Growing pressure on South Africa’s Reserve Bank (SARB) to do more to support the economy and finance the government is unlikely to result in a major shift in policymaking over the next year or two. But it’s a distinct possibility further out and, while this may prevent the public debt ratio from rising sharply, it would come at the cost of higher inflation and sharper currency falls.
- Growing pressure on South Africa’s Reserve Bank (SARB) to do more to support the economy and finance the government is unlikely to result in a major shift in policymaking over the next year or two. But it’s a distinct possibility further out and, while this may prevent the public debt ratio from rising sharply, it would come at the cost of higher inflation and sharper currency falls.
- In recent weeks, South African labour unions have called for more aggressive conventional interest rate cuts, while the ruling ANC party has put forward a policy discussion document to reinvigorate the economy. Various policies have been raised, including a government bond buying programme by the SARB (that would be larger in scale than the purchases made since March to stabilise markets), changing the central bank’s mandate and bringing it under state ownership rather than its current, partially private ownership.
- On the face of it, many of these policies may be aimed at boosting GDP growth. But they also fall under the umbrella of financial repression, characterized as policies that keep government borrowing costs artificially low by channelling funding to the public sector. We’ve noted before that the worrying state of South Africa’s public finances might tempt policymakers down this path, and explored more generally what forms financial repression might take across the EM world. (See our Emerging Markets Update.)
- At present, there seems to be more political disagreement than meeting of minds on the above proposals. Even with a united front, the practicalities of pushing through these changes are laborious. Nationalising the Reserve Bank, which would have no legal impact on its independence, looks to be an exception.
- Changing the SARB’s mandate to include employment or even shoring up the public finances may require amendments to the constitution, which protects the Bank’s independence (although some officials disagree, contending that a letter from the finance minister would suffice).
- In any case, the SARB could mount a court challenge if it deems its independence is under threat (as it has done so in the past). And unless Governor Lesetja Kganyago (who has rejected calls for a radical policy shift) resigns under pressure, removing him before his term ends in 2024, would be no mean feat.
- Political realities suggest that major changes to South Africa’s monetary policy framework (such as a substantially revised mandate) are at least a few years away. In the meantime, the authorities envisage aggressive fiscal austerity from fiscal year 2021/22 to deal with the weak state of public finances. That said, a more left-leaning political leadership, potentially following an ANC national conference in 2022 or general elections in 2024, could chip away at the independence of the SARB.
- If the above-mentioned policies were implemented, there would a number of key economic implications. In particular, real interest rates would be lower. The public debt ratio could even stabilize due to artificially low debt servicing costs. In the near term, the side effects may not be particularly damaging. With a large output gap and precautionary consumer behaviour lingering from the coronavirus crisis, inflation could remain low. The longer-term economic harm might be harder to escape.
- The erosion of the SARB’s credibility would weaken a bastion of South Africa’s strong institutional framework. Meanwhile, financial repression would allow the government to water down austerity, which could raise bond market investors’ concerns. Given South Africa’s low domestic savings rate, if foreign investors lost confidence and moved their money elsewhere, there could be a sizeable rise in the country’s risk premium. (For more on the market implications of financial repression, see our Global Markets Update.)
- What’s more, the resulting faster rise in money supply and credit growth would push up inflation. A wage-price spiral is not beyond reason either as inflation expectations are not well anchored and the labour market is relatively restrictive in South Africa. All of this would point to higher inflation and sharper falls in the currency than most currently expect.
Virág Fórizs, Africa Economist, firstname.lastname@example.org