Financial repression refers to a set of government policies and market interventions intended to alter equilibrium interest rates. The policy framework aims to artificially reduce the cost of debt by lowering interest rates, facilitating public and private expenditure. These interventionist policies have historically taken numerous forms, including but not limited to yield curve control, capital control, interest rate caps and reserve requirements.
Against a backdrop of strained public finances and constrained fixed investment in the domestic economy by both the public and private sector, it is little wonder that some economists have taken to suggesting financial repression as a panacea to South Africa’s weak fiscal position. The National Treasury has overseen the escalation of domestic gross debt-to- gross domestic product (GDP) from 23.6% in the 2008/09 fiscal year to 71.1% by the end of 2022/23. National Treasury estimated in the February 2023 Budget that the sovereign debt burden would escalate further to 73.6% by the close of the 2025/26 fiscal year – a projection that we believe to be overly optimistic relative to our own estimates which foresee public debt rising towards 80% in the medium term if growth continues to falter. If the provisions and contingent liabilities of the state are added to its gross debt burden, the domestic debt-to-GDP ratio careers towards 100%.
Could financial repression policies solve SA’s fiscal woes?
Despite the rapid build-up in sovereign debt, the South African economy has precious little to show for this in terms of historic, prevailing, and potential economic growth rates. And herein lies the economic threat of financial repression. The domestic public sector has proven itself to be an inefficient allocator of capital – historically prioritising current expenditure at the expense of fixed capital investment. While the domestic gross debt-to-GDP ratio has grown threefold since 2008/09, economic growth outcomes and potential growth have counterintuitively only etched lower. Moreover, the cost of debt has significantly increased over this period, further crowding out growth-enhancing public expenditure.
Financial repression is therefore an ill-advised policy mechanism for the domestic economy. What it seeks to do is undermine the returns to an already narrow base of domestic savers, while unduly propping up fiscal expenditure. In other words, lower interest rates discourage savings, and, in turn, encourage higher levels of borrowing and spending. This is great for short-term growth but has a negative impact on longer-term growth. Economies with higher levels of savings typically have higher levels of longer-term growth, since bigger pools of available savings help stimulate investment spending.
What impact would financial repression have?
History suggests that financial repression will, over the longer-term, serve to rob the economy of its growth potential by further marginalising domestic savings, legitimising ineffectual capital allocation in the public sector, stimulating short-term aggregate demand, and ultimately elevating inflationary pressure.
Structurally, higher inflation outcomes will have the effect of inflating nominal GDP, consequently “inflating away” the sovereign debt burden. Essentially, nominal GPD will grow because prices (and in turn the rand value of everything produced in the economy) are higher, and not because the actual number of goods produced is higher. Given that debt is measured as a percentage of nominal GDP (i.e., debt divided by nominal GDP), the more inflated the nominal GDP denominator becomes, the smaller the debt-to-GDP ratio becomes, assuming all else equal. This ill-advised policy path would require a complicit central bank that has eschewed its independence and inflation-targeting mandate – which we believe to be a very remote possibility at this stage. It also flies in the face of financial market liberalisation. The recent increase in offshore limits by institutional investors to 45% suggests that this remains a domestic policy priority.
Instead, what is required to sustainability heal fiscal finances in the medium-term is an acceptance of South Africa’s narrow tax base, constrained growth potential and consequently limited fiscal means. The room to avoid tough fiscal policy decisions (which are inevitable in an open, market-based economy) has materially narrowed in recent years – more so with the fiscal windfall from the recent super-commodity cycle decidedly behind us. The conversation on fiscal repression only serves as a distraction from the economic imperative, which is to speedily and decisively implement reformative macroeconomic policy aimed at liberalising (real) economic growth.