francois groepe : the expanded research opportunities for students in economics address by mr francois groepe, deputy governor of the south african reserve bank, to the economics department of the north west university, potchefstroom, 15 august 2013. * * * introduction prof. waldo krugell, director of the school of economics, staff members of the faculty of commerce, students, ladies and gentlemen. i wish to thank you for the opportunity to address you at your seminar series. global economic developments despite some positive developments recently, the global economic crisis continues and the recovery is best described as hesitant and fragile. in the past, the bank has referred to the mutating nature of the crisis, with the crisis starting out as a sub - prime crisis which mutated into a systemic banking crisis, a liquidity, fiscal deficit and sovereign debt crisis, and more recently in some countries a youth unemployment crisis. the altered patterns of capital flows and the rising long - term bond and mortgage interest rates that may follow the tapering of the asset purchases programme by the us federal reserve and the eventual exit of quantitative easing by monetary authorities in advanced economies could well result in a further mutation of the global financial crisis. six years into the crisis, most of the major advanced economies continue to grow below potential and unemployment, particularly in the eurozone area has remained elevated. the level of youth unemployment is of particular concern with possibly significant long - term implications for social stability in the worse affected countries. while there are signs of positive economic growth and rising employment in the us, this growth is still too low to significantly close their output gap. the haphazard fiscal contraction and the potential headwinds that may flow from this are likely to pose a risk to the robustness and sustainability of the recovery. the anticipated exiting of quantitative easing by the advanced economies is likely to contribute to rising long - term bond and mortgage interest rates. this could bring pressure to bear on the housing recovery in the us, but will furthermore have a pronounced impact on emerging market economies, particularly their financial market asset prices and currencies may prove vulnerable. the eurozone, after six quarters of contraction has finally emerged out of its recession in the second quarter of 2013, and recorded a growth rate of 0. 3 per cent, which was slightly ahead of the median forecast of 0. 2 per cent growth. this growth performance appears to be broad based on the economic outcome in core countries such as germany and france, as well as certain of

the poorer households who, unlike the wealthier ones, do not have the possibility of ‘ hedging themselves ’ from the consequences of a downgrade by diversifying their assets. there are five major channels through which the recent rating downgrades can undermine the well - being of poorer households, which i will discuss more in detail. page 2 of 10 the ratings of a listed entity ( be it a government or a corporation ) are meant to reflect its ‘ credit quality ’. hence, they are used by international investors to gauge the risk of buying the bonds issued by that entity. in theory, therefore, these investors will – subsequent to a downgrade – require a premium in the form of a higher interest rate, or they will shun these bonds altogether. south africa requires foreign investors to finance its external deficit ( as its imports regularly exceed its exports ). a rating downgrade therefore means that financial markets will move to a new equilibrium where the interest rates on bonds are higher and the exchange rate of the rand is weaker than before the downgrade. obviously, the recent empirical evidence is clouded by the fact that many other factors, bar sovereign ratings, influence the price of south african financial assets. nonetheless, a standard measure of sovereign credit risk for south africa, namely the credit default swap ( cds ) spread, has underperformed compared to its emerging - market peers in recent years, and is now trading at similar levels to non - investment - grade countries. this is clear evidence that investors are requiring a higher risk premium, if only in relative terms, on south african government debt. the increase in the yield on inflation - linked bonds issued by national treasury, over the past two to three years, is another such indication. even after being fully protected against inflation, bond investors require a higher return – even as global economic factors have continued to depress risk - free, real interest rates all over the world. these higher yields on south african bonds will, over time, negatively affect the poor. as the south african government faces a higher cost of borrowing, it will have to devote a larger share of its ( finite ) resources to page 3 of 10 servicing debt. already, estimates by national treasury indicate that government debt - servicing costs are expected to represent 10. 4 % of total budget spending ( and 3. 5 % of gdp1 ) in 2017 / 18, up from a low of 7. 0 % in 2009 / 10. this stands in contrast to the years prior to the global financial