In Brazil, a drought combined with an overlapping fiscal crisis and lack of public and market trust in the government’s ability to deal with these, plunged the country into economic freefall.
The drought scorched Brazil’s agriculture sector, hitting exports, income and jobs.
The Brazilian government also lost its grip on fiscal discipline. Public debt spiraled out of control. State-owned enterprises, states (provinces) and municipalities managed by political untouchables built up huge inefficiencies, waste and debt.
White elephant, pork-barreling and patronage infrastructure and ‘development’ projects further undermined public finances.
In Brazil the political elite lacked the will to curb public spending – when it was desperately necessary to stabilise public finances.
The Brazilian currency was volatile. Imports became expensive. Inflation ballooned. Consumption by Brazil’s rising middle classes had helped fuel growth. The rising inflation reduced consumer spending.
The fall in commodity prices, China’s slowdown and the impact of the US quantitative easing policy, which drove industrial country foreign investors to move from emerging markets for what they deemed to be ‘safer’ industrial markets, like the US, all hit the Brazilian economy.
Public corruption in Brazil rose uncontrollably. Finally, the Brazilian government, because of the stench corruption, lost credibility among the markets, and its own supporters. The markets did not believe the Brazilian government’s reform promises and its own supporters questioned whether its intended reforms were in the public’s best interests or merely for patronage purposes.
The final push over the cliff for the Brazilian economy was when rating agencies assigned the country junk status.
Brazilian President Dilma Rouseff in early January 2016 admitted that her government’s “biggest mistake” was to underestimate the scale of the economic crisis the country experienced.
While Brazil experienced only a drought, South Africa is simultaneously experiencing a drought, crippling water shortages and a power crisis. Each on their own, in combination with a fiscal crisis, has the possibility of wrecking the economy.
All three simultaneously is a veritable disaster. The three together – depending on the government response – may plunge the economy into a recession. So far, official responses to all three crises of drought, power and water shortages have been spectacularly feeble, piece-meal and in-comprehensive.
Failing to speedily tackle the most devastating drought in a century will sabotage South Africa’s public finances.
Mining is both water and energy intensive. Because of water shortage some factories and mines have already postponed new investments, decreased production and/or may close down.
The drought and the water shortage in return exacerbate a power crisis, undermine investment and choke economic growth.
President Jacob Zuma and Agriculture Minister Senzeni Zokwana have both said the drought is not a national disaster. In November last year, when still minister of Cooperative Governance, Pravin Gordhan said the water shortage was not a crisis because it could be “managed”.
It appears that many ANC and government leaders and officials do not understand how the drought would unleash cross-cutting devastation across the economy.
The drought will mean the agriculture sector shrinks – and with it jobs, investments and foreign currency. It is likely to increase food prices, which in turn reduce disposable income of consumers. Consumer spending has fueled growth the past years.
The rising public debt, inflationary pressures and currency volatility has meant that the authorities are tightening fiscal and monetary policy – which of course is meant to stabilise the economic crisis, but will instead undermine growth, unless simultaneous structural and political reforms take place.
One of the structural challenges is that there is little coordination of economic policy in South Africa. For example, administrative prices – the price of public services and goods, are allowed to rise steeply, even if it may undermine the rest of the economy, by deterring investment, job creation and household spending.
Many state utilities, municipalities and state-owned enterprises are now raising prices far above inflation, compounding the economic hardships of many households and companies who are already struggling because of the dire economy.
But above inflation administrative price increases will push up inflation, and inevitably reduce consumer spending.
The Reserve Bank last week raised the repurchase rate 50 basis points to 6.75%, taking the prime rate banks charge customers to 10.25%. While it is meant to tackle rising inflation, it at the same time makes it difficult for business and consumers to service their debts, reduce their investment and spending income – which in itself undermines growth again.
One problem is that South Africa is now in a spot where both fiscal and monetary policy changes on their own cannot stimulate growth. The country needs simultaneous structural and political reforms.
Although Finance Minister Pravin Gordhan has committed himself to “to restoring credibility in our fiscal path”, many of the solutions are political, and lie outside his domain of control.
Public debt is estimated to be at about 42.5% of GDP by March 2016 – the highest since the mid-1980s. Around 10% of the public debt is foreign-currency-denominated debt. The structural problem is that a large proportion of the rising public debt is not incurred for productive investments, but often on patronage, pork-barrel projects, or is wasted through seemingly never-ending mismanagement, inefficiency and corruption.
A big part of South Africa’s economic problems also stem from lack of confidence by the markets in whether the country’s current political leadership has the will, ideas and commitment to change track.
We must now deal with the structural and political problems which undermine growth – to restore confidence. One option would be to continue the current approach: publicly pledge reforms, but in reality only tackling those issues which won’t disturb current patronage and pork-barreling networks of political allies. This of course won’t do.
The other approach would be, with a local government election coming, to be populist: the government publicly stating intentions to curb spending. However, in reality government continues distributing largess to voting constituencies to boost its elections fortunes. This won’t do either.
Another approach would be for the government to become ultra-austere: tightening monetary and fiscal policy further by raising taxes and interest rates. This would kill-off growth.
A better approach would be to honestly implement the current fiscal framework – and holding those accountable who flout it. This will raise confidence. Just cleaning-up the system of waste, inefficiencies and corruption – no matter whether those who are responsible for it are politically connected will free public financial resources.
Ensuring appointments to the public service are based on merit – and making such appointments to key public institutions – will increase efficiency. Reducing public service red tape will be crucial as well.
Stopping pork-barrel infrastructure and ‘development’ projects such as nuclear energy projects will also free up public finances. In addition, the current black economic empowerment model – which empowers politically well-connected political capitalists has to be abolished immediately.
Rather, get businesses to fund education, skills and assets for the poor, and give their employees and surrounding communities BEE stakes in companies – this is a better form of empowerment, and will redistribute resources from small elites to the deserving impoverished masses as well.
It will be important for the state to link all welfare funding to social obligations from the recipient – such as ensuring that their children are in school, and providing industrial and society-relevant skills training for recipients.
Finally, there has to be a better partnership with South Africa’s private sector – to get the private sector to deliver on some projects where the government just does not have the capacity, information or ideas to do so.
South Africa needs to build social pacts between government, the private sector and civil society-based organisations where each group agrees on specific compromises, responsibilities and commitments to get growth going again.