Reserve Bank governor Lesetja Kganyago has urged emerging markets, including SA, to consolidate their fiscal positions in coming years — a stance he says will indirectly help to reduce exchange rate pass-through pressure on inflation and its wide-ranging economic costs.
Speaking at the 103rd AGM of Bank shareholders on Friday, Kganyago — who has made eyebrow-raising comments about the state of the country’s fiscus and its impact on borrowing costs, the volatile rand and elevated inflation — said “persistent fiscal dissaving” is a constraint to growth from a macroeconomic perspective.
He said SA’s low-investment problem is worsened by the composition of public spending, which is geared more towards current consumption than infrastructure. “One of the main challenges to achieving higher growth is weak investment levels. SA investment lingers close to 16% of GDP compared with the 25% level achieved by comparative peers. High public debt levels raise the risk premium, pushing up the cost of borrowing to round 11% today.”
He said the reversal of the SA economy’s terms of trade also risks worsening the fiscal outlook. Electricity shortages, infrastructure challenges, high public debt levels and weak investment continue to weigh on growth in the medium term in the country.
This is not the first time Kganyago has spoken about fiscal policy, indicating his frustrations with its management.
He kept the door wide open for interest rate hikes in coming months even as the Bank’s monetary policy committee left borrowing costs unchanged at 8.25%, their highest level in more than a decade after a prolonged tightening cycle that began towards the end of 2021.
Delivering the committee statement two weeks ago, Kganyago cited lower tax revenue, higher employee compensation and the persistent financing needs of state-owned enterprises as other risks likely to keep the cost of borrowing elevated for longer.
Speaking at the 2023 Michel Camdessus central banking annual lecture at the IMF in Washington earlier in July, Kganyago warned that while capital flows are good for emerging markets such as SA as they support investment and reduce financing costs, their misuse has permitted the build-up of large sovereign debt positions. He referred to the situation as “particularly problematic” because it often leads to fiscal slippage.
The misuse of capital flows can increase government debt and erode potential growth.
Kganyago said sovereign debt is particularly problematic because declining government creditworthiness also spills into the credit profiles of firms and households.
Fiscal drag
“With time, debt leads to higher taxes and lower public sector investment to accommodate higher interest payments. An unsustainable fiscal position can therefore become a drag on the whole economy.”
At Friday’s AGM, Kganyago warned that with the adjustment of global financial conditions and the widening of risk-adjusted real interest rate differentials, portfolio flows will become less certain and will affect the availability and the cost of external funding. “These rising credit costs will further impair the financing of large fiscal and current account deficits in many emerging market and developing economies, including SA.”
SA’s underwhelming economic performance is not new, and the chronic low-growth problem predates the pandemic.
In the five-year period before the emergence of Covid-19, growth averaged just 1% compared with the 3.5% growth achieved by a typical emerging market economy.
Between January 2020 and March 2022, the prices for SA’s main commodities — such as gold, iron ore, platinum group metals and coal — doubled.
But prices have consistently fallen since then, dropping 23.8% in six months. SA now finds itself with growing funding needs and weak domestic savings while the need for foreign savings has widened.
As a result, the Bank now expects the current account deficit to expand from 0.5% in 2022 to 3.3% by 2025.
The Bank has in the past year highlighted the financial stability risks associated with continuing electricity supply shortages, an upward repricing in government debt, SA’s greylisting by the Financial Action Task Force and the impact of escalating geopolitical tension, notably the war between Russia and Ukraine.
The Bank has raised the repo rate by a cumulative 475 basis points since November 2021, bringing the nominal repo rate into restrictive territory at 8.25%.
Kganyago said that many economies have experienced sustained increases in public debt levels, which, with higher inflation, create serious headwinds to economic growth.
“As exchange rates depreciate in response to the more adverse credit conditions, imported inflation tends to rise — a trend already seen in producer prices, fuel costs and food prices.
“Emerging markets will need to consolidate their fiscal positions in the coming years, helping indirectly to reduce exchange rate pass-through pressures and inflation and its wide-ranging economic costs.”
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