There is a growing chorus for SA to adopt a war footing to fight the coronavirus by copying the outsize responses of major developed economies. But with limited fiscal space, SA just doesn’t have the same firepower. Or could the Reserve Bank be doing more?
With more than 1-million people infected globally, the lesson from abroad is to go early and go big in responding to the outbreak, and to employ all possible monetary and fiscal policy tools.
The problem for emerging markets (EMs) is that most were running large fiscal deficits before the virus struck, and the cost of servicing these has soared due to capital flight.
At $62bn in the first quarter, the outflow of foreign portfolio investment from EMs was the largest ever recorded, and roughly twice as large as at the peak of the global financial crisis, according to the Institute of International Finance.
SA is in a particularly weak fiscal position and its access to financial markets at reasonable rates severely limited. This has capped its fiscal response, even compared with other EMs. The R30bn package that the government initially put together represents only about 0.6% of GDP, against packages worth roughly 10% of GDP in the case of both the US and the UK.
"If ever there was a lesson [from the coronavirus pandemic] it’s that you fix your roof before the rain comes so that it doesn’t leak when it does," says Bank governor Lesetja Kganyago. "In economic terms, when the economy is doing well you must build your monetary and fiscal policy and financial stability buffers."
He points out that at the start of the 2008 global financial crisis, SA was running a fiscal surplus and government debt was low, inflation was within the target band, and the banks were well capitalised. "It meant we could deploy all three buffers at the same time."
Coming into this crisis, inflation is below the mid-point and the banks have ample capital reserves. "Can you imagine where SA would be if we hadn’t created these monetary policy and financial-stability buffers?" Kganyago asks. "It’s exactly that which has provided us with the monetary policy space to respond. If we hadn’t had that we’d be talking all sorts of problems for SA policymakers."
In SA, as in other EMs where fiscal policy is heavily constrained, the onus has shifted to central banks to do more of the heavy lifting. Increasingly, EM central banks are turning to various quantitative easing measures, including purchasing their own government’s bonds.
"Until recently," says Liam Peach, an EM economist at Capital Economics, "it would have been hard to imagine that EM central banks would join the club of advanced economies undertaking bond purchases. But the current crisis has ripped up the rule book."
The Bank and six of its EM counterparts (in Romania, Croatia, Colombia, Chile, Poland and the Philippines) introduced such measures in recent weeks. Policymakers in Brazil and the Czech Republic are also pushing for the authority to do so.
Excluding the Philippines, all are buying local-currency sovereign debt on the secondary market to ease liquidity and financial-market stress. Crucially, they are not printing money to purchase bonds directly from their governments in the primary market to fund unlimited fiscal spending — a step known as "monetising the deficit".
In terms of the SA Reserve Bank Act, it is not permissible for the Bank to lend directly to the government or to print money to finance the government deficit.
But even if it were legal, it wouldn’t necessarily be advisable.
"I don’t think it’s appropriate for a central bank to be engaging in quasi-fiscal measures," says Kganyago. "Monetising the deficit is a very dangerous thing. Even the [US Federal Reserve] can’t buy bonds in the primary market because once you do that you no longer have price discovery and the function of a bond market collapses."
Some commentators think it’s dangerous for the Bank to open the door to quantitative easing by buying government bonds in any shape or form. After all, who can forget ANC secretary-general Ace Magashule’s call last year that the Bank use "quantity easing" to make funds available for developmental purposes.
But Stellenbosch University economic researchers professor Monique Reid, Dawie van Lill and Hylton Hollander believe the Bank’s track record of fierce independence gives it room to use all the instruments at its disposal in defence of financial stability, and that buying bonds is completely justifiable in terms of its mandate.
"While these measures may have some positive impacts for government, it would be a stretch to argue that this was the primary motive," they say.
Kganyago acknowledges that there is a big burden on central banks the world over to do more to counter the outbreak. "We’re in a fortunate position because we’ve got monetary policy space and are able to use it. What we’ve done has been within our mandate and in accordance with the Reserve Bank Act," he says.
So far, in addition to cutting the repo rate by 100 basis points, adding an additional repo window and intervening in the bond market, the Bank has reduced banks’ liquidity coverage ratio from 100% to 80% and lowered their minimum capital reserve requirements.
The Bank estimates that the cut in the repo rate alone has put R32bn back into the hands of households and businesses through lower interest costs. In addition, the latter two measures have freed up to R240bn and R300bn respectively for the banks to extend loan repayment holidays or to on-lend to their customers.
But could the Bank be doing more?
Kganyago says he is taking things one day at a time and the jury is still out on the effects of some of the measures taken over the past two weeks. But he adds: "We will not hesitate to use the tools we have."
One measure the Bank can still use is to lower the cash reserve requirement that stipulates banks must keep 2.5% of their adjusted liabilities with the Bank to protect depositors. If Kganyago were to lower this requirement, it would free up even more capital for banks to on-lend.
Sanlam Investments economist Arthur Kamp thinks SA’s economic interventions have been "swift and sensible" to date, but he believes the authorities will need to escalate their response.
"The idea is to get ahead of the problem and to arrest the downturn in the economy, rather than let it get to the point where insolvencies caused directly by Covid-19 arise," he says. "We need to give SA the best possible chance of achieving at least a U-shaped recovery … More interventions, including extraordinary interventions, are required."
Kamp says that if the corporate credit market becomes log-jammed, or if the bank system becomes unwilling to lend, more will need to be done — with the Bank lending to otherwise solvent firms, either directly or through commercial banks.
University of the Free State economics professor Philippe Burger suggests that the Bank establish a cheap-loan programme to get funding to companies to protect their balance sheets until the worst is over.
He explains that instead of the National Treasury paying a subsidy out of the fiscus to distressed companies, the Bank should provide low-interest loans to the banks, which in turn use them to extend low-interest, long-term loans (or to help finance mortgage and other loan repayment holidays) to companies in distress.
The loans from the Bank to the banks should be ring-fenced for this purpose and restricted to companies in need that were solvent prior to the crisis.
Based on the scale of assistance being considered in the EU, the US and the UK, Burger envisages that such a programme might have to be scaled up to about 5%-10% of GDP. (In 2019, total domestic credit extended in SA was roughly 80% of GDP.)
However, Kganyago points out that the Bank cannot lend unsecured money to any entity. If such a scheme were to be introduced, it would have to be underwritten by the National Treasury, which would increase the government’s contingent liabilities. As such, it would have to be driven by finance minister Tito Mboweni, in partnership with the banking sector.
"I’ve looked at the schemes in the US and UK to support business and consumers and they’re all underwritten by their treasuries, so they are fiscal, not monetary, policy measures," he says. "If it were to happen here, we would have to evaluate it against the law, the mandate of the Bank and [the need to maintain] its operational independence."
He adds: "People come with lots of schemes." The most important question is: what is the exit mechanism for taxpayers? A good scheme, Kganyago says, is one that breaks even or leaves the taxpayer holding a profit.
If Kganyago had a mantra, it would be: "Keep calm and stay in your lane."