South Africa’s macroeconomic policies face a complicated task of balancing between supporting domestic demand and maintaining stability. The Selected Issues paper for South Africa discusses economic development and policies. Although the opening output gap and declining employment do call for countercyclical fiscal and monetary policy easing, policymakers should also be mindful of the effects of such policies on external and internal macroeconomic stability. The combined package of monetary and fiscal policies has considerable effects on growth and employment.

Abstract

South Africa’s macroeconomic policies face a complicated task of balancing between supporting domestic demand and maintaining stability. The Selected Issues paper for South Africa discusses economic development and policies. Although the opening output gap and declining employment do call for countercyclical fiscal and monetary policy easing, policymakers should also be mindful of the effects of such policies on external and internal macroeconomic stability. The combined package of monetary and fiscal policies has considerable effects on growth and employment.

V. South Africa and Other Emerging Markets: Response to the global Financial Crisis39

In 2009 net private capital flows to emerging markets (and developing) countries are expected to be significantly lower than the substantial inflows of recent years.40 While global market conditions have improved following the bout of turbulence at the end of 2008, the outlook remains challenging for emerging markets. With a relatively high current account deficit, high degree of integration with global financial markets, and moderate reserve cover, South Africa is not immune from a further slowdown or sudden stop in capital flows. This note looks at the response of emerging markets to previous capital account crises and during the current crisis; and considers the implications for South Africa.

A. South Africa External Financing and Risks

127. South Africa’s current account deficit remains high relative to other emerging markets. South Africa’s current account deficit of 7.4 percent of GDP in 2008 compares to a median of just over 2 percent of GDP for other emerging markets (excluding emerging Europe). Financing through FDI has been relatively low at around 1 percent of GDP over the past ten years compared to around 3 percent of GDP in other EMEs and it has been focused on mergers and acquisitions which tends to be more volatile than greenfield FDI.41 Instead, external financing has been heavily concentrated on portfolio flows and in particular equity flows (errors and omissions have also been positive and large). In 2008 the negative contribution of portfolio flows was driven by outflows in Q4 during a period of global market turbulence.

uA05fig01

Current account deficit

Percent of GDP

Citation: IMF Staff Country Reports 2009, 276; 10.5089/9781451841107.002.A005

uA05fig02

South Africa: Financing the Current Account Deficit

Percent of GDP

Citation: IMF Staff Country Reports 2009, 276; 10.5089/9781451841107.002.A005

128. Portfolio inflows have been volatile. The tables below show that the volatility of portfolio inflows and equity flows, in particular, has been high in absolute terms and relatively high when compared with other emerging markets (the bottom two panels show the standard deviation normalized by the mean) and relative to GDP. The volatility of South Africa’s equity flows which form the bulk of capital inflows have increased over time possibly driven by domestic factors, portfolio rebalancing (see Section III on equity flows and monetary policy), and global factors.

The Volatility of Capital Account Inflows 1995-2008

Volatility of Capital Account Inflows 1995-2008 Standard Deviation

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A spike up in 2007 capital inflows followed by the end 2008 turmoil added substantially to the measure of volatility for Brazil.

Volatility of Capital Account Inflows 1995-2008 Standard Deviation normalized by mean 1/

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Where the mean is close to zero the data is reported as missing.

A spike up in 2007 capital inflows followed by the end 2008 turmoil added substantially to the measure of volatility for Brazil.

Volatility of Capital Account Inflows 1995-2008 As a Percent of GDP Standard Deviation

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A spike up in 2007 capital inflows followed by the end 2008 turmoil added substantially to the measure of volatility for Brazil.

Volatility of Capital Account Inflows As a percent of GDP 1995-2008 Standard Deviation normalized by mean 1/

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Where the mean is close to zero the data is reported as missing.

A spike up in 2007 capital inflows followed by the end 2008 turmoil added substantially to the measure of volatility for Brazil.

129. The volatility of capital flows raises the issue of whether South Africa could be vulnerable to a sudden reversal of flows in the face of further global market turbulence. While inflows have resumed recently, a sudden reversal remains a notable risk for the following reasons:

  • Developments in 2008 Q4 demonstrated that—along with other emerging markets—South Africa could be potentially vulnerable to capital outflows. South Africa’s exporters have faced a sharp decline in external demand and weak commodity prices and if the contraction of G3 demand is deeper or more persistent than currently expected then that would pose a downside risk to the current account. Reserve cover is relatively tight when compared to short term debt at remaining maturity plus the current account deficit (at 81.3 percent in 2008 and projected at 81 percent in 2009). It is also on the low side compared to other emerging markets—including other inflation targeters.

  • However there are some mitigating factors. First, the widening of the current account deficit in recent years was driven by strong domestic demand growth and a relatively lackluster performance of exports. The slowdown in the domestic economy is likely to help narrow the current account deficit together with a fall back in income payments.

  • Second, financing concerns have recently receded with the appreciation of the rand, a narrowing of spreads (see table) and a resumption of portfolio inflows. This is further demonstrated by the successful issuance of a 10 year Eurobond for $1.5bn on May 19 (with a spread of 375 basis points over U.S. Treasuries).

  • Third, given the high proportion of rand-denominated capital flows and the floating exchange rate, external investors share the costs of adjustment if there are pressures on capital flows.

Selected Emerging Markets Change in EMBI Spreads vs Sept 12 2008

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Source: IMF, Global Markets Monitor.
uA05fig03

Projected Reserves Coverage: GIR to Short-Term External Debt at Remaining Maturity Plus Current Account Deficit, 2008 1/

Citation: IMF Staff Country Reports 2009, 276; 10.5089/9781451841107.002.A005

1/ Source: IMF Vulnerabilities Exercise For Emerging Economies Database, updated for South Africa.

130. Given the possibility that South Africa could be subject to financing pressures, the following sections of the paper look at past experience and policy responses to capital account pressures and current policy measures being taken by other emerging markets.

B. Past Crises and Policy Reactions

131. All of the previous crises are characterized by a sudden reversal in capital flows reflecting sharp changes in investor confidence. However, the factors accounting for the reversals in capital flows differed, as did the policy response:

  • East Asia 1998: vulnerabilities were predominantly in the financial and corporate sector.

  • Mexico 1995: a risky debt management strategy was a key driver of the crisis.

  • Turkey 2001 and Brazil 1997-1999: debt sustainability and fiscal policy were concerns.42

132. The dynamics of the crises were as follows. Sharp changes in market confidence prompted very sudden reversals in capital flows accompanied by overshooting of the exchange rate. Where there were underlying balance sheet weaknesses and where public finances were weak (with high levels of public sector debt and fiscal deficits), this exacerbated the scale of crisis, complicated stabilization post crisis, and limited the scope for policy maneuver.43 Even where there was large scale official financing, there were large economic adjustments stemming from balance sheet effects and the interruption of other financing flows. For example, in East Asia balance sheet vulnerabilities were heightened by the effect of exchange rate depreciation on unhedged foreign currency exposures and this significantly added to insolvencies. This meant that the recessions following crisis lasted longer than expected at the onset of the crisis.

Policy responses

133. Exchange rates and monetary policy—there have often been changes in monetary policy and exchange rate regime. Exchange rate movements often significantly overshot estimates of equilibrium levels and movements in exchange rates were associated with a switch in exchange rate regime and search for a new nominal anchor—for example Brazil introduced inflation targeting. In other countries, such as Turkey, fiscal dominance precluded inflation targeting initially and they relied on a less formal stability objective. Where associated with a banking sector collapse, sometimes monetary policy is eased first (e.g. Indonesia) but then tightened later.

134. However, in the aftermath of a crisis choosing a sound monetary policy framework alone has not been sufficient to restore stability. Instead, it has often been accompanied either by the provision of external financing support (e.g. Mexico 1995) or action to default/reschedule debt Russia (1998) or a combination of external support/ rollover of debt (Korea 1997). At the height of the crisis there is a tension between setting domestic currency interest rates high enough to compensate for the risks of further depreciation and default, and keeping them low enough so that the adverse effects on balance sheets and real activity do not raise the probability of default.

135. Previous studies by the Fund have looked at whether monetary policy in the aftermath of crises was successful in stabilizing capital outflows and steadying exchange rates or whether policy was too tight (a criticism aimed at IMF programs in Indonesia, Korea and Thailand). Ghosh et al conclude that in crises monetary policy (through changes in interest rates) can play a crucial role in restoring confidence, stemming capital outflows and avoiding massive swings in the current account by providing an incentive to hold domestic currency and preventing a sustained increase in inflation. Similarly, the IEO Report on Capital Account Crises, contrasts the early experience of Korea and Brazil, noting that the key element was a clear framework to guide policy in the post stabilization period—they argue that Brazil’s switch to inflation targeting was clear whereas in the immediate aftermath of the crisis Korea’s policy was not as clearly understood, although subsequently Korea has successfully implemented inflation targeting.44

136. Fiscal policy played different roles in different countries. Where the root of the crisis was a market perception that large government deficits and high debt were the cause of the problem then they had to be tackled to restore credibility. In addition, fiscal consolidation also helped to share the burden of current account adjustment with the private sector, easing the adjustment process. Fiscal vulnerabilities were clear for Argentina, Brazil, Russia and Turkey. However where debt sustainability was not at the root of the crisis (for example Korea and Thailand) but there were prospective costs from financial restructuring, a mild fiscal adjustment was envisaged initially. However, overly optimistic macroeconomic forecasts meant that adjustment efforts were short-lived and unsuccessful in boosting confidence.

  • For Korea the IMF recommended allowing the automatic stabilizers work just one month after the program was put in place but the authorities were reluctant to deviate from a balanced budget philosophy.

  • In Indonesia fiscal targets were relaxed over time but it was difficult to use fiscal policy countercyclically because of the lack of automatic stabilizers and weak capacity to deliver targeted expenditure increases.45

137. Previous studies have found that unnecessary fiscal adjustment from a medium-term perspective may not help boost confidence where the contractionary implications are large. Instead in circumstances where the starting position of debt is low, and where fiscal tightening was envisaged primarily for signaling purposes then there may be a case for allowing the automatic stabilizers to work and deferring fiscal consolidation in the face of weaker than expected activity—the IEO report noted that fiscal targets were adjusted as evidence of the contraction in output became clear. Similarly, where the addition to the public sector debt burden arises from bank restructuring costs the lesson of previous crises is that it is preferable to allow the automatic stabilizers to work in the short run and to set policy rules to restore a viable debt path over the medium term.

138. In cases where fiscal tightening was unavoidable the lesson of these crises is that attention needs to be paid to the quality and durability of measures. Short-term measures should be guided by clear medium term objectives for tax reform and expenditure restructuring. Establishing social safety nets is important to mitigate the effects of recession and the impact on vulnerable groups. Institutional reforms may need to be made to limit fiscal vulnerabilities and allow more effective fiscal responses in a crisis (including revenue administration, budget management, intergovernmental relations and debt management).

139. In a banking crisis the government may have few fiscal policy options to stem the crisis other than to socialize part of the losses and take on contingent claims. This was the case in Indonesia, Korea, Iceland, and is necessary when there is a need to honor guarantees (such as from deposit insurance). In these circumstances it is important to ensure that the liabilities taken on by the public sector are consistent with its capacity to absorb them and to take into account the implications for public debt management and sustainability. Exit strategies may also be needed to mitigate moral hazard—for example deposit insurance schemes in some instances were withdrawn over time.

140. Systemic banking crises. In banking crises the key priority in the early stage of the crisis is to stabilize banking system liabilities by stopping depositor and creditor runs. The provision of sufficient liquidity is important to protect the payments system. Depending on the cause of the crisis, appropriate policy measures may include some combination of protection for depositors, upfront resolution of clearly insolvent banks, and a comprehensive macroeconomic stabilization package. If these measures are unsuccessful, administrative measures may also be necessary—such as a deposit freeze or capital controls, where capital controls are contemplated, their potential costs need to be carefully weighted against any short-term benefits. Where capital controls are considered the benefits and costs need to be carefully weighed. While capital controls can temporarily reduce pressures they cannot provide lasting protection and may introduce distortions in the long run (and could give rise to rent seeking). Thus, it is equally important to design an exit strategy from such controls over the medium term.

C. Policy Reactions to the Current Global Financial Crisis

141. Previous crisis episodes provide a number of lessons for the possible policy responses to the current crisis, but there are also a number of differences.

  • First, the global nature of the current shock means that some policy actions to attract more financing (aside from official financing) may not be as effective as they would have been in the past—as capital outflows are to a degree related to global factors rather than necessarily tied to country specific factors.

  • Second, the good news is that a number of emerging markets went into the global with policies in a much better shape than in previous years with lower external debt levels, sounder policy frameworks, and better fiscal positions. But that is not the case for all countries, and in Eastern Europe countries that entered the crisis with large current account deficits and which were dependent on capital inflows have been hit hard.

The appropriate policy response to the current global financial crisis depends on the nature of the shock and initial conditions in the country. Some countries have more room to relax policy than others. Thus, countries’ policy reactions to the current shock have varied depending on (i) initial conditions; (ii) the relative importance of the channels of the shock (for example commodity exporters, peggers versus floaters, others); and (iii) the type and sources of financing available. In general, the Fund’s policy advice has been to ease monetary policy except in circumstances where a loss of confidence in the currency precludes it, and where fiscal space is available, to use expansionary fiscal policy to support activity. However, caution is called for so it is clear that EMEs have a credible exit strategy.

142. Where emerging markets entered the crisis with strong fundamentals they have eased monetary conditions significantly and employed temporary discretionary fiscal stimulus for 2009 and 2010 (see Annex for a Summary of Selected Emerging Market Policy Responses). Policy interest rates have been cut significantly, for example by 350 basis points in Mexico, 400 basis points in Brazil, and up to 750 basis points in Chile. A number of countries have also introduced measures to ease liquidity conditions. With respect to fiscal policy, the change in the general government balance for G20 emerging markets—which captures both the impact of automatic stabilizers and any discretionary measures—is projected to widen by 5.1 percentage points in 2008 and 2009. Among selected emerging markets the cumulative change in the general government balance ranges from a cumulative widening of 9.4 percentage points in Russia to a cumulative surplus of 0.8 percentage points for Malaysia. Note that these estimates are based on the information currently available and countries are also adapting their fiscal positions and stances as new information becomes available on the scale of the economic downturn. The G20 emerging markets have generally adopted a mix of temporary expenditure measures and measures on the revenue side some of which are likely to have permanent effects (Table 23).

Growth Performance and Change in Fiscal Position in Selected Emerging Markets

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1/ Source: IMF Desk Economists, South Africa Article IV Consultation

143. Policy responses in countries hit by crises have necessarily been more constrained by difficult initial conditions; in some cases procyclical fiscal adjustment was unavoidable and policies were tailored to respond to the specific shock. In Hungary which had high external debt levels and foreign currency balance sheet mismatches, the economic program supported by the IMF focused on fiscal consolidation, a banking sector support package and large external financing assistance to minimize the risk of a run on Hungary’s debt and currency markets. In Ukraine, policies focused on restoring confidence and financial stability, through dealing with banking sector problems and allowing the exchange rate to float. And in Iceland policies focused in the short term on containing the negative impact of the crisis, stabilizing the exchange rate and bank restructuring; supported over the medium term by fiscal adjustment. In all of these cases policies have also been adapted as it become clear that the scale of the economic downturn was much sharper than first expected.

D. Implications for South Africa.

144. A comparison of market indicators between September 2008 and June 2009 suggest that South Africa has not been affected by the global financial crisis disproportionately relative to other emerging markets—indeed the rand has appreciated more strongly than other currencies since mid-February. Nevertheless, in times of strain such as October and November 2008 South Africa was affected by the market turmoil, spreads rose markedly, the exchange rate depreciated sharply, and there were capital outflows. This suggests a need for caution with policy changes especially in the context of febrile market conditions. Given past experience, a number of points emerge about South Africa’s position relative to other emerging markets.

  • The macroeconomic conjuncture is relatively favorable on most measures relative to other emerging markets (Figure 22) with the current account deficit the Achilles heel, and an external debt ratio that is creeping higher partly reflecting the public sector investment program.

  • The floating exchange rate has been an important safety valve and the extent of the depreciation in the autumn may have helped to stabilize capital outflows (a number of other inflation targeters such as Mexico, Brazil, Indonesia and Korea also experienced sharp movements in their exchange rates over the same period). The lower presence/lesser likelihood of unhedged corporate or household balance sheets in South Africa compared to many other EMEs (particularly in Emerging Europe, for example Hungary). This is a key strength in current conditions and means that South Africa has more scope for the exchange rate to adjust than a number of other economies.

  • In an environment where the global shock is leading to deleveraging and where markets are still discriminating between good and poor performers it is more important than ever to maintain policy credibility (for example countries with strong policy track records such as Chile have had more room to ease both monetary and fiscal policy in response to the crisis).

    • This suggests that monetary policy should be eased cautiously taking into account the impact on market sentiment and capital flows. Good communication of the future direction of policy is likely to be important.

    • Any fiscal stimulus needs to be consistent with medium-term sustainability to maintain confidence and to retain access to financing at reasonable terms. While South Africa’s public debt ratio is currently relatively low compared to other Emerging Markets, this position may not be maintained given the scale of the public sector infrastructure investment program.

Figure 22.
Figure 22.

South Africa: Macroeconomic Conjuncture Compared to Other EMEs

Citation: IMF Staff Country Reports 2009, 276; 10.5089/9781451841107.002.A005

Source: IMF Vulnerabilities Exercise for Emerging Economies Database.
Table 21.

Selected Emerging Markets: Impact of Crisis and Policy Responses Change September 2008 to June 2009

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Sources: IMF Emerging Markets Monitor, April WEO, Regional Economic Outlooks Asia, Europe, Western Hemisphere. Article IV Consultation Report and Press Releases

CDS spread

Table 22.

Growth Performance and Fiscal Policy responses of the G20 and Selected Emerging Markets

G-20 Countries: Change in Fiscal Balances and Government Debt 1/

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Source: IMF Fiscal Implications of the Global Economic and Financial Crisis, and IMF WEO April 2009

General government if available, otherwise most comprehensive fiscal aggregate reported in the WEO. Table reports PPP GDP-weighted averages.

Growth Performance and Change in Fiscal Position in Selected Emerging Markets 1/

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Source: IMF Desk Economists, South Africa Article IV Consultation

G-20 Stimulus Measures, 2008-10 1/

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Sources: IMF Fiscal Implications of the Global Economic and Financial Crisis, Country authorities; and IMF staff estimates.Note: T = temporary measures (with explicit sunset provisions or time-bound spending); S = self-reversing measures (measures whose costs are recouped by compensatory measures in future years); and P = permanent measures (with recurrent fiscal costs).

Measures announced through early May 2009.

Some of the corporate income tax (CIT) reductions in Germany, Italy, and Korea are temporary.

Some of the personal income tax (PIT) reductions in Indonesia are temporary. For Spain, some are temporary and some are self-reversing.

The reduction in the value-added tax in the United Kingdom is a temporary measure, but lost revenue will be replaced by restricting personal income tax allowance and increasing income tax for high earners in 2010-11. For India and Italy, indirect tax reductions include a mix of permanent and temporary measures.

Annex: Summary of Selected Emerging Market Policy Responses

(i) Crisis Prevention—Selected EMEs

Where emerging markets entered the crisis with strong fundamentals they have eased monetary conditions significantly and used temporary fiscal stimulus for 2009 and 2010.

Brazil is in a stronger position than in the past to withstand global turbulence, with a large reserves buffer, moderate current account deficit, and a banking sector that is generally well-capitalized and not overly exposed to currency risk.

  • Monetary Policy. The central bank has taken measures to address currency and liquidity pressures, with significant cuts in reserve requirements (3.5 percent of GDP) and a broadening of access to the rediscount window. It also eased in January, March, April, and June cutting the policy rates by a cumulative 450 bps, to 9.25 percent, consistent with declining inflationary pressures and slowing growth. Measures have also been taken to support the corporate sector—the central bank sold dollar futures contracts to help affected corporations hedge or unwind their positions, and to help reduce market volatility.

  • Fiscal policy In 2008 the primary balance recorded a surplus of 4.1 percent of GDP and the overall balance a deficit of 2 percent of GDP. A targeted fiscal stimulus package of 0.6 percent of GDP has been announced for 2009, mainly on the revenue side. The authorities have also announced a plan to provide loans of up to 3.5 percent of GDP over the next two years from the federal government to the state-owned development bank, BNDES, to help finance investment. Brazil also has a $30 billion swap line from the Fed.

Mexico The strengthening of Mexico’s policies and policy frameworks over the past decade mean that it is in a position to use countercyclical fiscal policy to respond to the crisis. Monetary policy has been eased. Mexico has a $30 billion swap line from the Fed which it has tapped to provide foreign currency support to corporates (of which $4 billion has been tapped). The Mexican authorities also have a precautionary FCL for $47 billion which they have said they will not draw but which provides insurance against tail risks, and $6.3 billion from the IDB and World Bank .

  • Monetary policy. The depreciation of the peso limited the scope for monetary easing in the early part of the year and the authorities intervened to steady the exchange rate. Interest rates were cut by 75 bp, to 7½ percent prior to the approval of the FCL. Following the favorable reaction of the markets to the FCL the authorities were able to cut interest rates further. Rates were cut again in response to the swine flu outbreak. In June 2009 the policy interest rate stood at 4.75 percent.

  • Fiscal policy a fiscal stimulus of about 1½ percent of GDP is expected in 2009 which includes a number of self-reversing measures for infrastructure investment, support to SMEs and housing construction and temporary indirect tax measures.

Chile has adopted the most expansionary set of measures in Latin America.

  • Monetary policy. Interest rates were cut by 775 basis points from December 2008 to July 2009 to 0.5 percent.

  • Fiscal policy. A fiscal stimulus package of 2.9 percent of GDP has been agreed comprising a wide range of temporary revenue and expenditure measures.

Colombia
  • Monetary policy the central bank cut interest rates by 550 basis points between December 2008 and July 2009.

  • Fiscal policy the authorities’ revised fiscal strategy is to allow automatic stabilizers to work in full and give priority to infrastructure and social spending.

  • Financing. The authorities have proactively secured external financing, including through US$2 billion in bond placements and US$1.95 billion in multilateral loans. The authorities have a (precautionary) Flexible Credit Line of $10.45 billion.

Indonesia
  • Monetary policy. Interest rates have been cut by a total of 275 bps to 6.75 percent since December.

  • Fiscal Policy. The government announced a revised fiscal deficit of 2.6 percent of GDP for 2009 that incorporates fiscal stimulus measures of about 1.5 percent of GDP.

  • Financing. The government has secured a US$5.5 billion contingency loan package from the World Bank, AsDB, Australia, and Japan. It has also extended its currency swap arrangement with Japan.

Korea
  • Monetary Policy. The Bank of Korea (BOK) cut interest rates by a cumulative 325 basis points to 2.0 percent.

  • Fiscal Stimulus. Parliament has approved fiscal stimulus measures equivalent to 3.6 percent of GDP in 2009.

  • Financing. The authorities provided US$55 billion in dollar-won swaps, made available US$100 billion in guarantees on banks’ new external debt, and relaxed conditions for won repos. The authorities secured swap lines from the United States, Japan, and China, with the total equivalent to $90 billion. Out of the US$30 billion under the Fed swap line, US$10 billion have been drawn.

(ii) Crisis resolution countries

Hungary was among the first emerging market countries to suffer from the fallout of the current global financial crisis and was particularly vulnerable to global deleveraging given the extent of securities trading in international markets and non resident holdings of portfolio investments exceeding 50 percent of GDP. Hungary’s high external debt levels, which amounted to 97 percent of GDP at end-2007, and significant balance sheet mismatches, negatively affected investor appetite for Hungarian assets. Hungary’s economic policies supported by the IMF program focus on:

  • Fiscal consolidation. With a public debt ratio of 67.4 percent of GDP and a gross external debt ratio of 106 percent of GDP in 2008, tackling Hungary’s large public debt, through substantial fiscal adjustment was a key part of the program. The program envisaged a large structural fiscal adjustment of 2½ percent of GDP in 2009 with emphasis on expenditure measures, consistent with the need to reduce the country’s large public sector. A rules-based fiscal framework was also introduced. At the First and Second Reviews under the IMF program it was clear that external financing remained difficult and the global downturn was sharper than expected, exacerbating the recession in Hungary (with implications for government revenues). Fiscal consolidation was adjusted to proceed at a slower pace than previously envisaged, while delivering permanent reductions in fiscal spending in the long run.

  • A banking sector support package to raise capital to ensure the banks are strong enough to weather the economic downturn and resources to finance a guarantee fund for interbank lending. The Hungarian government has also lent FX directly to some banks and the central bank has provided long-term FX swaps to banks.

  • Large external financing assistance to minimize the risk of a run on Hungary’s debt and currency markets, given its large stock of external debt.

  • Monetary policy was not subject of conditionality under the IMF program. The central bank initially tightened and interest rates were raised by 300 bps in October but were subsequently cut in four stages by a total of 200 basis points. However, concerns remain that overly rapid easing could provoke excessive exchange rate depreciation with knock on effects on the nonfinancial sector’s large unhedged foreign currency borrowing.

Ukraine The economy was hit particularly hard by the external demand shock and the decline in demand for commodity exports, in particular steel. Ukraine’s access to international capital markets was curtailed sharply, the hryvnia came under heavy pressure, and the credit rating agencies downgraded the country’s debt. Concerns about the stability of the banking system and exchange volatility triggered a deposit run and conversion of domestic currency deposits into cash foreign exchange. Ukraine’s government put together a comprehensive package of policies and requested IMF support. The IMF program includes three key goals:

  • Help the economy adjust to the new economic environment by allowing the exchange rate to float, maintaining sustainable fiscal finances, phasing in increases in energy tariffs, and pursuing an incomes policy that protects the population while slowing price increases.

  • Restore confidence and financial stability (recapitalizing viable banks, and dealing promptly with banks with difficulties).

  • Protect vulnerable groups in society (an increase in targeted social spending to shield vulnerable groups).

  • Since the adoption of the program the global economic environment has deteriorated markedly, hitting Ukraine harder than expected. This has required a recalibration of economic policies. The IMF team and the authorities revised the program’s fiscal target for 2009, taking into account the sharper than expected downturn and the availability of financing.

Iceland In October 2008, triggered by a loss of confidence and fuelled by the financial sector’s high leverage and dependence on foreign financing, Iceland’s three main banks, accounting for around 85 percent of the banking system collapsed. key asset prices plummeted: the onshore foreign exchange market dried up, the króna depreciated by more than 70 percent in the off-shore market, and the equity market fell by 80 percent. Severe disruptions in the external payments system threatened to quickly spread to the real economy. The objectives of the IMF supported program are:

  • To contain the negative impact of the crisis on the economy by restoring confidence and stabilizing the exchange rate in the near-term. In the immediate aftermath of the crisis interest rates were raised and capital controls were necessary to help stem capital flight. Some controls (on current account transactions) have been lifted and the Central Bank has cut the policy interest rate to 12 percent and the deposit rate to 9.5 percent.

  • Restructuring of the banking system to promote a viable domestic banking sector and safeguard international financial relations by implementing a sound banking system strategy that is nondiscriminatory and collaborative. The authorities adopted a new bank old bank approach (similar to the good bank bad bank approach) where the banks were split and the new banks would focus on domestic activity.

  • Safeguarding medium-term fiscal viability by limiting the socialization of losses in the collapsed banks and implementing a multi-year fiscal consolidation program from 2010.

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39

Prepared by Alison Stuart.

40

World Economic Outlook April 2009 and Update July 8, 2009; Global Financial Stability Report Market Update, July 8, 2009.

41

In 2008 direct investment was boosted by the acquisition of the remaining shares in a South African motor vehicle manufacturing company by its foreign parent company.

43

See C. Collyns and R. Kincaid, 2003, “Managing Financial Crises Recent Experience and Lessons from Latin America,” IMF Occasional Paper No. 217.

44

The IMF and Recent Capital Account Crises, Independent Evaluation Office, 2003, page 35.

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The IMF and Recent Capital Account Crises, Independent Evaluation Office, 2003, page 32.

South Africa: Selected Issues
Author: International Monetary Fund
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    Current account deficit

    Percent of GDP

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    South Africa: Financing the Current Account Deficit

    Percent of GDP

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    Projected Reserves Coverage: GIR to Short-Term External Debt at Remaining Maturity Plus Current Account Deficit, 2008 1/

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    South Africa: Macroeconomic Conjuncture Compared to Other EMEs