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

1. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

2. 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 economy This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

3. Household Final Consumption Expenditure Source: South African Reserve Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

4. Rapidly Growing Household Debt Source: South African Reserve Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

5. Very High Level of Household Debts Relative to GDP Source: Relevant central bank reports This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

6. Low Household Savings Explain the Low Gross Domestic Savings Source: World Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

7. 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? This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

8. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

9. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

10. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

11. Portfolio Inflows in BRICS before the Crisis Source: The World Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

12. Portfolio Equity Inflows are More Volatile than Bond Inflows Source: The World Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

13. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

14. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

15. Trade Deficits Account for Only Half of the Current Account Deficits Source: The World Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

16. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

17. Market Capitalization as Percentage of GDP in BRICS and other Economies This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

18. Market Capitalization Trends in BRICS: 1990-2010 Source: The World Bank This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

19. Share of Financial Services in GDP This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

20. Compensation of Financial Sector Employees as Percentage of Total Value Added This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

21. South African Banks are Highly Profitable! This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

22. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

23. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

24. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

25. Pace and State of Financial Market Liberalization in BRICS This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

26. Claims of Foreign Banks in BRICS This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

27. 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 This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

28. Highly Pro-cyclical Foreign Bank Lending This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter

29. 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? This does not represent the views of the UN or its member states. Not to be quoted or reproduced without the permission of the presenter