DESMOND LACHMAN: Fix the budget while the sun is still shining

Christine Lagarde, the former IMF MD, never tired of advising countries to repair the roof while the sun was still shining. By this she meant countries should take advantage of favourable international financial market conditions to strengthen their economic fundamentals. Maybe then they would be in a better position to weather a more difficult international economic environment.

If ever Madame Lagarde’s advice had relevance, it has to be in today’s SA economic context. This is not only because the days of ultra-easy global liquidity now appear to be coming to an end. Rather, it is because seldom before has SA’s economic roof been in need of major repair.

Since the pandemic’s onset last year the world’s major central banks have kept the world awash with liquidity. They have done so by engaging in a huge amount of bond buying that has increased the cumulative size of their balance sheets by a staggering $10-trillion.

This bond buying has had the effect of causing international investors to stretch for yield in the emerging market economies and to be more forgiving of fundamental weaknesses in those economies. That in turn has made it all the easier for the emerging market economies to finance their gaping budget deficits at relatively low interest rates.

Last week’s Federal Reserve announcement that it will soon start tapering its bond-buying programme would seem to constitute a strong signal that the days of ultra-easy global liquidity conditions are numbered. No longer will the Fed be buying $120bn a month in US Treasury bonds and mortgage-backed securities. Rather, the Fed plans to taper those purchases by $15bn a month with a view to ending those purchases completely by June next year.

The Fed is hardly alone among the world’s central banks planning to pare back on generous liquidity provision. The Canadian and Australian central banks have already started raising interest rates, while the European Central Bank envisages ending its large-scale bond buying programme by March next year.

Acute financial problems at Evergrande, the world’s most highly indebted Chinese property development company, point to China as another possible trigger for an end to easy global liquidity conditions. This would seem to be especially the case considering that Evergrande’s problems are all too likely a symptom of the unsustainability of China’s property and credit-led economic recovery. If China, the world’s second-largest economy, were to slow down, international investors might be much less willing than they are today to continue investing in the emerging-market economies.

Mounting challenge

In the best of times, weathering a marked reversal of capital flows and the drying up of international liquidity would be challenging for emerging-market economies. However, it would be particularly challenging today at a time when those economies are yet to fully recover from the pandemic’s economic damage and when they have highly compromised public finances. Those conditions heighten the risk of pronounced weakness in those countries’ currencies and of great difficulty in financing their gaping budget deficits in a non-inflationary manner.

It is in this sense that SA’s leaky public finance roof has to be of major concern. According to the IMF, the country will be going into the anticipated period of global liquidity tightening with a public debt to GDP ratio of about 80%. Such a ratio is unusually high for an emerging-market economy and is about double its corresponding level some 10 years ago.

Equally troubling is that is that the IMF now expects SA’s budget deficit to be about 8% of GDP in both 2021 and 2022. One would think such high budget deficits must be bound to heighten investor anxiety about the sustainability of the country’s public finances, especially at a time when the music of easy global money stops playing.  

With the rand already weakening yet again and the door of easy global liquidity starting to close, it would seem that time is running out for SA to mend its shaky public finances. This would seem to be particularly the case at a time that high budget deficits are limiting the room for the Reserve Bank to raise interest rates to defend the currency without further compromising the public finances.

Being no stranger to foreign exchange crises, one must hope SA policymakers lose no time in mending the country’s leaking budget roof by coming up with a credible medium-term budget adjustment programme. Maybe then the country’s economy will be able to better weather the coming international liquidity storm.

• Lachman, a former deputy director in the IMF’s policy development & review department and chief emerging market economic strategist at Salomon Smith Barney, is a senior fellow at the American Enterprise Institute.