good news as fiscal adjustments, bank deleveraging and the
weight of the cumulative impact of the crisis thus far take hold. For this reason the outlook for
the South African economy is not as bright as it could be, unless a concerted effort is made
to do something different. Currently the domestic economy is characterised by rising inflation
and slowing growth, which is a difficult combination for policy-makers to deal with.
This evening I will give a perspective on aspects of the global and domestic economic
backdrop. I will spend some time on the European situation, as the context within which we
operate, formulate policy, adopt strategies is critical to enable all of us to ensure that South
Africa is able to take advantage of what opportunities exist, and take appropriate measures
to try to protect us from the ravages of the global crisis. From a South African perspective,
what happens in Europe is important, given the trade links that we have with the region.
Although the percentage of South African manufacturing exports to Europe have declined
over the past few years, at around 30 per cent it is still an extremely important trading
partner.
In recent months there have been progressive downward revisions by analysts of the global
growth outlook. The IMF, in its latest World Economic Outlook, also downgraded its forecast
for world growth to average 3,3 per cent in 2012, and 3,9 per cent in 2013. There are still
significant risks to the global environment, but the intensity and immediacy of these risks may
have been reduced somewhat with the recent agreement on the Greek bail-out which has
helped to prevent a disorderly default. This agreement is expected to allow for Greece to
roll-over its debt that is maturing this month.
It would be premature to think that the European crisis has been resolved as there are a
number of interrelated and mutually reinforcing dimensions which mean that uncertainty
remains. Although the risks from the sovereign debt crisis appear to have been reduced for
the meantime, questions about the sustainability of the solution persist, particularly in the
light of the fact that the European authorities have emphasised that the Greek bail-out model
is not a precedent. The Portuguese economy is also under stress, and we could still see a
repetition of the Greek crisis being played out there in the coming months. In the absence of
a clear commitment to deal with a possible Portuguese crisis, the risk of contagion to other
more systemically important economies, such as Italy and Spain, will increase. Although
some of the peripheral European countries are relatively small, they have a combined
sovereign debt of around US$1 trillion, with a significant proportion being held by European
banks.
The actions to resolve the Greek debt problem have involved significant losses to private
sector bond-holders, many of which are European banks. In terms of the agreement, bond
holders will accept losses in excess of 70 per cent of the value of the debt. Partly as a
consequence of these developments, European banks are now undercapitalised, with
estimates ranging between US$300 billion and US$400 billion. This has resulted in
significant deleveraging by European banks, with indications of them selling assets in order
to achieve their required ratios. This credit crunch in Europe is being exacerbated by the
need to meet new capital requirements of raising the Tier 1 capital asset ratio to 9 per cent
by June 2012. There are concerns that European bank lending could decline by around
US$3 trillion over the next 18 months.
The interbank market is also dysfunctional in Europe, reflecting the lack of trust between
banks. The ECB has attempted to alleviate the situation with the establishment of the Long
Term Refinancing Operation (LTRO) facility, which has to date granted an estimated
US$1,35 trillion in loans to banks at low interest rates. There is some evidence that a
significant proportion of this money has gone in to purchasing sovereign debt, but it is still too
early to say how much will go to lending to households and businesses.
The credit crunch is likely to reinforce the negative growth outlook for the region, and will in
turn have its own negative feedback loop. The Euro area is expected to contract by around
0,5 per cent this year, and the European Commission expects negative growth in 8 of the
17 Eurozone countries this year. These countries include Belgium, Greece, Spain, Italy,
Holland, Austria and Portugal. Widespread fiscal consolidation, even in countries with
relatively strong fiscal positions such as Germany, has contributed to the negative growth
outlook. A number of countries, such as Spain, Portugal and Ireland are attempting to reduce
their deficit to GDP ratios by around 3 per cent per year for the next two years, and Italy by
about 2 per cent per year. The negative growth outlook raises doubts about the ability of the
Greek economy to adjust to the fiscal austerity that is being imposed on it. The economy has
contracted by about 15 per cent in the past two years, and is expected to contract by a
further 4,4 per cent this year, while unemployment has increased from 7,7 per cent in 2008 to
almost 20 per cent.
At the root of these problems is a balance of payments crisis within the euro area between
northern and southern Europe. The loss of competitiveness experienced by the southern
European countries and their consequent balance of payments deficits has in effect been
financed by borrowing from the Northern Europeans. This is not sustainable indefinitely.
Under normal circumstances the adjustment would be facilitated through exchange rate
depreciation, but with this option ruled out, a more difficult path of "internal devaluation",
involving absolute reductions in wages and expenditure, has to be followed. The more
reluctant the surplus countries are to increase their consumption of Southern European
goods, the more difficult the adjustment becomes and the more politically unpopular these
measures become in the deficit countries.
Apart from the European situation, prospects for other parts of the global economy appear to
be more promising, but risks remain. The US economic growth has surprised on the upside
in recent months, but fears remain that this nascent recovery could be short-lived. In
particular, there are risks that political conflicts over fiscal policy ahead of the November
elections could result in premature fiscal cutbacks, which, according to some estimates could
have the potential to reduce US growth by up to two percentage points.
There are also indications that the Chinese economy may be slowing, but the Chinese
authorities have the ability and resolve to intervene strongly to prevent a so-called hard
landing. One region with a more favourable outlook is sub-Saharan Africa, which is expected
to grow by around 5,5 per cent this year. South Africa's financial and trade links with Africa
have been increasing in recent years, and the continent is fast becoming the major
destination for our manufactured exports. During the financial crisis, Africa was relatively
protected from the fall-out, given the predominance of intra-regional trade, and South Africa
would do well to encourage further two-way trade and investment with the region.
One of the consequences of the global crisis has been the severe social dislocation that has
accompanied it, and it is questionable how long such pain can be endured. The recent
protests on the streets of Athens and general popular opposition raises questions as to
whether or not the latest initiatives are politically sustainable. History is replete with examples
of how circumstances similar to those described lead to political polarisation and the rise of
nationalism and/or populism. This is happening in the context of a divided Europe, with no
consensus on the appropriate solutions to the problems, and irresolute leadership reflected
in weak and tenuous coalition governments.
The social problems are reflected in the spiraling of unemployment in some of the advanced
economies. This is particularly the case when it comes to youth unemployment. In this
respect South Africa is no longer unique, with its estimated unemployment rate of 23,9 per
cent, and youth unemployment at around 50 per cent. The negative trends in Europe in
particular are quite dramatic. In the beginning of 2008 the unemployment rate in the
European Union was 6,9 per cent and the unemployment rate amongst the youth (i.e.
persons below 25 years of age) was 15,9 per cent. In January 2012 the unemployment rate
in the EU was 10,7 per cent, while youth unemployment measured 22,4 per cent. The
number of unemployed youth totaled 5,5 million.
There are some stark divergences within the region, with overall unemployment ranging from
4,0 per cent in Austria, to 23,3 per cent in Spain, and youth unemployment ranging from
7,8 per cent in Germany to 48,1 per cent in Greece and 49,9 per cent in Spain. As a rule of
thumb, the youth unemployment rate is between 2 and 3 times are high as the total
unemployment rate. Of the 27 EU countries, 20 of them have youth unemployment rates of
20 per cent or more, and 7 of these are in excess of 30 per cent. This phenomenon is of
particular concern, as the longer people remain out of work, the less likely they are to ever
work, or work again. The unemployment get deskilled, demotivated and disaffected, leading
to the attendant social hardships and drain on society.
It is also not just Europe where unemployment has become a problem. US unemployment
measured 5 per cent before the crisis, and peaked at around 10 per cent before declining to
current levels of around 8,5 per cent. Youth unemployment is currently 16,0 per cent. In the
UK, youth unemployment - at 22,2 per cent - is close to the 1 million mark.
The problem of youth unemployment in the advanced economies is exacerbated by an
ageing population which is putting strain on fiscal positions. The current low interest rate
environment in these economies will make it even more difficult for private pension funds to
generate adequate returns for this ageing population, with potential financial demands on
governments. This factor has resulted in an extension of the working age in a number of
countries, which makes it even more difficult to solve the youth unemployment problem, with
the associated fiscal demands at a time when such programmes are being scaled back. The
potential adverse social consequences of these developments are profound.
The underlying lesson for South Africa from all of this is the importance of generating
sustained and employment-generating growth that is needed to attend to the growing
inequalities. It is also clearly preferable, particularly in the short run, to improve a debt to
GDP ratio by increasing GDP growth, as opposed to cutting down on the absolute level of
debt. Fiscal consolidation that is done too quickly could cause growth to decline, and this will
cause the debt metrics to deteriorate and result in a negative debt spiral. When fiscal
sustainability is called into question, the challenge is to find a balance between such fiscal
consolidation and the need for growth.
As I have indicated, South Africa's growth outlook in the short to medium term will be
impacted to a significant degree by global developments. Domestic economic growth in 2011
measured 3,1 per cent following growth of 3,2 per cent in the final quarter of the year. The
growth forecasts for 2012 range between 2,5 per cent and 3,0 per cent, with the latest
forecast of the Bank being 2,8 per cent. This followed successive downward revisions during
2011 as the European crisis intensified.
Since the 2009 recession, growth has been driven primarily by household consumption
expenditure, which is clearly an undesirable and unsustainable growth path. Emphasis must
be given to ensure that growth is driven by investment. There are, however, signs that
investment expenditure growth is gathering pace, and this will be reinforced if the proposals
around increased infrastructure expenditure are followed through on. According to the latest
budget, public sector projects totaling R845 billion have been approved for the MTEF period.
This emphasis on infrastructure investment is appropriate as it is likely to contribute to
improved economic efficiencies and helps with the alleviation of existing bottlenecks in the
economy. But the focus on infrastructure is not new, and the plans have often not met
expectations, particularly since the 2010 World Cup. For example in 2009/10, only 83 per
cent of the amounts budgeted for infrastructure was spent. In 2010/11, this had declined
further to 68 per cent.
Importantly, it is not only the government and state-owned enterprises that need to invest.
Michael Spence, the respected growth theorist, in his book "The Next Convergence", has
shown that countries which have sustained growth rates of around 7 per cent or more for
25 years generally have government and public sector investment ratios of between 5 and
7 per cent of GDP, and total investment rates of at least 25 per cent of GDP. Why emphasise
a target of 7 per cent growth per annum? Because a consistent growth rate of 7 per cent will
allow for a doubling of income every 10 years, whereas a growth rate of 3 per cent will take
24 years to double incomes. South Africa's gross fixed capital formation as a percentage
GDP averaged around 15,5 per cent in the decade from 1994 and then accelerated to peak
at around 23 per cent in 2008. This positive trend coincided with economic growth rates in
excess of 5 per cent and a decline in the unemployment rate to 21,9 per cent by the fourth
quarter of 2008 . Since the crisis, this investment to GDP ratio has declined and in 2011
averaged around 19 per cent. Between 1994 and 2007, government and public sector
investment averaged 4,4 per cent of GDP, but since 2008 it has averaged 8 per cent.
We can conclude from this that the lack of investment is not simply a problem of government
failure to invest. Private sector investment has also been lacking. But government does have
an important role to play in providing the environment conducive to private sector investment.
For example, a notable area where private sector investment has been severely lacking is in
the mining sector. This may be due in part to uncertainties created by the regulatory
environment, and lack of investment in rail infrastructure which has impeded the ability of the
mines to get the ores to the ports. This also illustrates how government investment does not
necessarily crowd out private sector investment. To the contrary it can also crowd in
investment, as in this example.
Michael Spence sums it up appropriately as follows: "Put bluntly, growth requires investment,
and that means present sacrifice for future gain. The job of leaders is in part to get everyone
on board, to build a consensus behind a forward-looking vision, underpinned by a growth and
development strategy that is credible. Multiple classes of participants and organized
stakeholders need to be willing participants. These include labour, unions, businesses and
entrepreneurs, civil society organizations, and households at various levels in the income
distribution."
It is not only investment in fixed capital that is essential. Human capital is as important, if not
more so. It is generally recognised that South Africa's schooling situation is seriously lacking
in various respects, but of equal concern is the lack of training for technical skills. It is an
indictment, for example, that South Africa needs to import skilled artisans such as welders.
Germany has a very well established system of apprenticeships, but South Africa has gone
backwards in this respect. Not only does an undertrained and undereducated workforce
constrain economic growth, it reinforces the cycle of unemployment and widening
inequalities. As Michael Spence has noted, in a world in which knowledge and connectivity
are increasingly the basis for value creation, failures in the educational system are the surest
form of exclusion there is.
It would be inappropriate for me to conclude without saying something about monetary policy
and inflation, and the contribution monetary policy can make to the growth and employment
trajectory. We know that unemployment has serious socioeconomic consequences, but so
does high inflation. It is difficult to find examples in history where sustained economic growth
and high inflation went hand in hand. But it is easy to find glaring examples of high inflation
contributing to socioeconomic dislocation. The inter-war years in Germany, Latin America in
the 1980s, and closer to home in Zimbabwe in the previous decade are good examples.
Zimbabwe got no advantages out of the hyperinflation, but it created severe hardships, and
the Zimbabwe dollar has now disappeared. The burden of inflation gets borne by those who
lose their jobs through this, and by those who are unable to hedge themselves against the
ravages of accelerating price increases. These are generally the poor and often even the
middle classes, whose savings and pension funds would have been rendered worthless.
It is not only hyperinflation that is the problem. Even moderate inflation is bad for the poor
and for workers. An annual inflation rate of 10 per cent for example, which is regarded by
some as acceptable, means that a worker receiving R1000 per month will need to be earning
R2590 in 10 years time simply to be no worse off. With a 20 per cent inflation, this amount
would need to be R6,190 per month, and with a 25 per cent inflation, the required break-even
income would be R10,000. The higher the inflation rate, the more purchasing power would
be lost between bargaining rounds. In the latter case, workers will have lost a quarter of their
purchasing power by the time of the next wage adjustment. If left unchecked, high inflation
tends to breed higher inflation.
Apart from its redistributive effects, high and variable inflation also tends to undermine
long-term investment, so it is important that inflation is kept under control, and monetary
policy is best placed to do this. But in trying to stem high inflation, monetary policy may have
negative short run effects on economic growth. Conversely, monetary stimulus will only
impact on cyclical growth. Therefore there has to be sensitivity on the part of policy makers
to the state of the business cycle. This is what the essence of flexible inflation targeting is:
that if inflation is outside the target, there is some flexibility with respect to the time horizon
within which inflation is brought back to within the target, in order to smooth the cyclical
adjustment. Monetary policy can help growth by providing a stable and low inflation
environment conducive to investment, and by providing short-term stimulus, but it does not
determine the underlying growth potential of the country. This is the domain of other policies
and where the focus on infrastructure and other structural reforms is critical.
Monetary policy is currently facing the challenge of a rising trend in inflation and a slowing
domestic economy. According to the macroeconomic forecast of the Bank, inflation is
expected to peak at around 6,6 per cent in the second quarter of this year and then to
decline moderately before returning to within the target range by the end of the year. But
there are a lot of uncertainties related to this outcome. Upside risks are seen to be coming
from international oil prices, particularly in the context of elevated tensions in the Middle-East
relating to the Iranian nuclear programme and associated sanctions. Administered prices
also remain a concern, with the tendency for prices in many instances to be set without
regard to the inflation target. However recent developments, including the below-inflation
tariff increase granted to the ports, the reduction in the proposed e-toll tariffs and the
reduction in the electricity tariff increase granted to Eskom are encouraging.
The rand exchange rate could pose and upside or downside risk, depending on global
developments. The rand tends to depreciate when there are heightened risk perceptions in
Europe, as investors tend to seek so-called safe havens. But these flows tend to reverse as
risk perceptions improve. Currently the markets appear to be taking a more positive view of
global developments and this has been reflected in the recent appreciation of the currency.
However, as I indicated earlier, this can change very quickly.
Until recently, core inflation - that is inflation excluding petrol, electricity and food - was
relatively subdued, reflecting the absence of significant demand pressures in the economy.
In general, monetary policy can do little to combat the impact or first round effects of inflation
that is driven by exogenous shocks. However the most recent data seem to suggest that
inflation is becoming more generalised, and may reflect the emergence of demand
pressures. This is something that the Bank will monitor very carefully.
At this stage, monetary policy remains relatively accommodative, given the challenging
growth environment, with real policy interest rates slightly below zero. As I have outlined
earlier, raising the growth potential requires a concerted and sustained investment boost in
the economy. An accommodative monetary policy environment is only part of this story, and
as responsible monetary policy makers, we recognise that keeping inflation under control
must be done with due regard to the possible impact on employment and growth. At the
same time, maintaining price stability remains central to our mandate, and price stability
should be part of the societal consensus that is essential for the successful implementation
of a forward-looking sustainable growth strategy.
Thank you.