Last Chance for MPC action

South Africa’s structural inflation problem is about to rear its head once more. The benign level of SA inflation in recent years has been aided by the Rand, which has strengthened significantly since early 2009, depressing goods inflation and therefore the headline number. Over the course of the current year inflation has moved strongly upward. Inflation is now expected to breach the 6% upper limit of the target band, a view held by market participants even before the Rand’s sharp depreciation in September 2011. The depreciated exchange rate increases the risk that inflation stays out of the band for an extended period over the course of next year. Notwithstanding these negative inflation expectations, there is a still good case for a 50bp cut at this weeks MPC meeting.

Global interest rates remain at extremely low levels, with much of the developed world running highly negative real interest rates (interest rates below the inflation rate). While central bankers usually signal to the market that future interest rate decisions will be determined by the progression of inflation and growth, Ben Bernanke has taken the highly unorthodox step of setting a time period for which the Fed Funds rate will remain low. He has promised to keep rates near zero until mid 2013. This hard cap on US rates will serve to suppress interest rates globally. Despite the low level of global interest rates, growth concerns have recently led to rate cuts in Europe, Brazil, and Australia. For South Africa to run a relatively high level of rates in this environment, risks provoking Rand strength and stalling the weak economic recovery.

The last MPC meeting contained a very dovish statement by the MPC, and it was clear from comments made by Governor Gill Marcus that, save for the extreme market volatility and Rand depreciation that was occurring throughout their deliberations, the MPC would have cut rates on growth concerns. While we haven’t seen the Reserve Bank’s updated inflation projections, they are no doubt aware that the Rand depreciation has increased the risks to the upside. While inflation is currently below the target at 5,7%, it is projected to breach the target when November’s inflation data is released next month. This means that when the MPC meets in 2012, inflation will in all likelihood be above the 6% target, with a deteriorated outlook. If the MPC cuts rates while inflation is above 6%, it would serve to damage some of the inflation fighting credibility that has been painstakingly built up over many years. While many have pushed their rate cut projections out to next year, we believe that developments in inflation will soon shut the door on cuts. If the Reserve Bank does intend to cut rates to support the economic recovery, the November MPC meeting presents their last credible opportunity to do so.  

Rashaad Tayob

Referendums are the Solution to the European Debt Crisis

The most recent “comprehensive package” for the Euro lasted all of four days as the Greek Prime Minister George Papandreou announced plans to put the bailout package to a referendum on the 31^st of October. Three days later, he was forced to backtrack on this initiative under pressure from both the European leadership and the opposition in his own country. The decision by Papandreou on the referendum took everyone by surprise and while he was roundly criticised for it, we view this move towards a referendum as a positive step and one that should be quickly implemented in Italy, Spain, Portugal and Ireland. While it may create uncertainty in the short term, it does push Europe to a resolution, and forces all parties to take the tough decisions which have to date been avoided.

Both Greece and the European powers are still convinced that they can manoeuvre themselves out of Greece’s current debt situation, but in reality there are only simple but tough choices which exist.  Current polls show that 60% of Greeks reject the summit deal, and 70% of them want to remain in the Euro. Unfortunately those numbers don’t add up. Greece can either accept the bailout and implement the austerity measures that come with it, or negotiate their exit from the Euro.

While the European powers are panicked at the thought of Greece exiting the Euro, the bailout packages they have put forward have always left Greece with unsustainable levels of debt. The latest offer was painted as generous, but even under highly optimistic scenarios it leaves Greece with debt of 120% of GDP. In essence then, as in the case of Greece, the Euro powers can either choose to subsidise the weak economies or they can negotiate their exit from the Euro.

While these decisions are obviously difficult, postponing them is no longer feasible and risks further damage to an already poor economic outlook. Papandreou has been cast as a pariah for bringing up the possibility of a referendum but with virulent opposition to austerity in Greece it is difficult to see if he has any other choice. The power of the referendum is the fact that it gives the government the mandate to fully implement the required reforms should the Greeks vote to remain in the Euro; essentially it amounts to a buy-in from the Greek people themselves. It also gives lenders certainty that there is a will to repay borrowed money, and not just repudiate the debts later when it is politically convenient. In turn, should Greece choose to leave the Euro, a well defined exit mechanism for the common monetary area can ensure that this is done in an orderly fashion. While Greece’s debt levels are beyond reprieve, Italy can still be saved and should arguably also move quickly to a referendum: Rising Italian bond yields risks making their debt service costs unsustainable too, and the political impasse means that economic reforms have stalled.

While the market has been pricing in a Greek default since the middle of last year, the European leadership has been too slow to react. They have continued to be in denial as to the extent of the debt problem, while attempting to buy time with ineffectual bailout packages. Time has run out, and the difficult decisions have to be made now. Giving the people the decision through the referendum process and forcing them to live with the outcomes is the only credible step to a full resolution of the crisis.

Rashaad Tayob

South Africa, the IMF and European Bailouts

"I would not join any club that would have someone like me for a member."

  --  Groucho Marx

Earlier this year, emerging markets reacted with giddy excitement at the prospect of being given greater representation and voting rights at the IMF. Several, including South Africa, put forward their own candidates to head the IMF after Dominique Strauss-Kahn’s resignation. While a small emerging market country such as South Africa may feel exalted to sit at the table with the world powers, it is going to come with a steep bill. Given the level of indebtedness of the developed economies; it is clear which way money is going to flow in the coming years. After his return from the IMF conference in Washington, South African finance minister Pravin Gordhan has recently stated that South Africa would contribute “a couple of hundred million US dollars” to the EU rescue package.

This ‘contribution’ cannot be allowed to happen for two reasons. Firstly, it effectively involves the transfer of wealth from the poor to the rich. South Africa is a developing market with a per capita income of around 6000USD, and a highly skewed income distribution. The per capita income of Europe at over 30000USD is at least 5 times ours. Why our Finance Minister feels that we should ‘contribute’ to improving the living standards of those 5 times richer than ourselves is inexplicable. The second reason we should not be willing to contribute to any EU bailout package is due to the fact that IMF bailouts have always been creditor bailouts, with the focus on repaying bank loans. These country “bail outs” are simply bank bailouts in disguise, and the proposals being floated for the EU ‘rescue package’ are no different.

The term ‘bailout’ was used to define the IMF involvement in the 1997 Asian financial crisis in order to imply that the they were “bailing out” or assisting countries with their economic problems. However, the nature of the programs implemented by the IMF merely served to bail out the western banks who had taken excessive exposure to companies in Thailand, South Korea and Indonesia during the years of high growth. The prescribed IMF policies of high interest rates, maintaining currency pegs and allowing the failure of weak banks served to exacerbate the economic crisis. With IMF policies designed to increase the ability to repay western debtors, it is hardly surprising that per capita income in countries such as Thailand, Malaysia and South Korea fell around 10%. The 20% fall in Indonesia was particularly severe, with the impact in their country similar to that of the great depression. 

When the credit crisis hit the developed world in 2008, policies were and continue to be precisely the opposite of what was implemented in emerging markets in 1997. The prescriptions are now currency devaluation instead of currency pegs, zero interest rates instead of rate hikes, and bank bailouts instead of failures. The IMF has always existed to forward the interests of the US and Europe, and it is particularly galling that after years of being victims of IMF policies, emerging markets are now expected to contribute to funding the organisation. South Africa has its own pressing economic concerns, and any funds which the South African treasury intends to send to Europe are better used to aid our own development.

Rashaad Tayob