The risks shaping us

FNB Comment, by Cees Bruggermans

Our interest rates are being kept unnecessarily high by massive tax increases imposed through public charging and excessive unionized labour demands, keeping both our inflation and inflation expectations overly elevated.

Vastly better public sector governance and less rigid labour market conditions would have lowered our inflation rate and expectations further by 1%-3% and made the outlook less risky.

That would have warranted a prime rate near 7%-8%. Instead, we are stuck at 10%.

Despite these heavy domestic millstones around our necks, these aren’t the only influences shaping us.

In late March the firm Rand may after all have had a downward influence on inflation and its expectations and may therefore have been part reason for lowering interest rates further.

There was also the background reality of political turmoil and apparent understandings at the highest levels between the social partners, at least when going by outward appearances.

Logic then tends to take a backseat to intuition, a very old standby one should never discard, especially in so-called rule-bound eras when discretion is supposedly constrained, if not banished.

But this domestically-driven analytical frame governing interest rate setting should be supplemented with global overlays, for there are moments when the external completely overwhelms the internal.

One example is commodity price surges as seen during 2006-2008, boosting our inflation and interest rates. And the commodity price collapse of 2H2008 and the way it invited inflation collapse, with interest rates following in its wake in 2009.

But there is more to the outside world that can overwhelm our internal bickering and twisted logics.

SARB Governor Marcus three weeks ago seems to have started a global trend when the MPC release heavily accented European events and the risks these held. Some observers choose to interpret her emphasis as dovish, but the real message was vigilance and readiness for all eventualities.

Last week, there was a massive echo globally as European events, especially drastic fiscal cutbacks, lowered growth expectations and greater reliance on monetary policy accommodation was universally interpreted as the ECB doing a Fed, now potentially also remaining ‘low for an extended period’ (indeed beyond the Fed if necessary).

JP Morgan reported East European central banks seemingly having changed their interest rate trajectories, with expected interest rate hikes delayed well into 2011.

BNP Paribas reported Aussie reflecting on Euro contagion conditions and apparently being influenced thereby.

Citibank India mentioned similar sentiments being noticed all over Asia.

Like Icelandic volcanic ash causing massive air travel delays over Europe, so the remarkable turn of events regarding sovereign debt and Euro seems to be creating a mass delay to European monetary tightening. Its interest rates may well remain on hold into, even through, 2011.

When superimposed on similar US sentiments this is making other central banks cautious, not wanting to raise their rates too early or too high from fear of reaping unwanted currency appreciation at a time Sterling and Euro are falling, Asia non-committal, with Dollar prospects still uncertain.

So yes, those Marcus remarks may have appeared dovish at the time and indicative our interest rate trajectory could be less steep than expected only recently. Markets presently discount the first 0.5% rate increase only by 3Q2011. Much could still happen influencing that outcome.

Yet when the Monetary Review was released last week, the main fear was apparently for European events to cause a risk-related pullback in the global periphery, marked potentially by export decline, Rand weakening and consequently adding to our inflation momentum. That suggests quite a different vigilance, in other words upward risk to the interest rate outlook, especially when coupled to local upward pressures on inflation.

It makes all local demands about more interest rate cuts and proactive depreciation of the Rand to lower levels (and then fixing it) sound so very risky.

Perhaps that suits.

Not for the first time, we get warning SARB references to potential risk of sudden capital flow reversals, implying potential to disturb growth and Rand to the downside, with inflation and interest rates to the upside.

This may be part reflection of the IMF/BIS global disaster culture (based on decades of crisis experiences) regularly highlighting such risk to client central banks.

But it is also part reflection of own experiences (most notably 2008, 2001, 1998, 1985). These were true horror events that have become embedded on SARB retinas.

In contrast, one rarely hears our macro policymakers talk as animatedly about that plover-related definition of South African realities.

The Dutch-Afrikaans term for plover is Kiewiet. Two generations ago, a young Dutch immigrant to South Africa was CW De Kiewiet. He subsequently disappeared again overseas on an illustrious career, but did not forget his shaping African experience, long studying and dissecting it to its, to him, defining essence.

His conclusion, hardly a modern one shaped as these mostly are by instant global capital flow reversals, favoured a different emphasis (ironically as much influenced by cyclical and structural global phenomena).

“South Africa advances by way of political disasters and economic windfalls” (1940).

It is perhaps understandable our politicians prefer not to emphasize the undeniable political disasters in their lives. But the external economic windfalls regularly befalling us, truer of our development heritage than many other countries?

Is this windfall aspect also perhaps asymmetrically politically inconvenient?

Windfalls can make big spenders out of Ministers and can cause bigger demands by electorates, special interests and labour forces. Yet windfalls by nature tend to be temporary while the euphoria they create tends to be longer lasting (echoing) and capable of going to excess. Is this a reason to downplay windfalls and being more vigilant about their reverses?

Perhaps it simply isn’t fashionable, but the policy analysis isn’t particular heavy about such windfall risk shaping us already for over 150 years and likely doing so still for many decades.

Yet what is primary and what is secondary at present?

Is it the possibility of global risk-related pullbacks and reversals or the appearance and sustained presence of externally-induced windfalls shaping our balance of payments, the Rand, inflation and growth environments?

Clearly the immediate fear is for external ambushes of the negative kind resulting in export declines, capital reversals, Rand implosions and inflation boosts. Yet even so these may prove secondary and short lasting, even during massive crises like the ones apparently being encountered regularly at present. For the world continues to respond successfully to crisis with institutional renewal, overcoming the sometimes greatest odds which on first sight apparently only offer catastrophic downside.

At least, that’s what the Anglo-Saxon banking crisis of 2008 did and what the European sovereign debt and Euro crisis of 2010 ultimately may offer. Yet instead of disaster, there may be progress. Instead of deep reversals, merely pullbacks marking broad windfall advances for us associated with global renewal and recovery, as prior to 2008 and during 2009.

More often recognizing the windfall risk alongside the sudden reversal risk might perhaps give a different nuance to some of our national risk analysis, perhaps more becoming to a country which (according to a recent Wall Street Journal article quoting Citigroup Global Markets) is by far the richest (endowed) non-energy commodity producer in the world.