Why talk of interest rate hikes is premature

Weblog 6 November 05
Jozi South Central Zone One


Why talk of interest rate hikes is premature

At the moment all Thabo's good wo/ men
And all Thabo's horses want to knock Humpty Dumpty
Off the wall again with a battering ram of rising interest rates.
And we all know about the problem of putting things back together again.

It is this Blog's view that a rise in interest rates should be postponed for as long as
reasonably possible towards the end of next year. There are in my view various
reasons why this would be sensible.

Firstly I think it is a bad move from the point of view of the BEE programme.
Secondly our interest rates are still far too high for us and should in fact come down even further than they already are. They are our interest rates not some other country's. Thirdly it is my opinion that we have a change of investor in the offshore foreign investor category and this may well indicate a shift in investor behaviour significant enough to test by squeezing the margins traditionally expected by offshore investors.

But firstly to the BEE programme [for offshore readers: South Africa has embarked on a programme to remedy the past evils of the ancient Apartheid system by introducing a counter ' Togetherheit' programme which the government of SA calls BEE or Black Economic Empowerment. It's rapidly becoming more Byzantine than the Apartheid wankers dreamt of in their philosophy [sorry willy]]

This Togetherheit programme is turning into a quagmire of bureaucratic black tape as increasingly the beady eye of the State is brought to bear on every facet of commercial life; with the intention that no one should even contemplate any commercially oriented action that does not intimately involve a black person. Even black people have to be intimately involved with black people.

One of the emerging downsides of the programme is that it creates discriminatory vested interest structures between competing black individuals. In having to make a decision to employ or share ownership with a statutory black person the most logical and sensible approach [for a non black whatever that is or any other person] has to be to choose someone who is connected to the system in some way: someone that is, who is 'greased'. Logically therefore when choosing between a competent qualified and skilled black person and a buffoon who represents the Party's interests or who has a cousin on the tender board: but both of whom can be considered as 'having grease', then centuries of history and present anecdotal evidence suggests that the latter gets the job. Grease always trumps merit.

Therefore notwithstanding that Black people make up 91 % of the population only a few thousand have Grease. Because of this we have an explosion in upper end remuneration packages as the handful of well-connected dudes trot around factoring their prices higher and higher. This pursuit of those who have 'grease' pushes up the price of greasemongers at the broad expense of those less connected giving rise to the currently accelerating wage gap between the well-connected rich and the generally unwashed poor. It also facilitates a skills exodus of alarming proportions [ if anyone could get their noses out of the trough long enough to care], as those unconnected, greaseless black citizens seek a level playing field elsewhere where grease counts for less than know how or, less fashionably, 'merit'.

What this means at a practical level is that huge chunks of the economy are increasingly under the guidance of persons whose prime business skill and acumen is suspect, since grease power is not necessarily the same as business savvy [although obviously there are instances when it is and we will later discover some ratios].

This means that a rising tide of interest rates will do the 'market's' traditional work of weeding out the weak and the inept, the corrupt and the useless with perhaps rather more brutality than would be politically convenient, given that the top of the next rates cycle could be somewhere in the run up to the next general election.

Because so many appointees may be suspect under stress, it is better that the present crop of BEE winners should have a bit more practice on the smooth fields of the longest period of economic expansion in our history, before they have to start riding bareback on a rocky slope. The real issue here is the size of the debt burden, in the debt for equity swap that has characterised the past few years and which is unknown, or like almost all statistics in our fair land something of a thumb suck.
Currently this debt is being liquidated by the healthy profit flows of the past two years. However it could be that five fat years are needed to push most of these deals into positive debt limited cash flows.
As we all know monetary economics discriminates against those who use borrowed capital to develop their businesses. Why should we whack our newly emerging entrepreneur base with the heavy reality of monetary theory before it's absolutely necessary.

In fact what the logic of BEE demands is that the interest rate regime be lowered even further so as to consolidate debt into more manageable packages while building profits to offset debt. To throw an entire emerging class to the wolves as they are just beginning to gain their spurs would add cruelty to the growing resentment the ruling party is facing amongst discontented mobs in a rising number of backwater places.

Of course the Reserve Bank would argue, plausibly, that we are hostage to foreign trends and that we must start to raise our interest rates or get out of 'sync'.

One of these 'trends', is that we have for decades now had a spread of three, four or even five percentage points between our rate and that of our trading partners, to encourage investment, by party's in those places, in our economy, which by default therefore has to be considered a risky environment.

In other words America's present rate is 4% [after being raised twelve times in the past year or so] versus our 7% historically 'low' rates, giving a 'low' spread of three percentage points. When you consider that in many [developed world] regions a quarter of one eighth of one percent may be a margin sufficient to attract one of the billion dollar funds investors who proliferate in the first world you can imagine that a three point spread is munificent, and even seen as risky.

Yet we need it. Most of our foreign investment is hot investment. This doesn't mean it is illegal although some probably is FICA notwithstanding. It means it's the money a fund manger is looking to use to balance his* quarterly earnings growth profile and meet his* targets. Stick some money in the SA market for a few months and pull some guaranteed percentages. [* Apparently fund managers are almost always 'he']

Now you may argue why should we citizens have to pay higher rates of interest so's some offshore punter can get a fatter guarantee than he could at home. Well firstly it works and brings in money that wasn't coming anyway. Secondly you're right why should we?

Mostly we have to do it because the laws we are cobbling together to facilitate our new "Togetherheit" policy are complicated enough for we to live here to figure out, but mostly, as far as foreigners are concerned, it's like a game of Marabaraba. Most canny investors know that the more complicated the rules the greater the risks of business. In all probability one attracts a class of investor who enjoys the Byzantine because it affords strategic hiding places.

This historical spread between 'our' rates and 'their' rates suits offshore investors at our expense. Achieving an official 6% growth rate [I'm ignoring unconfirmed reports with which I agree that the true rate of growth is probably already 6%] requires an acceleration of activity. Rising patterns of interest rates have as their rationale the curbing off growth to restrain cost and wage inflationary pressures. Therefore raising interest rates in the near future will work counter to our expressed desire.

This raises the third issue. Given that risks of business under conditions of bureaucratic excess is not going to disappear how can I suggest lowering rates when the rest of the world is raising theirs.

It is because of the canny class of investor I've just mentioned. I believe we have a different type of investor today than we had in the past when the four-point spread was critical.

To illustrate this I ask you to cast your mind back a few weeks to a most eventful week when the murder of a prominent mining financial personality drove the headlines while page three carried the story of the governments expropriation moves on a clutch of farms. A funny thing happened on our way to the interest rate argument.

The exchange rate never moved. More recently the Gov't has announced it intends to expropriate another sixty farms [and, I predict, about a thousand by end 2006]. Again the rate never flickered. Five years ago a similar event sent the rand crashing to thirteen to the dollar and financial mayhem ensued.

Now, notwithstanding considerable urban and rural unrest, expropriations, high profile crimes and other things that would normally cause investor jitters we have not a murmur. Interest rates have remained what Michael Coulson of the financial press calls 'range bound'. [okay it is nudging above the top of the range at the moment but this is hardly dramatic.]

My suspicion is that we currently have a different breed of investor to what we have had in the past. They certainly seem tougher and with a much lower 'whine' factor. They may possibly even be those to whom our issues are small beer, and are as such demonstrably people who may be here for more than a train ride.

In fact I would speculate that many are hovering on the sidelines to swoop in and buy up the shareholdings of BEE empowerment entities when those groupings find it expedient to 'sell off' when the debt service burden becomes unbearable, as it inevitably must do when interest rates are fifty percent higher than they are today and the monthly instalment on the family Merc jumps from ten grand to fifteen, simultaneously with the relevant revenue stream shrinking by twenty percent. It's a well-worn story.

As a side issue on this I am also speculating that those many business entities that have structured their BEE ownership equity with forced 'buy back' provisions: i.e.: a 'You have to sell your shares back to us if you want to sell them' clause will be challenged in court and the court will rule against them, quite possibly on onerous restraint of trade grounds. In fact it is possible that too early a resort to hiking interest rates may well see us emerge from the next round of the 'grand old' business cycle with a radically transformed ownership structure in the national economy-albeit not necessarily the transformation we envisaged.

So to nurture the BEE programme and sustain the present 'good times' we should take account of a changed behaviour response pattern on the part of our current crop of offshore and other sources of FDI's [foreign direct investments] and accept that all this gives us the potential to track at least a half to one percentage point closer to the American rate.

We have to act with the courage of our convictions here. Since we have chosen to go this complex BEE route we must hold true to our conviction. We have demonstrated to some investors at least that ours is a stable financial environment, albeit with some curious quirks, and an expanding market maintains this stability. As such, ours is appears to be a reliable investment destination end in itself. Holding ourselves steady in the present interest regime place, or even lower, for the next twelve months would extend our present buoyant market conditions for at least another twelve months, and that may then piggy back us into the era of 'Grand Spending' the Government intends to initiate when they get around to it-with Gautrain and other tales. Only then should we be thinking of tightening the taps a tad.

Loves ya all
NiK