National income accounts: Demand side reality check

Aggregate demand is not growing at anything like the rate that could justify additional fixed capital expenditure by the private sector or a larger formal workforce. Decisions by firms to invest in people or capacity are derived from the state of demand for their goods and services, which are predominantly exercised by households rather than government agencies. The SA economy currently has a short term lack of demand problem that has to be resolved if the economy is to pick up momentum. The danger is that demands will remain subdued for an extended period of time, prolonging the failure of the economy to fulfil even its modest, economic policy-constrained supply side, potential of, at best, 4% GDP growth.

Where will the spark that lights up the SA economy come from? Just as the damage has come from higher prices and interest rates, relief can only come from a reversal of these price trends. The light at the end of what appears to be a long dark tunnel would have to be a stronger rand or a stable exchange rate that brings down inflation and interest rates. Furthermore, it would be helpful if the government, local governments and Eskom did not look to higher prices for electricity and other services as their preferred funding mechanism, given the state of demand. Raising what are in practice expenditure tax rates (in the form of higher charges for electricity and other utilities , including road use taxes, to fund government spending is a particularly bad idea right now. It would make much more sense to fund capital expenditure undertaken by government agencies (including Eskom) with as much debt as possible, so spreading the interest rate burden on to future generations who will benefit from the additional infrastructure. It would make even better sense to sell off some of the government owned infrastructure to private operators who would manage the assets better and help to reduce Budget deficits and the incentive to raise tax rates.

The only wiggle room for the Treasury would be the proceeds from privatisation. The aging, poorly managed Eskom plant should be a prime candidate for sale. The alternative is for the government to borrow more to meet Eskom’s cash shortfall of up to R200bn or to allow still higher electricity prices that slow household spending and undermine the competitiveness of manufacturers and mines. More government borrowing and / or slower growth would be reason to downgrade RSA debt, thus perhaps raising government borrowing costs and adding to the fiscal deficit and the case for raising tax rates. Only a serious privatisation programme can reverse the rot of slower growth, leading to lower tax revenues, higher tax rates and less growth.

The state of the economy in Q2 would surely have justified much lower borrowing costs. The ability of households to spend is being pressurised by higher prices linked to a weaker rand and to rising administered prices. These trends are being accompanied by the weaker labour market, making it difficult for even those who retain their jobs in the private sector to achieve the inflation adjustments to nominal salaries and wages.

How likely then is a stronger or stable rand? How likely is it that the government will worry less about its balance sheet and much more about the immediate state of the economy? The latest news about the state of the SA balance of payments has not been helpful to this end. The deficit on the trade account of the balance of payments deficit widened. This was the result largely of increased imports of fuel oil needed to run the gas turbines that expensively help Eskom keep the lights on. Lower prices for commodity exports combined with strike disrupted mining and manufacturing production were another reason for a weak foreign trade balance.

The large current account deficit was largely funded by inflows of foreign capital in Q2 without pressure on the rand. Foreign capital therefore continued to be made available despite the slow growth and the want of real capital expenditure.

There is continued foreign appetite for SA equities and bonds, at a competitive price or yield. But such sales of securities by local owners or issuers (mostly the government) made to fund the current account deficit are no free lunch. They result in a usually growing flow of interest and dividend payments abroad. The weak state of the economy helped reduce the growth in dividend payments to increasingly important foreign shareholders in SA companies. But we would have been in a much stronger position to attract essential foreign capital on favourable terms had more profitable SA companies been able to pay out more by way of dividends.

Faster growth and the capital gains and stronger dividend flows that follow it, would surely attract foreign capital. Stronger growth could then be accompanied by a rand made stronger by capital inflows – that is faster growth with less inflation is surely the right goal for monetary policy to pursue. Imposing higher interest rates that inhibit growth that in turn drive the rand weaker and discourage the flows of foreign capital is the wrong approach. It would be helpful were the Reserve Bank to appreciate that the lack of SA savings is not a constraint on growth unless it leads to a weaker rand and more inflation – as it appears to have done recently.

The economy needs a dose of lower interest rates to stimulate household spending and the capital expenditure and foreign capital inflows that would follow. Only privatisation can avoid a round of government induced austerity – in the form of higher tax rates and slower growth in government spending. Correcting the supply side of the economy needs mostly a reform of labour regulations. Essentially it requires an economic reality check that the Reserve Bank and the Government generally need to undertake urgently. The economy and all who depend on it deserve no less.