Lesetja Kganyago: The global economy and South Africa's challenges
Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the
Conference of the Industrial Development Corporation (IDC), Sandton, 19 October 2015.
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Good morning and thank you for the opportunity to address you at this important milestone in
the history of the Industrial Development Corporation.
South Africa's industrial development was initially shaped by mining, but linkages to the rest of
the economy spurred the growth of the manufacturing sector. Today, industrial development is
still seen as central for economic growth and employment creation in the country. However,
South Africa's manufacturing sector is currently facing significant short-term as well as
longerterm challenges. Fifteen years ago, the sector accounted for about 18 per cent of GDP, but
today its share is 12,5 per cent, with the finance, real estate and business services sector now
the single largest sector at almost 20 per cent.
Since the global financial crisis in particular, South Africa's global competitiveness has been
deteriorating, as reflected in the country's declining share of world trade. Longer-term
constraints to industrial development include the pace of global technological change, the
changing nature of global value chains, the lack of appropriate skills, logistics and
infrastructural deficiencies as well as rising input costs, to name but a few. These issues will be
discussed in some depth by the panels during the course of the day.
My address this morning will attempt to set the scene by focusing on the current global and
domestic contexts as well as the challenges that these pose to future industrial development.
No discussion about competitiveness is complete without reference to the exchange rate,
which is often too easily seen as either the cause of or the potential panacea for South Africa's
competitiveness woes. Given its volatile behaviour, the exchange rate is an important focus of
monetary policy, and I will make some comments on this issue as well.
The global economic outlook
Allow me to begin with the outlook for the global economy that has not fully recovered from the
global financial crisis.
While emerging-market economies recovered relatively quickly from the crisis, recovery in the
advanced economies has been hesitant at best. In the past four years or so, we have seen a
familiar pattern: one of optimism at the beginning of the year that the global economy will
improve, only for these hopes to be disappointed quite early on in the year. More recently,
however, there have been convincing signs that some of the advanced economies are well on
the road to recovery, particularly the United States and the United Kingdom. But even in these
economies forecasts have been scaled down somewhat, particularly after the very weak first
quarter in the US. Nevertheless, growth next year is expected to be in line with, or to exceed,
estimated potential output growth. Labour-market developments in both economies have been
favourable, with the unemployment rate falling to 5,1 per cent in the US. Nevertheless, there is
still uncertainty about whether these trends will result in an increase in labour-market
participation, which would cause the unemployment rate to increase. And while these
economies are improving, it is unlikely that their recovery will be sufficient to take the rest of
the world along with it, as the US is no longer the locomotive of global growth that it used to be.
This positive prognosis is not generalised to all the advanced economies, with the euro area in
particular still facing significant challenges. While there have been signs of a more sustained
recovery in the region recently - particularly in countries such as Ireland, Italy and Spain -
growth in the German economy has disappointed. The Greek debt crisis seems to have been
averted for now, but the general view is that any re-emergence of the crisis is unlikely to have
a systemic impact. The slow pace of recovery in the region is expected to result in a
continuation, or even an expansion, of the monetary stimulus from the European Central Bank.
The outlook for Japan also remains quite uncertain. The favourable first-quarter outcome was
followed by a contraction in the second quarter, and the economy remains dependent on
monetary policy support as it battles to get out of its deflationary trap on a sustainable basis.
While recovery in the advanced economies remains patchy but positive overall, the lack of
synchronisation in the global recovery is even more pronounced when we look at the outlook
for the emerging-market economies. The post-crisis view that emerging markets would replace
the advanced economies as the epicentre of global growth has been shaken, despite their
important initial role in leading the global recovery. Central to the risks to the outlook has been
the slowdown in China, where growth rates have declined persistently in recent years as the
economy rebalances away from investment-led growth to a more consumption-led focus. The
implications for much of the emerging market and the developing world have been profound,
but given the increasingly important role of emerging markets in global economic prospects,
the risk of spillbacks to advanced-economy growth prospects has been significant as well.
There are conflicting views as to the extent of the slowdown, the ability of the Chinese
authorities to counteract it, and the impact on emerging markets of a rebalancing of the
Chinese economy. Despite these concerns, the latest IMF growth forecast for China, as
published in the October World Economic Outlook, is unchanged since the April forecast, with
growth of 6,8 per cent forecast for this year (compared with a forecast of 7,3 per cent in April
last year) and 6,3 per cent for 2016. This follows growth of 7,7 per cent and 7,3 per cent in
2013 and 2014 respectively. A number of other forecasters are, however, not as optimistic.
To some extent, this slowdown is to be expected, as the previous stellar rates of growth were
unsustainable, particularly as the Chinese economy grows off a larger base. Furthermore,
previous growth was predominantly driven by unsustainably high investment ratios in excess of
40 per cent of GDP. Previously, the government policy response to the slowdown was to
stimulate investment in the industrial sector and infrastructure. Given the new focus, there is
uncertainty about the nature and efficacy of possible policy responses to the current slowdown.
Furthermore, if the authorities do manage to engineer a soft landing and persist with a more
consumption-led path, there is a great deal of uncertainty as to what the implications of a more
services sector-oriented economy would be for emerging markets and commodity prices.
To date, while the measured growth slowdown appears to have been moderate, the impact on
other economies has been quite strong. The main impact for South Africa and a number of
other economies (not only emerging markets) has been on commodity prices. This is not new;
this trend began in 2011 already, but accelerated around the middle of this year. Since the
beginning of 2012, for example, platinum prices have almost halved and iron-ore prices are
down by about 25 per cent. The IMF estimates that the weak commodity price outlook will
subtract about 1 percentage point annually from the average growth rates of
commodityexporting countries from 2015 to 2017, and in energy-exporting economies the impact is
expected to be more than double this amount. These developments are reflected in the recent
economic performance of Brazil and Russia, both of which are experiencing recessions, India
being the only one of our BRICS partners with a strong growth outlook. Although African
economies have been experiencing relatively strong growth, some downside revision has been
seen in response to commodity-price developments.
Apart from commodity prices, another global factor impacting on South Africa is the prospect of
monetary policy tightening by the US Federal Reserve, which has had a significant impact on
capital flows to emerging markets. The recovery in the US has prompted expectations of a
tightening of monetary policy, and this process effectively began with the phasing out of
quantitative easing during 2013. The focus then became the timing and extent of policy
interest-rate increases, but successive growth disappointments, very low inflation and
uncertain labour-market developments delayed the expected commencement. The
everchanging views on the timing of the so-called 'lift-off' have contributed to the uncertainty and
volatility in emerging-market exchange rates, with every data point overly scrutinised. For
example, the weak US retail data, released last week following worse-than-expected payrolls
data, resulted in a sharp weakening of the dollar as expectations of an interest-rate increase
were moved out.
That the Fed will tighten is inevitable. The question is one of timing. But the associated
uncertainty has affected the financial conditions in many emerging markets, particularly those
with current-account deficits. Furthermore, the start of interest-rate normalisation will not do
away with uncertainty completely, as the focus will then move to the next meeting. While the
Fed has signalled its intent to follow a very moderate path of interest-rate increases, the
socalled 'dots', which represent the expectations of FOMC members of future interest-rate
moves, have changed significantly from meeting to meeting, reflecting uncertainty even among
policymakers.
Emerging markets have therefore been facing a double negative in terms of capital flows:
capital which had previously been chasing relatively higher yields and higher growth in
emerging markets is now reversing, with the prospect of interest-rate increases in the US. In
addition, the lower growth associated with the slowdown in China and declining terms of trade
have also contributed to a reversal of capital flows towards the advanced economies. But at
the same time, concern about the slowing global economy and its possible spillbacks to
advanced economies has also weighed on the Fed's decision making.
Do these developments point to an impending crisis in emerging markets? Some
commentators point to parallels with the Asian crisis in 1998/99. The outlook is challenging, but
I would not characterise it as a crisis. Emerging markets in general are better equipped today
to meet the challenges posed by terms-of-trade deterioration and capital-flow reversals.
Macroeconomic frameworks are far more robust, and exchange rates are more flexible to act
as a shock absorber to these changes. That is not to say that it will be without pain.
Unfortunately, capital flows which could help to cushion the adjustment to deteriorating terms
of trade are drying up precisely when most needed. Some adjustment will have to take place,
and the exchange rate is an important part of this process.
Furthermore, there are differences between emerging markets which will determine how they
are affected by these developments. For example, countries with sizeable current-account
deficits will have a different reaction to capital-flow reversals than those with surpluses. And
while non-commodity exporters will benefit from lower commodity prices, particularly emerging
markets in Asia, these economies are already experiencing a decline in their manufactured
exports to China.
The domestic economic outlook
These developments provide a challenging backdrop for the South African economy going
forward. Apart from the impact of lower commodity prices, the continued slow growth in the
euro area and further risks from a slowdown in Africa constrain the growth in our manufactured
exports. In addition, the persistent current-account deficit needs to be financed at a time when
capital flows to emerging markets are declining.
South Africa's growth outlook is extremely fragile. Following the disappointing
quarter-onquarter GDP growth outcome of 1,3 per cent in the first quarter of this year, growth surprised
on the downside when a contraction of 1,3 per cent was recorded. Of concern was the fact that
it was broad-based across sectors, with only the finance, real estate and business services
sector showing reasonable performance, recording growth of 2,7 per cent.
At the heart of this low growth is the weak growth trend in gross fixed capital formation. This is
particularly true of the private sector, and reflects in part the persistently low levels of business
confidence. Total gross fixed capital formation contracted by 0,4 per cent in 2014, with the
private sector contracting by 3,4 per cent and public corporations increasing by a mere 1,6 per
cent. In the second quarter of this year, private-sector growth was barely positive at 0,1 per
cent, the same as that of public corporations. The main area where there has been some
growth in private-sector investment in recent years has been with respect to renewable energy.
While this is a welcome development, we need more broad-based investment. The weak
public-sector investment growth reflects the slow pace of infrastructure expenditure growth,
which is central to any industrial development strategy.
One of the main constraints to investment is of course the uncertainty of electricity supply. This
has both short- and long-term impacts. Load-shedding affects output immediately, and is
reflected in the weaker current GDP growth outcomes. But of greater concern is the
longerterm impact that electricity supply constraints have on potential output growth, as
forwardlooking investment plans are delayed or even shelved because of the lack of guarantees of
electricity supply. This constraint has contributed to the decline in our estimate of potential
output growth to 1,8 per cent. Clearly, if we want a vibrant and expanding industrial sector, we
need to have investment as well as an adequate and reliable supply of electricity.
Unfortunately we cannot solve this overnight.
The production-based sectors of the economy have been particularly weak, and face a difficult
outlook. The agricultural sector is beset by drought, which resulted in a contraction of around
17 per cent in the first two quarters of this year. The mining sector contracted at an annualised
rate of 6,8 per cent in the second quarter, and monthly production data indicate that the third
quarter is also likely to disappoint. The manufacturing sector has also experienced two
consecutive quarters of contraction, of 2,4 per cent and 6,3 per cent, and the outlook is also
constrained although a further contraction is not expected in the third quarter.
The Bank's forecast for growth has recently been revised down by half a percentage point in
each year of the forecast period, to 1,5 per cent in 2015 and to 1,6 per cent and 2,1 per cent in
the subsequent two years. This weak outlook is consistent with the Bank's leading indicator of
economic activity, which has exhibited a more pronounced downward trend in recent months.
Apart from the continued electricity supply issues, growth is expected to be constrained by
weak private-sector investment and subdued growth in household consumption expenditure
amid low levels of both business and consumer confidence.
Competitiveness and the exchange rate
One of the main themes of today's discussions is that of competitiveness. Competitiveness has
a number of different dimensions, one of which is the exchange rate, and it is perhaps
appropriate for me to say a few words about this, as the exchange rate is of course also of
importance from a monetary policy perspective.
Between 2009 and 2011, the rand experienced a strong recovery from the global financial
crisis in the wake of strong commodity-price increases and inflows of capital seeking higher
yields. This created stress for parts of the manufacturing sector, in terms of both exports and
import competition. Not surprisingly, the Bank came under pressure from parts of this sector to
weaken the exchange rate. However, since 2011 the rand has followed a relatively volatile
depreciating trend, driven by various factors, including the terms-of-trade deterioration,
idiosyncratic domestic factors, bouts of global risk aversion (related in particular to the
eurozone crisis) and, more recently, the partial reversal of capital flows in anticipation of higher
interest rates in the advanced economies.
However, the response of both the manufacturing sector and exports to the weakening
exchange rate has been disappointing, although in recent months we have seen tentative
signs of current-account adjustment, both through higher export volumes and through lower
import volumes. The current-account-to-GDP ratio has been declining steadily for the past four
quarters and measured 3,1 per cent in the second quarter of this year, from a peak of 6,2 per
cent in the second quarter of last year. In the second quarter of this year, the trade account
recorded its first surplus since the final quarter of 2011. Despite these more favourable
developments, we expect the current-account deficit to average in excess of 4 per cent of GDP
this year and the next.
There are a number of reasons why we would expect a slow current-account response. First,
from a competitiveness perspective, it is the real exchange rate that is of relevance: that is, the
nominal exchange rate adjusted for inflation differentials (although there are debates as to
what the appropriate deflator should be). Because our inflation has generally been higher than
that of our trading partners, the real depreciation has been lower than that of the nominal
effective exchange rate. Since July 2011, the nominal effective exchange rate has depreciated
by almost 40 per cent, compared to a real depreciation of around 20 per cent. We also need to
bear in mind that the real exchange rate is a very broad macroeconomic measure, but
companies and sectors have different import intensities and different cost structures, so firm-
or sector-specific real exchange rates may differ markedly.
Second, the global environment is important. Slow growth in our major trading partners will
dampen our export potential as income elasticities are higher than price elasticities. As outlined
earlier, our major trading partners are experiencing subdued or declining growth, consequently
constraining demand for our manufactured exports.
Third, intermediate goods (including fuel) and capital goods account for about 80 per cent of
imports, and these are often tied to capital investment projects. This imparts a degree of rigidity
to import volumes. Too often in the past was current-account compression achieved through
declining investment expenditure, with adverse implications for employment and growth.
Fourth, there are lags in adjustment, and manufacturers will want to be certain that the more
competitive position will be sustained.
Fifth, strikes and labour disputes have periodically affected exports adversely, as was the case
in the platinum sector in 2014.
Sixth, for commodity exporters, the exchange rate acts as a cushion for lower commodity
prices but it does not necessarily provide an impetus to higher export volumes.
Seventh, there is the possibility that the increased role of global value chains may have
weakened the relationship between the exchange rate and trade in intermediate products used
as inputs into other economies' exports. This issue is discussed in depth in the latest IMF
World Economic Outlook. Although the main finding is that the bulk of global trade is still
conventional trade, this issue may be relevant in a number of sectors. This may be of particular
relevance to the motor industry in South Africa.
Finally, we also need to look carefully at some of our own domestic policies that have the
potential to undermine our exports or to counter the favourable impact of depreciation.
So how does the Bank view the exchange rate, and should we try to intervene in the interest of
competitiveness? Monetary policy is concerned about the exchange rate because of its
potential impact on inflation. As we have outlined in our monetary policy statements, the
exchange rate remains one of the main risks to the inflation outlook despite the fact that the
pass-through has been relatively muted compared with previous episodes of rand weakness.
However, this does not mean that we try to act against rand weakness. Rather, our reaction to
exchange-rate changes is focused on the potential inflationary impact of exchange-rate
depreciation in conjunction with a range of other variables that may be concurrently affecting
inflation, both positively and negatively.
Similarly, we do not try to explicitly lean against rand strength, although we did take advantage
of such conditions in 2009-2011 to continue with our policy of accumulating international
reserves. However, the view that we prefer a strong rand to a weak rand is not well-founded.
Ideally, what we would like to see is an appropriately valued stable exchange rate, one that is
not a significant issue for inflation. However, that is in an ideal world. In reality, the exchange
rate is buffeted by a number of fundamentals which require adjusting to; in South Africa's case,
these fundamentals include commodity-price changes and capital flows.
Over time, we have learned the hard way that trying to 'lean against the wind' in the face of
markedly changing fundamentals can be both futile and expensive, and any success in this
respect is likely to be short-lived at best. That is not to say that we will never get involved,
particularly in the event of liquidity drying up in the market. That said, let me be clear: no
amount of central bank intervention, no matter how well intentioned, can prevent an
exchangerate adjustment from aligning with fundamentals. The best contribution that the Bank can make
to competitiveness is to ensure that inflation is contained to the extent possible during periods
of rand weakness to ensure that the depreciation is real. It is then up to the relevant sectors to
take advantage of the increase in competitiveness.
Conclusion
In conclusion, the domestic economy is facing a challenging future. While the global economy
is a constraint, it is important that we do not focus on that only and ignore the very real
domestic impediments to growth as well as the opportunities. It is too easy to sit back and
bemoan the fact that we are hostage to global developments. There are things that can be
done, many of which are clearly spelled out in the National Development Plan. We often hear
about a focus on infrastructure, but we always seem to under-deliver in this respect. If South
Africa wants to develop its industrial sector, it needs to improve its infrastructure apart from
electricity. There also needs to be policy coherence and less regulatory uncertainty.
If we are to succeed in reducing unemployment, we must have a growing, competitive
economy. Competitiveness is not simply about the exchange rate; it is a multidimensional
concept. These dimensions include the quality of goods and services produced, reliability of
delivery, reliable and appropriate infrastructure, appropriate technologies, appropriate and
sufficient skills, the ease of doing business, and the minimisation of red tape. Our financial
sector is regarded as one of the most efficient in the world, and we have a sound legal
framework. We need to build on these strengths, but we have to be proactive if we don't want
to fall further behind.
These are some of the issues that will be discussed during the course of the day, and I look
forward to the deliberations.
Thank you.