Anti-Fragility: South African Central Banker On Dollar And Rand

Lesetja Kganyago, Deputy Governor of the South African Reserve Bank, spoke on November 27th about what he called the “normalization of world monetary policies.”
 
Kganyago addressed the Merrill Lynch 2d Annual Fixed Income Investor Conference, and began with the fact that South Africa, like other emerging countries, has benefited from the extremely loose monetary policy of the United States and other developed economies since the global financial crisis. But what will happen to South Africa in particular when that looseness comes to an end, he asked.
 
Why should readers of AllAboutAlpha care what Kganyago has to say? First, because the subject is of intrinsic interest, and he is well positioned to have something illuminating to tell us. Second, because South Africa is one of the ‘CIVETS’ countries, poised for take-off according to one fashionable hypothesis. Third, and most importantly, we should care because Kganyago suggests a rather disturbing buried premise: that everyone can win the same race, as countries race each other in currency devaluation.
 
Very Recent History
As Kganyago observes, U.S. monetary policy has captured the attention of much of the developing world in recent months, especially since May, when Ben Bernanke told Congress that he expected to “taper” the Fed’s QE program later in the year.
 
The result of this announcement, Kganyago tells us, “was a worldwide increase in medium and longer term interest rates and outflows of capital from emerging markets.”
 
Capital has gone to EMs largely in search of an edge, in search of an alpha that has been very elusive in the developed world of late. But the promise of tapering in the U.S. suggested higher yields for lenders there and by extension in the rest of the developed world, so money left the EMs.
 
This was a “strong market reaction,” one that included the weakening of exchange rates for EM nations, especially those (like South Africa) with “large current account and fiscal deficits.”
 
Yes, Kganyago acknowledges, in September the Fed “declined to fulfill expectations” and put off the normalization of monetary policy for an indefinite period of time. But he clearly does not believe that this indefinite period will prove very much longer. Some normalization soon is inevitable, and the question for people in Kganyago’s position is: how vulnerable is the economy of my own nation when that happens?
 
South Africa
In answering that question as a South African, Kganyago notes that the current account deficit in that country at present is more than 6% of the GDP. This, for purposes of comparison, is more than twice the percentage of the GDP for which the same deficit in the U.S. accounts.
 
What is worse, the deficit in South Africa arises both from an import problem and an export problem. In other emerging economies with a large deficit, the problem is either on one side or the other. Indonesia and Brazil have large deficits due to the falling price of certain commodities:  an export problem. Turkey, on the other hand, has a large deficit due to the increase in the value of their imports while their exports have remained flat. South Africa is vulnerable on both sides.
 
Also, South African consuming households are leveraged. They have used low interest rates to increase their debt, so that the ratio of debt to disposable income is nearly 76%. If interest rates head up, presumably so will the default rates. But Kganyago says that South Africa’s banks are well-capitalized and thus capable of handling this. That won’t make it any less painful for the affected families, though. Also, it won’t change the fact that anything that hits consumers in such a way will hit aggregate demand as well.
 
But, more optimistically, Kganyago says that his country has avoided one common trap. It has not denominated much of its debt in any foreign currency, so the movement of exchange rates by itself doesn’t increase the debt load.
 
In a related point, South Africa hasn’t tied the Rand to any other currency, so it doesn’t have to defend such a tie at the expense of its public.
 
Scenarios
Kganyago considers three possible futures for South Africa in the face of the eventual normalization of monetary policy. First, there is the worst case, a “sudden stop” in which foreign funders refuse to finance the current account deficit and domestic crisis results. He rules this out. The floating Rand and the way in which depreciation will re-jigger incentives should prevent it.
 
Second, there is the best case, one in which growth returns on a global scale and the normalization of monetary policy is well timed to meet that return. This outcome is good for South Africa, “as faster world growth translates into higher domestic growth” and stronger exports help narrow the current account deficit.
 
Third, there is an intermediate case, in which normal monetary policies are resumed even while world growth remains disappointing: perhaps because central bankers misjudge the timing, or perhaps because their domestic circumstances force their hands. Kganyago believes that South Africa can adapt and lessen the pain. Here, too, a depreciating Rand will help the country’s cause, in part by shifting the current account toward balance.
 
In conclusion, Kganyago employs a term made famous by finance iconoclast Nassim Nicholas Taleb. South Africa’s economy, he says, isn’t merely robust; it is “anti-fragile.” It will “move with the shocks” and will not collapse.
 
Current Accounts
This is what worries me about Kganyago’s speech: his repeated reliance upon the prospect of a depreciating currency makes it seem as if he plans on winning a race to the bottom. Then a reduction of the current account deficit will result, and various other good things will result from that.
 
But consider: don’t imports and exports have to net out to zero? If South Africans aren’t exporting to Martians, then they are going to be exporting to other places on earth where the same value will show up as imports. Lots of those other places have the same ‘plan’ he seems to have.
 
I suspect investors in South Africa will not acquire new confidence from this speech, or from a deeper understanding of the degree to which South Africa’s idea of anti-fragility involves simply devaluing its currency faster than the next guy can.