Monetary policy-makers and economists who met in Cape Town last week spent a lot of time talking about fiscal policy. It was a reflection of the extent to which this has become an issue for central bankers in advanced economies and emerging markets in the post-Covid period.
And SA’s own growing budgetary and borrowing woes raise questions all of their own — which no doubt is why the Reserve Bank devoted a special session to SA at the conference that it hosts every second year.
For years when Reserve Bank governor Lesetja Kganyago was asked for his views on SA’s national budget his habitually tart response was “We don’t comment on fiscal policy and they (government) don’t comment on monetary policy”, or words to that effect.
Kganyago, a former Treasury director-general, might have been particularly cautious about treading on toes at his old department. But he was hardly alone among central bankers in his approach.
These days the budget is very much there in the Bank’s monetary policy committee statements even if the language is delicate. “Achieving a prudent public debt level ... would strengthen monetary policy’s effectiveness ….” is one from the latest statement, which repeats warnings that SA’s fiscal malaise is likely to keep long-term borrowing costs high across the economy.
Globally, two things have changed since the Covid pandemic to bring fiscal policy on to central bankers’ radar screens in a way that it wasn’t before. First, public debt levels rose dramatically during the pandemic as governments upped spending while revenues fell, and they have mostly stayed high.
Second, the long decade of low inflation and ultra-low interest rates that followed the global financial crisis came to an abrupt end in the wake of the pandemic. And that in turn has made financing those high debt burdens more costly.
The two related dynamics have affected inflation, interest rates and financing conditions across rich and poorer countries. But the way they’ve played out is quite different.
In advanced economies such as the US, UK and Europe the immense quantities of fiscal stimulus governments injected into the economy to cushion households and firms from Covid directly fed into higher prices. They boosted demand at a time when supply chains were disrupted, first by the pandemic and later by Russia’s invasion of Ukraine.
And they kept boosting it, even as economies reopened and inflation started climbing sharply. Advanced economy central banks were slow to respond and then had to hike interest rates steeply. Now the debate is whether interest rates will have to go higher or simply stay high for longer to combat inflation, which is not yet back at advanced central bankers’ 2% targets.
By contrast, in emerging markets enormous quantities of fiscal stimulus were simply not an option because they didn’t have the space — so their inflation was not as directly fuelled by fiscal dynamics. But emerging markets instead have seen their own inflation rates driven up as a result of the fallout of global dynamics.
They felt the supply shocks, first from Covid and later particularly from the Russia-Ukraine war. But also, crucially, they felt the impact of higher inflation and interest rates in advanced economies through their exchange rates and borrowing costs.
Borrowing costs have soared and financial conditions have tightened globally in an environment of high interest rates in the US and other advanced economies, which has pulled capital back into those markets and strengthened the dollar in particular.
Emerging markets have been hit particularly hard by that tightening of financial conditions. It’s made it more costly, and more difficult, to finance their large debt burdens. And it’s seen depreciation in their exchange rates.
Speaking at the conference, IMF deputy MD Gita Gopinath detailed a “daunting external landscape for emerging markets”, starting with tougher global financial conditions. Not only are global interest rates expected to remain high for quite some time, they may never return to the era of “low for long”.
The effect on emerging markets has been clear. In the 18 months since the US started its aggressive interest rate hiking cycle average long term yields for emerging market dollar bonds have increased by about 200 basis points, sovereign bond issuance in foreign currency has dropped by half, and portfolio flows to emerging markets have decreased sharply.
What’s more, interest payments on public debt owed by emerging markets are set to rise from 11% of revenue to about 14%, the IMF estimates, reflecting the far higher cost they are paying to borrow, as well as their higher debt burdens.
Slot SA into that environment and it doesn’t look good. It went into the pandemic heavily indebted and came out even more so. The commodities boom and resulting huge revenue overruns, plus a revision to the GDP data, helped make government’s deficit and debt ratios look better than originally expected during 2021 and 2022.
But the revenue overruns are set to turn into a large revenue shortfall in the current fiscal year. Add higher spending on wages and state-owned enterprises, and a weak growth outlook, and the fiscal outlook the finance minister presents in October is going to look a lot worse than the one he showed in February.
The IMF and the markets do not expect the public debt to stabilise in 2025 as Treasury projected: they don’t see it stabilising at all. SA risks a debt spiral, with debt servicing costs that could consume more than a quarter of the tax government collects within five years.
It’s more on the side of what one conference speaker called the fiscally profligate than the fiscally prudent. Its deep domestic financial markets and strong central bank prevent it getting into debt distress. But the rising fiscal risk has fed into a sharply higher “country risk premium” that investors attach to SA, fearing default or runaway inflation in 10 or 20 years.
That feeds into monetary policy through rand depreciation, which feeds into inflation; it also directly feeds into the “neutral rate of interest”, so monetary policy has to be tighter than it would otherwise have been because fiscal policy is so loose.
All of which is why it is urgent for government to rein in spending and try to get the public debt back on track to stabilise, sooner rather than later. But the debt problem is not just a spending problem: it is even more profoundly a reflection of SA’s chronically low growth, and the lack of any real underlying consensus on how to get growth going in a meaningful way.
While Gopinath and Treasury budget office head Edgar Sishi zeroed in on the need to curb spending to stabilise the debt, both also emphasised the growth side of the fiscal equation. Without sustained higher growth, fiscal consolidation may prove impossible for SA.
And while monetary policy-makers in SA, as elsewhere, may point to fiscal profligacy as one of the reasons for higher interest rates, they too need to look carefully at the growth side of the equation — and make sure, in a highly uncertain environment, that they do not overtighten monetary policy.
• Joffe is editor-at-large.
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