Macro Economic Commentary – November 2019

Author: Ntsekhe Moiloa

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The overcast forecast for global growth seems to have given way to an improved outlook in the past few weeks, aiding gains in key equity markets around the world. Nevertheless, cloud cover has remained over South Africa where retail sales, auto sales and building plans completed all continued to reflect less than robust consumer finances. The press speculated on the prospects of a rating cut from Moody’s, then shifted attention to S&P once Moody’s was out of the way. From both agencies the verdict was downbeat, yet not unexpected. Moody’s moved to negative watch, while S&P also moved to negative. There are few investors around the world who would be surprised to learn that South Africa has been in an extended political and economic storm that has affected its growth outcomes. In response the country hosted an investment summit early in November, highlighting its recovery plans in the process. Well, a famous pugilist once remarked, “Everyone’s got a plan until they get punched in the mouth.” Mike Tyson did not have countries in mind when he said that, but the sentiment is just as applicable to a country; it remains to be seen whether South Africa can execute when the storm intensifies. But why should anyone think that the storm could intensify?

The national power utility managed to find itself the hot topic of conversation once again when a new group chief executive officer was announced. The announcement was supposed to herald a new dawn of reform and recovery, but it quickly descended into accusations of political meddling to surface a winner who was not on the speculated shortlist, nor particularly knowledgeable about power utilities to hit the ground running. Eskom’s viability and restructuring plans currently dominate all discussions of the prospects for South Africa, underlining the utility’s importance to the country’s single biggest issue – moving to a higher growth trajectory. Resolving the twin deficits, resolving the national debt burden, alleviating the crushing unemployment situation, keeping taxes bearable and more, all rely on an economy growing faster than it is at present.

The Inequality Report published by Statistics South Africa was a stark reminder of the length of road the country still has to travel to make South Africa a better place for all. Apart from one population group whose expenditure share is approximately in line with its population share, there is still a small population group whose expenditure share is significantly larger than its population share. The largest population group spends – and can only afford to spend – a much smaller share than its share of the population. Statistics South Africa reports that intragroup inequality did not get worse for any of the population groups except black South Africans. In practice that means that a segment of black South Africans likely become wealthier while the rest remained stagnant or regressed financially. Such poor wealth results for the largest population group bring into question the approach of the State in promoting wealth disparities, and could once again raise the spectre of heightened discontent in society. The least troublesome solution for all population groups is for the economy to experience faster growth and to attempt some form of redistribution from the extra gains.

We have witnessed around the world what disproportionate distribution of income and wealth can do to social harmony. The Brexit referendum results in the United Kingdom is often attributed to factors that include a sense that the native-born population has been left behind economically. The vote to “take back the country” has placed meaningful sections of the British economy under strain, including the property market. While Britons are not yet brandishing pitchforks against each other, an almighty tussle for influence is raging through society about the terms under which Great Britain exits the European Union, the end of which it is hoped will result in a restoration of economic opportunity for the native-born. The trouble is that in Britain as in the United States as in South Africa, it is the political class that has been left alone to bring relief to the discontented. And in all these instances it appears to voters as if the political class is only invested in blowing the solution slightly further out of reach.

For instance, a few months ago a case came before the UK Supreme Court that was about the limits of the power of the government to advise the Sovereign to prorogue parliament. In its unanimous finding, the Supreme Court said that accountable government requires that parliament should not be prevented from exercising oversight by a decision of government to exercise its prerogative power, if there is no reasonable basis. According to the Court, no justification for so extreme an act as to remove Parliament from the decision-making mechanisms of a significant constitutional change, was put before it. The plan to suspend parliamentary business for 5 weeks could not be justified by the instance of the Queen’s Speech, which normally requires about a week of preparation. And thus, rather than adding hours for parliament to work out a Brexit solution, the government of Boris Johnson tried to take away time instead.

Despite the ham-handed political moves, to Britain’s incidental advantage has been additional anxiety in the barely audible yet persistent dilemma facing the Eurozone central banking fraternity. As the rising tide of European economic growth begins to ebb, it is leaving a shoreline of debris that is the consequence of negative interest policy. European growth has not been strong enough for long enough to give the ECB confidence that the Eurozone economy could bear higher interest rates. While zero to negative rates look like a boon for retail borrowers, they have come at the cost of bank profitability. In Germany, retail banks are tiring of the cost and while large depositors have had the cost passed onto them, it has thus far been taboo to make small savers bear the costs. Now German retail bankers are seriously considering lifting the exemption on smaller savings pots, or at least on new small savings products. For a country of people with a propensity to save when they can, there is a political fear that negative rates on small savers would ramp up their critical eye on the ECB and the European peace project in general.

Of interest to central bankers in European countries is the concept of the “reversal interest rate”. As the name alludes, this is the rate at which monetary policy begins to have the opposite outcomes to what was intended. Thus, where the ECB is attempting to be accommodative, it is of interest to understand what rate instead leads to a contraction in lending. There has been a debate in ECB monetary policy circles about whether Mario Draghi’s preferred lever of rates is the right one, or whether asset purchases have fewer negative externalities for the monetary transmission mechanism. Nearly a year ago Markus Brunnermeier and Yann Koby authored an NBER paper on the monetary policy reversal rate. The topic was not new – having been explored by the BIS in 2016 – however, Brunnermeier and Koby extended the thinking to incorporate banking frictions and impacts on the monetary transmission mechanism.

Brunnermeier and Koby note that the reversal rate “occurs when banks’ asset revaluation from duration mismatch is more than offset by decreases in net interest income on new business, lowering banks’ net worth and tightening their capital constraints”. Interestingly, there is not a universal reversal rate. For any economic area, Brunnermeier and Koby find that the intensity of capital constraints, the capitalisation requirements, the level of fixed-income holdings in the capital structure (because these provide coupon flow), and how much pass-through of negative rates is allowed, come together to determine the reversal rate. From the foregoing, it is evident that the greater the extent of pass-through, the less punitive for lending is a negative rate. The authors conclude that lower-for-longer is probably the worst outcome for the transmission mechanism. As we know, this has been the situation in the Eurozone for the past several years. While a renewed crisis in European banking is to no one’s benefit, it appears to weaken the strength of European financial authorities in their efforts to migrate more European flows from London to the continent. And while South Africa could benefit from a reinvigorated search for yield, one can expect that the country’s fiscal and public debt woes will temper the enthusiasm of investors.