The market seemed determined to end 2023 on a hopeful note, unwinding the intra-year losses in global stock and bond indices. The rationale rests in the eager anticipation of the US Federal Reserve’s (the Fed’s) interest rate cutting cycle, with market expectations for the overnight rate to fall from 5.5% to sub 4% over the course of 2024. Fed Chairman Jerome Powell does not explicitly endorse such an outlook, instead emphasising his desire to pause and evaluate the impact of higher borrowing costs on the US economy and to assess whether inflation is falling back to the Fed’s 2% target.
Monetary and fiscal policy remain at odds
While the market exhibits a keen obsession with monetary policy, almost no attention is paid to the current tensions between monetary and fiscal policy. While monetary policy has been kept tight with high overnight interest rates to suppress borrowing appetite and to control inflation, fiscal policy remains at the loosest levels we have seen in a multi-decade period, with almost every major sovereign country in the world running a large fiscal deficit due to government overspending.
Aside from the usual national expenses, fresh overspending is taking place in areas like military defence, given current geopolitical tensions and wars. Additional capital is also being allocated towards domestic protectionist agendas and the revival of local manufacturing to protect the supply chain from overreliance on non-allied countries. In this regard, the East versus West narrative is rewriting the relationship rulebook for global trade alliances. Green agendas are also attracting an extra allotment of capital, with ambitious targets to extend transmission grids and pour money into renewable energy subsidies and tax incentives. Such initiatives are coming at a time when government debts were already imprudently high due to a decade of overspending on stimulus measures post the global financial crisis and the COVID-19 pandemic. In the US, this was exacerbated by the sinking of much capital into a burgeoning healthcare system in part due to obesity-related illness and opioid drug addiction.
While such overspending can be inflationary for prices, it can also create scarcity of capital, which ultimately puts downward pressure on equity valuations and upward pressure on bond yields, in particular in the periphery of financial markets. In such an environment, emerging market assets must be priced more cheaply to incentivise scarce capital and savings to flow towards those assets. It is this tension between tight monetary policy and loose fiscal policy that casts doubt on the narrative of hubris currently implied by many asset valuations.
A wave of electoral uncertainty faces the globe
Global political tensions continue to rise, as witnessed via the ongoing war in Ukraine, the Israel-Gaza conflict, violent terrorist insurgencies in the African Sahel region, and even the heightened polarisation between conservative versus progressive ideologies in the West. High inflation has been a great dethroner of reigning political administrations throughout history, as disillusioned constituents express their frustration with economic hardships and rally against the status quo and its incumbents. Such global dissatisfaction now coincides with the phenomenon of a spike in the election cycle – roughly 45% of the global population will be in an election year in 2024, representing the highest percentage in a single year in modern history. Recent election outcomes in the Dutch parliament and Argentina, as well as strong polling figures for former US President Donald Trump, point to a swing towards nationalist ideas, a backlash against progressive ideologies, and a growing hostility towards immigration and the green movement. As such, the election outcomes across the United States, European Parliament, Taiwan, India and the United Kingdom will have important implications for future policy agendas and fiscal spending priorities.
South Africa seems to continually lurch from one watershed moment to the next. The 2024 elections are likely to see the ANC lose its national majority for the first time in 30 years, as an increasingly urbanised population express their dissatisfaction with a crisis of service delivery and the breakdown of municipal functions like the provision of electricity and water, as well as their disillusionment with corruption and cadre deployment. While some votes have flowed towards newer parties like ActionSA that promise to restore service delivery, others have been redirected towards smaller niche independent parties who appeal to their local communities. The rising tide of economic dissatisfaction and joblessness may also have lifted the ship of populist parties like the EFF, who promise their constituents a radical redistribution of wealth.
Looking for a fiscal lifebuoy for South Africa
The South African government ended 2023 with the lowest cash balances in over a decade, after drawing down on these balances to make up for corporate tax collection shortfalls, rising government wages and the large multi-year Eskom bailout package. An estimated cash balance of roughly R100bn is a meagre amount when weighed against the R2tn of government debt maturities taking place over the next seven years. It is against this backdrop that National Treasury and the South African Reserve Bank (SARB) have begun investigating drawing down on the foreign exchange reserves that are held against both SA’s offshore debt liabilities and as cover for international US dollar imports. While SARB governor Lesetja Kganyago has prudently rallied against the simplistic and reckless notion that this is a free pot of gold, international experts have now been brought in to determine what might be a feasible solution to tapping into some of these reserves before the February 2024 Budget plan is announced.
This is not the only way that fiscal rescue measures are being put in place. National Treasury has unveiled a set of cost-cutting initiatives that amount to roughly R200bn in spending cuts over the next three years, almost offsetting the size of the Eskom relief that was granted. These cuts will take place across a range of government departments and provincial and local government budgets. A voluntary severance programme for older government workers is also being considered, perhaps creating room for rehiring amongst a younger cohort of potential workers who sit far lower down the compensation cost curve.
These initiatives reflect a growing realisation that the South African economy is not growing fast enough to support the size of the state and the size of our debt. As always, the challenge in cost-cutting will be to avoid decimating the expenditure budget earmarked for maintenance and expansion of critical infrastructure. Allowing the private sector to play a greater role in the energy, road, rail and water spaces can mitigate such risks. Progress is being made in refining the plan to offer private rail operators key sections of the rail line to manage. Interesting work is also being done to investigate the feasibility of ringfencing the water networks of failing municipalities and implementing an external services provider model. The wheels of change have moved slowly, but remedial frameworks and the restructuring of the role of the state might now pave the road to a more prosperous future.