Publications
Partners
THE deficit on the balance of payment current account is the result, or the consequence, of other events in the country's economy. Because of this, the deficit or surplus on the current account itself cannot play any role in the formulation of monetary or fiscal policy.
It was in words to more or less this effect that the chief economist of the SA Reserve Bank responded years ago to a proposal by Afrikaans commercial body the Afrikaanse Handelsinstituut (AHI) that the country should draw up a balance of payments policy to cope with the typical stop-go economic policy at the time.
The idea was that I, as a youngster, would second the AHI proposal by one of the country's leading private-sector economists. Luckily, the tide turned, forestalling the chance of me making a fool of myself all those years ago.
The current account is simply the result of other events in the economy, and it's these other events that must be addressed by policy, not their consequences. This will be obvious at a glance to any student of financial affairs looking through the national accounts.
Economists and commentators with a fixation on the current account deficit of about 8% of the gross domestic product are correct if they turn their attention to the consequences, but wrong if they draw policy conclusions from the deficit itself.
Monetary policy and interest rates in particular do not focus on the current account deficit, but on its causes.
Perhaps the following simple interpretation of the national accounts will help.
Economic activity at any given time can be summarised as follows:
Y=C+S
Where Y = income, C = consumption and S = savings.
If income Y is under pressure, as is the case at present with an impending worldwide economic recession, the authorities cut interest rates sharply, and they also help by throwing fiscal discipline out of the window, cutting tax and chasing expenditure.
When consumption C is too high, causing rising prices and inflationary conditions, the Reserve Bank increases interest rates.
The simple Y=C+S equation can also be formulated as Y=C+I. Here, I is investment, or, more fully, gross capital formation. Simplification of the two equations leaves S=I, gross savings = gross capital formation.
That's an idyllic situation and only occurs for a few moments in an economic cycle, just like a broken watch is right twice a day.
In an economic cycle, it's more usual for S>I or S
If the present current account deficit on the balance of payments is simply the result of domestic capital formation exceeding gross savings, it's clear that monetary policy (interest rates) must still address consumption (C), so that savings (S) can increase.
Getting Y, that is economic activity, to grow in the short term, so that deficits can be eliminated, is simply not possible.
The Reserve Bank's latest Quarterly Bulletin shows gross savings in SA for the year to December 2007 as R281bn.
Gross capital formation was R426bn. That gives a deficit of R145bn, which is exactly equal to the current account deficit of the balance of payments. The R145bn is more than compensated for by the R185bn capital inflow into SA in 2007.
This means that the difference between domestic gross savings and domestic gross capital formation, the current account deficit, could easily be financed by foreign capital, and that there even was a foreign capital surplus that could be used to supplement the country's foreign exchange reserves.
Economists and analysts' fears are that not enough money will flow into the country in 2008 to finance the difference between S and I, the current account deficit.
This is quite a valid fear, especially if we look at the current net sales of listed shares on the JSE by foreigners. Some economists' methods of interpreting and dealing with the current account deficit and the heavy financing don't always sound right, because just like the AHI in the past, we want to focus on the current account deficit rather than on its causes.
Remember that the deficit is merely the result of what is happening elsewhere in the economy.
Shift the focus to the causes, with consumption (C) that is still so high that there is little left for savings (S), and it's clear that there is little, if any, room now for lowering domestic interest rates simply because consumer prices are falling here and there, mainly as a result of the fall in the crude oil price.
The second myth is that a devaluation of the currency will make the large difference between S and I disappear. SA's ministers of finance of 15 to 30 years ago used to believe this myth.
A devaluation, such as the recent approximately 20% weakening in the weighted exchange rate of the rand, helps in the long term.
It restores the competitive ability of locally-manufactured goods against imported competitors and helps with the profitability of exports. However, a devaluation is valuable only if its inevitable inflationary effect can be checked with high interests.
The current account deficit doesn't say that interest rates must rise or fall. The deficit is merely the result of other economic forces, such as consumption, which is still too high, and savings, which are still too low.
These two economic forces show that there is not yet any room for a fall in interest rates in SA.
- Fin24.com
