James Carville, former adviser to US president Bill Clinton, once said that were he to be reincarnated, he would choose to return as the bond market; he could then intimidate anyone. This is an overstatement of reality, but it highlights the extent to which we live in a highly competitive world and that countries need to make tough choices.
SA has now had time to digest the real and potential economic implications of the recent cabinet reshuffle — in which Pravin Gordhan was replaced by Malusi Gigaba as finance minister — and the subsequent credit rating downgrades to junk status by S&P Global Ratings and Fitch. These have been key political decisions with economic consequences.
As these political developments were not entirely unexpected and had been partially priced in by the markets, optimists rejoiced that, although these political developments were unwelcome, the market and currency reactions were relatively muted. And many were pleased that the economy, although jolted by the events, displayed its inherent resilience and ability to adjust to further shocks.
However, as realists we must not underestimate the seriousness of the wake-up call given to SA by the advent of junk status and the significance of the economic signals being sent. The currency, investment, inflation, growth, interest rates and employment are all at risk in the new situation and we have entered a large, new, uncertain terrain. The bond market arguments may sound arcane and technical, but they will have real economic effects, especially for the general public.
A threshold has been crossed that could have wide economic implications and might take years to reverse. The economy is becoming a casualty of political infighting, but there will be an asymmetrical effect.
Although these decisions are commonly seen as headline events, under the surface their consequences are gradually being absorbed into an economic process, that, unless remedial action intervenes, will unfold negatively over time. The margin for error has shrunk. Yet the piecemeal process nonetheless also creates opportunities to deflect the situation into more positive outcomes, if we act sensibly and we do so timeously.
Time is of the essence if certain economic costs and negative perceptions are not to metastasise through the economy. The challenge is to build on existing institutional strengths, create a new, acceptable sense of direction and urgently tackle the weaknesses that have brought SA to junk status.
In the meantime, the pace of the economic process after the cabinet reshuffle and recent junk status decisions will be shaped by several main drivers. The most imminent is whether Moody’s will join S&P and Fitch soon in a further investment downgrade of SA. It is the combination of Moody’s and S&P, rather than Fitch, that will eventually make junk status truly effective for SA in global bond markets.
If that happens, it will initially mainly affect the cost of borrowing for the public and private sectors. It will ultimately have a negative effect on SA’s ability to augment its low level of domestic savings with relatively cheap overseas capital to finance its development. Like many emerging economies, this country needs to see a higher investor commitment, rather than a lower one, to fund its socioeconomic development.
Another driving factor will be the outlook for fiscal policy and probity as the new political team takes over at a Treasury with a hitherto high reputation for professionalism and integrity. Regarding "state capture", the focus will obviously be on decisions taken around procurement, nuclear power, state-owned enterprises and banking licences. The challenge will be whether Gordhan’s antipatronage approach will be upheld or abandoned.
On the broader fiscal front, Gigaba has promised to maintain fiscal discipline but has also vaguely spoken of "fiscal reprioritisation". Acrimony and controversy have already developed around the minister’s choice of outside advisers. The litmus test for how fiscal management is unfolding under a different Treasury regime will be the next medium-term budget policy statement in October. The public debt to GDP ratio will become a regular dipstick for analysts and markets.
The financing of state-owned enterprises such as Eskom remains a high-risk area for fiscal stability and governance uncertainties persist at state-owned entities. And by October, we should also have a better idea of what stance the Treasury will have taken on pending wage negotiations in the public sector. With the public sector wage bill already seen as too high by his predecessor, Gigaba will need to manage it to secure a better balance between the state’s consumption and investment spending.
The planning cycle for the 2018-19 budget begins in mid-2017 and assumptions will need to begin to be made about the economic outlook for 2018. With the concerns about public debt levels in relation to GDP, the emphasis should be on three things: economic growth prospects, the current burden of taxation and the net effect of junk status on borrowing costs. It would be wise for the Treasury to consult widely on how the economic outlook may change and, in particular, the fiscal implications of a possibly much lower economic growth rate in 2017, perhaps even a recession. Downside risks for the economy predominate at present.
The next determinant of outcomes will be confidence and credibility around policy. The changing of the guard at the Treasury, the narratives of the credit ratings agencies and the rhetoric around "radical economic transformation" have converged to heighten policy uncertainty. "I cannot recall," says one business leader, "when the gap between the kind of words politicians use and what is happening in SA is as great as it is now." The trust and confidence recently built up by Gordhan through his Team SA with business and labour have been badly damaged by recent developments and need to be repaired urgently.
This may be embarrassing given the extent to which mainstream business has publicly deplored the decision by which Gigaba was appointed. But it is difficult to see how the aftermath of junk status can be handled successfully without continued collaboration, especially with business. The terms of engagement between the government and business will need to be reconfigured. Winning investor confidence means Gigaba must offer a constructive path, not a destructive one, for the way ahead. "Improving business confidence," says prominent US economist Larry Summers, "is the cheapest form of economic stimulus."
One of the major lessons emerging from SA’s recent experience confirms what professors Daron Acemoglu and James Robinson say in their classic study Why Nations Fail. It is that promoting shared prosperity is not just a question of "good" economics, it also requires "good" politics. The policy makers and politicians who are supposed to act on well-intentioned advice may be part of the problem, and many attempts to rectify the situation backfire because checks and balances have been compromised. While economic institutions are critical for determining how prosperous a country might become, say Acemoglu and Robinson, politics and political institutions determine what economic institutions exist.
Another important feature of the past few years in SA seems to be that even good institutions may work badly if wrong methods of procedure are followed or if there is insufficient pressure for accountability or if implementation fails. Good institutions erode under the weight of corruption, racism, careerism and patronage. There needs to be widespread acceptance in SA that development without efficiency constraints cannot long endure, as such institutions and structures are inherently brittle. The strength of the National Development Plan is that it adopts a holistic framework about what needs to be done to get both the economics and the politics "right". We need to rediscover that message quickly.
Even though 2017 is a year of political contestation and turbulence in SA, that does not mean it inevitably needs to inflict maximum collateral damage on the economy. It also does not necessarily need to be entirely at the expense of the confidence of capital markets, which is required for a growing economy. This can be achieved if SA can still demonstrate the necessary leadership that strengthens its credibility, makes progress with implementing promised economic reforms, promotes good governance and pursues policies that are clear, coherent and growth-oriented.
It is a tall order for policy makers in current circumstances, but it is what SA needs most if the economy is to regain its investment credentials sooner rather than later.
• Parsons is a professor at the North-West University School of Business and Governance
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