South Africa had a current account deficit (overdraft) of R111,1 billion at the end of 2006. While capital inflow balanced it, this situation cannot continue indefinitely.
SA’s overdraft increased during 2006 to R111,1 billion, compared to R58,4 billion in 2005. The overdraft, as a percentage of the gross domestic product, has increased steadily since 2001 to 7,8% in the fourth quarter of 2006 (Fig 1). Economists got excited about the 7,8% deficit, the largest in many years. To understand why, one has to grasp how the current account reflects on a country’s transactions with other countries. The current account is similar to a farmer’s bank account. If a farmer buys seed, fertiliser and fuel, his or her current account balance will decrease. When the farmer sells his or her crop the current account balance will increase again. The country’s current account balance is similar. If we import goods and services the balance decreases, and if we export to other countries the balance increases.
A farmer spends money on production goods, but also on non-productive goods. If too much is spent on non-productive goods his or her current account will move into a permanent overdraft. Similarly, if we import production goods we improve our capacity to produce goods for export. However, if most imports consist of consumer goods we will not be able to pay for imports in future. Debt run-up on a farmer’s current account must eventually be paid back. SA’s overdraft must be balanced by capital inflow from abroad. In the past, SA sold off many assets such as Absa, Iscor and Vodacom to foreigners. The capital inflow to pay for these, balanced the overdraft. A farmer can also sell assets to repay debt, but this may result in decreasing income.
In 2006, the deficit increase was mainly caused by increased imports, service and income payments. The increased exports were not enough to balance the imports driven by growth in consumer expenditure. Although the rand weakened against the US dollar by 23% since the beginning of 2005, the current account did not improve. The rand will have to weaken further before we’ll see exports increasing. Government’s proposed planned capital expenditure will need higher imports.
Foreigners can invest capital directly in SA. However, in 2006 foreigners decreased direct investment by R47 billion. Portfolio investment in SA shares and bonds increased by R130 billion, while other investments increased by R18 billion. The decrease in long-term investment and increase in portfolio investment increase the risk of financial crises.
The increased overdraft is still comfortably covered by capital inflow from portfolio investments. But if the trend continues, it may become impossible to pay for the excess imports to exports. The Reserve Bank can try to limit imports to discourage consumer spending, but as the rate of inflation lay comfortably at 3% to 6% at that time, the bank decided not to increase the repo rate.
The high level of portfolio investment creates risk for our currency, leading to a weaker rand, increased inflation and higher interest rates. We can expect the rand to weaken during 2007, which is good news for exporting and import-sensitive industries. Farmers must keep their eyes open, for export opportunities will open up again.
Dr Koos Coetzee is an agricultural economist at the MPO.All opinions expressed in this column are his own. |fw