More than crisis management – Talking reforms in the economy and doing what’s right 

By Brian Kantor, Head: Research Institute, Investec Wealth and Investment

It seems that investors in Emerging Markets would hold their governments and central banks to a much higher fiscal and monetary standard than is expected of their highly indebted developed market peers. What is deemed so right for the increasingly indebted developed world hoping to recover from Coronavirus – that is massive doses of extra government spending and money creation in support of government debt – is treated with suspicion when proposed or attempted by increasingly indebted emerging market economies, including South Africa.

We have argued that poorer economies, such as our own, that have suffered even more damage from the lockdowns, given much more widespread poverty and absent reserves of capital of accumulated by most households and businesses, need all the unconventional help they can get.

Yet not all EM central banks have taken the chastity vow. In Indonesia, as the Financial Times of London reports, (June 15th) “…… Jakarta to use QE for as long as needed to tackle pandemic, Finance Minister, Sri Mulyani Indrawati says quantitative easing and other policies are restoring confidence Indonesia is at the forefront of emerging markets in implementing monetary policy that was once seen as the preserve of developed economies….

The minister said “…Indonesia will use unprecedented quantitative easing and other emergency monetary and fiscal policies for as long as it takes to recover from the coronavirus pandemic, according to the country’s finance minister.  With the private sector in retreat after weeks of lockdown, massive state spending was needed to shore up the economy, …….” adding that Indonesia would not rely on central bank financing in the long run. “…That is not good policy practice,”

According to the FT in another report (June 8th), Brazil has granted its central bank extraordinary powers for the next twelve months. Though the Bank seems somewhat reluctant to employ them, Central Bank President Campos Neto says he will not employ measures until traditional tools have been exhausted. To quote him as per the FT “…We still think we have monetary space on the traditional policy. If you start using unconventional policy before you exhaust the conventional policy, you create noise that makes the central bank lose credibility”.

However, also according to the FT, the central bank has slashed Brazil’s benchmark Selic interest rate to a historic low of 3% and is expected to cut by a further 75 basis points this month. The BCB president said there was now greater clarity on the extent of the damage likely to be wrought by the Coronavirus pandemic and that “uncertainty regarding the extreme cases has diminished”. The Bank in March launched a $300bn financial liquidity package — equivalent to 16.7% of the country’s gross domestic product — to try to mitigate the efforts of the broad economic shutdown caused by the pandemic. “I don’t think any other country has done anything close to that,” Mr Campos Neto said.

The case for extraordinary policies is clear enough. When economies are allowed to normalize, it is hoped that extra demand will match extra potential supplies that than become available. Extra spending to accompany extra output can be assisted meaningfully by extra government spending – on income relief and relief for creditors. And with money creation by central banks to make it cheaper to issue much more government debt and to encourage banks to lend more freely. In the absence of the stimulus, the willingness of firms to increase output and to offer employment on normal terms would be even more highly compromised. They are unlikely to hold very optimistic forecasts of revenues and profits upon which to budget. The case for stimulus is every bit as strong in the less developed world, including South Africa.

There is as yet no indication that the South African Reserve Bank sees the crisis as calling for anything like as vigorous a response. It remains largely in conventional inflation targeting mode. The supply of central bank money, notes in circulation together with the cash deposits of the banks with the Reserve Bank, defined as the money base or M0, sometimes more evocatively described as high powered money, had not increased at all since the end of last year to May 2020.

South Africa desperately needs the same extraordinary interventions to counter the impact of the lockdown now underway in the developed world, and as we have indicated, also in some developing economies. Given the responses of the SA Treasury and Reserve Bank, it is not surprising that the consensus forecasts of market analysts are for a below average reduction in SA GDP in 2020 of 6%, but thereafter a well below average increase in GDP in 2021 – only around a very pedestrian 2% extra is expected next year.

What is called for is firstly a properly vigorous response to the crisis. It also calls for a credible commitment to a return to fiscal and monetary normality when the crisis is over, and when the economy is operating at something close to its potential. That long-term growth potential has surely to be above 2% p.a. growth. Realising permanently faster growth calls for more than effective crisis management – it calls for reforms of the economy.

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