the gordhan knot

we have a new finance minister here in south africa. he is called pravin gordhan. [i refer to him as "sahib pravin"elsewhere, and will probably do so here as well.]

he inherited the economy at a time during the global economic crisis, and he has to find his way to be able to fund a lot of election manifesto campaigns on the back of a contracting economy, tightening credit, and decreasing tax revenues.

yesterday he declared that he will run budget deficits in order to fund these things, and it's starting to reflect on the [artificially high] exchange rate of the rand.

this is a good thing, but the thing that both he and the reserve bank governor need to sit down and figure out is just how steep the devaluation which *must* come needs to be.

this article says that stagflation could be on its way to south africa. if the next central bank governor raises interest rates next year, which is what mboweni almost certainly will do if he is re-hired when his mandate is up in august, that will almost definitely be the case.

a week ago, the central bank governor chose not to decrease interest rates, not even by 50 basis points, due, in part, to the "inflationary effects of the electricity price hike". this, of course, was complete balderdash for the following reason: an interest rate cut of 50 basis points would have mitigated the effects of the electricity and petrol increase for anyone holding a bankloan or a car note; 100 basis points would have completely erased the effects of the price hike in electrity, and 150 would have erased the effects of *both* for small, most medium, and almost all large businesses.

[full disclosure: i have both a small business and a mortgage, but no car. 100bp, based on my electricity consumption and my bond amount/payments, would have been more than enough to wipe out the electricity price rise. i've been telling my son that i want to hire him part-time so that i can increase my workload, but the interest and exchange rates are not making this possible.]

the south african reserve bank, according to its website, has as its sole mandate to target inflation. it says that it does this in line with this main trading partners, and as a result uses interest rates to keep it in a band of 3% to 6%.

the problem with this is several-fold. firstly, the reserve banks of south africa's main [read: western] trading partners have additional mandates: growth AND/OR [more *and* than *or*] full employment -- and, where there is a conflict, inflation targeting has the lowest priority among these. in addition, even when there is no explicit mandate, the electorates of these other countries are very likely to toss out legislatives and executive branch members during negative growth and high unemployment. in short, there are exogenous factors to push policies encouraging both growth and full employment.

now let's examine the south african situation. the reserve bank does not only gets to claim "inflation is our only mandate" but the electorate is loath to remove legislators and presidents who do not deliver sustainable growth or full employment. even if you give the mandela administration a free pass, the mbeki years have been pretty much a wash in terms of top-to-bottom, sustainable growth as well as employment. but because of other factors, the ruling party continues to secure a mandate. it can be a lose-lose situation and it was definitely was during much of 2008; the south african reserve bank raised interest rates during a period when nearly all of south africa's major trading partners lowered rates. nonsensical.

now, i don't exactly get that. it would appear that neither the reserve bank nor the finance ministry particularly have taken small businessmen -- who collectively employ more people than the international conglomerates and corporations for whom the government has bent over and to whom the government has handed lube before opening its cheeks -- into consideration during this time. smaller businessmen are more exposed to the ups and downs in the interest rate than larger ones, and often make greater effort to *not* fire people in a down market. remember, listed companies have a primary responsibility to their shareholders, not their employees or the communities in which they operate. the government does not seem to understand this. hmph.

the actions of the reserve bank, connected with the situation within the fiscus, overlaid with the global recession has been an interlocking puzzle for sahib prev to solve. while china has been inadvertantly helping somewhat with this knot -- by propping up the rand through buying gold -- it's doing it to cover its impending losses in dollars, and at some point this will not be helpful when the united states gets its act together.

instead of keeping the foreign markets happy, south africa really needs to look after its people or else the people will bite back. later on, i will talk about more about the causes and potential solutions for this.