When the politics are volatile, as is likely this year, policy must overcompensate and be less volatile
This year will likely be one of the most challenging for policymakers, and very volatile for financial markets. First, there are two major wars — Russia vs Ukraine and Israel vs Hamas — that continue to pose risks to global supply chains, energy markets, inflation resurgence and general geopolitical stability. Second, it is the global election year, given that more than 70 countries, including South Africa, the US, India and the UK, will head to the polls to elect leaders or governments. There are various implications for economic policy and how to respond to them.
Let’s begin with the financial markets risks that lie ahead. In many countries there is the possibility that elections can produce unexpected outcomes. In South Africa there are two possibilities with fat tail risks — an unstable coalition, or an outright majority for the ANC. Both can lead to wide swings in asset prices, significant sell-off in the case of potentially populist and unstable coalitions, or a significant rally in the case of the governing party maintaining its majority at the national level. The financial markets are pricing neither of these possibilities.
From a policy perspective, the critical question is how policy markers set economic policies in this highly uncertain outlook, both from an economic and political perspective. Both fiscal and monetary authorities can be seen to be aiding or working against the existing governing parties if they loosen or tighten policy, even where economic conditions demand those policy stances. Effectively, policymakers are doomed if they do and doomed if they don’t.
It is critical to assess the body of evidence policymakers put forward in justifying their policy decisions. However, even with enough evidence from a technical perspective, there are always other considerations beyond the actual functioning of the economy that critics can level against policymakers for making certain policy choices. Thus, evidence alone will not cushion criticism.
“It is critical to assess the body of evidence policymakers put forward in justifying their policy decisions”
With two wars keeping geopolitical uncertainty and global fracturing high, global economic growth is expected to slow down, which will reduce external demand for domestic exports. There will therefore be a drag on domestic demand that will keep a lid on South Africa’s economic growth prospects. Tax revenues will likely struggle due to muted domestic economic growth.
Fiscal policy will therefore remain constrained this year, on account of limited potential for tax revenue growth in an environment in which fiscal consolidation is the right policy choice due to debt levels that are already on the upper side relative to other emerging markets. A fiscal stimulus in this environment will be unwarranted and can be viewed with suspicion that it’s driven by political considerations ahead of elections.
The blockage of some ships in the Red Sea, forcing them to go around Cape Town, has the potential to push prices and thus inflation up. It is a clear risk for monetary policy this year. Already, several major central banks, including the Reserve Bank, have highlighted these risks and signalled that cuts in policy rates will unlikely be soon. Inflation and inflation expectations remain well above many central bank targets, thus expectations of earlier cuts in rates are potentially too optimistic.
Many of the considerations for stimulating economic growth appear to be unsupportive for loose policy. Debt is unsustainable and inflation expectations are still high and off targets. Complicating all of these is the uncertain global environment, with the potential to yield unexpected electoral outcomes that can destabilise the world economy.
Monetary policy decisions must offer predictability for investors, businesses and households as they guide investment and consumption decisions. When the politics are volatile, as is likely this year, policy must overcompensate and be less volatile. In essence, monetary policy must necessarily be more boring now in that it must not be the source of instability that can affect the ability of the economy to attract investment. Still, when evidence suggests particular policy choices, though they must be considered, they must not stand in the way of good policymaking in an effort to accommodate the politics of the day.