South Africa needs tougher exchange controls before junk status hits
- Patrick Bond
There was nothing radical or transformative in the medium-term budget announced by Finance Minister, Pravin Gordhan last month.
During this interminable period of economic stagnation, with no prospects of an upturn in sight thanks in part to Donald Trump’s victory, South Africa desperately needs the “radical economic transformation” repeatedly promised by the ANC.
Gordhan’s budget revealed how the foreign credit rating agencies’ threat of a “junk” rating was reaching maximum power just before they follow through with a dreaded downgrade. Under the agencies’ thumb, Gordhan felt compelled to adopt a deficit target for 2018 of just 2.5% (down from 3.9% last year and 3.4% this year).
Yet, within the next month rating agency Standard & Poor’s Konrad Reuss recently hinted, his firm is likely to be first to announce a downgrade, especially if Gordhan faces more unfounded state prosecution.
South Africa is, in any case, already suffering de facto junk bond status, measured by the interest rate paid to international investors on major countries’ state bonds now nearly the highest in the world at 9%. Only Brazil, Venezuela and Turkey are slightly worse.
The South African Reserve Bank could urgently lower local interest rates and insulate the rand from further financial chaos by imposing tighter capital controls. These will ‘delink’ the economy from the most destructive global circuits of capital.
Where the global economic rules are unfair or malicious, the delinking strategy is the only alternative. There’s plenty of evidence that the rules are unfair. For example, denying world pharmaceutical monopolies a patent monopoly on vital medicines has raised life expectancy from 52 to 62 over the past decade thanks to generic, locally-made replacements.
Financial delinking is most important. Intense capital outflows, which can be triggered, for example, by threats of a downgrade, lead to higher interest rates. This affects local borrowing costs.
Prior to the 2008 crash, the last such major South African episode was in 1997-98 when crises in Thailand, Indonesia, South Korea, Malaysia, Brazil and Russia caused investor flight from rand investments. This forced the South African Reserve Bank governor Chris Stals to raise interest rates by 7% within two weeks, amid a 40% Johannesburg Stock Exchange crash.
For bankers, an even more frightening episode was in August 1985 when short-term foreign debt of $13 billion came due for repayment. The President, PW Botha’s ‘Rubicon Speech’ caused international lenders like Chase Manhattan’s Willard Butcher to cut off new loans. Botha’s response was to temporarily shut the stock market and default on foreign debt repayments. He also imposed capital controls – most famously the financial rand (FinRand) as a parallel currency to the commercial rand – to keep funds from escaping using a monetary penalty.
The FinRand stayed in place until March 1995. South Africa still has prudential regulations in place that limit how much financial institutions can invest overseas. For example, most insurance companies and pension funds must keep 75% of their funds invested in local assets. Such controls prevented far worse damage in 2008 than transpired, it is acknowledged by people as different as Johann Rupert and Jeremy Cronin.
The South African rand is now one of the most volatile major currencies in the world (with the Mexican peso obviously a victim of Trumpism). Gordhan and the South African Reserve Bank should consider tightening capital controls to reduce the currency’s vulnerability. This could include immediately halting outflows to foreign corporations, and rolling back generous (R10 million/year) offshore allowances enjoyed by the richest South Africans.
A mountain of foreign debt
One reason for tougher capital controls is the country’s dangerously high foreign debt. Just before Botha’s 1985 crisis, debt owed to overseas lenders hit 42% of GDP. Today it is around 40%, a modern national record.
With foreign debt of $135 billion and hard currency reserves of less than $50 billion, an emergency loan may be needed from the International Monetary Fund (IMF) or the closely-related BRICS Contingent Reserve Arrangement. This could well mean extreme austerity.
The most important outflows are to foreign shareholders of multinational corporations. Those regularly amount to more than R150 billion per year in licit (legal) profits and dividends, plus an average of R300 billion in illicit financial flows (during the 2004-13 period measured by the Washington NGO Global Financial Integrity). Paying these profit outflows requires yet more foreign borrowing. (In contrast to such payments outflows, South Africa’s trade deficit from January-September 2016 was only $75 million.)
Delinking needs to be on the agenda
Acclaimed Indian political economist Prabhat Patnaik, who delivered the 2016 Wolpe Lecture last month, is an advocate of countries like South Africa ‘delinking’ from the global economy. The objective would be to insulate them from world financial chaos through imposing tighter capital controls.
Prabhat cites the 1933 Yale Review endorsement of capital controls by John Maynard Keynes, often regarded as capitalism’s greatest economist. Financial Times columnist Wolfgang Münchau expressed concern that Keynes’ lessons have been forgotten:
The point is to prevent hot money flowing in during the good times, and to stop it from draining out in the bad times. This is not yet a subject of polite conversation among policymakers.
Diverse countries have successfully re-imposed exchange controls. These include Malaysia (1998), Argentina (2001), Venezuela (2003), Cyprus (2013) and China (2016).
‘Delinking’ alone isn’t enough, Patnaik argues: “It must be accompanied by an expansion of the home market through redistributive policies. Otherwise it could become merely a kind of ‘beggar-my-neighbour’ policy.”
According to a new World Bank study, the top 1% of South Africans increased their share of national income by nearly 10% over the last quarter-century.
But even more urgently, before finance flows out even faster next month, South Africa desperately needs a discussion about capital controls – even in polite company.