Macro economic commentary – February 2019

Author: Ntsekhe Moiloa

In 1974 a share of the Nobel Memorial Prize in Economic Sciences was awarded for the idea that a change in one place has a ripple effect on successively neighbouring places or institutions. The principle is formally known as circular cumulative causation, and at first glance it looks so terribly basic that one wonders how it attracted the attention of the Committee. The economist was Gunnar Myrdal who stated that all aspects of a community feed into its production result; therefore, an alteration to one aspect affects demand, employment and income in other areas via a multiplier effect. This idea was in focus in February as the South African finance minister, Tito Mboweni, delivered his Budget speech.

The main talking point after the speech was the support pledged for the national power utility, Eskom. South Africans hope for a return to an era of power abundance while investors hope that they are not being sold a chimera. In the speech, mention was made of financial support of ZAR 23 billion a year over 3 years; however, the Budget document mentioned a period of ten years for a total support package of ZAR 150 billion, on a net-present value basis. The question on many lips was understandably how the South African Treasury with its empty coffers could afford this. Cue the chimera.

State-owned enterprises remain a thorn in the side of South Africa’s prospects for increased production, employment and income. Myrdal’s thinking is well illustrated in South Africa, whether one contemplates Eskom, Transnet, or many of the hundreds of other state-owned companies that to one extent or another are not self-sustaining. When economists and investors previously looked at South African debt, contingent debt was not considered practically relevant especially as it decreased. In the 2007/08 financial year, contingent liabilities decreased by ZAR 8.4 billion to ZAR 177.1 billion. Guarantees alone totaled ZAR 64.5 billion across the whole of government with ZAR 50.5 billion accrued in provisions. Today, there are no provisions to speak of and the sum of guarantees to public institutions come to ZAR 483.1 billion. Today it would be highly imprudent to think of the state’s debt burden without directly adding the contingent liabilities to the known debt pile. Based on the government’s numbers – which include a fairly optimistic prediction of GDP growth of 2.7 percent per annum over the coming decade – the country’s public debt pile will peak just above 60 percent and then more or less stabilize. For at least the past decade similar predictions have consistently been shown to be over-optimistic. In other words, there is a credibility problem at hand.

The government’s credibility deficit appears to have eroded the confidence of some of the country’s highest-earning individuals if one looks at the official statistics of the changes in the number of South Africans living abroad. Over the past three years it is estimated that about 90,000 adults have left South Africa, with the one bright spot being that the totals have decreased in each of the past three years. However, many consider the numbers to be an under-estimate because they usually count only those who have registered in a foreign country using a South African passport. There are many others who might be missed in the count because, for example, they have multiple nationalities and have arrived overseas using a non-South African nationality. Considering the cost of making a move abroad, it is typically higher-income earners who are in a position to make this election, and the loss of such people has negative multiplier effects on income, employment and demand spheres.

Demand continues to lack verve. After dropping 7.4 percent year-on-year in January, vehicle sales were down 6.5 percent year-on-year in February. Domestic inflation surprised to the downside, registering a year-on-year increase of 4.0 percent compared to a consensus view of 4.3 percent. Investors with perhaps short memories have already started to wonder whether the recent tendency of inflation to print somewhere near the mid-point of the SARB’s inflation band warrants consideration of a single-point inflation target. According to an advisor to the SARB governor, there is no inclination to abandon the target range in favour of a single-point target such as 4.5 percent. The central bank will continue to guide policy around the achievement of a 4.5 percent inflation rate, but that is not to be confused with implying a firm response if the result is anything other than 4.5 percent.

Aside from administered price inflation, inflation pressure is largely absent in South Africa. This is also true for several key markets around the world including the United States where year-on-year inflation has trended lower from about 2.3 percent to around 2 percent. The data are not very supportive of a rate hiking bias even if the US Federal Reserve would like to create more interest rate headroom for troubled times in the future. In theory the US Federal Reserve should not worry that it has insufficient headroom. The San Francisco branch recently published a note on negative interest rates which helpfully reminds us why negative rates are possible. After all it seems counter-intuitive that people would willingly pay to put money on deposit, which explains at least in part why standard economic theory suggests that the lower bound on interest rates is zero. In practice, we have observed negative interest rates in a number of countries such as Switzerland. Interest rates can be negative without a discernable problem for a number of reasons, some of which the San Francisco Fed highlights. One is that while depositors or investors may avoid costs by holding physical cash, it is impractical and exposes people with large sums to risks such as fire or being robbed. Another reason is that investors such as pension funds are required to hold most of their assets in accounts of one sort or another.

Thus, after peaking slightly north of 3 percent in the recent past, US 10-year government yields have now held around 2.7 percent despite what seems likely a less pessimistic tone in equity markets.

The less pessimistic tone is everywhere, including in the United Kingdom. At this writing, Brexit is a month away and no transition deal has been agreed. It is a situation that has consequences not only for trade but for cooperation arrangements in general. An example illustrates both this and Myrdal’s circular cumulative causation: in September last year, Apple Inc. announced an electrocardiogram (ECG/EKG) feature for the Apple Watch series 4. It is a feature that has already been approved by the Food and Drug Administration in the United States. It may only reach other parts of the world much later, depending on the approval of regulatory agencies in other jurisdictions. It emerges that even for an advanced country like the United Kingdom, the new Apple Watch feature could be delayed by years, not months. It turns out that by its own rules the UK’s Medical and Healthcare Products Regulatory Agency requires applicants to have pre-notified it of studies before commencing them. That could make it difficult for Apple to rely on its US data in its UK application. Fortunately for Apple, the UK remains a part of the EU for the time being and the company had the option of applying to an EU supranational agency to grant approval, but with Brexit a month away and without a transition deal in place, fragmentation in political arrangements is showing up as a medium-term risk to general cooperation arrangements. When Liam Fox, the British Secretary for International Trade, wrote that the US-UK “special” relationship had a once-in-a-generation opportunity to deepen as a result of Brexit, it seems that he misread the mood in Donald Trump’s administration. As in negotiations with the European Union and with Japan, the administration’s published negotiating aims were undeniably “America First”. In their opening salvo the Americans paid no homage to any “special” relationship with the UK at all. To be fair, American interests have been the lodestone of US trade negotiators for decades, over and above global interests. The difference with the Trump administration is a desire to achieve those American interests in a bilateral fashion rather than a multilateral fashion. Good luck to Mr. Fox.