The Reserve Bank recently released the latest update of its biannual financial stability review but before contemplating the results it is valuable to ask: why is financial stability in the economy important for the average citizen?
Financial stability, as the central bank puts it, is not itself an end goal but rather an important precondition for sustainable economic growth. Financial stability or instability therefore refers to how well the links are working between households, firms, the government and financial institutions and how stable the system is that allows for financial flows to occur between these players in the economy. Just as a human body relies on the circulatory system and its organs to generate and distribute blood and oxygen, an economy’s success is based on its ability to generate and distribute finance in an efficient manner to where it is needed most.
If this system breaks down, consumers struggle to borrow or save, investors struggle to invest, foreign sources of income dry up, inflation becomes unstable and, as market signals break down, money gets allocated incorrectly.
The financial stability review published on Tuesday, which covers the first six months of the year, mirrors the conclusions of the Global Competitiveness Report published by the World Economic Forum in May – that the financial institutions in South Africa are mostly sound, but labour relations provide the greatest risk to economic stability.
The three highest risks to financial stability in South Africa, which are also the three largest changes since the previous report, are: higher levels of domestic unemployment, labour unrest spreading to other industries and a global economic recovery causing a decline in the search for yields and lower demand for financial assets.
International risk factors have decreased in severity, but these gains are countered by the rise in domestic risk.
Labour unrest affects financial stability through its impact on growth, investment and the credit rating. The first consequence of labour disputes is a decrease in production and slower economic growth, turning South Africa into a less attractive destination for foreign investors.
The increased burden on the state and decreased tax revenue puts pressure on the budget deficit, and coupled with decreased inflows on the financial account of the balance of payments, the sovereign credit rating soon comes under threat.
The major credit rating agencies such as Moody’s Investors Service and Standard & Poor’s – misinformed, biased and illegitimate wielders of power in my opinion – have the power to change the dynamic of the economy at the flip of a switch. Were they to downgrade South Africa’s credit rating, government borrowing costs would increase, further extending the budget deficit, capital inflows would decrease significantly and economic growth would take a knock. It is therefore critical, both for labour and the economy, that the process of wage negotiation is brought under control.
Another concern is the level of household debt and the vulnerability to changes in the financial sector. Currently at 75.8 percent of disposable income, such high levels of debt are made possible by the current low interest rate environment. Were a decrease in the credit rating to occur and interest rates to increase, households would see the cost of debt rise and many could buckle under the higher expenses.
Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein