In a recent lecture at the 2023 Michel Camdessus Central Banking Lecture, hosted by the International Monetary Fund (IMF), Lesetja Kganyago, the Governor of the South African Reserve Bank, offered his insights on the impact of capital flows on emerging market growth.
Drawing from his extensive experience in macroeconomic policy, Kganyago provides a nuanced understanding of both the benefits and risks inherent in financial globalization. His viewpoint—that global finance is a double-edged sword—resonates with sentiments shared by Atif Mian (Prof.) during a recent IMF discussion. Here are my key takeaways.
Attitudes towards capital flows: A shifting landscape
Kganyago began by acknowledging the changing attitudes towards capital flows. Once considered as a catalyst for economic growth, the predominant perspective has evolved towards caution.
The IMF now endorses the use of capital flow management measures under specific circumstances, such as when economies are overheating or when there’s an imminent risk of financial instability. Outside the IMF, the reputation of capital flows has been marred by spillovers from US monetary policy and geopolitical tensions.
Despite the criticisms, Kganyago underscored the immense opportunities that access to the global financial system presents. He pointed out that capital flows can be beneficial by fostering better risk sharing, motivating sound policies, and providing financing at lower rates than countries could achieve independently.
Learning from Australia’s experience
Australia’s financial journey was highlighted by Kganyago as a valuable case study. Despite maintaining sizable current account deficits for over 150 years, Australia has successfully retained high levels of prosperity. However, it’s worth noting that Australia hasn’t always been comfortable with large current account deficits.
In the late 1970s and early 1980s, these deficits were a major concern for policymakers, primarily because they were fueled by fiscal policy and were depleting foreign exchange reserves.
Even after the Australian dollar was floated and fiscal consolidation was achieved, significant current account deficits persisted. This phenomenon led to the formation of the so-called “consenting adults’ thesis” that suggested current account deficits, driven by private sector decisions, were both optimal and sustainable, thereby alleviating policymakers’ concerns.
However, as Kganyago noted while discussing other countries’ experiences, the fact that deficits were privately driven doesn’t necessarily guarantee security. Spain and Ireland’s experiences during the Euro area crisis, where massive private capital inflows led to a property bubble and subsequent crashes, serves as a stark reminder of the risks.
South Africa’s perspective on capital flows
Kganyago noted that South Africa has largely favored the Australian model. The country has typically observed a correlation between growth and capital inflows. After the end of apartheid, South Africa eagerly sought to reestablish access to global financial markets.
The macroeconomic strategy adopted by the Mandela government in 1996 aimed to attract more foreign savings and enforce fiscal discipline to enhance the country’s investment profile.
In retrospect, Kganyago considers this strategy mostly successful. Despite certain downsides, such as a massive depreciation of the rand in 2001 and a phase of currency strength during the mid-2000s, the strategy led to consistently high investment and growth.
He argues that it’s highly unlikely South Africa could have achieved better results by isolating itself from global capital.
The shift and its implications
From 2009, South Africa experienced a decline in investment and growth. The influx of foreign capital post-global financial crisis led to a build-up of sovereign debt, transforming the country from a “consenting adults” arrangement to a twin-deficit situation.
In the decade following the crisis, South Africa, buoyed by low interest rates, saw an average current account deficit of just over three percent of GDP. However, the nature of investment shifted towards government debt and away from private sector assets. The share of financial flows directed towards the government and public corporations soared to 78 percent in the 2010s from a meager 16 percent in the 2000s.
This shift had three destabilizing effects. Firstly, the availability of foreign capital compromised policymaking. Secondly, the inflow of capital facilitated a large sovereign debt position, which, over time, had a negative impact on the economy. Lastly, capital flows eroded potential growth by undermining institutions and shifting efforts away from productive enterprise.
Reflecting on this, one can relate to Daron Acemoglu’s argument in a Project Syndicate piece, suggesting that South Africa exemplifies how capital flows, rather than promoting good governance and development, can ‘facilitate’ a “hollowing out of a country’s economy and institutions.”
Today, the consequences are evident. Excessive borrowing, inadequate domestic saving, and reduced foreign interest in assets necessitate a rise in interest rates. The alternative would be an inflationary balance of payments problem, which contradicts the South African Reserve Bank’s mandate.
The significance of efficient resource utilization
Notably, Kganyago emphasized that the predicament of poorer nations isn’t necessarily due to a lack of funds, but rather stems from an inability to efficiently utilize the capital at hand. The common tendency to devise solutions, estimate costs, and aim at fund-raising, without adequately considering the feasibility of implementation, is a recurring pitfall he identified.
The volatile and often damaging history of capital flows can be viewed as a battle between budget constraints and capacity constraints.
Capital inflows can drastically alter budgetary frameworks by providing a surge in spending capacity; however, the pace at which implementation capacity adjusts is slower, which often results in budgets that outstrip the capacity for efficient implementation.
Navigating the future of capital flows
In the ever-changing global financial landscape, policymakers must stay adaptable, responding to evolving roles of capital flows. Countries like South Africa and Australia provide lessons on the benefits and risks of capital flows for emerging markets.
Success lies in a balanced approach: recognizing benefits, being alert to risks, and decisively intervening when needed while allowing market adjustments. This balance will enable harnessing capital flows for sustainable growth.
(Daniel Gurara is a senior economist at the International Monetary Fund). (This article first appeared on Linkedin)
Contributed by Daniel Gurara