Government’s appetite for debt, in part to pay for its rising wage bill, is working to keep the rand strong according to economists.
Riding on the coat tails of an international trend in which foreign investors have rushed into emerging markets chasing better yields, South Africa’s bond market has experienced record inflows this year, of more than R61-billion, according to Stanlib economist Kevin Lings.
But it is coming back to haunt government, in what Lings calls a “self-fulfilling prophecy”, as it is driving up the rand’s strength, in turn attracting more investors and further boosting the rand. This phenomenon is becoming a growing worry for government, as a strong rand erodes the competitiveness of South African exports and threatens jobs.
It is also under pressure from its trade union partners in the ANC-led tripartite alliance to take overt steps to weaken the currency in a bid to create jobs. But union pressure to secure a wage increase for the million-strong public sector workforce may indirectly be undermining the push for a weaker currency as government issues more bonds to pay for the increases and more foreign investors enter the market, bumping up the rand.
Earlier this week Business Day quoted Public Service and Administration Minister Richard Baloyi saying that government would need to
raise an additional R7-billion to pay for the increases. Government already pays about 40% of its tax revenue to salaries in the public sector.
Combined with the growing cost of servicing state debt, about 51% of tax revenue will be spent on employee compensation and interest payments by 2012-13. But Lings warned that the R61-billion in inflow could reverse as quickly as it built up, depending on the global perception of the trade.
South Africa’s credit ratings have held steady through the recession, its bond market is deep and liquid, making it easy for investors to enter or exit, and while our interest rates have been dropping, they are still higher than the rates off ered in developed economies, which are at an all-time low in the wake of the global financial crisis.
In these circumstances any attempt by the central bank to weaken the rand would be impossible to control, said Lings. Should the Reserve Bank take steps to wake the currency, it could result in investors exiting bonds rapidly as the rand declined, with the result that it could plummet.
“These kinds of measures can run away with you. It’s like trying to control a speeding freight train, the market gathers its own momentum,” said, Lings. “Then you have panic over rising inflation and interest rates.”
Lings said that South Africa should not chase a weak or a particularly strong rand, but rather a moderate rate that would help exports and boost the local economy.
“This is a particularly dangerous game to play and governments that have tried it have lost.” He was confident, however, that amid the noise, both the Reserve Bank and the finance minister were well aware of the risks involved.
Economist Mike Schussler echoed this observation, saying that investors were chasing yields. “But we must be careful of calling for a weaker rand,” he argued. The stronger rand has made life easier for consumers, he noted, as many of the consumer items imported are cheaper.
“It is lowering the cost of doing business and allowing us to participate as consumers,” said Schussler. It is also working to keep inflation low, in spite of continuing increases in administered prices for services such as electricity, healthcare and water.
Schussler noted that, combined with higher commodity prices, it has also helped keep South Africa’s trade balance in a surplus. “But we do need to move to a point where more long-term capital is invested in the country, through large greenfields projects,” he said.
South Africa’s trade surplus was more than R2-billion for July, according to data released by the South African Revenue Service. Lings said that as the global economy recovered from the recession, demand for exports had grown.
However, while the local economy is still recovering in line with the rest of the world and imports have picked up, the private sector is still not undertaking large investment projects, whereby “big ticket items” must be imported into South Africa.
These include capital equipment and machinery, which South Africa does not produce, requiring imports and creating the trade defi cits witnessed in the past. He noted that this was unlikely to last as the economy began growing again and private sector business expanded.