Capital Flows, Credit Markets and Growth in South Africa

The Role of Global Economic Growth, Policy Shifts and Uncertainties

Nombulelo Gumata, Eliphas Ndou

• Publisher: Palgrave Macmillan
• Year: 2019
• ISBN:
  9783030308889
• Topic: Business
• Subtopic: International Business
• Index: Business

This book examines the dynamics in capital flows, credit markets and growth in South Africa. The authors explore the role of global economic growth, policy shifts and various economic policy uncertainties. Central banks in advanced economies are engaged in unconventional monetary policy tools such as balance sheet policies, negative interest rates and extended forward guidance to assist them to meet their price, financial and macro-economic stability objectives. This book determines whether BRICS GDP growth is a source of shocks or an amplifier of global growth shocks. The authors find that global economic growth and policy uncertainty reinforce each other via capital flows, credit conditions and business confidence on the domestic economy. Furthermore, they demonstrate that there is momentum in the changes in the spread between the repo rate and federal funds rate. In addition, global real policy rates impact domestic GDP growth and labor market conditions. The authors examine the economic costs of capital flow surges, sudden stops and elevated portfolio volatility shocks and their interaction with GDP growth and credit. They show that equity and debt inflows matter in the attainment of the price stability mandate. Moreover, business confidence transmits sovereign credit ratings upgrades and downgrades shocks to the real economy via GDP growth, the cost of government debt and borrowing to impact credit growth. High GDP growth increases the likelihood of sovereign credit ratings upgrades, hence policymakers should implement pro-growth policies. Inflation regimes impact the transmission of positive nominal demand shocks to the price level. Low and stable inflation (inflation below 4.5 per cent) reduces the pass-through of positive nominal demand shocks to inflation.

© The Author(s) 2019

N. Gumata, E. NdouCapital Flows, Credit Markets and Growth in South Africahttps://doi.org/10.1007/978-3-030-30888-9_1

Begin Abstract

1. Introduction

Nombulelo Gumata¹ and Eliphas Ndou^{1, 2, 3}

(1)

South African Reserve Bank, Pretoria, South Africa

(2)

Wits Plus, University of the Witwatersrand, Johannesburg, South Africa

(3)

School of Economic and Business Sciences, Johannesburg, South Africa

Nombulelo Gumata (Corresponding author)

Eliphas Ndou

End Abstract

The period subsequent to the global financial crisis highlighted that global demand plays an important role in driving economic recoveries. At the time, when global policy uncertainties have become elevated and global interest rates reached low levels to mitigate the adverse effects of these uncertainties. Current global growth is characterised by diverging GDP growth rates with the United States of America (US) growing at a high pace while the Chinese growth is slowing down. The World Bank and IMF downgraded the world economic growth forecasts, following heightened trade tensions between China and the US. We apply a variety of econometric techniques to capture various aspects of the transmission of global and domestic shocks into the South African macroeconomy. We test several hypotheses to determine whether they are agreeable and relevant for the South African economy. In all instances, we use various econometric techniques to assess the robustness of the empirical findings and the policy implications derived from the results.

Recent developments which happened during the writing of this book include the following:

• Most central banks in advanced economies have not wound down their balance sheet policies, some embarked on negative interest rate policies and have extended forward guidance to assist them to meet their price, financial and macroeconomic stability mandates.
• South Africa’s sovereign debt credit ratings has been downgraded further by the Standard and Poor as well as the Fitch rating agencies. However, Moody’s rating agency is still maintaining South Africa’s investment rating level.
• The US Federal Reserve Bank (Fed) raised the policy rate at the end of 2015 in an effort to normalise the policy rate settings. This monetary policy stance was supported by high economic growth, very low unemployment and a promising rebound of inflation towards the target. However, the Fed has since reversed course in July 2019 and started easing the monetary policy stance in order to achieve its price stability mandate and support the growth expansion. This contrasts with South Africa, which has had to deal with extremely low growth, a recessionary environment accompanied by increasing unemployment, bouts of sharp exchange rate depreciation shocks and elevated inflationary shocks. This has implications for capital flows and the financing of the current account. Changes in investor risk perceptions are evident in the changes in the direction of the purchases of domestic assets by non-residents.
• Trade tensions between the US and China continue to weigh on global trade activity. China also experienced a slowdown in economic growth in recent times. These global developments have heightened global growth and trade policy uncertainties regarding the momentum of global growth.
• The South African Bureau of Economic Research business confidence index has remained below the midpoint for most of the time post-2009, indicating the persistently low levels of confidence.
• Domestic credit growth has also remained weak even during times of elevated capital flows.

This book is divided into six parts which cover diverse themes. Part I covers the effects of global economic growth and trade uncertainty on the South African economy. Part II focuses on global interest rates and how they are transmitted into the South African economy. Part III deals with capital flow surges, sudden stops and elevated portfolio inflow volatility shock effects. Part IV focuses on the transmission of sovereign debt credit ratings downgrades into government debt costs and real economic activity. Part V deals with the output–inflation trade-off and the role of external shocks, labour market conditions and inflation expectations in shifting the Taylor curve in South Africa. Part VI focuses on the policy ineffectiveness issues.

1.1 Why Do We Author This Book?

We dedicate a number of chapters in the book to deal with the role and transmission of global economic and trade policy uncertainty, the policy normalisation process by the US Fed, global real policy rates and the role of Brazil, Russia, India, China and South African (BRICS) GDP growth as sources of shocks and/or amplifiers of global growth. The book also deals with the policy trade-offs as captured by the Taylor curve. We explore how external shocks; labour market conditions and inflation expectations shocks shift the South African Taylor curve. We also dedicated a number of chapters to explore the transmission of sovereign debt credit ratings downgrades, consumer and business confidence shocks into the South African credit markets and the real economy. This is accompanied by various chapters which deal with the role and interaction of capital flow surges, sudden stops and elevated portfolio inflow volatility shocks. We explore the nature of their interaction with output and credit growth and their economic costs, thereof.

1.1.1 There Are Policy Shifts in the Global Economy Which Include Trade Policies and the Role of Global Economic Growth Impulses

Figure 1.1 shows that global economic policy and trade uncertainty have increased. These economic uncertainty indices have featured strongly in academic and policy discussions and debates in recent years. It remains unclear as to how these global policy shifts and trade uncertainties will be resolved and their effects on the domestic economy thereof. At the same time, the direction of capital flows and the availability of global liquidity are interlinked and transmitted through various channels to affect the domestic economy. This book fills academic and policy research gaps on the transmission of global economic policy uncertainty, capital flow episodes and sovereign debt credit ratings shock effects into the South African macroeconomy.

Fig. 1.1

Global economic policy uncertainty and the US trade policy uncertainty. (Source: http://​www.​policyuncertaint​y.​com/​global_​monthly.​html)

1.1.2 The Extent to Which BRICS Growth Could Be a Source of Shocks and an Amplifier of Global Growth Responses Is Unknown

The South African GDP growth has been very weak and volatile post-2009. However, pre-2009, South African (SA) GDP growth was more comparable to global GDP growth and well above that of the US as shown in Fig. 1.2. Furthermore, SA GDP growth has remained well below its 2000–2016 average growth since 2011. At the same time, US growth recovered and has oscillated around its 2000–2016 average growth.

Fig. 1.2

Global, US and South African GDP growth. (Source: South African Reserve Banks, IMF database and authors’ calculations)

Of note is the fact that post-2009, US and SA average growth converged towards 1.5 per cent, the positive association and correlation has increased and yet, the US economy has managed to lower the unemployment rate to pre-2009 levels in stark contrast to the SA experience. What might explain this divergence? In part, the divergence might be explained by the persistent divergence and decline in SA GDP growth post-2013 when global and US recovered and continued to increase as shown in Fig. 1.3. The implication of global and US GDP trends is that, had SA GDP growth remained at minimum 2010 and 2011 growth rates and maintained these levels of growth momentum, SA GDP growth would have compared favourably with average global and US GDP growth.

Fig. 1.3

Global, United States and South African GDP growth post-2009. (Source: South African Reserve Bank, IMF database and authors’ calculations)

At the same time, the 2009–2016 average global GDP growth of 3.4 per cent in Fig. 1.3 would have been more than enough to persistently lower the unemployment rate in South Africa as suggested by vast empirical evidence. In addition, Fig. 1.4 shows that SA growth is positively associated with global trade albeit, very weak relative to global growth. These trends indicate that SA can use the “exports-led GDP growth” strategy to benefit from global trade growth. The association of SA GDP growth with global trade growth indicates that there is room for improvement.

Fig. 1.4

Global GDP growth, trade and South African GDP growth. (Source: IMF database and authors’ calculations)

1.1.3 Changes in the US Fed Funds Rate, Global Real Policy Rates Matter for the South African Economy

The US Fed normalised its policy settings December 2015. We explore the implications of this by assessing the direction in which there is a momentum effect in the changes in the long run spread between the repo rate and the Federal Funds Rate (FFR). Evidence shows that the starting point matters for such an analysis as shown in Fig. 1.5. The repo rate-FFR spread hardly moved during the period of the FFR zero-lower bound. The level of the repo rate was the same as the repo rate-FFR spread. This means that the repo rate movements explain all the variation in the repo rate-FFR spread during the zero-lower bound of the FFR. However, the spread has adjusted as the US Fed started to increase the policy rate. The scatterplots in Fig. 1.5(b) indicate that the repo rate movements explain almost 42 per cent of the variation in the repo rate-FFR spread over the sample period.

Fig. 1.5

The repo rate and the repo rate-FFR spread. (Note: Grey-shaded area represents the period of the zero-lower bound for the US FFR. Source: South African Reserve Bank and Fred data)

Central to the repo rate adjustments is the performance of domestic inflation relative to the inflation target as shown in Fig. 1.6. The scatterplots in Fig. 1.6(b) show that inflation is positively associated with repo rate-FFR spread. In addition, inflation explains about 34 per cent of the movements in the repo rate-FFR spreads. The slope of the relationship suggests that a one per cent rise in inflation raises the repo rate-FFR spread by about 0.52 per cent. The policy implication is that low and stable inflation has benefits for the level of the repo rate-FFR spread. Furthermore, this evidence further corroborates the findings in the book indicating that inflation below 4.5 per cent within the target range reduces the pass-through of positive nominal demand shocks to inflation.

Fig. 1.6

Headline inflation and the repo rate-FFR spread. (Source: South African Reserve Bank, Fred data and authors’ calculations)

1.1.4 To Show That the Policy Trade-off Between Inflation and Output Volatilities Is Im...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• Part I. Global Economic Growth, Economic Policy Uncertainty and The Influence of Trade Dynamics
• Part II. Global Policy Rates and The South African Economy
• Part III. Capital Flow Surges, Sudden Stops and Elevated Portfolio Inflows Volatility Effects
• Part IV. The Transmission of Sovereign Debt Credit Ratings Downgrades and Upgrades into the Credit Markets and the Real Economy
• Part V. The Output–Inflation Trade-off, External Shocks, Labour Market Conditions and Inflation Expectations
• Part VI. The Policy Ineffectiveness Issues
• Back Matter