The South African Reserve Bank (Sarb) has managed, for the most part, to keep the economy within its mandated inflation target of 3% to 6%. Unfortunately this has been a blunt instrument for job creation, with unemployment rising despite low interest rates.
According to University of Cape Town professors Haroon Bhorat and Alan Hirsch, who wrote a research note on the real outcomes of monetary policy, rising unemployment is largely due to factors beyond the Sarb’s control, such as the country’s electricity shortage.
Their paper describes how the unemployment rate rose steadily until the fourth quarter of 2009, and sharply thereafter regardless of declining interest rates.
This, the authors say, “suggests that short-run labour market adjustments are not within reach of monetary policy in South Africa. For an economy with one of the highest unemployment rates in the world, it is a significant policy concern that monetary policy, within the inflation-targeting framework and with the policy interest rate as its instrument, is ineffective in changing the level and rate of cyclical joblessness”.
Bhorat and Hirsch add that inflation targeting is misguided given the country’s inequality. They argue that the basket of goods tracked in the Consumer Price Index is more consistent with middle- to higher-income households and understates the inflation experienced by poorer households.
To complicate matters, the Reserve Bank’s monetary policy committee expressed concern in May about stagflation in the South African economy, characterised by high inflation and low growth. This is a predicament for the Sarb because conventional economics dictates that there is a positive correlation between the two. Ordinarily, rising interest rates are reflective of a rapidly growing economy, but in South Africa inflation hasn’t been driven by higher demand, growing incomes, or prosperity. It’s been driven by costs; fuel, electricity and imported goods.
When the Sarb responded to the Global Financial Crisis (GFC) by dropping interest rates the intention was to stimulate growth. But instead of buying homes, starting businesses, or studying further, South Africans saw cheaper debt as an opportunity to consume more, buying cars, clothing and gadgets instead of investing.
This consumption-led growth is at the centre of the country’s monetary policy dilemma. Investment Solutions’ chief strategist Chris Hart says he is more concerned with inflation now being higher than the interest rates, meaning real interest rates are negative, discouraging saving.
“When you look at South Africa today, we see interest rates too low. We’re not even compensating the saver for inflation, let alone the time value for money. And that’s an irony because they say you can’t increase interest rates because it will hurt growth… of course it will because of our debt-led consumption growth model.”’
Not everyone agrees
The Sarb has kept the benchmark repo lending rate on hold at 5.75% since hiking it by 25 basis points in July 2014. While it is widely expected that the MPC will raise the repo rate next week, the International Monetary Fund (IMF) believes the central bank could still resist this. In June consumer inflation was at 4.6% and the Washington-based lender said any breach of the upper target limit of 6% was likely to be temporary as demand pressures in the country remained subdued.
“The Sarb could stay on hold unless core inflation or inflation expectations rise, or external financing becomes problematic,” it said in a statement released after a recent staff visit to South Africa.
SA facing solvency crisis
Fiscal policy hasn’t inspired much confidence either, according to Hart, who believes the ANC’s leadership since 2008, when Jacob Zuma deposed Thabo Mbeki in Polokwane, was the economy’s turning point.
He says the contrasting performance of South Africa’s economy since the GFC, compared to most of its emerging market peers, such as India and Nigeria, shows that the biggest shocks to the economy came from within.
“We’re one of the few emerging market economies where unemployment has risen since 2008,” say Hart.
“If our performance was solely due to the GFC then you would expect all emerging economies to have had similar experiences. Most emerging countries have seen unemployment fall since then, and that tells you it’s an internal problem, not an external one.”
According to Hart, South Africa is headed towards a financial solvency crisis. He says the country’s debt-levels have shot up and are now back to where they were in 1994.
“Debt-to-GDP levels are at the same levels they were at that time. The difference is that we were financing it at around 15% then, and now we’re doing so at around 8%. That hides the severity of our indebtedness.”
Fiscal spending, he says, has exacerbated South Africa’s consumption-driven culture, with its heavy wage bill and social grants straining the budget and limiting opportunities to create investment-led growth.
“The wage bill is close to being 11% of GDP. Our peers are close to 5%. It is higher than Greece’s public sector wage bill. That alone could take us to a solvency crisis,” says Hart.
Government’s proposed national health plan and inefficient state-owned companies, like South African Airways, add to the fiscal burden carried by the state.
Equally concerning for Hart is the government’s commitment to nuclear energy. Government argues that the plan is affordable because the nuclear provider will build, operate and own the plants, and SA will simply procure the electricity from them. However, this would worsen South Africa’s already alarming current account deficit.
“The price will be set in dollars, which means we will effectively be importing electricity,” says Hart.
OECD and World Bank encouraged by SA policy
The Organisation for Economic Cooperation and Development recently released an economic survey on South Africa recommending increased taxes on wealthier individuals to help boost revenue needed for the nation’s growing demands. It lends credence to the country’s recent income tax increases, which only applied to its richer population.
Similarly, the World Bank recently released a report commending South Africa’s fiscal policy, which it said was progressive and works to reduce inequality.
It says the country has had more success than other peer countries such as Brazil, Mexico, Argentina, Indonesia, and Ethiopia in using fiscal policy to tackle inequality and poverty.
The report finds, however, that despite the strides made, the sheer size of the problem meant the level of inequality after fiscal policy was still much higher than it is in most other countries.