The National Budget to be presented next Wednesday may well be the last under the full control of the ANC led government. The ANC may need support the from other parties to govern after the elections to set Budgets. And these other parties should have different and perhaps even better ideas about taxes and government expenditure. They might even mirabile dictu insist that continuing to award comparatively well paid and well cossetted public sector officials well above inflation increases in their compensation is not the best way to utilize tax revenues. That employing more doctors, nurses, teachers and prosecutors, unable for want of a large enough budget to break into public sector employment, might be a much better idea than paying the establishment more. They may understand that ever rising tax revenues are a major drag on economic growth and that the country therefore cannot afford to increase government expenditure at the rate it has been increasing over many years now. It has meant an ever-growing interest bill that crowds out other spending and threatens fiscal sustainability and brings very high borrowing costs in its wake.
Though the major threat to the Budget outcomes this year has been the lack of revenue. The weak economy and its negative impact on company earnings and taxes has taken a heavy toll on revenues. They are expected to fall some R80b below year ago estimates- about a 4 % miss. Weaker prices for our metal and mineral exports have dragged on mining revenues and earnings. It will all mean more borrowing, perhaps also some drawing down on Treasury cash and foreign exchange reserves to reduce debt issuance. But this will but paper over the cracks. Something very different is called for.
Higher tax rates will seem counter productive and expenditure growth will have to be constrained even in an election year. Though it is surely hard to argue that the SA economy has suffered for want of government spending. The opposite must be argued – that the economy has suffered from too much and too much unproductive government spending and hence too heavy a burden of taxes.
Ever since the recession of 2009 government spending and tax collected at national level have grown at a rapid clip – ahead of inflation and nominal GDP. With the growth in expenditure slightly faster than the growth in revenues and the consistent shortfalls made up with much extra borrowing. You can describe it, up to a point, as conservative budgeting. Necessarily so in the circumstances, but surely economic policy must hope to do better than slowly strangle an economy. Being re-elected demands no less.
If we base our fiscal history on 2010 levels, National Government Expenditure is up 2.9 times, Revenue up 2.8 times, compensation of public officials up 2.7 times while interest paid is 3.39 times higher than it was in 2010 and runs at about R28 billion a month- a heavy price to pay for the mere right to borrow more. The CPI is up a mere 2 times since 2010. And the ratio of revenue to GDP is up from about 22% to 26%. These are the unimpressive statistics that damage growth and make losing elections inevitable.
A Fiscal Summary
Key Fiscal Statistics (2010=100)
South African fiscal policy settings have been seen by investors in RSA bonds and bills as a slow-moving train wreck. They have demanded high interest rate premiums to overcome the risks to fiscal sustainability undermined fundamentally by slow growth and insufficiently restrined spending and taxing. And to satisfy their expectation that the rand will weaken consistently and inflation stay at high levels and eat into their rand incomes in real or USD dollar equivalents. It will take a much different fiscal path to reverse such expectations and lift growth rates. That is in short for government spending and revenues to grow no faster than the real economy. Will the next SA government be able to grasp this nettle?
They never promised us – nor did we realistically expect – a public sector in SA that performs as well as they seemingly do in say Scandinavia. What we have in SA is however widely recognised as an almost complete failure. The government offers little defence of its current practice – only long agendas for reform. Which raises the question – why does the SA public sector perform quite so badly?
One feature of the SA public sector deserves notice. The financial rewards it offers its officials – salaries, medical and pension benefits and secure tenure, are clearly very attractive when compared to the private sector. Such that there is very little movement from public to private employment. The regret of the government is that the limited flow of taxes has provided minimal scope for raising the numbers of teachers, nurses or humble pothole fillers. For those that have jobs are given more– in the form of regular above inflation increases in their salaries. While the hospital wards and classrooms become increasingly crowded and the roads impassable and the lights are off rather than on.
Given the superiority of public employment and given the abject failure of the economy and the labour market to absorb many more men and women of working age into formal employment, the issue of just how the favoured jobs in the public sector are allocated becomes especially important to understand. Recruiting strictly on the merits of potential recruits is clearly not the overriding modus operandi in SA. Observing racially prescribed quotas are one of the binding constraints. And a key performance indicator by which institutions and their leaders are measured.
ANC Cadre employment is another important objective of government employment policy. That notwithstanding the implications drawn by the Zondo Commission of Enquiry, is a practice that has not been disavowed by the President. And yet should cadre deployment not be the overriding mission and practice of the HR specialists in government, nor merit their North Star, the tempting gap between the supply and demand for highly prized employment opportunities with governments, of all kinds and agencies in SA, is very likely to be filled by unorthodox procedures in exchange for a finder’s fee or some equivalent. The opportunity to capture some of the ongoing rents will not have escaped those with bargaining power or influence. Historically in other regimes, shop-stewards, backed by Unions with the power to strike down essential services, have exercised such powers when allocating limited and well-paid jobs as on the Docks or the construction sites or among the waste removers. Nepotism may be another description for it. As they say nature, including homo economicus, abhors a vacuum.
If employment in the public sector is not explained by objective measures of ability to perform important functions – by qualifications carefully vetted and by psychometric measures of potential etc objectively administered. And when advancement is based upon years of service, and not key performance indicators (KPI’s) of the kind common in the private sector, how are the officials so appointed, likely to behave, all the way up the hierarchy? As may be presumed of all in the workplace, they will behave mostly in a self-interested way. You do get what you pay for.
Absent any link between merit, performance and reward, accepting the grave responsibility for carefully spending hard earned taxes, or of being a conscientious public servant for its own reward, is much less likely to be the outcome. Denying the capture of highly valuable contracts with government, opening the tender honestly, whistle blowing when procurement rules are flaunted, becomes essentially quixotic, even dangerous. Going the extra mile when nursing or teaching or policing all becomes much less likely. After all, where else is the citizen to go for a permit or essential documentation, or the poor to go for schooling or medical care or protection? They are easily treated as supplicants rather than valuable customers. Producers rather than consumer’s interest will prevail.
The case for meritorious public service is essential to the purpose of good government. Introducing much more of it in SA will however have to overcome powerful interests in the established favour and crony driven system. It will take the recognition, resentments and ultimately the votes of the victims of poor service to do so.
A great deal of commercial, domestic, and speculative energy is spent pondering the future of the rand (ZAR). The foreign exchange value of the rand will remain highly variable and unpredictable. The best prediction for tomorrow’s exchange rate is today’s rate but with a high level of variance that increases with time. As in the past, the rand is unlikely to be a one-way bet. It will experience periods of negative and positive turbulence. On average, persistent rand weakness is expected in the currency markets due to the higher inflation and sovereign risk of South Africa relative to the US dollar (USD) and other hard currencies. The rand cost of a US dollar is priced to rise at an average rate of 5.5% p.a. over the next five years and by about 4.5% this year. Yet, for all its volatility, changes in the foreign exchange value of the rand can be almost fully explained by but two persistent influences on its value. These are the exchange rates of other emerging market currencies with the dollar and the dollar prices of industrial metals that SA exports. 1
Since 2010, daily movements in the EM currency basket explain 54% of daily movements in the ZAR/USD exchange rate. This is a highly significant association. If you had a crystal ball that foretold future EM basket to USD rates, you could make confident and profitable bets on the trajectory of the rand’s exchange rate. Unfortunately, exchange rates are random walk processes that are impossible to precisely predict. And commodity prices also follow a random walk process. Your best guess for tomorrow’s ZAR/USD exchange rate is today’s rate plus or minus 1% (and ±2.2% if you’re looking a week ahead).
Knowing why the rand behaves as it has may however not help much to predict where it is heading. Forecasting the USD/ZAR demands an accurate forecast of the dollar value of other EM currencies and metal prices. A clearly formidable task. A strong dollar, as measured vs its developed economy peers, will clearly force EM and ZAR weakness and probably also weigh on metal prices, when expressed in USD – and vice versa. Though the major force acting on metal prices will be the state of the Chinese economy- the major destination for industrial metals – and so another known unknown with relevance for the ZAR.
The other forces acting on the rand are South African specific events. Political shocks and own goals that move the rand irregularly and unpredictably one way that then may be reversed. These shocks account for up to 46% of the movement in the rand relative to other emerging markets.
This is where wise economic policy and effective implementation of those policies can positively influence the exchange rate. The persistently weaker bias of the rand when compared to not only the US dollar, but also when compared to other emerging market currencies, is due to the failure of the South
African economy to deliver meaningful growth and attractive returns. The rand is riskier than the emerging market basket to a significant degree. A drop of 1% in the EM basket typically translates into a 1.5% drop in the rand. Government’s job is not only to shoot fewer own goals, but to convince through positive coordinated action that South Africa is not significantly riskier than other emerging markets. The potential gains are a less risky rand, a lower cost of capital, greater investment, job creation, and more wealth for the country to share.
Exchange Rates and Metal Prices (USD) Daily Data (July 2010=100)
The ZAR and the EM basket. Higher number indicate rand weakness.
The RSA can hope to raise tax revenues at a faster rate and reduce the pace at which government spending is growing to escape the debt trap. Reversing the direction of government spending and revenues is made very difficult by a stagnant economy. But there is also another way. That is to sell assets owned by the government. Not only could asset sales or leases be a source of extra income for government to replace extra borrowing and interest paid, but it could also be a most valuable exercise in the broad public interest. Regardless of how much the asset sales would fetch which after much neglect might need much maintenance and repair.
The assets would be made to work much better in private hands and with private business interests managing the outcomes for a bottom line- as private owners are empowered to do. The assets would come to be worth more and their owners and service providers, including employees, would increase their output. Incomes and taxes. Sadly the status quo, the well rewarded private interests of the managers, workers and especially those of the suppliers of services and goods to the state owned enterprises on highly favourable corrupted terms stand in the way of the pursuit of a broad public interest.
But there is another way. That is to sell assets owned by the government. Asset sales or leases could be a source of extra income for the government to replace extra borrowing and interest paid. Regardless of how much the asset sales would fetch, they would be made to work much better in private hands. The assets would come to be worth more and their owners and service providers, including employees would increase their output. Incomes and taxes paid.
Do the foreign exchange reserves managed by the Reserve Bank on behalf of the government fall into this category of assets that could usefully be sold down? It is possible to hold too much as well as too little gold and foreign currencies on the national balance sheet. They are held as a useful reserve against unforeseeable contingencies. That is a possible collapse of exports or capital inflows, or a flight of capital that would make essential imports unobtainable or foreign debts and interest unpayable.
South Africa’s foreign assets have grown strongly over recent years, in current rand value. Since 2010 these reserves have grown from R299 billion to the current levels of approximately R1200b. But when these reserves when measured in foreign purchasing power, in US dollars, while they have doubled since 2010, they still only amount to 62b dollars. There are not many battleships or jet fighters you can buy with that loose change.
Much of the growth in the stock of reserves is the result of a weaker rand. Which is accounted for in the SARB books by mark to market value adjustments of their higher rand values. Which currently have an accumulated value of over R400b. They are described as the Gold and Foreign Asset Contingency Reserve and is recorded as a liability to the Government on the SARB balance sheet. On any consolidated Treasury and SARB balance sheets these assets and liabilities cancel out leaving only the market value of the forex reserves as a net government asset. As SARB Governor has pointed out, these reserves would have to be sold to realize any value.
The other R800 of foreign assets on the SARB balance sheet originally come from the positive flows on the balance of payments when the Reserve Bank buys dollars in exchange for deposits in rands at the Reserve Bank. The extra foreign asset held by the SARB is then held in the form of a dollar or other foreign exchange deposit in a foreign bank. The extra liability is a (cash) deposit at the SARB.
In recent years the source of extra dollars supplied to the SARB is very likely to have come from the Government Treasury rather than the private banks and their customers. A flexible exchange rate will have balanced the supply of and demand for foreign currency transactions that originate in the private economy. The extra dollars acquired by the Treasury will have been borrowed by the government offshore or have been the result of flows of foreign aid or concessionary finance provided SA. And then sold by the Treasury to the Reserve Bank for an additional credit on the Government Deposit Accounts with the SARB.
The Gold and Foreign Assets of the South African Reserve Bank. R million
Source; SA Reserve Bank and Investec Wealth and Investment
It is striking how rapidly the Government Deposits with the Reserve Bank, deposits denominated in foreign currencies and rands grew since 2010. Though these cash reserves peaked in 2020 at close to R250b and have been drawn down sharply in recent years. It may be asked why these cash reserves need to be as large as they are? Why expensive debt must be raised by the government to hold cash.
Yet running down the Treasury deposits to spend in SA increases the cash reserves of the banking system. The SA banks now hold large amounts of excess cash reserves- upon which they earn now high market related interest rates. Should however the banks turn the extra cash into extra bank lending the supply of bank deposits, the money supply, will grow rapidly and encourage inflation. It is a possibility that will bare close attention.
SA Government Deposits with the South African Reserve Bank
Source; SA Reserve Bank and Investec Wealth and Investment
SA Private Banks; Required and Actual Deposits with the Reserve Bank and Cash Reserves Borrowed (to August 2023)
Source; SA Reserve Bank and Investec Wealth and Investment
South Africans this week benefitted from a powerful demonstration of our integration into global capital markets. On Tuesday November 14th, the interest yield on the key ten-year US Treasury Bond fell by about 20 b.p. from 4.63% to 4.44% p.a. By the end of the day, the 10 year RSA bond yield had declined by the same 20 b.p. from 11.66% to 11.45% p.a. The yield on a RSA dollar denominated five year bond fell from 7.52 to 7.19 per cent p.a. leaving the yield spread with the US TB, an objective measure of SA sovereign risk, slightly compressed at 2.76% p.a. The dollar weakened across the board. And with higher bond values the share markets almost everywhere responded very agreeably for investors and pension plans. The JSE gained nearly two per cent on the Tuesday (5% in USD) and again by a further near 2% on the Wednesday.
All this on the news that inflation in the US had fallen to by a little more than had been expected after the CPI remained unchanged in the month. The chances of further increases in short term interest rates therefore fell away as they have in SA. And long rates moved in sympathy. Should the US economy slow down sharply as slowing retail spending as strongly suggested in a print released on Thursday, declines in US short rates will follow in short order adding to dollar weakness and rand strength. Or at least as investors, if not yet the Fed, thinks.
US Inflation; Annual, Quarterly and Monthly
Source; Federal Reserve Bank of St.Louis and Investec Wealth and Investment
All it might be thought as much ado about relatively little- a mere blip on the CPI. If you could predict nominal US GDP and interest rates over the next ten years you would be able to predict share and bond values with a high degree of accuracy- if the past is anything to go by. Predictions that will not be much affected by the failure of the Fed to manage inflation during the Covid lockdowns. Or by what has been its near panic and confusing rhetoric in dialing back inflation. That so roiled the equity and bond markets in 2021- and 2022, a strong bull market in most of 2023 has yet to fully recover from.
Perhaps the most intriguing feature of recent trends in the US GDP has been the growing share of Corporate Profits after taxes in GDP. The ratio of these profits to GDP- have nearly doubled since the early nineties. A profit ratio that investors must hope managers, with the aid of R&D, in which they invest so heavily, can defend to add to share values.
Another question about the long run value of US corporations and their rivals elsewhere will be about the cost of capital by which their expected profits will be discounted. A puzzle is why have long term interest rates in the US have increased as much as they have this year? It is not more inflation expected that have driven up yields. They have remained well contained below 3% p.a. despite higher rates of inflation. Quantitative tightening – the sale by the Fed and other central banks of vast amounts of government bonds bought after the GFC and during Covid, is surely part of the explanation.
But it is not only vanilla bond yields that have risen this year. Real yields- the inflation protected bond yields – have risen dramatically this year. From near zero earlier in 2023 to their current over 2% p.a. Clearly capital has become not only more productive of profits in the US – it has also become more expensive in a real sense, to counter productivity and profit gains when valuing companies. Will it remain so? That is the trillion-dollar question.
US Share of after tax corporate profits in GDP.
Source; Federal Reserve Bank of St.Louis, Investec Wealth and Investment
The gap between real interest rates in SA where a very low risk ten-year inflation linker offers over 4% p.a. – making for very expensive capital for SA corporations, and the US – has narrowed sharply. Surprisingly perhaps, real interest rates in SA have not followed global trends. Making for at lease relatively lower costs of capital for SA based corporations, good news, which we can hope will lead to more investment.
Inflation Protected Real Bond Yields RSA and USA – 10 year bonds
Source; Bloomberg and Investec Wealth and Investment
Risk Spreads – RSA-USA 10 year Bond Yields
Source; Bloomberg and Investec Wealth and Investment
The short fall in government revenues of R56.8 billion reported in the Budget Review of 2023 came as no surprise to observers of the monthly tax returns. It represented a moderate miss in volatile circumstances – equivalent to 3.1% of the revenues expected in the February 2023 Budget of R1787.5 billion. A very large number and equivalent to 25% of GDP. This real tax burden (Taxes/GDP) is not expected to change over the next few years. Underestimated company tax, lower by R35.8b and net revenues from VAT down by R25.6b, accounted for much of the revenue shortfall. Weaker metal prices and massive investments in alternatives to Eskom power were largely responsible for both declines. Personal Income Tax grew as expected by 7% in line with some growth in real wages and salaries for those employed in the formal sector. The shortfall will be fully covered by raising additional loans of about R54b.
The higher ratio of national government expenditure to GDP, currently 29.1%, is estimated to decline to about 28% of GDP over the next three years. Still leaving scope for a positive Primary Balance of 0.3% of GDP this year and 1% next year. Raising revenues to exceed expenditures, net of borrowing expenses, is the first and necessary step to reducing the burden of National Debt to GDP-now about 74%, though predicted to decline to about 71% of GDP in three years. National government expenditure, is estimated to increase by an average 4.6% p.a. over the next three years, including servicing our debts, currently over 20% of all revenue that will cost the taxpayers about R400 billion this year. That would represent a decline after inflation.
The SA government is still practicing fiscal conservatism despite persistently slow growth that weighs so heavily on revenue. And inhibits expenditure. And raises persistent doubts about fiscal sustainability. That is the willingness of the government to avoid money creation, that is a heavy reliance on its central and private banks to fund its expenditure over the long run. Which raises the risks of more inflation and is already well reflected in high borrowing costs. Risks incidentally that have not trended higher in the run up to the Budget Review. Encouragingly the debt and currency markets reacted positively to the statement itself. The rand strengthened to improve the outlook for inflation and long bond yields declined by about 15 b.p.to help reduce debt service costs.
Source; Bloomberg
South Africa; Risk Spreads- Differences in borrowing costs. RSA-USA
Source; Bloomberg, Investec Wealth and Investment
In reading the Budget Review and listening to the Minister one is struck by how deeply dissatisfied the government is with its own performance. The statement is a catalogue of government failure.
To quote the statement
The case for reconfiguring government, as it is put, is vigorously argued by the government itself. It will however need its own genuine champions informed by events rather than a stale ideology. It will have quite simply to put the private sector and private sector incentives in control of much of the activities so badly performed by the SOE’s and government departments generally, that could be outsourced. It can be called private public partnerships rather than privatization, but the essential reforms required will be to incentivize operating managers on the bottom line and return on capital- as the private sector does – to thrive and survive. The upside is incalculable.
And as far as funding a reformed public sector, the place to start would be to dispose of key underperforming assets on the best possible terms. Selling assets or leasing them over the long term would be equivalent methods for raising capital and reducing government debt. The leases can be sold to funders (foreign and local) who would be very keen to provide finance on favourable terms, given credible operators. The Transnet iron-ore line from Sishen to Saldanha would be an obvious candidate for sale or lease. There will be many other such projects made much more valuable under different operating control. For the mines to lease and operate their essential gateways to the market would add many billions to their values and taxable incomes.
The odds on a US recession in the next twelve months have receded in the light of the continued willingness of US households to spend more- despite much higher interest rates and reductions in the supply of money and bank credit. Spending on goods and food services rose by 0.7% in September on top of a robust increase of 0.8% in August. The annual increase in retail sales is 3.7% and the increase over the past three months is running at an annual equivalent of 8% p.a. Prices at retail level are falling. They stimulate demand but they also devalue the inventories held to satisfy demand. Prices have their supply and demand causes. They also have their effects on demand- and supply. Lower prices stimulate demand and incomes are now growing faster than prices.
All that is holding up the US CPI – now 3.7% up on a year ago – are house prices – and what are imputed as owners’ equivalent rent. That is at what the owners could earn if they rented their homes They are up 7% on a year before. They have a huge weight in the CPI – over 25% – and if excluded from the CPI – would have headline inflation running in the US below the 2% target. Cash rentals account for a further 7% of the US CPI. By contrast food eaten at home carries a weight of only 8.6% in the CPI and food eaten out is 4.8% of the US CPI Index. SA also includes owners’ equivalent rent in its CPI with a weight of 12.99% and actual rentals account for only 3.5% of the index. Both rental series in SA are up by a below average 2.6% on a year before. The headline inflation rate in SA was 5.4% in September.
Owners equivalent rent is a very different animal to other prices. Higher implicit rentals based on the improved value of an owner’s home are not the usual drag on spending. The extra wealth in homes, as would all increases in household wealth, more valuable pension plans, more valuable share portfolios, etc. will encourage more, not less spending. The boom in US house prices post Covid has had much to do with the ability and willingness of US households to spend more and help push up prices generally. Average house prices in the US are now falling under pressure form much higher mortgage rates and house price inflation to date will be falling away rapidly as will owner’s equivalent rentals. Thus helping to reduce headline inflation.
The question investors are asking about both inflation (falling) and the state of the economy ( holding up) is what will it all mean for interest rates. The stronger the economy the lesser the pressure on the Fed to lower short rates. And the greater will be the pressure on long term rates in the US. The key ten-year Treasury Bond is now offering 4.9% p.a. reaching a 16 year high. In the share market what is expected to be gained on the swings of earnings may be lost on the roundabouts of higher interest rates, used to discount future earnings. But if inflation is subdued, any visible weakness in the economy, can be followed immediately by lower interest rates. This thought will be consoling to investors.
The attention paid to GDP by investors is fully justified. Where GDP goes so will the earnings reported by companies. Their correlation since 1970 is (R=0.97) Though helpfully to shareholders in recent years earnings have been running well ahead of earnings indicating widening profit margins from the IT giants. GDP , on a quarter-to-quarter basis, is a highly volatile series. Though growth in earnings is much more volatile.
US GDP and S&P 500 Earnings. Current values. (1970=100)
Source; Bloomberg, Federal Reserve Bank of St. Louis and Investec Wealth and Investment.
The underlying trend in GDP and earnings will never be obvious. To make sense of their momentum, to recognize some persistent cycle, the data has to be smoothed and compared to a year before. Thus we will know only in a year or more whether the US economy has escaped a recession. It is not recessions that move markets, only expected recessions do so. And the jury will always remain out.
GDP and S&P 500 Earnings Growth Quarter to Quarter % Annualised.
Source; Bloomberg, Federal Reserve Bank of St. Louis and Investec Wealth and Investment.
We all know that market determined prices reconcile supply and demand. Higher prices discourage demand and encourage supply. What is true of an individual price is true of all prices on average, as represented by a Consumer Price Index(CPI) That prices generally tend to rise with increased demands or reduced supplies and vice versa seems obvious enough.
Higher prices discourage demand and encourage supply. That prices generally tend to rise with increased demands or reduced supplies and vice versa seems obvious enough. But the supply and demand for all goods and services are not determined independently of each other. The supply of all goods and services produced in an economy over a year is equivalent to all the incomes earned producing the goods and services that year. The value added by all producers (GDP) is equal to all the incomes earned supplying the inputs that produce output. Incomes are received as wages, rents, interest, dividends, taxes on production and what is left over, the profits or losses for the owners after all input costs have been incurred.
Produce more, earn more and you are very likely to spend more. The economic problem, not enough of everything, too little income, is surely not the result of any reluctance to spend on the necessities or luxuries of life. The problem is we do not produce enough, earn enough income to spend really more.
Extra demands can be funded with debt. Yet for every borrower spending more than their incomes, there must be a lender saving as much. Matching financial deficits with financial surpluses, is the essential task of financial markets and financial institutions, and may not happen automatically or seamlessly. There may be times when the demand for credit and the spending associated with it may run faster or slower than the supply of savings. If so incomes and output may increase temporarily above or below long-term trends. We call that the business cycle. Interest rates (yet another price) may be temporarily too low or too high to perfectly much the supply of and demand for savings. But such imbalances must sooner or later will run up against the supply side realities, the lack of income.
There is a further complication. The supply of goods and service is augmented by imports. And demand includes demand for exports. In South Africa both imports and exports are each equivalent to about 30% of the economy, making a large difference to supply and demand. But the prices of these imports and exports are not set in South Africa. They are set in US dollars and translated into rands at highly unpredictable and generally weaker exchange rates. The prices paid for imports and exports affect average prices. And they mostly push the averages higher. It has been the case in SA of a weaker exchange rate leading, equivalent to a supply side shock, and prices following.
And the rand is still expected to depreciate against the dollar by more than the difference between SA and US inflation. The bond market expects the rand to weaken against the USD by an average 7.3% p.a. over the next ten years, being the spread between RSA bond yields (12%) and the US yield(4.7%) While the difference in inflation expected in SA (7.2% p.a.) and in the US (3.2% p.a) over the next ten years is much less, only 4.8% p.a. according to the break-even gap between vanilla bond and inflation protected bond yields.
Lenders to the SA government remain suspicious of SA’s ability to grow fast enough to raise the taxes that could sustain fiscally responsible policies. That is the government will not avoid resorting to funding expenditure with money supplied by the central and private banks. A sure source of extra demands without extra supply that leads to ever higher prices as it does persistently in most African countries.
There is little monetary policy and short-term interest rates can do to strengthen the rand and bring inflation down further against this backdrop. That is without resulting in too little demanded and even less supplied than would be feasible. That in turn bringing still slower growth more fiscal strain, higher borrowing costs and a still weaker rand- and higher prices. The call is not to inhibit already depressed demand but for economic policy reforms that would stimulate the growth in SA output and incomes enough to change the outlook for fiscal policy, the exchange rate and inflation.
The group of countries that will make up the enlarged BRICS, Argentina, Egypt, Ethiopia, Iran, Suadi Arabia and the UAE have little in common other than a deep suspicion of the motives of the US and its close allies. A state of mind also shared by left wing opinion everywhere including in the US itself. If the unlikely combination of kingdoms, autocracies and genuine democracies is to become more than a another talking shop with an anti-West bias, then it should take an important lesson from the economic development of the US and Europe.
What has been of great benefit to the US and to Europe, since it established a common European market and Euro are their highly significant common currency areas. The same money is used everywhere in the US and Europe as a medium of exchange and a unit of account. Thus unpredictable rates of exchange when buying or selling goods and services across frontiers are avoided, as are the direct costs of converting one currency into another- usually converting US dollars -into the domestic money.
Trade and financial flows between the states of the US and now of Europe is greatly encouraged by what is a fixed exchange rate regime within a common market, also free of protective of domestic industry tariffs or discrimination against foreign suppliers, by regulation. As it does incidentally when transactions of one kind or another take place within any country. The important trade between Gauteng and the Western Cape for example is facilitated by prices set in the rand common to both.
In the nineteenth century when which international trade and finance first flourished and economies came to benefit from wider markets for their goods and labour, and the ability to realise productivity and income enhancing economies of scale, currencies were mostly linked by fixed rates of exchange. The link was the ability to convert the different monies, if necessary, into gold at a fixed rate. And the issuers of different monies made sure to maintain convertibility by protecting their balance of payments through adjusting domestic interest rates. If gold generally flowed out interest rates could be raised to conserve and attract gold reserves and vice versa. Provided the commitment to currency convertibility was fully credible, the extra interest received would balance the payments by attracting or retaining capital.
A modified fixed exchange rate system was re-established after the second world war with the US dollar as the reserve currency- but dollars that could be converted into gold at the request of other central banks. This commitment was abandoned unilaterally by the US in 1971 and market determined exchange rates, with the still dominant US dollar, became the norm. Highly variable rather than predictably fixed exchange rates have become the unsatisfactory order of the day. The rates of exchange of other currencies with the dollar, both in money of the day terms and when adjusted for differences in inflation of different currencies have varied very significantly – and unpredictably- damaging volumes of international trade and real investments.
US Dollar Exchange Rate Index. Market Determined and Inflation Adjusted
Source; Bloomberg, Federal Reserve Bank of St.Louis and Investec Wealth and Investment
It has not been a case of exchange rate moves levelling the playing field for traders in goods and services- so maintaining purchasing power parity in the face of differences in inflation rates across trading partners. Rather the exchange rates have adjusted to equilibrate independent flows of capital – large and reversible flows – in search of better risk adjusted rates of return- to which inflation then responds. Weaker exchange rates lead to more inflation and vice versa. Without stable exchange rates, controlling inflation in the face of capital withdrawals and a suddenly weaker exchange rate with the US dollar can become a severe interest rate burden on the domestic economy – as South Africa demonstrates.
The enlarged BRICS could establish fixed exchange rates between each other to promote trade and investment. They might usefully adopt a Chinese standard- that is offer convertibility of their own currencies into Renminbi at fixed rates. And rely on the Bank of China to manage the float of the crucial rate of exchange of Renminbi into US dollars, as it now does.
An unexpected shortfall in SA government revenues, has provoked something of a fiscal contretemps. R60b less revenue than was estimated in the February Budget has followed an even larger windfall in 2021 linked to the post Covid inflation of metal prices. The recent pull back in metal prices and in mining company profits has seen government revenues falling back sharply from peak growth rates of 25% in late 2021 to zero growth. Government expenditure has stayed on an essentially modest growth tack of about 5% p.a.
Recent Trends in SA National Government Revenues and Expenditure. Growth smoothed Y/Y
Source; SA Reserve Bank and Investec Wealth and Investment
Less revenue means more borrowing. South African taxpayers are already paying a high price for our highly compromised credit-rating. We pay an extra 2.7% p.a. more than Uncle Sam to borrow US dollars for five years. And a rand denominated RSA five-year bond offers investors 5.5% p.a. more than a US Treasury of the same duration (9.89-4.39) The spread on a ten-year RSA over the US Treasury yield is even higher, over 7.3 % p.a. (11.57-4.25). The reason for such expensive, after expected inflation, borrowing costs and risk spreads is the persistent skepticism of potential investors in SA bonds, local and foreign, about the willingness and consequences of South Africa having to live within the limits of government revenue- heavily constrained as it is expected to be – by very slow growing GDP. The further forward lenders are asked to judge our growth prospects and fiscal policy settings, the wider have been the risk spreads and the higher the cost of issuing long dated debt.
RSA and USA 10 year bond yields and risk spread.
Source; Bloomberg and Investec Wealth and Investment
Yet if it is a crisis in the bond market (not immediately obvious given modest recent interest rate movements) the heavy burdens of raising debt for the SA taxpayer has been a long time in the making. SA national government revenues have consistently lagged government spending- by a per cent or two each year ever since the recession of 2010. And the Covid lockdowns were naturally much harder on revenues than government expenditure. These difference between revenue and expenditure have had to be covered by large extra volumes of additional government borrowing. The share of interest paid by the national government in revenues and expenditure has been rising sharply, doubling since 2014. Interest paid in serving the national debt is now 20% of all national government revenues and about 16% of all expenditures. It is not the kind of expenditure that helps win elections.
SA Government Revenue, Expenditure and Debt
Source; SA Reserve Bank and Investec Wealth and Investment
Share of Interest Payments in National Government Revenue and Expenditure
Source; SA Reserve Bank and Investec Wealth and Investment
The share of RSA debt of more than ten years to maturity rose strikingly from 30 to over 70 per cent of all national government debt between 2008 and 2020 – at inevitably much higher rates. The government could immediately relieve part of the burden of high interest rates by reducing the extraordinarily long duration of RSA debt. As indeed it has been doing since 2018.
The extended duration of RSA debt. Long dated debt as share of total debt and average duration of all debt in years (Monthly data)
Source; SA Reserve Bank and Investec Wealth and Investment
RSA Bond yield differences- by duration of debt
Source; Iress and Investec Wealth and Investment
It was a form of hubris to think that lenders would be willing to take a twenty year and longer view on the fiscal outlook for SA on reasonable terms. The long-term lender is highly exposed to inflation and default through inflation, that the short-term lender largely avoids. The benefits of borrowing long are apparently that it avoids the risks that rolling over short-term debt that may prove to be difficult at inconvenient moments in the money markets. But this makes even less sense when the SA Treasury was building its cash reserves at the Reserve Bank from R70 billion in early 2010 to R183 billion by January 2023.
Managing the interest burden of national debt can play a small part in solving the problem of slow growth for the SA government. Even should government and private spending in real terms remain as deeply and unpopularly constrained as it is likely to be this year and next. Only faster growth can avoid the interest rate trap as interest paid/all government spending should rise further. Absent growth the burden of paying interest, rather than undertaking other forms of spending, is very likely to make a resort to money creation, as an alternative to more borrowing, irresistible. The growth enhancing choices for economic policy should be obvious. There is really no other way.
Peter Bruce has pointed to something in the Stellenbosch water of the late sixties and seventies that produced so many rand billionaires. They would not have been inspired by some professor of economics enthusiastic about the power of free markets telling them to do good for the nation by getting rich. They are much more likely to have been told the opposite. Told why markets will not work nearly well enough and that any faith in entrepreneurial flair would be entirely misplaced. I have yet to meet a Stellenbosch economist who believes that an economy is best left guided by the forces of competition.
And one can perhaps understand why. The interventionist economic policies, long adopted in SA before 1994, clearly helped to completely transform the economic and educational status of the Afrikaner nation, in a generation, both absolutely and comparatively. They might have done even better with freer markets, but this would not have been self-evident. By every measure, the Afrikaner, on average lagged well behind the standards enjoyed by the average English speaker in the nineteen thirties. By the sixties they had caught up. Even, as the average incomes of both communities had improved significantly.
Many of the best and brightest Maties sought their futures working for the state and its agencies. The case for ownership by the state of some of the commanding heights of the economy, steel, electricity, railways and ports was taken as a given and not contended. And they were not, with few exceptions, seen as the path to private riches through corrupted procurement and biased tenders to which SOE’s are so conspicuously vulnerable. Nationalism and strong sense of community may have had something to do with this restraint.
Perhaps with Johan Rupert a fellow student, the example of the ineffable Anton Rupert was the inspiration. He who went door to door selling shares in his fledgling enterprise that was to take down a powerful near monopoly of the cigarette market in SA. The billions of the Stellenbosch cohort, like those of the Ruperts, were made in a conventional way. By competing successfully with established businesses for their customers and executing better combined with intelligent financial engineering that is always the leveraged and risky path to great wealth. Taking the opportunity provided by contestable markets is characteristic of successful, dynamic economies.
Peter Bruce is quite wrong to assert (Business Day July 27th) That Stellies route to billions is gone — and it’s undesirable. Apartheid-era billionaires can’t be reproduced in today’s democratic conditions.
It would be highly desirable were the South African economy to produce a few more billionaires in a similar old-fashioned way. By taking on established interests, winning market share and reviving businesses that have lost their way and are now valued at far below what can be regarded as their replacement cost. With the help of value adding, better designed financial structures and appropriate incentives for managers based on what really matters, return on all capital employed. It seems to me the opportunity to acquire great wealth in rands and dollars is as open, perhaps more open than it has ever been given current market pessimism.
The aspirant billionaire will not have to rob the taxpayer to get rich – though it is still unfortunately the most obvious route. Yet more than a few new billionaires are hard at work proving my point that Bruce may not have noticed from his rural retreat.
Though admittedly a billion rand today is a lower target, worth a lot less than a billion in 2000 – about 35% as much, after SA inflation. To compare purchasing power in US dollars, you might do as the IMF does – divide billions of rands by 7 not 19 to convert SA GDP into purchasing power dollar equivalents. If the rand just compensated for differences in SA and US inflation since 2000, a dollar would cost R13.5 and a billion rand would buy the equivalent of USD74m – more than nickels and dimes.
The exchange value of the Rand (USD/ZAR) and its purchasing power equivalent
The group of countries that will make up the enlarged BRICS, Argentina, Egypt, Ethiopia, Iran, Suadi Arabia and the UAE have little in common other than a deep suspicion of the motives of the US and its close allies. A state of mind also shared by left wing opinion everywhere including in the US itself. If the unlikely combination of kingdoms, autocracies and genuine democracies is to become more than a another talking shop with an anti-West bias, then it should take an important lesson from the economic development of the US and Europe.
What has been of great benefit to the US and to Europe, since it established a common European market and Euro are their highly significant common currency areas. The same money is used everywhere in the US and Europe as a medium of exchange and a unit of account. Thus unpredictable rates of exchange when buying or selling goods and services across frontiers are avoided, as are the direct costs of converting one currency into another- usually converting US dollars -into the domestic money.
Trade and financial flows between the states of the US and now of Europe is greatly encouraged by what is a fixed exchange rate regime within a common market, also free of protective of domestic industry tariffs or discrimination against foreign suppliers, by regulation. As it does incidentally when transactions of one kind or another take place within any country. The important trade between Gauteng and the Western Cape for example is facilitated by prices set in the rand common to both.
In the nineteenth century when which international trade and finance first flourished and economies came to benefit from wider markets for their goods and labour, and the ability to realise productivity and income enhancing economies of scale, currencies were mostly linked by fixed rates of exchange. The link was the ability to convert the different monies, if necessary, into gold at a fixed rate. And the issuers of different monies made sure to maintain convertibility by protecting their balance of payments through adjusting domestic interest rates. If gold generally flowed out interest rates could be raised to conserve and attract gold reserves and vice versa. Provided the commitment to currency convertibility was fully credible, the extra interest received would balance the payments by attracting or retaining capital.
A modified fixed exchange rate system was re-established after the second world war with the US dollar as the reserve currency- but dollars that could be converted into gold at the request of other central banks. This commitment was abandoned unilaterally by the US in 1971 and market determined exchange rates, with the still dominant US dollar, became the norm. Highly variable rather than predictably fixed exchange rates have become the unsatisfactory order of the day. The rates of exchange of other currencies with the dollar, both in money of the day terms and when adjusted for differences in inflation of different currencies have varied very significantly – and unpredictably- damaging volumes of international trade and real investments.
US Dollar Exchange Rate Index. Market Determined and Inflation Adjusted
Source; Bloomberg, Federal Reserve Bank of St.Louis and Investec Wealth and Investment
It has not been a case of exchange rate moves levelling the playing field for traders in goods and services- so maintaining purchasing power parity in the face of differences in inflation rates across trading partners. Rather the exchange rates have adjusted to equilibrate independent flows of capital – large and reversible flows – in search of better risk adjusted rates of return- to which inflation then responds. Weaker exchange rates lead to more inflation and vice versa. Without stable exchange rates, controlling inflation in the face of capital withdrawals and a suddenly weaker exchange rate with the US dollar can become a severe interest rate burden on the domestic economy – as South Africa demonstrates.
The enlarged BRICS could establish fixed exchange rates between each other to promote trade and investment. They might usefully adopt a Chinese standard- that is offer convertibility of their own currencies into Renminbi at fixed rates. And rely on the Bank of China to manage the float of the crucial rate of exchange of Renminbi into US dollars, as it now does.
There is a certain balance of payments (BOP) outcome. That the dollar payments and dollar receipts in the currency market will strictly balance over any period- an hour, day quarter or year. The exchange rate and interest rates will continuously adjust to make it so- to equalize supply and demand for dollars and other currencies traded. And it is a very good idea for the authorities not to intervene in or attempt to influence this market determined exchange rate with interest rate adjustments. Or to directly control demands for or supplies of foreign currencies to achieve a temporarily better, perhaps less inflationary rate of exchange. A shadow market will emerge to siphon off undervalued dollars, leading to an official scarcity of dollars. Making it very difficult to do normal helpful income enhancing business across the frontiers and discouraging to foreign investment so important to any economy. As MTN knows only to well from its experience in Nigeria.
Another BOP relationship will also always hold. The current account of the BOP- that measures payments and receipts for imports, exports and the flows of dividends and interest paid or received by South Africans, will always be matched equally and oppositely by what are measured as flows of capital over the exchanges. A current account deficit will always be matched by a capital account surplus of the same amount and vice versa. There is no cause-and-effect relationship implied by this identity. The current account does not determine the capital flows – any more than the capital flows determine net flows of foreign trade, interest, and dividend payments. It is an accounting identity.
The capital and current accounts- an identity, identified.
Source; SA Reserve Bank and Investec Wealth and Investment
Over most years the current account of the SA balance of payments has been in deficit. Exports of goods and services almost always exceed imports – generating a consistently positive balance of trade (BOT) While the deficit on what might be described as the asset service account, dividends and interest payments, almost always exceeds dividend and interest received by enough to exceed the positive BOT. The interest and dividend yields on SA liabilities much exceeds the dividend and interest yield on SA assets held abroad. But between 2020 and 2022 South Africa ran current account surpluses and exported capital on a significant scale. So much so that the market value of SA assets held offshore now exceeds that of the market value of foreign owned assets in SA. This was not good for the South African economy.
There is a National Income Accounting Identity to help make the point. The current account deficit also equates to the difference between Aggregate Incomes that are equal to Aggregate Output (GDP) and Total Expenditure on final goods and services (GDE) It is also by definition the difference between Gross Savings and Gross Capex. Post Covid, Gross Savings, almost all in the form of cash retained by the corporate sector, held up better than Capex and capital – from a capital starved economy – flowed out.
South Africa, Gross Savings and Capital Formation – Ratio to GDP – Annual Data, Current Prices
Source; SA Reserve Bank and Investec Wealth and Investment
South African Non-Financial Corporations; Cash from Operations Retained and Net Lending (+) or Borrowing (-) Annual Data
Source; SA Reserve Bank and Investec Wealth and Investment
South Africa; Gross Savings and the Composition of Capital Expenditure by Private and Publicly Owned Corporations
Source; SA Reserve Bank and Investec Wealth and Investment
South Africa; Inflows and Outflows of Capital; Direct and Portfolio Investment. Quarterly 2022-2023
Source; SA Reserve Bank and Investec Wealth and Investment
All Capital Flows to and from South Africa; Quarterly Data (2022.1 2023.1)
Source; SA Reserve Bank and Investec Wealth and Investment
SA; Total Foreign Assets and Liabilities; Direct and Portfolio Investments and Yield
Source; SA Reserve Bank and Investec Wealth and Investment
SA Foreign Investment Income (Dividends + Interest) Annual Data
Source; SA Reserve Bank and Investec Wealth and Investment
South Africa; Gross Savings Annual Data (R millions)
Source; SA Reserve Bank and Investec Wealth and Investment
Both the ratio of Gross Savings – and Capex to GDP can be regarded as unsatisfactorily low in SA. The opportunity to raise the savings rate seems limited, given low average incomes. However, the opportunity to raise the rate of capex to GDP and to attract foreign capital to fund income growth encouraging capex and the accompanying larger current account deficits is always open. SA must be able to offer faster growth and the accompanying higher expected returns, to attract more foreign capital and to retain a greater share of domestic savings.
Supply side reforms are urgently needed for the SA economy. We all know what they are. Demand will keep up with supply automatically. Extra Supply – extra incomes earned producing more goods and services- creates its own demands. Yet until the economy can deliver more growth and better returns, the best we can do with our savings is to invest them abroad. (including buying shares of companies listed on the JSE that do almost all of their business outside the SA economy) Without such opportunities, the pension and retirement funds, upon which we depend for our future income, would be in a truly parlous state.
I wrote as following in a letter to the Wall Street Journal in response to an op-ed piece by John Cochrane a formidable youngish economist very much in the Chicago School tradition – where he was a professor. He is now a Senior Fellow at the Hoover Institution. You can follow his blog Blog: http://johnhcochrane.blogspot.com/
Incidentally I have not yet had any acknowledgment from the WSJ – nor do I expect them to publish my letter.
Here is an answer to Cochrane’s (WSJ, August 1st ) question – … does money alone drive inflation? Money (mostly) in the form of deposits in banks held by households and by firms, on behalf of their shareholders, is clearly an asset of the depositor and a component of their wealth. Because the deposit liabilities issued by the shareholders of banks are not expected to be repaid (net wealth goes up with bank deposits because they are expected to grow with the economy and the demand for deposits and will not have to be repaid or be expected to be repaid). Similarly as Cochrane posits, government bonds, or any paper issued by a government, that are never expected to be repaid by taxpayers, are another component of wealth. An excess supply of net money (deposits) or an excess supply of net bonds- over and above the willingness of wealth owners (savers) to hold those assets –would lead to an increase in the demand for other assets and goods and services- and so generally higher prices for goods, services and other assets as portfolios are adjusted to excess holding of money or bonds. That is lead to inflation.
But where could the excess supplies of money and or bonds come from? As Cochrane indicates only and always from a fiscally undisciplined government. A fiscal theory of inflation is essential in explaining all inflations everywhere. It is hardly an original concept.
A fiscally constrained government can call on its central bank and its private banks to fund all the bonds it wishes to issue. The central bank most simply might directly fund the government by buying its additional paper and crediting the government’s deposit account with it. Which, as the Treasury deposits with the central bank run down as the government spends more, would increase the cash reserves of the banks. And their ability and perhaps willingness to lend more- including to the government. And if extra bank lending ensued by banks flush with extra cash, the supply of bank deposits would increase by a multiple of the additional cash deposits injected into the system.
Or the central bank could at its initiative supply (lend) extra cash to the banks so that they may be willing to fund the government with the same influence on the supply of bank deposits as the government spends more. And if the increase in the supply of deposits – bank liabilities and of government paper – bank assets – exceeded the willingness of the public to add to their deposits or bonds – inflation would follow. The deposit liabilities of the banks and their loans to government (bonds) would be increasing at a similar rate. The banks, perhaps more than a wider set of financial institutions, would be holding many of the extra bonds issued by governments- particularly in many countries mostly without a well-developed bond market but very vulnerable to fiscal difficulties and high rates of inflation. Inflation is not an American invention.
Inflation is explained by the inter- actions of governments, banks and the wealth owning public. The exchange of a hugely increased supply of extra deposits held by US banks with the Fed (QE) (cash) for extra private or publicly issued securities after 2010 was restrained – it was understandably not a risk loving lending encouraging time for the US banks after the GFC. The money multiplier (M2/Cash Reserves) collapsed – and the supply of deposits grew slowly and more or less in line with the demand for extra deposits issued by the banks, so avoiding much inflation. But not incidentally of share or real estate prices that were on a tear. Predicting inflation will always demand a close watch of fiscal policy – of the supply of and demand for government bonds in wealth portfolios – and of the behavior of banks- central and private. It will always be complicated.
The case for a company buying back its own shares is clear enough. If the shareholders can expect to earn more from the cash they could receive for their shares than the company can expect to earn re-investing the cash on their behalf, the excess cash is best paid away.
Growing companies have very good use for the free cash flows they generate from profitable operations. That is to invest the cash in additional projects undertaken by the company that can be expected by managers to return more than the true cost of the cash. This cost, the opportunity cost of this cash, is the return to be expected by shareholders when investing in other companies. Such expected returns, a compound of share price gains and cash returned, are often described as the cost of capital. And firms can hope to add wealth for their shareholders when the internal rate of return realized by the company from its investment decisions exceeds the required returns of shareholders.
All firms, the great and not so good, will be valued to provide an expected market competing rate of return for their shareholders. Those companies expected to become even more profitable become more expensive and the share prices of the also rans decline to provide comparable returns. How then can a buyback programme add to the share market value of a company? Perhaps all other considerations remaining the same- including the state of the share market, the share price should improve in proportion to the reduced number of shares in issue. But far more important could be the signaling effect of the buy backs. Giving cash back to shareholders, especially when it comes as a surprise, will indicate that the managers of the company are more likely to take their capital allocating responsibilities to shareholders seriously.
The case of Reinet (RNI) the investment holding company closely controlled by Mr. Johann Rupert is apposite. Mr. Rupert believes the significant value of the shares bought back by Reinet have been “cheap” because they cost less than their book value or net asset value (NAV) Yet the market value of Reinet still stands at a discount to the value of its different parts and may continue to do so. Firstly, shareholders will discount the share price for the considerable fees and costs levied on them by management. Secondly, they may believe the unlisted assets of Reinet may be generously valued in the books of RNI, so further reducing the sum of parts valuation suggested by the company and reducing the value gap between true adjusted NAV and the market value of the holding company. Finally, the market price of RNI has been reduced because the returns realized by the investment programme of RNI may not be expected to beat their cost of capital and will remain a drag on profits and return on capital. Therefore the value of the holding company shares is written down – to provide market competing, cost of capital equaling, expected returns- at lower initial share prices. And realizing a difference between the NAV reported by the holding company (its sum of parts) and the market value of the company – share price multiplied by the number of shares in issue (net of the shares bought back)
Yet for all that, the shares bought back may prove to be cheap should Reinet further surprise the market with further improvements in its ability to allocate capital. And the gap between NAV and MV could narrow further because the value of its listed assets decline. Indeed, shareholders should be particularly grateful for the recent performance of RNI when compared to the value of its holding in British American Tobacco (BTI) its largest listed investment. RNI has outperformed BTI by 50% this year. Unbundling its BTI shares – an act normally very helpful in adding value for shareholders because it eliminates a holding company discount attached to such assets- would have done shareholders in RNI no favours at all this year.
Fig.1; Reinet (RNI) Vs British American Tobacco (BTI) Daily Data (January 2020=100)
Source; Iress and Investec Wealth and Investment
The recent trends in flows of capital out of and into businesses operating in SA are shown below. It may be seen that almost all the gross savings of South Africans consist of cash retained by the corporate sector, including the publicly owned corporations. (see figure 2) Though their operating surpluses and retained cash have been in sharp recent decline for want of operational capabilities and revenues rising more slowly than rapidly increasing operational costs. Their capital expenditure programmes have suffered accordingly as may be seen in figure 3. The savings of the household sector consist mostly of contributions to pension and retirement funds and the repayment of mortgages out of after-tax incomes. But these savings are mostly offset by the additional borrowings of households to fund homes, cars, and other durable consumer goods. The general government sector has become a significant dissaver with government consumption expenditure exceeding revenues plus government spending on the infrastructure. It may be noticed that the non-financial corporations in South Africa have not only undertaken less capital expenditure with the cash at their disposal- they have also become large net lenders- rather than marginal borrowers- in recent years. (see figure 5)
Fig.2; South Africa; Gross Savings Annual Data (R millions)
Source; South African Reserve Bank and Investec Wealth and Investment
Fig.3; South Africa; Gross Savings and the Composition of Capital Expenditure by Private and Publicly Owned Corporations
Source; South African Reserve Bank and Investec Wealth and Investment
In recent years, during and post the Covid lock downs, total gross saving has come to exceed capital; formation providing for a net outflow of capital from South Africa. Rather a lender than a borrower might be the Shakespearean recipe, but the problem is that both gross savings and capex in South Africa commands a comparably small share of GDP as shown below. South Africans save too little it may be said for want of income to do so. But they invest too little in plant and equipment and the infrastructure that would promote the growth in incomes, consumption and savings. The source of capital exported is that the gross savings rate held up while the ratio of capex to GDP fell away significantly.
Fig.4; South Africa, Gross Savings and Capital Formation – Ratio to GDP – Annual Data, Current Prices
Source; South African Reserve Bank and Investec Wealth and Investment
Fig. 5; South African Non-Financial Corporations; Cash from Operations Retained and Net Lending (+) or Borrowing(-) Annual Data
Source; South African Reserve Bank and Investec Wealth and Investment
The reason many SA companies are buying back shares on an increasing scale is the general lack of opportunities they have had to invest locally with the cash at their disposal. And the cash received has been invested offshore rather than onshore on an increasing scale. For want of growth in the demand for their goods and services for all the obvious reasons. As a result the aggregate of the value of South African assets held abroad at march 2023 exceeded those of the foreign liabilities of South Africans, at current market valuations, by R1,699 billion. Total foreign assets were valued at approximately 9.5 trillion rand.
Fig 6; South Africa; Inflows and Outflows of Capital; Direct and Portfolio Investment. Quarterly Flows 2022.1 – 2023.1[i]
Source; South African Reserve Bank and Investec Wealth and Investment
Fig.7; All Capital Flows to and from South Africa; Quarterly Data (2022.1 2023.1)
Source; South African Reserve Bank and Investec Wealth and Investment
The reluctance to invest in SA makes realizing faster growth ever more difficult. That the cash released to pension funds and their like is increasingly being invested in the growth companies of the world, rather than in SA business, is the burden of a poorly performing economy that South Africans have to bear. Rather a borrower than a lender be- if the funds raised can be invested in a long runway of cost of capital beating projects. Faster growth in the economy would lead the inflows of capital and restrain the outflows of capital required to fund a significant increase in the ratio of capital expenditure to GDP and a highly desirable excess of capex over gross savings.
[i] The investments are defined as direct when the flows are undertaken by shareholders with more than 10% of the company undertaking the transactions. And as portfolio flows when the shareholder has less than 10%. Much of the economic activities of directly owned foreign companies in South Africa, including their cash retained and dividends paid to head office will be regarded as direct investment. For example, describing the activities of a foreign owned Nestle or Daimler Benz in SA.
Starbucks has a prominent notice. Responsibly Cashless. It might have read better or more honestly as profitably cashless. Avoiding the costs and dangers of handling and transporting cash and the associated bank charges – including the likelihood of cash not making it to the till in the first instance – will surely be in the owner’s interest and justifiably so. On the proviso that the sales lost would not be at all significant as affluent and tech savvy customers tender their telephones. It is not a conclusion the owner manager of a small stand-alone enterprise in control of what goes in or out of the cash register will come to. For them cash is still king.
Starbucks and other cash refusers are probably within its rights refusing legal tender. Only the notes and coins issued by the Reserve Bank qualify as legal tender in SA – money that cannot be refused in proposed settlement of a debt. But presumably can be rejected when offered in exchange for a good or service. SARS would probably approve of a cashless society for obvious income monitoring purposes. The Reserve Bank might, were it a private business, have mixed feelings about reducing the demand for a most valuable monopoly. It pays no interest on the notes it issues and earns interest on the assets the note liabilities help fund. In 2004 the note issue funded 40% of the Assets on the Reserve Bank. That share is now down to 15%. It was 20% before Covid.
Clearly notes, have lost ground to the digital equivalent- a transfer made and received via a banking account. A trend that becomes conspicuous after the Covid lockdowns. Since then, the transmission and cheque accounts at SA banks have grown very strongly from R790 billion in early 2020 to nearly 1.1 trillion today- or by about a quarter. By contrast the notes issued by the Reserve Bank since have increased only marginally – by R20b – with most of the extra cash issued being held by the public. The private banks have managed to reduce their holdings of non-interest bearing cash in their vaults and ATM’s. By closing branches and ATM’s and retrenchments. Replacing notes with digits- have been a cost saving response. A central bank replacing paper notes with a digital alternative could be an alternative. But it would be very threatening to the deposit base of the private banks and their survival prospects.
South Africa; Money Supply Trends.
Source; SA Reserve Bank and Investec Wealth and Investment
The Banks in SA have however dramatically increased their demands for an alternative form of cash- deposits with the Reserve Bank. They now earn interest on these deposits. What used to be significant interest charged to the banks when they consistently borrowed cash from the SARB – to satisfy the cash reserve requirements set by the SARB – at the Repo rate- has now become interest to be earned on deposits held with the SARB. These deposits have grown by R100bilion since 2020 while cash borrowed from the SARB has fallen away almost completely from an earlier average of about R50 billion a month.
SA Banks – demand for and supply of cash reserves since Covid
Source; SA Reserve Bank and Investec Wealth and Investment
The SARB, following the Fed, regards the interest it pays on these deposits as fit for the purpose of preventing banks from converting excess cash into additional lending. Which would lead to increased supplies of money in the form of additional bank deposits. It takes a willing bank lender and a willing bank borrower to power up the supply of cash supplied to the banking system by a central bank into extra deposits The testing time for central banks in a banking world full of cash will come when increased demands for bank credit accompany the improved ability and willingness of the banks to turn excess cash into extra bank lending. Then interest rate settings may not control the demand by banks for cash reserves to sufficiently restrain the conversion of excess cash into additional bank lending, that in turn will lead to extra and possibly excess supplies of money and so extra spending as money is exchanged for goods, services and other assets, that will force prices higher. Clearly not for now the banking state of SA or of the US where the supply of money is in sharp retreat.
