South Africa’s key macro-economic question is whether any adjustment can be made to improve the performance of economic and development indicators over a sustained period.
A useful starting point to answer this question is to review the recently released macroeconomic policy recommendations of the international panel on Asgisa, popularly known as the Harvard panel. First the panel recommends that government should run a budget surplus; second, that fiscal policy should be counter-cyclical; third, that exchange controls should be lifted; and fourth, that although inflation targeting should be retained, policy should also focus on weakening the exchange rate.
The panel’s main impetus is to argue that South Africa’s growth path should create jobs through exports. The panel proposes that macroeconomic policy instruments be recalibrated to facilitate an export-oriented growth path. Exchange rates are to be made competitive and, to assist this, a budget surplus is proposed. The effect of the budget surplus will be to reduce borrowing and increase savings. This will lead to reduced interest rates, which will assist in the process of weakening the currency.
There are a number of problems with the panel’s scenario. First, there are serious institutional and practical problems with the proposed policy of targeting a weaker exchange rate.
The South African Reserve Bank said in response to the proposal that a policy of currency depreciation is likely to add further to currency volatility as it has the potential to create a “one-way bet” for currency speculators.
Second, to some extent circumstances have overtaken the panel’s recommendations, as a number of these were responding to the perceived problem of an overvalued exchange rate during the period 2004 to 2006.
Since the middle of 2007 the rand has depreciated quite sharply. In the new context it seems highly inappropriate to configure fiscal and monetary policy with the aim of depreciating the rand to promote exports. The rand has already depreciated because of other factors such as perceived increases in political risk, electricity-supply problems, negative sentiment towards emerging markets and possible exchange control reductions.
Most significantly from the perspective of the principles underlying the democratic developmental state, the panel’s proposed macro-economic policy framework undermines the ability of fiscal policy to alter the fundamental structure of opportunity in South Africa.
The proposal of limiting South Africa’s fiscal stance to weaken the currency deploys a blunt instrument without any analysis of the short-run and long-run consequences.
How will this work?
Methodologically, the suggested approach by the panel is that of a counter-cyclical fiscal policy. Such a counter-cyclical budget framework does deal with the long-run strategic growth and development issues, which would need to be dealt with through reconstructive fiscal policy.
A counter-cyclical approach operates in the short to medium term. It looks only at the impact of fiscal policy on demand side factors — such as inflation and interest rates — and offers no insights into the supply side impact of public-sector programmes.
A commitment to stabilising monetary policy would be complementary to reconstructive fiscal policy, as credible low inflation policies — indicated by a willingness to raise short-term interest rates when there are inflationary pressures in the economy — would assist in keeping long-run interest rates in check. This is important as long-run interest rates are determined by long-run investment decisions.
Explain the process
The greatest current monetary policy challenge is supply-side shocks, particularly in food and energy prices. The panel misses one of the key ways that monetary policy could be modified to deal with this dilemma — through the formalisation of an inflation targeting “explanation process”.
Through such a process, the commitment to keep inflation in the target range remains firmly in place, but where inflation is driven by external factors, the monetary authorities should offer formal explanations to communicate their strategy to bring inflation back under control.
The South African Reserve Bank’s communication is limited now to stating its commitment to the inflation target but, in the context of ongoing supply-side shocks, this means that there is decreasing credibility in such a message. It fails to reveal the actual strategic questions under consideration by the monetary authorities.
The authorities need to be granted the space to communicate over what period and by what methods they believe inflation can be brought back within the target band.
A recent example of such a monetary policy explanation process was undertaken by Brazil in 2002 and 2003. In the context of an exchange rate shock which resulted in missed inflation targets, a public explanation was given in the form of an open letter by the central bank governor. The letter included the period in which inflation was expected to be brought back into the target range and by what means.
In broad terms the macroeconomic stance of the panel can be characterised as follows: tight fiscal policy, expansionary monetary policy, competitive exchange rate.
A more appropriate macro-economic stance for South Africa’s democratic developmental state would be the following policy mix: reconstructive fiscal policy, stabilising monetary policy, floating exchange rate.
Underlying this would be the vision of moving South Africa on to a new long-run growth path through the increasing inclusion of those who have been historically excluded and under-serviced into the economic mainstream.
This would be a programme of economic growth and employment creation through structural inclusion, which would be driven both by growing domestic supply and demand-side potentialities.
Kenneth Creamer is an economics lecturer in the School of Economic and Business Sciences, Wits University