Marcus on recent global developments and South Africa

Speech by Reserve Bank Governor Gill Marcus on recent global developments and their implications for South Africa

The global economy is at a crossroads. The world is in the midst of significant change, and the events in Europe are the most vivid examples of how complex and difficult the current environment is. The previous euphoria that the recovery was well underway has now translated into greater caution.

Last week saw an almost synchronised decline in PMIs [Purchasing Managers' Index] around the world, with the slowdown in manufacturing taking place more quickly than previously anticipated.

While some analysts now see a double dip as a likely scenario, even the more optimistic who have retained a positive outlook now have a downside risk built into their forecasts, or greater “fat tail” risks.


The reality is that we probably never really emerged from the crisis, which is now entering its next phase.

These developments have serious implications for the domestic growth outlook.

The global economy

Until recently there had been a progressive upgrading of growth forecasts. For example, in the April World Economic Outlook, the IMF exemplified what can be regarded as the perceived wisdom:

• that the recovery was proceeding faster than expected;
• that the recovery would be uneven but would proceed;
• that exit strategies from expansionary monetary and fiscal policy would be required, and
• that these should be done carefully so as not to upset the recovery.

It soon became evident that the extent of the required fiscal consolidation would be much more significant than initially thought: the explosion of fiscal deficits and debt ratios, that were seen to be part of the initial solution to the crisis, was now seen as a problem, as both solvency and sustainability issues came to the fore.

The Secular Outlook of May 2010 issued by PIMCO’s Mohamed El-Erian, stated that “the drama paying out in Europe (includes) … the generalised and simultaneous nature of the debt explosion in industrial countries, the application and content of regulatory initiatives across the globe, the headwinds to job creation in some industrial countries, the extent of political polarisation and … the further shift of growth and wealth dynamics to emerging economies… “

It also became clear that in a number of countries and regions growth was dependent on the continued stimulus provided by the fiscal and monetary authorities. Initially fiscal expansion was required to fill the gap left by the collapse in private sector demand. However, the private sector, particularly in the advanced economies, was not ready to step back in to support domestic demand, largely because of impaired balance sheets.

Households remain cautious, and the initial driver of the recovery - inventory adjustments - cannot continue indefinitely without a recovery in domestic demand. The withdrawal of the fiscal stimulus in the US is therefore coming at an inopportune time.

In some countries, eg in Europe, the approach has moved beyond mere fiscal stimulus withdrawal, as in the US, to one of fiscal austerity or consolidation. These measures, while necessary from a sustainability point of view, are coming at a time that is in effect premature, and could well undermine the pace of recovery further. For example, it has been estimated that an attempt by the Greek government to reduce its budget deficit over the next three years by the 10 percentage points of GDP needed to bring that deficit into line with the Maastricht criteria could cause GDP to decline over the next few years by between a cumulative 15 and 20 percent.

The process of fiscal consolidation will place most of the burden of adjustment on monetary policies. In effect, we are likely to have low interest rates globally for much longer than previously thought. These low interest rates will counteract the negative growth impact of the fiscal consolidation.

Furthermore, central banks will, in all likelihood, need to continue to use their balance sheets to help support the financial markets.

The PIMCO Secular Outlook has described the crisis as one of serial balance sheet contamination. It started off with private sector balance sheets being expanded unsustainably (households and banks). With too many balance sheets deleveraging simultaneously, threatening global depression, governments were forced to step in with their balance sheets which led to the current sovereign risk issues. Now fiscal authorities have to deleverage, leaving the monetary authority balance sheets as the only ones left to prevent a downturn. At a regional level, it is the German balance sheet that is bailing out the rest of Europe.

There are concerns that this implies inflationary pressures down the line. Given the size of output gaps, it is probably premature to be concerned about inflation at this stage in the advanced economies, but there are limits to what can be done by monetary policy on its own. There is also the risk of temptation to solve debt crises through monetisation.

All this is also playing out in the political terrain, and social contracts are coming under considerable stress. Nowhere more so than in Europe where the social fabric in a number of countries is coming under strain as people are being asked to pay the price of the adjustment in terms of either lower wages, or in terms of their jobs.

This is occurring at a time when elections are resulting in an increasing number of weak coalition governments, reflecting a lack of social consensus on the way forward.

The obvious solution, namely to grow out of the crisis, is not that easy as growth is likely to remain lower for longer.

Strategies for dealing with unemployment, particularly in Europe, are creating further problems. For example, the extension of the working life of individuals in a number of countries, while helping with the demographic problems of dealing with an ageing population, is leading to more youth unemployment. In Spain the unemployment rate is 20 per cent, but youth unemployment is closer to 40 per cent. There is a real danger of young people remaining unemployed for some time to come, resulting in deeper structural and social problems. ... more