Growth is the problem in SA, not inflation

Fiscal and monetary policy in the US and SA will command close attention in 2022. The US will be expected to adjust to its success in overcoming the Covid-19 threat to its economy, which has led to excess in the form of higher inflation.

Larger fiscal deficits that approached 16% of GDP in late 2020 were incurred to supplement incomes, with cheques drawn on the treasury causing the rise in the federal debt-to-GDP ratio to 128%. Consequently, the ratio of money (bank deposits) to income (GDP) is now 25% higher than before Covid-19.

This huge stock of money will continue to be exchanged for other assets, goods and services when the time is right. The money will not go away, it will merely lose more of its real value as prices — asset prices too — rise at the inflation rate.

It is now a question of how much and how quickly interest rates will rise to restrain spending. Longer-term rates may rise should inflation be expected to rise permanently, which is not yet the case.

The problem with higher interest rates is that they have important fiscal implications. Paying higher interest rates to keep the bond market open to issuance of more government debt takes away from other spending and may demand higher taxes or less government spending, which does not make governments popular.

Given the current low cost of raising debt, the US remains in a favourable fiscal position. The average yield on federal debt is below 2%, while the debtservice ratio — interest paid relative to the federal budget — is below 9%. It was about double that rate in 2000, when the debt-to-GDP ratio was about 50%.

Every percentage point increase in the average cost of funding US debt means an extra $250bn of interest paid out on top of the current $500bn in payments. It will require a resolute, politically independent and inflation-fighting central bank to tame inflation.

The comparison of SA with the US is not altogether unfavourable. Our debt-to-GDP ratio is much lower — only about 60%. The debt-service ratio is significantly higher, equivalent to 13% of the national budget, but it was more than 20% in 2000. The average yield on all RSA treasury debt has gradually fallen to about 6%

from 10% in 2008.

The Reserve Bank did not do quantitative easing (mistakenly in my view). Broader money supply has hardly grown since early 2020. The money-to-GDP ratio has fallen back to where it was before Covid-19. There is no excess demand.

Of further relevance is that SA government revenues have been growing significantly faster than government expenditure, thanks to global inflation reflected in higher metal and mineral prices, leading to higher taxable mining incomes. Monetary and fiscal policy settings therefore remain austere, which explains why the economy is growing so slowly.

The problem is that our market-determined credit ratings have remained unchanged and our cost of raising long-term debt is therefore high. SA pays about 8% more for 10-year money than the US. Even more discouraging is the extra real 4% we offer on long-dated inflation-protected bonds.

Every one percent move in the SA government’s borrowing costs is worth an extra R37bn a year to the Treasury. Lower interest rates would also reduce the returns required by businesses and help revive the very depressed rate of capital expenditure. The world of bond investors demands compensation for the risk that SA will sooner or later confront a debt service trap, and that printing money — and the accompanying debt-destroying inflation — might be the preferred escape. They are far more generous to the US.

It is fundamentally the failure to grow faster that puts government revenues and budgets at risk. The best SA can do in 2022 to lower borrowing costs would be to sustain a smaller fiscal deficit. And for the Reserve Bank to recognise that growth — not inflation — is the problem, and set short-term interest rates accordingly to keep debt-service costs down and improve tax revenues.