The current global health pandemic is undeniably both an economic and public health crisis, and is expected to have an enduring societal impact for years to come. Gross domestic product (GDP) growth rates will decline significantly, as economic activity is curtailed and will only recover over the medium term. As is already evident, budget deficits, particularly in South Africa (SA) and other frontier and emerging markets, will balloon as governments try to spend their way out of the problem. For SA, current estimates of GDP contraction range from 6% to 10% over the current year, with a moderate rebound subsequently in 2021 and 2022, depending on the optimism of the forecaster and whether they expect a V-, U-, W- or L-shaped recovery. On average, most commentators only expect economic activity to reach 2019 levels in 2022/2023 in most countries.
With the focus now turning towards the post-COVID aftermath, it is becoming clearer that the costs associated with both the economic stop as a result of the government-instituted nationwide lockdown and the public health reaction only represent the initial bills to be paid in the fight against the virus. An economic stimulus will also be required to restart the economy and place it on a growth trajectory. The combined cost will be more than any other programme seen outside of wartime. For SA, estimates put the projected budget deficit at over 12-15% of GDP, while government debt to GDP could go over 100%. Interest rates have already been cut to long-run lows, and it is unlikely any further cuts can actually stimulate or help the economy to restart.
The finance minister will table an amended budget this month that will seek to fund the economic restart plan and answer two key questions on most people’s lips: how much is needed and where will this money come from? This is especially pertinent for SA, which went into the crisis with an already weakened fiscal base, and has already committed to reprioritising and borrowing significant amounts in just addressing the first two actions. What about the third action? Suggestions have included borrowing from multilateral agencies, the issuance of a special “COVID Bond”, increased taxation and bond issuance among others. The key issue, however, is that, regardless of funding sources, spending needs to be incurred upfront in order to kick-start the economy and put it onto the right footing.
Yet another question being asked is how will all of this borrowing be paid back? Undoubtedly, the risk of falling into a debt trap is significant. Economic studies have shown us that when debt service passes certain levels, it becomes impossible to manage as income becomes increasingly diverted away from productive uses in order to pay down interest.
Herein lies SA’s problem. Even before the pandemic struck, the combined burden of declining tax revenue, dysfunctional state-owned enterprises (SOEs) and the rapidly rising debt burden had already brought the country to the precipice. At this point, any significant further domestic borrowing risks crowding out the private sector, while international borrowing has become more expensive with the loss of our investment grade status, and the conditionality around multilateral lending remaining a significant concern.
Some commentators have spoken about quantitative easing (QE), an elegantly appealing model that explains how, in simple terms, the government would expand its monetary base by printing money and using this currency to repay its debts. While seemingly unrealistic, there are sound fundamental reasons why such an approach can be considered reasonable and even rational at times like these. To do this, we will now explain the meaning of QE, how it works and why it may be the answer to the questions above.
What is quantitative easing (QE)?
QE is a tool that central banks such as the South African Reserve Bank (SARB) use to inject money directly into the economy to boost spending and investment. They do this by creating new money to buy government bonds or other securities, primarily from the Treasury.
How does it work?
The SARB creates new digital rands and sends them to the Treasury, which in turn sends back a treasury security indicating that the Treasury has borrowed new money from the SARB. Given that this is new money, it allows the government to add to the amount of money already in circulation in the economy when it spends this new cash. This would typically have occurred through the primary dealer banks. As an alternative, if the banks had bought securities from the public or reduced taxes, the aggregate money supply would have remained constant. With this method, however, money supply increases when they opt to spend the freshly created cash.
Why is it such a controversial model?
There is great concern that QE causes high inflation (for example, hyperinflation as experienced in Zimbabwe, Venezuela, as well as in Germany after the Second World War) as the amount of currency in circulation increases without a corresponding increase in the productive resource of the economy. Others suggest, however, that it has no impact on inflation because the newly created money does not reach the ordinary man on the street, or that the increase in printed money is offset by the deflationary forces of rising debt. What drives controversy is that the debate always goes to either crippling deflation (declining prices on account of inadequate spending or demand), or hyperinflation (continually rising prices on account of excessive currency relative to resources). There appears to be no middle ground.
What is the catch?
On the surface, this seems like a well-designed solution, which could be applied with very little cost to society: create currency from nothing and pay down SOE debt, invest in infrastructure or reduce taxation. The catch, however, is that this the newly created money must be used in such a way that it increases the levels of productivity in society. The growth it catalyses ensures that over time, the country’s increased monetary base would be offset by its increased productivity, i.e. higher GDP per capita, which increases the productive resource in the economy.
Why do we think this is a plausible path to follow?
In truth, it is a poorly kept secret that even before the pandemic, SA’s finances were already well stretched, hence the downgrade and the higher-than-average yield on the local currency bonds. It is therefore clear that the likelihood of securing sufficient debt to resolve the old problems and restart the economy is very low. The alternative solutions that have been proposed, such as selling assets, using pension funds, or prescribed asset legislation, have seemingly limited scope or magnitude and also come with some significant downsides to be reckoned with. In reality, only a significant shift in paradigm can push us away from the brink and allow the country to chart a new path for all its citizens.
The path requires some sincere introspection
We have to ask ourselves some tough questions:
a) Does paying down South African Airways or Eskom debt using QE generate increased productivity in the absence of a plan that prevents them from going down a similar path that brought them to their current financial worries?
b) Does it make sense to persist with significant wage adjustments for government employees at a time when unemployment is rife and many others stand to lose their jobs in the absence of a significant stimulus plan – particularly considering that the current contribution to total government expenditure that relates to public sector wages ranks among the highest in the world as a percentage of GDP?
There is also the moral hazard involved. If we are sure that it was state capture or corruption that brought some of the state-owned institutions to their knees, then surely some punitive action is expected.
In summary, yes we can pay, but…
At a time of significant need, such as today, the debate about what instruments we can or cannot use to rescue the economy should not be limited to affordability. Instead, the focus should be on how best the spending can be directed to firstly fighting the pandemic, secondly to resuscitating the economy, and finally to increasing future productivity to ensure that adequate productive resources are created. At this stage, the goal of monetary and fiscal policy should be that of creating a balanced economy over time and not just a balanced budget.
Debt monetisation as required under QE should not be viewed as either a game-changer or a catastrophe. For now, government should continue putting more emphasis on protecting the health of the economy and all South Africans. In the words of the US Federal Reserve Chair, Jerome Powell, governments must do “whatever it takes”. The South African government should cut back on unnecessary expenditure and focus on spending that can stimulate the productive capacity of the economy. Concerns about the budget deficit and high debt levels should only be reviewed over the medium to longer term.
In conclusion, it is important to recognise the unique situation we find ourselves in. Rarely has there ever been a situation where both supply and demand sides of the economy have been brought to a complete standstill. The tools we have used up to this point are no longer able to summon the level of investment required to start up production, while providing consumers with sufficient confidence to restart consumption and get the economic chain working. Thousands of people have lost their jobs, while many businesses have had to shut down. We cannot expect a return to normality without an extraordinary push. We think QE, as we have described it above, or some form of it, provides SA with the opportunity to restart its economy while plotting a new sustainable path into our “new” world.