PARLIAMENT Portfolio Committee on Finance 28 SEPTEMBER 2001 GETTING THE GROWTH EQUATION RIGHT.

PARLIAMENT

Portfolio Committee on Finance

28 SEPTEMBER 2001

GETTING THE GROWTH EQUATION RIGHT

AGENDA

1 INTRODUCTION

2 MODERN ECONOMICS - BUTTERFLIES

3 FDI VERSUS ECONOMIC GROWTH

4 GETTING THE GROWTH EQUATION RIGHT

5 CONCLUSION

CONVERTING IDEAS INTO WEALTH

Introduction•Key positive contributors to economic growth

•high quality human capital

•Government’s overall policy approach

•institutional factors

•external factors

•socio-political stability

•sufficient savings


Modern Economic Theory•Conventional economics view economy as machine

•Behaviour predictable and controllable

•Economies complex systems living on edge of chaos

•Uncertainty and unpredictability features of such systems

•Individuals, firms & governments adapt behaviour in light of events

•Makes precise control & regulation impossible


Butterfly Economics•Economies & societies not like machines, more like living organisms

•Complex systems living on edge of chaos

•Such systems inherently difficult to predict and manage

•Beating of butterfly’s wings on one continent, can cause tornado to start on another

•As long as we cling to orthodox economy theory we will remain powerless either to understand disasters or offer solutions


Changing Global Environment•World we operate in today, very different from decade ago

•Terrorist attacks introduced major element of uncertainty

•Not yet possible to anticipate political & economic consequences thereof

•Bring about major changes in world’s geo-political landscape

•Even before tragic events we failed to understand why domestic financial markets operate the way they do


International Determined Policy Rules

•Sound Balance of Payments position

•Surplus on current account

•Small & falling budget deficit

•Inflation well below 10% level

•Healthy foreign debt profile

•Why then do we not feature prominently on investors’ radar screens?


International Determined Policy Rules

•Financial markets do not operate according to conventional economic theory any longer

•Shifted their attention away from purely focussing on macro fundamentals

•Now also concentrate more on structural & socio-political factors

•Factors that affect country’s risk premium


Structural & Socio-Political Factors

•Broader political environment

•Tensions within ruling alliance

•Slow pace of privatisation

•Impact of HIV/AIDS on economy

•Regional instability

•Government’s soft stand on some of these issues


Structural & Socio-Political Factors•Crime & corruption

•Beaurocratic inadequacies

•Inflexible labour market

•Exchange controls

•High unemployment levels

•Lack of skills

•Tough immigration laws

•Sluggish economic growth

•Government’s inability to ensure effective social spending

•Poverty


•As long as we cling to orthodox economic theory, we will fail to understand financial market developments

•Move our focus to address structural factors mentioned earlier with much more vigour

•Not take eye off the ball

•But, need to be able to juggle more than one ball at a time

•When seen actively addressing these issues, investor sentiment should improve


•Unfortunately for emerging markets, attention given to fighting terrorism, will make more difficult to attract FDI

•Even more reason to listen to investors’ & credit rating agencies’ concerns and addressing them with vigour


Economic Growth versus Investment

•Debate something of chicken & egg scenario

•Conventional economics states growth first then investment will follow

•In SA’s case: Is lack of FDI main or only reason for economy’s inability to generate growth?

•Needed to address huge unemployment problem


Economic Growth versus Investment•Three broad factors contributed to weak growth

•structural adjustments

•significant tightening in fiscal policy

•series of external shocks

•These factors & events together with remaining structural weaknesses depressed consumer, business & foreign investor confidence

•Financial markets driven by sentiment

•Sentiment towards SA negative according to capital profile

Flows into the Equity and Bond Markets Flows into the Equity and Bond Markets

- 8

- 6

- 4

- 2

0

2

4

6

8

Jan- 01 Feb- 01 Mar- 01 Apr- 01 May- 01 Jun- 01 Jul- 01 Aug- 01 Sep- 01

Bonds

Equities

Net

R billion

Foreign Direct Investment (FDI)

- 7000

- 6000

- 5000

- 4000

- 3000

- 2000

- 1000

0

1000

2000

3000

4000

5000

92 93 94 95 96 97 98 99 00 01

R million

SA’s Contribution to World Output SA’s Contribution to World Output South Africa

1%

Rest of World99%

SA’s Contribution to Developing World Output

SA’s Contribution to Developing World Output

South Africa2%

Rest of Developing World98%

Composition of FDI Flows to Developing World

East Asia & Pacific28%

South Asia2%

Latin America & Caribbean

23%

Sub-Saharan Africa2%

Europe & Central Asia9%

Middle East & North Africa2%

Other developing countries34%

Comparative AnalysisFDI Flows to Four Major Emerging Markets

-1000

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

South Africa Turkey Argentina Poland

$ millionUSD$ millions

Equity Portfolio Flows vs Direct Investment in the Developing World

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

All DevelopingCountries

East Asia &Pacific

Europe &Central Asia

Latin America& Caribbean

Middle East &North Africa

South Asia Otherdevelopingcountries

Sub-SaharanAfrica

South Africa

PORTFOLIO FLOWS

FDI

ZAR Weakness Against Majors

-13.45

-17.20

-15.57

-10.94

-14.46

-13.95

-11.79

-14.30

-11.00

-11.88

-18.00 -16.00 -14.00 -12.00 -10.00 -8.00 -6.00 -4.00 -2.00 0.00

Euroland euro

US dollar

British pound

Japanese yen

Trade Weighted

Depreciation since July 2001

Depreciation since Jan 2001

Net Open Foreign Currency Position Net Open Foreign Currency Position

- 25

- 20

- 15

- 10

- 5

0

1998 1999 2000 2001

US$ bn

Gross Domestic Savings

12

13

14

15

16

17

18

19

92 93 94 95 96 97 98 99 00 01

percentage of GDP


Savings and Domestic Investment

•To stimulate domestic savings, sentiment would have to improve

•Primary role of private sector to seek profitable opportunities for business

•Opportunities only actively sought if potential returns exceed risks taken

•Many issues that’s conducive to risk taking


Issues Conducive To Risk Taking•Policy certainty

•Political stability

•Maintenance of law & order

•Streamlined business friendly & service oriented regulatory structure

•Strong financial system

•Availability of decent pool of skills

•Competitive currency

•Competitive tax environment

•Low inflation environment



•Issues crucial to determine attractiveness of economy to foreign investors

•If unfavourable, may also encourage domestic investors to seek opportunities abroad

•Physical emigration versus financial emigration


Savings and Domestic Investment•In aftermath of US terrorist attacks, more important for all role players in economy to work together

•Consistent debate & consultation

•Over time produce better policy outcomes

•Government could look at more aggressive measures to promote savings and domestic investment

•Policies should create investment growth friendly environment by focussing on structural issues

•Balanced by attempts to address plight of the poor



•Short-term management of economy in uncertain times

•government consider fiscal stimulants

•confidence of investors seriously diluted

•wealth dramatically reduced

•Government can however for instance change implementation rules of CGT


Capital Gains Tax (CGT)

•Tax realised gains in values as at 10 September 2001 instead of average of 5 trading days ahead of actual implementation date

•Tax gains in sales during next 12 months on current proposed basis i.e. 1 October 2001 as basis for gains

•Tax gains after 12 months on basis of higher value calculated on average of monthly closing prices of 12-month period or market price as at 1 October 2001


Capital Gains Tax (CGT)

•Advantage: will reflect sense of fairness during already trying times

•Would serve as incentive not to rush into selling frenzy

•Could work towards greater stability in financial markets


Conclusion

•SA somewhat insulated to current developments than other emerging markets

•Why?

•Low level of foreign debt

•low exposure to US imports

•healthy financial position

•However, no doubt affected by impact of terrorist attacks


Conclusion

•SA’s fundamentals strong

•Overall macro-economic policy framework sound & market-oriented

•Number of issues that create obstacles to attract FDI

•Prerequisite for sustainable faster economic growth

Getting the growth equation right…What piece of the puzzle is missing?

-3

-2

-1

0

1

2

3

4

5

6

7

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

-8000

-6000

-4000

-2000

0

2000

4000

6000

8000FDI R millions (RHS)

GDP Growth (LHS)

Where we need to go…

AND FDI?

PARLIAMENT Portfolio Committee on Finance 28 SEPTEMBER 2001 GETTING THE GROWTH EQUATION RIGHT.

Documents

converting ideas

conclusion slide

structural factors

growth equation right

conventional economic

orthodox economic theory

countrys risk premium

orthodox economy theory