The Global Financial Crisis and Emerging Economies: Role Model South Africa
“The continual demand and the extraordinary consumption made the price of commodities become exorbitant. The value of house prices rose by a third, as no limit was placed on expenditure and only pleasure, luxury and comfort were studied, without any thought that days of trial might succeed to these days of prosperity.
Everyone spent with both hands, and every facility was given to people to obtain what their frivolous needs demanded. Unlimited credit was the order of the day, and everyone could obtain large sums quite out of proportion to their standing or to their income …
The abundant source of the fortunes ran dry the moment more economical rulers came to the head of affairs; credit suddenly ceased, and poverty became more evident from day to day.
The methods which were introduced and the careful expenditure prevented money, which had always kept the wheels going, from circulating as rapidly as before, and people were pulled up in their headlong career of apparent happiness and pleasure.”
Were it not for the archaic turn of phrase, the above quote could have been pulled from a newspaper anywhere in the world just yesterday. Many of those reading this article will now be assuming that if it’s old, it must have been clipped from an American newspaper circa the early 1930s when the Great Depression was starting to bite.
In fact, it is an extract from a pamphlet written more than 200 years ago in Cape Town by a maverick Dutch bureaucrat, Baron Andries van Pallandt, who had a secretarial post in the Batavian administration that ruled the then Cape colony from 1803 to 1806.
So the southern tip of Africa has survived the collapse of commodities markets, the bursting of asset bubbles, and the credit crunch that inevitably follows such events before, and it will surely survive the current one too.
South Africa - insulated from world financial markets?
Until quite recently, it appeared that South Africa would not just survive but emerge relatively unscathed, being insulated from the worst of the financial contagion by the vestiges of the exchange controls that were introduced during the apartheid era to prevent capital flight. Foreign investors are no longer restricted in their ability to repatriate funds, but the government was nevertheless criticised at home for adopting a gradualist approach to easing restrictions on domestic institutions and individuals.
South African banks were consequently prevented by exchange controls from dabbling with the more perverse derivative instruments available internationally, and this combined with the fact that they are more tightly regulated and conservatively capitalised than their peers in much of the rest of the world, ensured that none was exposed to any material extent when the house of credit cards started to collapse. The average South African bank’s capital adequacy ratio (the ratio of capital to risk-weighted assets) is well above 12%, significantly higher than the 10% hurdle European banks are expected to clear.
So far, this combination of good fortune and prudence has stood South African banks in good stead - while interbank interest rates have risen slightly, they have continued to lend to each other as normal and there has been no indication that the catastrophic loss of confidence that resulted in the panicked withdrawal of funds from banks in the US and Europe will take hold here.
Rising interest rates
Inflationary pressures caused by the commodities boom had already caused South African interest rates to rise, reducing demand for credit a while before the global crisis hit, and tighter bank lending requirements imposed after the implementation of the National Credit Act in early 2007 had helped curb reckless lending practices and reduced the number of borrowers who were over-stretched. In addition to placing the onus on banks to ensure that customers can afford to repay loans, the new law introduced the concept of early debt counselling to avoid defaults and minimize home repossessions by changing spending behaviour and renegotiating repayment terms. Consequently, while the banks’ default rates have worsened in recent months, this has not been to an alarming extent.
South African Reserve Bank (SARB)’s Financial Stability Review for September, released in October 2008, revealed that household debt levels are actually dropping, with the ratio of household debt to disposable income having reached 78.2% in the first quarter of the year before declining to 76.7% in the second quarter. However, debt servicing costs increased over that period due to rate hikes - interest costs as a ratio of disposable income rose to 11.6% from 11.3% - and debt levels will have to drop a lot further before the banks can be said to have dodged the default bullet.
Like most consumers around the world, South Africans were already under pressure from rising food and fuel prices before the crunch hit, and this was compounded by higher interest rates. Yet while the residential property market has come off the boil, negative equity is the exception rather than the rule and there is none of the widespread mortgage defaults that have plagued the US and exacerbated the plight of its financial institutions.
Secondary effects of the crisis
The biggest threat to the South African economy is therefore not the credit crisis itself, but its secondary effects. As a resource-based and open economy, the country depends on revenues from commodity exports to fund the imports of capital goods and equipment that keep industry ticking over. With the dollar prices of precious metals and primary export products such as coal plunging along with demand from developed countries, the country’s potential to drive economic growth by aggressively expanding exports will be restricted going forward.
Similarly, exports of manufactured products such as motor vehicles, which have allowed large multinational companies to expand their production in South Africa and helped compensate for reduced domestic demand, appear set to drop sharply. About half of South Africa’s exports are to the US and the euro zone, and the rest to places like China, where demand has not been hit as hard. Based on this, the International Monetary Fund estimates that growth in the country’s export volumes will drop to about 4% next year from 9% in 2007. The expected continued buoyancy of other emerging markets could help avoid one of the most worrying consequences of the financial crisis from a social perspective - the spectre of mass job losses in a country where as many as four out of every ten adults who would like to work are already unable to find employment. However, there are grounds for real concern that particularly the mining sector, which was already under pressure due to the effect of electricity supply restrictions on production, would have little choice but to shed jobs if global demand for commodities continues to contract.
With South Africa’s political stability is being tested as never before in its history as a democracy by ructions within the ruling African National Congress and the likelihood that a split in the party will result in meaningful political opposition for the first time, the coming six months before the scheduled 2009 general election could get rough if mass retrenchment is thrown into the mix.
The rand under severe pressure
The other telling spin-off from the global credit crunch has been the rise of the dollar as US institutions sought to improve their liquidity by repatriating funds invested abroad. The disinvestment from South African equity and bond markets in recent months has not only caused share prices to collapse in line with global equity markets, but has dire implications for the current account of the balance of payments and has put the rand exchange rate under severe pressure.
A substantially weaker rand is a double-edged sword for South Africa, serving as a safety valve to release some of the pressure arising from the ballooning current account deficit - expected to come close to double figures next year - by softening the blow in rand terms from reduced dollar-denominated export earnings. However, just as inflationary pressures were starting to abate due to falling commodity prices, the SARB is now faced with the spectre of imported inflation. Interest rate cuts that were forecast for the first quarter of next year may now be on hold, prolonging the pain for bonded property owners and businesses that depend on debt financing or credit sales.
One of the biggest successes of the post-apartheid era has been the growth of the black middle class, many of whom have entered the housing market for the first time and are highly indebted. A prolonged period of high interest rates combined with elevated inflation would be both socially and politically undesirable. There are already rumblings of discontent from the trade unions over the effect higher food and energy prices are having on the poor, and the government’s ability to respond with increased welfare spending is being limited by competing demands on the budget.
Competing demands on the budget
South Africa imports more than 60% of the crude oil it consumes, and the more than halving of dollar oil prices should have provided consumers with considerable relief at a time when they most needed it. The rand’s dramatic depreciation has robbed them of much of that benefit, just as its appreciation when oil prices were rising helped reduce the energy price shock.
While South African banks are not dependent on international markets to raise cash, large parastatal companies such as transport utility Transnet and power generator and distributor Eskom’s expansion plans will be affected by the increased cost of borrowing abroad. While much of the developed world braces itself for recession, South Africa’s economic growth as a percentage of gross domestic product (GDP) is forecast to slow from an average of 5% in recent years to about 3% next year and the year thereafter, supported by an ambitious infrastructure investment programme funded partly by debt.
This will now be more expensive to service, as will the rand cost of imported capital equipment, especially as concerns the much-needed expansion of Eskom’s electricity generation capacity. Since power shortages are already resulting in rationing that affects industrial and mining output, building new power stations cannot be delayed and the state may have little choice but to take on more of the funding burden.
Financing new power stations
As expected, Finance Minister Trevor Manuel’s medium term budget framework, released in October, reflected a move from budget surplus to a small deficit next year, mainly as a result of the investment in infrastructure. Capital spending has already risen from 6.3% of total spending in 2004-05 to 9.3% by 2007-08, and it is expected to reach 11% by 2011-12.
Manuel has followed a deliberately counter-cyclical budgetary strategy to “save for a rainy day”, and the ability to use deficit financing during the coming few years without exceeding a prudent ratio of national debt to GDP could be a godsend now that the storm clouds have gathered overhead.
Meanwhile, South Africa’s National Credit Act has attracted the attention of policymakers worldwide who are keen to prevent the reckless lending practices that were the root cause of many of the recent bank failures. Peter Setou, a senior manager at the National Credit Regulator (NCR), says he has briefed delegations from Botswana, China, Mongolia and the European Coalition for Responsible Credit (ECRC) wanting to learn about the Act. The NCR is already assisting neighbouring Namibia to develop similar legislation, and Setou travels to London on November 12 to address a two-day conference hosted by the ECRC.
David Marrs is Cape Editor of South African financial daily newspaper Business Day, and editor of its trade supplement, The South African Exporter. He has been working as a journalist and commentator on the South African political economy for more than 20 years.