The federal budget is out of control – Ronald Reagan, 1981
This rather famous take on America’s domestic finances resurfaced in my memory when it played on a TV in the background in the heart wrenching movie, The Pursuit of Happiness.
Reagan was the American president who believed a sound economic future can only be secured on a budget surplus. He worked tirelessly during his tenure to ensure American finances come back in line.
In 1981 it was a budget problem. In 2015 the jury is still out whether it is a budget problem or a bloated Federal Reserve balance sheet that is out of control. When one approaches the problem from the House’s point of view, it is a budget problem. When one sits in the Federal Reserve chairman’s seat, it is a balance sheet problem, and a very severe one.
For more than a year, the US Federal Reserve has been signalling the need for “normalisation” of short term interest rates. So far, this intent has not been followed up by action. But every time there is a whiff of an interest rate rise, the markets react in some way. It happened last year, it happened early this year, then again two months ago, and now it seems it will happen again before Christmas. I read so many analysts who have simply given up trying to time the Federal Reserve’s anticipated interest rate move.
In the meantime, even very liquid markets in developing countries get hammered and emerging currencies are taking a knock. The Rand, for instance, has weakened by about 30% over the past year, starting its precipitous decline early in December last year, when international markets again went into convulsions over a US interest rate hike. Granted, all the local ails are not entirely due to dollar strength and American interest rates, but the culpability of the South African monetary authorities pale in comparison to macro-economic shifts in global trade. All emerging market currencies have taken a beating of some sorts during the past year.
If we look at local conditions, it is relatively clear that there is not much room to move as far as the South African repo rate is concerned. In October the Bank of Namibia opted to keep interest rates on hold, citing local household indebtedness and adverse domestic economic conditions. Two weeks before that the South African Reserve Bank punted more or less the same line when it too, chose not to increase the repo rate. That was offered as a unanimous decision of the Monetary Policy Committee of the SARB.
However, this week, the Reserve Bank changed its tack, announcing on Thursday the SA repo rate increases by 25 basis points to 6.25%. This was not entirely a surprise given the dismal exchange rate but it certainly places a different slant on their very weak growth prospects for this year. It also brings an obnoxious flavour to earlier monetary policy statements where stable interest rates were sold as the universal remedy for consumer retraction and economic weakness.
But when the Rand started hitting a new record low, every second week or so, reality finally knocked on the SA door. Interest rates had to go up only this time there was another valid excuse, the Rand has gone through the floor.
After Thursday’s announcement, local sentiment improved slightly and the Rand ended the trading day marginally stronger but still 4 cents north of R14 for one American dollar. It remains to be seen what happens to the JSE Allshare index between now and December.
The point for us to consider is how long this yo-yo sentiment in international markets will continue to harm our local economies. When the Federal Reserve signals an interest rate increase, the Rand tumbles but it never fully recovers when the scare dissipates. And when the next Federal Reserve announcement is made, it weakens again, going even weaker than what is was the previous time.
For us this creates a particular conundrum. We think we need the link to the Rand to effect and protect our international trade but I am no longer convinced of the soundness of this point of view.
Going by happening with some of our other neighbours, perhaps we should consider going for a link to another currency or to a basket of currencies. Of course in the end, this can only work if our own house is in order. Using macro-economic benchmarks, I would say this is the case. Applying micro-economic criteria, I am wondering about the soundness of the Namibian House.
The bad news for local consumers is that the Namibian repo rate will probably increase by 25 basis points at the next MPC meeting in December.