South Africa’s post-recession economic recovery is built on fragile foundations, leaving it vulnerable to unfavourable global developments – most notably unexpected increases in global risk-free interest rates.
The current business cycle upswing could not be more different from the former upswing, which commenced in September 1999 and peaked in November 2007. An outstanding feature of the last one was higher productivity growth, which encouraged fixed investment spending.
In contrast, productivity growth has been weak during the current economic upswing, which began in September 2009. Labour productivity, for example, advanced by just 1.2 percent during 2012. Consumption, including spending by government, has been the major contributor to domestic spending and growth and the recovery in investment spending, which collapsed during the recession, has been tepid.
While the upswing has been in place for nearly four years, the ratio of total gross fixed capital formation to GDP (a measure of investment taking place in the economy) remains below the level recorded at the peak of the previous upswing. Not surprisingly, real GDP growth has disappointed.
Ordinarily, a sharp increase in commodity export prices (relative to import prices) raises income growth and domestic savings. However, the increase in South Africa’s commodity export prices has been accompanied by higher consumption spending and a decline in the domestic savings ratio. The fall in the savings ratio is reflected in a wider current account deficit, in large part financed by foreign investors purchasing local government bonds.
Government consumption, which in part reflects its wage bill, is at its highest level in history (22.4 percent in 2012), while households have de-leveraged. At 60.9 percent of GDP in the first quarter of 2013, the ratio of household consumption spending remains below 61.7 percent – the level recorded in 2008. But the share of government consumption in GDP had climbed from 18.6 percent of GDP in 2008 to 22.1 percent by the first quarter of 2013.
Government’s dissaving is reflected in the significant shortfall on the current account. This twin deficit problem – a combination of a high fiscal deficit and a current account deficit – has left the country vulnerable to any unexpected upward adjustment in global risk-free interest rates.
South Africa’s current account balance has been in deficit since the second quarter of 2003. During this period, the country’s gross foreign debt ratio has climbed from less than 20 percent of GDP in 2004 to 35.7 percent of GDP (120.1 percent of export earnings) at the end of 2012.
While the overall level of foreign debt, per se, is not high and some 60 percent of the total foreign debt is rand-denominated, it is higher than it has been historically. The increase in the ratio of foreign debt in recent years in large part reflects public sector borrowing. And the persistent upward trend in this ratio is set to continue.
Moreover, in time investors are far more likely to fund productivity-driven investment spending that holds the promise of generating good growth (and returns on investment) in a low-inflation environment. Currently, this is not the case here.
We cannot predict the level of foreign savings inflows into South Africa. But, we do observe that, historically, current account deficits of this magnitude have not been sustained. US Federal Reserve chairman Ben Bernanke’s warning in May that the Federal Open Market Committee would need to consider scaling back its purchases of financial assets “within the next few meetings” focused attention on emerging market countries that run large current account deficits and rely on debt capital inflows to fund domestic investment – a group that includes South Africa. As US Treasury yields increased, subsequent to the announcement, the rand and the domestic bond market sold off aggressively.
At least we can argue the currency, at the time of writing, is undervalued.
Given current forecasts, the US policy rate could remain unchanged until 2015. Even so, the US Fed is unlikely to hold off indefinitely. So it is imperative that progress is made in reducing SA’s government budget deficit which has been running at about 5 percent of GDP for four years. In the absence of fiscal consolidation, the private sector will need to save more should foreign capital inflows wane.
Less government consumption and higher productivity growth are needed to reduce the vulnerability of the upswing.
Arthur Kamp is an economist at Sanlam Investment Management