OPINION: SA’s path to effectively handling Covid-19’s macroeconomic devastation
JOHANNESBURG - Much of the debate about how to handle the macroeconomic consequences of the Covid-19 pandemic on the South African economy appears to revolve around the role of monetary policy and SA Reserve Bank (SARB) in helping mitigate, if not, to eventually eliminate them.
Some advise that SARB can directly assist the government to handle the fallout, others worry about possible inflationary effects of such direct assistance, and yet others observe that SARB’s ability to directly assist is limited by statutes.
To join this debate in a productive way, we need: a clear understanding of the problem and its sources, consider what possible macroeconomic stabilization strategies can help us address the problem, and push for the strategies that would be most effective in resolving the problem in a cost effective manner.
The Covid-19 outbreak, first reported in South Africa when the country was on the verge of an economic recession, substantially compounded the country’s parlous economic situation.
Like many other countries, South Africa has resorted to physical distancing, contact tracing, testing and isolation, encapsulated in the coinage, lockdown, as a means to protecting the population from the new disease’s potentially life-threatening consequences.
During lockdowns, only a few production activities, particularly those that are digitized, remain operational. In reality, close to 90 percent of the production process in South Africa is not digitized. This, in turn, means that close to a corresponding 90 percent of the formerly employed adults might become unemployed and, thus, making many households unable to feed and/or pay their debt.
Similarly, the majority of businesses would earn reduced revenues, pile up unused and perishable inventories, and become insolvent, with increased likelihood of soon going out of business. In the aggregate, under lockdown, the economy literally shrinks and portends greatly terrifying intermediate- to long-term misery.
Moreover, one must consider the magnitude of this misery in the context of a base 27-35 percent unemployment rate in an economy where the majority of the population eke out a living in the informal sector, which lacks meaningful support mechanisms. And it is all of these consequences, both current and anticipated, that are the problem hat the South African government must address
To guide the effective resolution of this problem, the government needs to appreciate the fact that this problem is coming at us, in the form of two cascading boulders from opposite ends of the valley, as it were – i.e., demand shocks and supply shocks. In other words, without employment and its associated incomes, there will be no consumer demand and, by extension, no private investment expenditure by firms, which themselves are currently inundated with piled-up/unutilised inventories. And due to shuttered company offices, factories, assembly lines, sea-ports, airports and borders, there is no production of most goods and services.
And if these two fast cascading boulders are not stopped and kept apart, they will inevitably collide and crush the entire economy. And the potential ensuing fire and decimation could take years to put out and several more years to rebuild. It took the world until 2010/2011 to restore global gross domestic product to its pre-global financial crisis (2007) level.
Any effective response by the South African government, must address both demand- and supply-side shocks by: assisting individuals, households and businesses in order to immediately put a floor on the fast falling aggregate demand, with intent to restart its upward movement in the intermediate term; and assisting businesses to maintain a meaningful production and supply of essential goods and services, and also with the intent to reverse upward the trend.
Economists have rightly noted that much of such countercyclical macroeconomic interventions are largely amenable to fiscal policy – i.e., use of government spending and tax reduction, via deferral and/or outright cancellation, to keep the economy at its near full employment level.
The key question, under the current scenario where government faces a shrunken or lost tax base and is already hugely indebted, is: where would government get the necessary funds for this necessary stimulus spending?
Governments traditionally use two sources for funding their fiscal activities: by dipping into their revenue, which mainly comes from taxes and by borrowing from the public via domestic capital markets and/or from offshore sources.
However, the Big Elephant in the room right now is that the government revenue faucet is currently off, offshore sources are equally dry because foreign individuals and firms are either dis-saving or their ‘deep-pockets’ are highly cautious, and multilateral organisations like the International Monetary Fund and World Bank already face overwhelming funding requests from about 100 member states.
In other words, offshore borrowing, if at all possible, will be hugely costly, by way of high interest cost. And this high cost of borrowing offshore, would inevitably be compounded by the avoidable uncertainty of future exchange rate for repaying the offshore debts when they come due. And should these debts become unsustainable; it would further depress an already struggling/recovering economy.
Consequently, for the South African government to raise the necessary funds for handling these consequences of the pandemic, it is left with near-zero sources. Fortunately, there is a creative and “relatively affordable” way out: borrow from your nationals by way of the central bank (SA RB , the lender of last resort to financial institutions, and central governments, during extraordinary times, such as now) in a “deferred way”.
It has to be in a “deferred way” because, like households and businesses in all other countries, South Africa’s households and businesses, are also dissaving and/or handling wealth management cautiously.
Therefore, by whatever creative contracting the central bank deploys and labels fancifully (as is the practice in effective central banks); SARB should provide the necessary funds that the government needs to implement the required stimulus spending. By deploying this option, SARB will carry huge government debts on its books for the period needed to get out of the economic downturn. Thereafter, it can then unwind this debt stock by selling it to the public (households and financial institutions) who would have returned to normal and are eager to manage their incomes/wealth traditionally, once again.
Sovereign debts are famous for low-risk wealth portfolio growth. And particularly worth pointing out here, is that this unwinding will be facilitated by one of the most active and developed bond/debt markets in the world; an important advantage for South Africa's government.
Importantly, I took pains to describe this available way out, which in my view is the most sensible and affordable option, because some of the ongoing debates I alluded to in the beginning of this piece appear to have taken this option off the table by worrying about a ‘suspected’ inflationary effect – which under the current situation, is evidentially and theoretically doubtful.
First, the lockdown’s effect has increased both unemployment/under-employment and incredibly shrunk aggregate demand, and consequently dispensed with demand-caused inflation. Second, the expansionary fiscal spending proposed here would increase aggregate demand, while also eliciting output increase in response to the spending support also given to businesses; thus, minimizing prospects for ‘cost-push’ inflation.
Moreover, the erroneous way in which the monetary policy tool of “inflation targeting” is misconstrued as the entirety of what constitutes monetary policy in South Africa, appears to be unproductively. It focuses monetary policy overwhelmingly on forestalling inflation.
SARB has defined ‘inflation target’ by a band of 3-6 percent, which is curiously inconsistent with “full employment” in an economy that has for about three decades persistently posted over 20 percent unemployment rate.
The overriding focus on inflation control appears counter-productive and defeats the broader objective of monetary policy, which is to use money supply or the interest rate to nudge the economy to near its full employment level without being inflationary.
This is not the time for such a misreading of the functions of the two engines of South Africa’s economy that an airplane needs to effectively fly us out of the pandemic’s eye of the economic storm. It is not only the time to be bold and creative in addressing these economic consequences, it is also, as Joe Biden, who is presumptively running to become the next president of the US, puts it: is an opportunity to re-imagine the structures of our economy and governance for the betterment of our people.
And no country could be more in need of such a “re-imagining” opportunity than South Africa, which has several severe structural macroeconomic imbalances that have curiously persisted since the official abrogation of the destructive apartheid regime. And that re-imagining should include replacing outdated statues that precludes productive use of macroeconomic stabilisation mechanisms, including monetary policy tools, which have worked in other countries and can work in South Africa.
Kalu Ojah is a professor of finance at Wits Business School, Johannesburg, South Africa.