Challenges to Stimulating Employment-led Growth in South Africa: An Outside Perspective

Hamid Rashid, Ph.D.Senior Adviser for Macroeconomic Policy

UN Department of Economic and Social Affairs, New York

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Evidence of Consumption-led Growth The average consumption growth during 1990-99 was 1.4% but

it increased to over 4% during 2000-09 The growth in consumption sharply accelerated during 2004-

2008 Since 1994, the growth rate of household final consumption

expenditure outpaced the growth in household disposable income

Household met their consumption demand largely through borrowing

Imports increased rapidly to meet the growing consumption demand - exports grew by an average rate of only 2.9%, imports grew by over 6% during 1994-2009

Evidence of a growing consumption bias in the economy2

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Household Final Consumption Expenditure

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to be quoted or reproduced without the permission of the presenter

Source: South African Reserve Bank

Rapidly Growing Household Debt

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quoted or reproduced without the permission of the presenter

Source: South African Reserve Bank

Very High Level of Household Debts Relative to GDP

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be quoted or reproduced without the permission of the presenter

Brazil China India Russian Federation South Africa

13% 12% 10% 10%

65%

Household Debts as Percentage of GDP in 2008

Brazil China IndiaRussian Federation South Africa

Source: Relevant central bank reports

Low Household Savings Explain the Low Gross Domestic Savings

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China

Malaysia

Indonesia

India

Thailand

Korea, Rep.

Russian Federation

Argentina

Mexico

Poland

South Africa

Brazil

Turkey

0 10 20 30 40 50 60

Gross Domestic Savings as Percentage of GDP in 2009

Source: World Bank

A Few Pertinent Questions Are consumer lending and growing household debt crowding out

credit to productive sectors? Are portfolio investments crowding out long-term investments? Are portfolio inflows necessary to finance current account

deficits? Has financial sector development gone too far in South Africa? Do financial and capital market liberalization and excessive

financialization pose a threat to long-term growth, equity and stability in South Africa?

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Triggers of the Consumption Boom

High commodity prices, attracting large capital inflows and strengthening Rand

Leading to an asset price bubble, both in financial assets and real estates since 2004

Strong wealth effect, increasing the borrowing capacity of households and contributing to growing household debts

Strong Rand keeping import cheap and supporting the consumption boom

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How the Consumption Boom and Growing Household Debts can crowd out credit to the

productive sectors? Household credit is typically highly profitable for banks – payroll-based, no

collateral requirements, high interest rates, short-term (except for mortgages)

Banks have less incentives to extend credit to productive sectors when household loans are highly profitable and the opportunity cost for loans to productive sectors rises

Growing household debts diminishes the capacity of households to build savings and equity for investments

Most small businesses start with small personal and family savings, which can be collateralized to raise more capital

Demand for productive sector loans weaken when households are highly leveraged and the cost of borrowing is high

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reproduced without the permission of the presenter

Are Portfolio Inflows Crowding Out Long-term Investments?

Relative to GDP, South Africa has one of the highest portfolio capital inflows in the world

It is the only BRICS where portfolio inflows are larger than FDI inflows

In 2010, portfolio inflows were nearly ten times larger than FDI

Portfolio inflows are highly volatile and pro-cyclical and can negatively impact credit and liquidity

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Portfolio Inflows in BRICS before the Crisis

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quoted or reproduced without the permission of the presenter

  Net Inflow of Portfolio Equity in 2008 (USD billion)

Net Portfolio Equity Inflows as Percentage of GDP in 2008

China 28.2 0.56%

Brazil 37.1 2.32%

India 21.1 1.53%

Russian Federation 33.6 0.28%

South Africa 9.4 3.31%

Source: The World Bank

Portfolio Equity Inflows are More Volatile than Bond Inflows

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1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Portfolio and Bond Investments in South Africa as Percentage of GDP (1990-2010)

Portfolio equity, net inflows (BoP, current US$)Portfolio investment, bonds (PPG + PNG) (NFL, current US$)

Axis Title

Source: The World Bank

How Portfolio Inflows Can Affect Long-term Investments

Do not allow the “automatic stabilizer” to work – prevents depreciation and makes export less competitive

Contributes to strong Rand, which increases the cost of labor and local inputs for foreign investors

Strong Rand reinforces the consumption and import bias Make the exchange rate more volatile, making the cost of doing

business unpredictable Increases the opportunity cost of lending to real sectors, especially

when banks are allowed to participate in portfolio trading in the secondary market

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Are Portfolio Inflows Necessary to Meet Growing Current Account Deficits?

South Africa ran a positive external balance on trade in goods and services until 2003

The trade balance shifted from +3.92 billion in 2003 to -0.65 billion in 2004

Overall current account balance deteriorated even more because of increased repatriation of dividend and factor income

In 2009, income transfers represented 56% of the current account deficit while trade deficit accounted for only 21%

It appears that more portfolio inflows are needed to meet an increasing burden to repatriate profits that these short-term portfolio inflows earn in South Africa

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Trade Deficits Account for Only Half of the Current Account Deficits

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be quoted or reproduced without the permission of the presenter

2004 2005 2006 2007 2008 2009

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

Main Components of South Africa's Current Account Deficits

External Balance of Goods and Services as % of Current Account

Net Income as a % of CA

Source: The World Bank

The State of Financial Development in South Africa

Relative to GDP, South Africa has one of the largest stock markets in the world

Market capitalization increased from 118% of GDP in 2001 to 291% of GDP in 2007 before the onset of the crisis

The stock-market also has a very turnover ratio, marking high volatility Economic fundamentals can not explain the huge mark-up on book values

and the level of market capitalization It is likely that the capital market is absorbing most of the corporate savings,

diverting resources away from productive investments Financial services accounted for nearly 21% of South African GDP in 2010 Financial sector compensation account for a large portion of financial

services value added South African banks are one of the most profitable in the world

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quoted or reproduced without the permission of the presenter

Market Capitalization as Percentage of GDP in BRICS and other Economies

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Poland

Brazil

Korea, Rep.

Russian Federation

Turkey

United Kingdom

United States

Singapore

India

South Africa

0 0.5 1 1.5 2 2.5 3 3.5

Stock Market Capitalization-GDP Ratio in 2008

Poland

Brazil

Korea, Rep.

Russian Federation

Turkey

United Kingdom

United States

Singapore

India

South Africa

Source: The World Bank Financial Structure Database, 2010; Data on China not available

Market Capitalization Trends in BRICS: 1990-2010

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1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

0

50

100

150

200

250

300

350

Market Capitalization in South Africa and Other BRICS: 1990-2010

BrazilChinaIndiaRussian FederationSouth AfricaAxis Title

Source: The World Bank

Share of Financial Services in GDP

19

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South Africa

Korea

Turkey

Poland

Brazil

Russian Federation

India

China

0 0.05 0.1 0.15 0.2 0.25

Share of Financial Services Sector Value Added to GDP in BRICS and Other Countries: 2007

South Africa

Korea

Turkey

Poland

Brazil

Russian Federation

India

China

Source: Compiled by author from UN Statistics Dvision National Accounts Data and OEC

Compensation of Financial Sector Employees as Percentage of Total Value Added

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Brazil India South Africa Russia

19.1% 19.5%

36.9% 37.0%

Compensation of Financial Sector Employees as Percentage of Total Financial Sector Value-Added in 2007

Brazil India South Africa Russia

Source: UN Statistics Division National Accounts Data,

South African Banks are Highly Profitable!

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Brazil

Russian

Federa

tionTu

rkey

Poland

IndiaChina

South Afri

ca0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

Banks Returns on Equity

BrazilRussian FederationTurkeyPolandIndiaChinaSouth Africa

Source: The World Bank Financial Structure Database, 2010

How Financial Development Affects Growth of the real sector and Employment

South Africa represents an extreme level of financial development or financialization

Financialization is neither necessary nor sufficient for long-term economic growth

The US economy grew very fast during the 1960s when financialization was low but experienced slow growth in 2000s when financialization increased dramatically

East Asian economies grew very fast and created millions of jobs without high degree of financialization

Brazil and India are more recent examples

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How Financial Development Affects Growth of the real sector and Employment

Financialization can convert savings into financial assets, which may not be productive investments – non-financial firms can choose to hold financial assets instead of reinvestments and expansion that are necessary for employment generation

Can increase the intermediation costs through various channels and depress demand for productive investments

Firms facing high degree of financialization and high intermediation costs can cut back on employment

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Do liberalization and financialization pose a threat to long-term growth and stability?

South African financial and capital market is more liberalized than any other emerging economies

There is no restriction on banks on their trading and insurance activities

Banks are allowed to hold reserves and deposits in foreign currencies and make loans to, and borrow from, overseas clients

Foreign bank presence is more pronounced in South Africa than in any other BRICS countries

As percentage of GDP, claims of foreign banks increased from 14% to 42% during 2004-2007

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Pace and State of Financial Market Liberalization in BRICS

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19801982

19841986

19881990

19921994

19961998

20002002

20040

0.10.20.30.40.50.60.70.80.9

1

The Pace and State of Financial Market Liberalization in BRICS countries: 1980-2005

China India South Africa Russian Federation Brazil

Source: Abiad, Abdul, Enrica Detragiache, and Thierry Tressel, "A New Database of Financial Reforms," IMF Working Paper WP/08/266, December 2008. Fully Liberalized =1; Fully Restricted = 0

Claims of Foreign Banks in BRICS

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19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20100

0.050.1

0.15

0.20.25

0.30.35

0.40.45

Claims of Foreign Banks as Percentage of GDP: 1990-2010

South Africa Brazil China India Korea, Rep. Turkey

Source: Bank of International Settlement Consolidated Banking Statistics, 2011

Highly Pro-cyclical Foreign Bank Lending Foreign banks increased their lending by USD 90.0 billion

during the boom years of 2004-2007 But as the economy was hit by the crisis, foreign banks

reduced their exposures in South Africa by about USD 20.0 billion between December 2007 and December 2008, which was 7% of GDP

Contraction of loans from foreign banks was significantly lower in other BRICS countries

The contraction in foreign bank credit was twice as large as portfolio outflows

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Highly Pro-cyclical Foreign Bank Lending

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  Net Reduction in Foreign Bank Claims (USD Billion) between Dec 2007 and Dec 2008

Net Reduction as % of Total Foreign Bank Claims in Dec 2007

Net Reduction of Foreign Bank Claims as % of GDP in 2007

South Africa 20.17 16.82% 7.05%

China 30.42 11.02% 0.87%

India 11.06 5.07% 0.89%

Russia 1.48 0.65% 0.11%

Brazil 34.22 11.12% 2.51%

A Few Policy Options South Africa is unique – so what worked in other countries may not work in

South Africa But the experiences of other emerging economies and the policy

instruments they use can provide some guidance A low interest rate policy, with effective credit guidelines, introduction of

priority sector lending, statutory liquidity ratio, asset based reserve requirements and micro-prudential regulation may ensure that banks lend to productive sectors

Restrictions on banks to engage in equity trade Restrictions on foreign currency reserves Restrictions on banks lending overseas Financial transaction tax, reserve requirements and restrictions on outflows Other options?

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