Government’s lack of credibility scares off investors

The government’s lack of credibility due to its poor economic policy, unsustainable debt burden, and policy uncertainty adds to the risk premium on South African assets, making investors fearful of investing in the country.

Following the South African Reserve Bank’s (SARB) Annual General Meeting (AGM) last week, Old Mutual investment strategist Izak Odendaal told CNBC Africa that the SARB is right to be concerned about the country’s fiscal policy.

SARB governor Lesetja Kganyago has been vocal about the government’s failings throughout 2023, particularly emphasising the structural constraints of load-shedding and logistics.

Kganyago has bemoaned the “idiosyncratic factors such as load-shedding and the country’s greylisting” that keep local inflation elevated while it is declining globally.

In particular, the ongoing energy supply challenges are fuelling inflation by raising operating costs for businesses which are passed on to consumers.

The Reserve Bank has to fight inflation “in a context where many of the drivers of both inflation and growth are outside of its control”, according to Kganyago.

It can only “effectively smooth business cycle fluctuations” by raising or cutting interest rates.

Furthermore, “fighting inflation is much harder when the economy is already underperforming” due to structural constraints that must be solved at the government level.

The Reserve Bank is not capacitated to solve these structural issues nor influence long-term growth – this requires sound economic policy from the government.

South African Reserve Bank governor Lesetja Kganyago. Copyright: World Economic Forum/Faruk Pinjo

The governor reiterated these concerns during the SARB’s 103rd AGM last week.

“It is always controversial for the monetary policy authority to comment on what the fiscal authority is doing,” Odendaal said, “But it has a direct bearing on the SARB, and so it must be concerned about it.”

The government’s fiscal policy is expansionary, while the Reserve Bank is trying to slow the economy down to tame inflation – the SARB and the National Treasury are pulling in opposite directions.

The Reserve Bank cannot address structural economic problems keeping inflation elevated, such as electricity prices and deteriorating infrastructure – only the government is capacitated to do that.

Another factor, the government’s lack of fiscal credibility, also complicates the Reserve Bank’s effort to ensure price stability in the country.

“The lack of fiscal credibility of the government and the fact that the market always questions whether the government’s debt is sustainable and is unsure of government policy results in a higher risk premium being placed on South African assets,” Odendaal said.

A higher risk premium on local assets makes foreign and local investors fearful of buying those assets.

This results in a weaker currency – particularly if foreign investors are reluctant to invest in the country – which, in turn, results in higher inflation.

A decrease in demand for government bonds also results in a weaker currency, although there are signs that demand for local bonds is beginning to pick up again.