Kganyago urges cautious embrace of capital flows

South Africa’s central bank governor urged nations where investment opportunities exceed local saving rates to cautiously embrace capital flows, rather than shun them and miss out on the potential economic growth benefits.

A better approach “is to welcome capital flows, control risks and nurture institutions that can deliver productive investment choices. That applies to climate finance, too,” Lesetja Kganyago said in a lecture given at the International Monetary Fund in Washington on Tuesday. “We need to remain optimistic about capital flows and vigilant about the risks, rather than pessimistic about the flows and allergic to the risks, or naïve about the flows and blind to the risks.”

South Africa’s domestic savings rate is just 13%, the lowest level since at least 1980. The IMF projects that investment will equate to 16% of gross domestic product this year, far below the ratio needed for adequate growth.

Recent capital flows into South Africa have permitted the build-up of a large sovereign debt position, which has eroded potential growth, the governor said. Gross government debt stood at 70.9% of GDP for the year through March 2023, from 23.6% in 2008-09.

Debt risks

Debt accumulation can weaken institutions if money is used to fund systems of patronage and corruption, skilled and diligent public servants are driven from their posts and private sector firms redirect their efforts from productive enterprise, according to Kganyago.

He proposed that central banks accumulate foreign reserves to hedge against risk stemming from the public sector balance sheet and that central banks’ independence be safeguarded, enabling them to protect those assets against spending demands.

The “reserve accumulation approach may well work better than trying to restrain surges with capital flow measures, in a general sense, with reserve growth during inflow phases and the option to release reserves during outflows,” the governor said. “And it is a particularly useful option where flows are going to government debt and regular capital flow measures are not viable,” he said.

The governor also recommended that policymakers remain alert to the dangers of government borrowing, develop a “more responsible set of narratives” around fiscal risk and think more clearly about the effective allocation of money.

“We have seen many times that the sum of money is secondary to the quality of policies, the incentives they create and the capacity of the institutions available to invest funds,” Kganyago said. “My hope is that when the next boom comes, we will have learnt lessons that make that boom as safe, as long and as large as possible.”