Downgrade may be just what SA needs

28 February 2016 - 02:00 By Thabi Leoka

There is a large body of literature that argues that often things have to get really bad before the necessary economic reforms are introduced.

Economists have shown that crises can be welfare-improving in the medium term, because their heavy costs force economic adjustment and reform, eventually leading to faster growth.

In their paper "Do crises induce reform? Simple empirical tests of conventional wisdom", Allan Drazen and William Easterly argue that a crisis does not only induce reform, but is also necessary for it.


Therefore, in countries where the political system does not lead to reform when needed, forced adjustment may be the only solution.

A related argument is that easily available external funding may delay economic reform further and therefore make the eventual adjustment more difficult.

For example, a government that can easily borrow abroad may use such borrowing to postpone necessary reforms, because there is less urgency to cut a high fiscal deficit when it can be easily financed by borrowing abroad.

As argued by the IMF, external financing acts like a "pain reliever", postponing the much-needed treatment.

If this is indeed the case, a sovereign rating downgrade may not be as bad as it's made out to be because it could be the rude awakening we need.

We talk of "structural" problems as if they are a permanent and unsolvable characteristic of South Africa. They are not. The most certain solution for our structural problems is economic reform.

South Africa has not made sufficient progress in tackling its many constraints. These include a shortage of skills, infrastructure blockages, the structure of the labour market, barriers to entry that limit new entrants into product markets, the regulatory burden on small business and the capacity of the public service.

I tend to agree with the National Treasury's view that South Africa is a resilient country, but that's because in the past we have been buffered either by strong global growth, subdued developed country growth or the downgrade to sub-investment grade of our emerging-market peers.

We have not, of our own volition, reformed the economy to the extent that we have become resilient to global headwinds.

Finance Minister Pravin Gordhan's budget 2016 confirmed that South Africa has a long way to go before it can see sustained growth.


The Treasury revised downwards GDP forecasts to below 1% this year, 1.7% next year and 2.4% in 2018. The forecasts are above market expectations but definitely lower than we ought to grow.

Kicking the can down the road is as good as delaying the necessary reforms.

We continue to increase social grants without dealing with the problem of job creation and education.

We increase our education budget without dealing with the issue of our low quality of education. Policy measures that provide short-term solutions are counterproductive and delay the needed reforms.

South Africa's 10-year bond yields are trading at about 9.30%, a little higher than when Nhlanhla Nene was removed as finance minister in December.

At these levels, the market has not been particularly punitive, but should we see an increase in risk premiums, we may be forced to make tough decisions.

Leoka is an economist at Argon Asset Management