Investment, not regulation, will drive growth – Kganyago

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JEREMY MAGGS: South Africa has strengthened its financial defences, but the economy remains trapped in low growth, failing municipalities and declining living standards.

Reserve Bank Governor Lesetja Kganyago suggests the country protects powerful incumbents, regulates too much, and is unwilling to take the risks needed to grow. But what interests is he talking about and what exactly must change?

Also, I imagine forecasting, scenario planning and modelling must have become a lot more difficult for him and the MPC (Monetary Policy Committee).

So, Governor, let me start with this, we are living in a fast-moving and increasingly complex world, I wonder how difficult it’s become for you and the MPC to both forecast, scenario plan and model.

LESETJA KGANYAGO: It has become more difficult. Not that it was easy before …

JEREMY MAGGS: Why?

LESETJA KGANYAGO: Well, I’ll tell you a word, the one thing that impacts on the decisions we make is our ability to paint an outlook of what we think the future looks like, and setting up policy for that environment.

The impact of the policy decisions we make as the Monetary Policy Committee, get felt 12 to 18 months down the line.

So we invest a lot of resources, both technology and people, in forecasting what we think will happen to the economy over the next two to three years, and then set policy in that manner.

In an environment where key commodity prices like oil and exchange rates could move on the basis of a social media posting from someone powerful, it becomes very difficult to forecast, and the question becomes then how do you navigate in that environment?

You would notice that we now provide a forecast.

The way in which we had navigated this was we put on a forecast and we say, what are the risks to those forecasts? So we will say there are upside or downside risks to inflation or there are upside or downside risks to growth and then set policy on that basis.

But now we are having to do scenarios to say, what if this happens or what if that happens?

So we will find that we have done scenarios about the oil price and we had to do scenarios now about the potential for an El Niño setting in, identify the channels through which those uncertain events would actually feed through the South African economy and, in a way, say to economic agents should this play out, this is how policy will adjust.

If it plays out this way, this is how policy would adjust. It is now becoming an increasingly common approach by central banks now to set out scenarios of what they think could happen in the future.

JEREMY MAGGS: Based on those scenarios, Governor, what do you see then as the biggest short-term risk facing the country right now?

LESETJA KGANYAGO: I will talk to both growth and to inflation and say that with respect to inflation, we had identified geopolitical risks, which is central bank speak, for saying that there are wars taking place and how those geopolitical risks would impact on a key commodity like oil.

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In many instances, you would find that central banks can navigate dealing with high oil prices. It’s quite another where you also have that the price is not just high, but it is difficult to actually access the oil.

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We’re fortunate in South Africa because we are still able to access the oil, but for the other countries that, for example, rely on oil going through the Strait of Hormuz or going through the Suez Canal, it becomes a challenge.

Be that as it may, even for countries that are like South Africa, which are able to access crude oil, it comes at a price. So you have that.

Again, if the price shock comes and you say, okay, the price has risen to this level and it stays there, you can set policy easily on that basis. But if it goes up and comes down, like in the manner that we have seen, where it becomes volatile, it becomes very difficult to set policy.

That is a risk to the inflation outlook.

But the challenge is these geopolitical risks have led to a situation where you are not just having an impact on the availability of crude and the price of crude, but it is also impacting on the availability and access to fertiliser.

Again, South Africa was fortunate that when the war broke, we had already gone past our planting season. The planting season is coming, and we are going to have to access fertiliser, which we have access to that. Combine that with the possibility that we could have a severe El Niño, and if that sets in, it’s going to also impact on food prices.

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So there is a risk that food prices could be impacted firstly via the fertiliser and secondly through the impact of the weather on agricultural production.

Then, of course, on the growth side, oil is also an important input. It’s an important energy asset. It does have an impact on growth, but the impact of the oil price is more pronounced on the inflation front than on the outside.

The other impacts to growth, of course, have to do with the global factors.

Those global factors affect the demand for South African exports. But we still have our own domestic constraints. Every business has got to operate from a particular locality, and if municipalities are not functioning optimally, it has got an impact on economic activity.

JEREMY MAGGS: Governor, against that backdrop then, you say that South Africa must take uncomfortable risks, I think your words. What is the single biggest risk then, that you think we need to take right now?

LESETJA KGANYAGO: I talk to a lot of people and they like saying that, and I say there isn’t a magic bullet here. We had identified this and for South Africa, the stuff that we had painted that had to be done that we identified, government’s programme and response to that is Operation Vulindlela.

To keep government honest, Business Leadership South Africa has got this BLSA Tracker. It makes for fascinating reading. I try to visit that tracker once a week. It’s only Thursday today, so I still have time to get through that tracker.

It just paints the steps that we have to take in order to make progress. It would then also state where government is actually lagging behind in those circumstances.

JEREMY MAGGS: So Operation Vulindlela then is targeting the right reforms, I think that’s common cause, but also moving too slowly. Who should be accountable for the delay?

LESETJA KGANYAGO: Well, you would say that Operation Vulindlela is being driven by government, so it goes without saying that if there is a delay, it means government had not taken particular steps.

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But you’ve got to give it to South African business here, because South African business decided that they would partner with government in particular ways.

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One of the conversations you should have is actually with Business Leadership South Africa, because they had identified particular work streams that they are working with government on and in all of those streams, in many respects, you will find, well, government must still do this, government must still do that.

So government has got to come to the party here.

Jeremy, when we look back, you would say that we are lagging behind in terms of not just economic growth, GDP per capita growth. We’re not just lagging behind there. We are lagging behind in investment.

At the top of the cycle, around 2005, 2006 and early 2007, this economy was talking of investment-to-GDP of around 20%, closer to 20%, and we were talking about raising that to 25%. We are now bubbling at just around 15% or just below 15%.

That is problematic. You are not going to get growth unless you have investment, and that talks to the investment environment.

When you talk to people whose job it is to pass legislation, and generally when you say that you have a problem, they will think about passing even more legislation or even more regulation. We need a different conversation about the investment environment.

JEREMY MAGGS: Let me circle back to something you’ve just said. Government must come to the party. In what way?

LESETJA KGANYAGO: The programme has been announced, it’s Operation Vulindlela. Vulindlela basically means open up the way, open up the path.

JEREMY MAGGS: And the consequences of falling back further and further are what?

LESETJA KGANYAGO: I do not see us falling back again. We are making progress. The progress is still slow, but we have definitely turned the corner. That is actually recognised. Unfortunately, in the conversation in South Africa, you find a discourse that almost says that the problem is our macro settings.

Yes, we had a problem with our macro settings a couple of years ago, but our macroeconomic anchors are now in place, both monetary and fiscal. They are now in place. Now the challenge for us has to do with this structural reform. That is where you’re coming up with Operation Vulindlela.

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Interestingly, the Bureau for Economic Research at the University of Stellenbosch did a study that showed that if Operation Vulindlela is implemented, we could actually accelerate growth by up to 2%. When I’m saying up to 2%, I’m not saying to 2% but beyond 2%.

JEREMY MAGGS: Do you think, Governor, municipal failure has now overtaken Eskom as the greatest domestic threat to economic growth?

LESETJA KGANYAGO: I wouldn’t say the greatest, but it is a big threat. Let me paint this picture so that we can get to it. Eskom has got a huge build programme ahead of it, including … transmission and so forth. That build programme has to be funded.

It gets funded through Eskom generating resources, and those resources are from electricity sales, and it has to be funded with Eskom borrowing money in the bond market. That money must be repaid.

Eskom sells electricity in bulk to the municipalities. The municipalities bill you, you pay, but the municipalities do not pay Eskom, which puts Eskom’s credit standing on a weaker footing because they are not being paid.

We are a water-scarce country, but the water boards supply bulk water. They provide water to the municipality and again, South Africa is full of euphemisms.

So it said some municipalities, including this one, are losing up to 50% of their water through water leaks.

Instead of saying that the water is wasted, we say that a lot of water is non-revenue water. No, no, no, it’s not non-revenue water. This is water wasted, period. And you have got to confront that and say, how do we stop wasting the water?

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So if you’re thinking that for now, let’s suppose and let’s just accept and say that it is 50%, 40%, whatever the figure is, that means that the 60% or the 50% of the water that is revenue-generating, those users end up having to pay more for the water to compensate for the 40% that is actually wasted.

Water and electricity are important inputs into industry. For a city like this one, which is a manufacturing hub, you actually need those two important inputs.

You can go through these things, municipalities, and the National Treasury and the Minister of Finance (Enoch Godongwana) ended up having to take hard positions where they said that, okay, we’re transferring some money to the municipalities, but this money does not seem to be spent on the things that are supposed to be spent, and they are going to hold on to it.

That seems to have spurred some action.

JEREMY MAGGS: Governor, I want to end with a question that comes from a small business owner, and it’s this: is it fair to ask indebted households and small businesses to carry the immediate cost of moving inflation to 3%?

LESETJA KGANYAGO: What do you mean, immediate costs? There were immediate benefits of moving the inflation target to 3%. What did we see? Once we said that we are moving the inflation target to 3%, we saw the cost of government borrowing decline by 300 basis points.

Even after the shock of the war, when government borrowing costs went up, they reverted to what they were before the war.

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Why are government borrowing costs important? Because before any financier would lend to you, they will first look at how much is government borrowing at and if the cost of government borrowing is high enough, they would rather lend to government than to you and I.

So by bringing down the cost of government borrowing, it becomes attractive for the financiers to put their money elsewhere. Secondly, we said for South Africa to have lower borrowing costs, we must have lower inflation.

Because think of it, Jeremy, if anybody is to lend you money, the first point of call, of course, is going to be how do I protect this money against the erosion of value? There is no lender who will lend you money below the inflation rate.

So that is the point of departure. Once you said you are lowering this to 3%, you have changed the arithmetic immediately. So we said if we realise that lower inflation target, South Africa will realise lower interest rates.

And actually, immediately when we announced this, we said we believe these things, and so we lowered the inflation target and lowered interest rates at the same time.

We were on path for the Sarb (South African Reserve Bank) policy rate to decline to 6% by the end of this year, before the war broke out.

That was only possible because inflation was lower. Now that inflation is higher, we had to change course. So in May we had to adjust the policy rate higher because inflation was creeping higher.

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So for small businesses and small households, the best protection that the Reserve Bank would offer them is to bring price stability. That means that we must have an inflation rate that is on target, because at 3%, our inflation rate is in line with those of our peers.

JEREMY MAGGS: Governor Lesetja Kganyago, thank you very much.

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