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Eurozone risks

14th October 2011

By: Terence Creamer
Creamer Media Editor


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The two key threats for South Africa should the current eurozone crisis become a Lehman Brothers-type event would be a marked increase in risk premiums, making it harder for the country to borrow, and a fall-off in demand, which would damage South Africa’s exports, a leading UK economist has warned.

Speaking at a recent lecture at the University of the Witwatersrand earlier this month, University of Birmingham’s Professor Peter Sinclair also cautioned that the longer the Greek crisis was allowed to endure, the higher was the likelihood of a “very painful adjustment”.


There was a “slender hope” that the worst could be avoided. But the threat of Greece defaulting on its debt remained high and, should such a default take place, Greek banks would be seriously harmed, while other European banks, particularly French banks, would also be vulnerable.

“If this is going to be as bad as Lehmans (and the longer it lasts the greater the probability of a very painful adjustment) . . . it could result in a huge increase in risk premiums – countries that wanted to borrow and needed to borrow [after the Lehmans collapse], found that they were often frozen out.


“Secondly, exports could fall – South Africa was affected after the 2008 Lehmans crash by a weakening in world demand, which led to a big tumble in world production and the gross domestic products of many countries in the developed world fell by four, five, six per cent,” Sinclair outlined.

He said that South Africa’s policymakers should prepare for a possible crisis by allowing the rand to “slip a bit” against the dollar and the euro. “I think that would be wise – going into a recession with a weaker currency is, in the short term, a healthy development.”

In the “improbable” event of an outright implosion of world trade, the main policy intervention should be to weaken the rand, possibly through a “big temporary loosening in monetary policy”.

But Sinclair remained bullish on the immediate outlook for China, which was a key driver of demand for South African commodities. However, he felt that the risk of a sharp pullback from China in the medium to longer term was real and growing.

More immediately, interest rate reductions should also be considered, particularly in light of the risk of softening exports squeezing domestic demand and increasing unemployment.

All possible foreign-currency-denominated obligations by South African businesses and banks should also be interrogated and South Africa should also begin considering some form of depositor insurance, notwithstanding the relatively sound position of South African banks.

On the fiscal side, Sinclair said that South Africa should draw lessons from Greece in ensuring that budgetary sustainability is achieved, possibly by shifting away from income tax in the longer term towards indirect taxation. “Income tax is always a little bit of a leakier bucket than value-added tax.”

“I think the big thing about the fiscal side is that, while things are quiet, do the long-term planning. Think about demography and entitlements, such as pension obligations, as well as the structure of taxation, ideally for 2020 and beyond,” Sinclair added, stressing that, in the shorter term, efforts should be made to sustain a reasonable debt-to-income ratio.


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