Listening to the experts
A foreign expert, Gabriel Palma of Cambridge University, has advised SA to “curb the inflows of foreign capital to beat recession”, according to a report from Business Day yesterday. Palma was quoted as saying that “capital controls were needed to address the erratic volatile and uncertain capital flows that could be expected in SA and that would bring a great deal of uncertainty into the domestic economy…..”
The new new thing – foreign capital abundance
In fact capital flows to SA since 2003 have flowed in large and highly consistent volume to fund the current account deficit that grew rapidly as the economy picked up momentum. Without the growth the foreign capital would not have been forthcoming – there would have been no demand for foreign capital nor any supply of it. But without supplies of foreign capital the growth could not have materialised. This year SA economic growth unfortunately has slowed down sharply and the capital inflows have more than halved, both in rands and as a percentage of GDP.
The current account deficit is by definition approximately equal to net capital inflows. The small balancing item that equalises capital flows and the current account deficit are flows into or out of foreign exchange reserves held by the banks and the Reserve Bank. These reserves have been increasing, making capital inflows larger than the excess of imports, net debt and dividend service over exports and net foreign income receipts.
Foreign capital sets the limits to growth – the more growth the more capital – the more foreign capital the better
Clearly the SA economy cannot grow at more than a pedestrian 3% rate without infusions of foreign capital. Our domestic savings rate has declined to about 15% of GDP and cannot finance the growth in the capital stock, the real investment that is necessary to support faster growth. And so we come to a very different conclusion. SA must come out of its recession and grow faster to attract the extra foreign capital that has proved to be available to fund our growth. Unless SA is resigned to the 3% or less growth experienced before 2003 that did not require nor attract foreign capital, the case for encouraging as much foreign capital as we can remains as strong as ever.
Ignoring the new more favourable realities does SA a disservice
Palma and those who think like him do South Africans a grave disservice. They would inhibit the growth in living standards and the improved returns on capital invested that come with growth and which provide the essential attractions for foreign investment. The ability to attract capital to fund faster growth in SA is a relatively recent phenomenon as our figure shows. In the uncertain past the very risky SA economy would soon run up against the limits of its foreign credit. And these limits we would suggest were but 3% pa growth, constrained by domestic savings.
Testing the limits
Just how much capital SA could now attract before foreign lenders would be discouraged for fear of a balance of payments crisis is not known – there is too little evidence to make such judgments with any degree of confidence. SA should do all it can to encourage growth and test the limits set by the global capital markets. The economy is far from testing these limits now. The sooner it does so the better. Fear of foreign capital should be the last thing on our collective minds.
SA: Gross Savings Ratio and the Current Account Deficit
Source: I-Net Bridge and Investec Private Client Securities
Moreover the rand has strengthened this year against the US dollar and the euro. It has furthermore maintained its value against the other much stronger emerging and commodity currencies despite the highly unsettled state of global capital markets and the presumed vulnerability of the SA economy given its dependence on capital inflows (see below). This vulnerability is presumed rather than proved and the strength of the rand in potentially very difficult circumstances proves otherwise. However rand strength, to the degree experienced recently, is not especially welcome to our miners and manufacturers. Perhaps if the economy had grown faster and the current account deficits were sustained at their previous levels, the rand might not have been quite as strong as it has been. If we are to worry about rand strength then let us do it for the right rather than wrong reasons, reasons to encourage rather than discourage growth.
The rand vs the US dollar, the Brazilian real and the Australian dollar (Jan 2009=100)
Source: I-Net Bridge and Investec Private Client Securities