My many years of experience as an international macroeconomist both at the International Monetary Fund (IMF) and on Wall Street has taught me one thing: It takes many years for a country to build up market credibility, but it takes only moments to lose that credibility. And, once lost, that credibility is not easily or painlessly restored.
{mosads}In last week’s market bloodbath after President Jacob Zuma summarily fired Nhlanhla Nene, his finance minister, one has to hope that this lesson has not been lost on the president and his cabinet. Bold and decisive action, beyond that of bringing Pravin Gordhan back to his old post, needs to be taken soon to correct the damage if the South African economy is not to go into a deep economic recession.
One reason to be concerned about Zuma’s precipitous firing of his finance minister is that it could not have come at a worse time in the global economic cycle. In anticipation of the start of a Federal Reserve rate hiking cycle, the large amount of foreign money that flowed into the emerging market economies during the period of ample global liquidity is already being withdrawn from those economies at an alarming pace.
Similarly, as the Chinese economy shows every sign of slowing, the super international commodity boom of yesteryear has now turned into a super commodity bust. Indeed, international commodity prices have now declined to levels last seen in 2002 and there is little prospect in a slowing global economy that those prices will soon recover.
Equally concerning is the fact that Zuma’s firing of his respected minister took place at a time when the market already had good reason to question South Africa’s economic management. After all, the country was suffering from twin budget and external current account deficits, which were both of the order of 4 percent of gross domestic product. These deficits are the highest amongst the major emerging market economies. It also appeared to market participants that South Africa was losing control of both its public expenditures and its wage settlements.
There are many reasons to fear that the year ahead will be a difficult one for the emerging market economies in general and for South Africa in particular as United States monetary policy is set to diverge further from that in Europe and Japan. This is bound to lead to a strong U.S. dollar and to the further withdrawal of money from the emerging markets. It is also likely to keep pressure on international commodity prices, which continue to be priced mainly in U.S. dollars.
In such a difficult international context, South Africa can ill afford to court the disfavor of the global financial markets on which it has become overly dependent to finance its gaping external current account deficit. This is especially the case when markets are dismayed by South Africa’s apparent lack of public expenditure control, its outsized wage settlements, and its climate of corruption and heavy regulation that make it an unattractive location for foreign investment.
The country can also ill afford to have the South African rand long remain anywhere near its current very depressed level. A weak rand is bound to translate into very much higher domestic inflation. That, in turn, risks forcing the Reserve Bank to raise interest rates and to plunge the country into a recession.
Bringing back the internationally well-respected Pravin Gordhan to his old post is a welcome development. However, it will not be nearly enough to restore the country’s tarnished image abroad in light of its recent political fumbling. Rather, what investors will be looking for are concrete measures in the budget policy area that would show that the country is seriously addressing its basic savings deficiency. Investors would also want to see real reforms to the country’s wage-setting procedures and to its regulatory framework that might put the country on a sustainable economic growth path.
It is of course conceivable that the South African government can restore investor confidence on its own. However, confidence would more easily and more quickly be restored were it to be done with an external seal of approval. This raises the question whether South Africa might not be advised to turn to the International Monetary Fund or to some other highly regarded international body for support in its confidence rebuilding exercise.
Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.