Macro economic commentary – October 2018

Author: Ntsekhe Moiloa

For a sixth time within 5 years South Africa has a new finance minister. Tito Mboweni stepped into the position in October with barely 2 weeks to go to the presentation of the mini-Budget and faced the unenviable task of selling a framework of revenue and spending that he had hardly had a hand in formulating. A budget framework delivered by a minister who knew relatively little about it would normally present a credibility problem, but Mboweni came into the position with gravitas. Not only was he the eleventh biggest vote-getter among the 80 members of the ANC’s national executive committee at the December 2017 elective conference, but his outspokenness gave some the sense that he would not be timid in making hard fiscal choices. It also helped that this was not his first outing as a Cabinet minister; during his two full terms as governor of the South African Reserve Bank he appeared to be a forceful defender of the SARB’s independence and the unapologetic face of inflation-targeting in South Africa.

Nonetheless, the new finance minister found himself announcing over ZAR 9 billion worth of additional funding for the two state-owned airlines and the rapidly decaying Post Office. Professional investors have been quite critical of these infusions, yet the government has argued that it would be costlier to wind down the national airline. Amidst the grumbling about continual support for failing SOEs, the rest of the mini-Budget was considered reasonable despite the main budget deficit being expected to rise above 4 percent for each fiscal year in the medium-term horizon. This rise is partly on the back of some conservative assumptions about tax collections. Although growth projections remain comfortably above 1 percent for the year, the National Treasury has revised down its expectations of inflows from taxes, especially value-added tax. Until some of the institutional problems in the tax collection agency are resolved, it seems that a lower tax buoyancy assumption was considered prudent, dropping to 0.91 compared to 1.00 last October and 1.26 in the year before that. The net result is to shave about 2 percent off expected tax revenues.

To fund the larger gross borrowing requirement, we expect the National Treasury to increase issuance in each of the forecast years. The South African government has some loans that come due in the 2019/20 fiscal year for which it is already accumulating cash. We also expect that National Treasury to step up switch auctions to free up funding stress in the shorter term. National Treasury has indicated that it is more likely to issue into the 5-year part of the curve, giving some respite to longer-dated bonds.

Although National Treasury is able to use tools such as switch auctions to manage the sovereign debt profile, the department still has to contend with the reality that the debt burden as a percentage of GDP has not yet stabilized. When S&P Global Ratings downgraded South Africa’s sovereign debt to junk status last year, one of the issues mentioned in remarks was that for years the South African State had promised to stabilize debt and yet with each subsequent budget presentation the year in which the debt would stabilize kept getting pushed out. A credibility gap thus began to build up. This year’s mini-Budget anticipates a higher gross debt-to-GDP relative to the February 2018 main Budget, but it still predicts that the burden will stabilize just below 60 percent in 2023/24 compared to the previous expectation of a peak at 56.2 percent in 2022/23.

While South Africa faces a soft limit imposed by investors who do not wish to see its debt-to-GDP growing beyond 60 percent, the United States does not yet face market-driven debt capacity constraints. The US government’s overall debt pile of USD 21 trillion is now actually greater than the economy’s USD 20 trillion annual production, yet there has been no obvious sign that credit-rating agencies or investors are worried that the United States no longer deserves its top-shelf rating. As to why, one part of the answer probably has to do with the importance of the US dollar as the main global currency, and another part probably has to do with the post-Bretton Woods policy landscape that the United States has travelled along.

In the wake of the abandonment of the gold standard in 1971, a debate arose between supporters of liberal, democratic free market capitalism and those of a more Keynesian persuasion. Arguably the most pronounced difference between the two sides is how each camp views price. Free market capitalists consider price to signal the equilibrium where sellers and buyers are willing to transact. In the view of free marketeers, without the friction of government or regulation the market should respond rapidly to changes in supply, demand, or both. Keynesians, on the other hand, are of the persuasion that prices do not move as quickly as free marketeers think and therefore are less reliable indicators of equilibrium. One might think that the debate is merely an academic matter but that 1970s debate had profound consequences for how the world would develop in the decades thereafter.

The essential question of the price debate was: does unfettered capitalism select for success? If one could convince policymakers that it does, then by the axiom of the almost forgotten Herbert Spencer free market liberals would have the upper hand in public policy debates for decades and perhaps generations to come. A polymath, Spencer coined the term “survival of the fittest” and his free market heirs also knowingly or unknowingly assumed his Lamarckism which is the idea that characteristics in one generation may be inherited by subsequent generations.

The recent confirmation battle to seat Judge Brett Kavanaugh on the US Supreme Court echoed the 1970s battle for long-term influence in a sphere important to the shape of public policy. While political liberals feared that seating Kavanaugh would upend what they considered settled law in abortion rights, it seems to us that actually the greatest victory for conservatives is the chance to protect free market liberalism against a potential impulse for social democracy in the United States. Thus, as American electioneering reached fever pitch at the end of October ahead of the early November midterm elections, Bernie Sanders as a possible President in the next few years would have a more difficult path through the Supreme Court in re-establishing Keynesian, social democratic-style policy as a lodestone for American life. More leftist impulses such as those of Sanders’ friend, Yanis Varoufakis, or of Sanders’ political protégé Alexandria Ocasio-Cortez, would face an even steeper path to power.

Beyond the entrenchment of an economic status quo, the November plebiscite is a referendum on whether Americans have a short or long-term view on the health of their economy. President Trump certainly hopes for them to have a short-term view because he cannot stop agonizing or enthusing about the stock market. However, it is worthwhile noticing that the December 2017 tax cuts that have aided enthusiasm in capital markets came at the expense of a wider fiscal deficit that may or may not pay for itself over ten years. Not only has the tax cut come towards the end of a long economic upswing but Trump has dangled the notion of pushing for a further cut. For investors paying attention it may be time to start asking whether the US economy is still breathing on account of defibrillation.

In the November election American voters face choosing between individualism and collectivism. A key question is whether Americans are more interested in the current health of their pocketbooks or whether they worry that the current fiscal path will visit pain on future generations. A closer look reveals that the US government has been subsidizing more and more parts of the economy to support what we have eventually seen in stock markets. Consider Trump’s trade conflicts: for instance, USD 12 billion was made available in emergency relief to farmers whose produce was no longer welcome in key markets such as China. Such bailouts have been funded in the capital markets, including by foreign investors whom President Trump has labelled foes.