The credit crisis and its aftermath

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By Johan Snyman

The Centre for International Research on Economic Tendency Surveys (CIRET) is an organisation that focuses on business cycle research. Conferences are held every second year in a different part of the world. This year it was held in Santiago, Chile, during 8-11 October. MFA attended this conference, together with about 100 other economists from 40 countries.

Naturally, with such a large gathering of economists, the current financial crisis was top of the agenda. In this Report we aim to explain the linkages that exist between the financial sector and the real economy. This is done first in general terms, and later applied to the South African situation.

The way down
The transmission mechanism between a credit crisis and an economic recession can be summarised as a sequence of events.

• Credit crisis in which banks are less willing to lend to other banks, to corporations and consumers (mortgages, vehicle finance, etc.)
• Drop in business and consumer confidence because businesses experience cash flow problems, and consumers, especially investors, homeowners and retired people, are faced with sharply declining asset prices (housing, stock prices and pensions under threat)
• Drop in business investment and consumer spending
• Drop in sales
• Drop in orders
• Rising inventories
• Lower production
• Lower employment
• Rising unemployment
• Lower income and higher saving.

The consensus among economists at the CIRET conference was that the global economy was entering a recession and that business conditions would get worse before they got better.

The recovery
History shows that each recession is followed by an economic recovery. The question is whether the economic rebound would be ‘V – shaped’ or ‘U – shaped’.

Here again, the consensus was that the recovery would be slow and gradual (i.e. ‘U – shaped’). The following reasons can be proffered for this view.

• Credit would be harder to obtain because the monetary authorities would be inclined to greater regulation and would, in future, force lending institutions to apply stricter credit rules
• This could take the form of higher deposits on consumer credit, shorter pay-back periods and more stringent credit application procedures
• Lending institutions could charge relatively higher interest rates than in the past to avoid another credit crunch
• This would imply greater saving and less consumption and investment and a slower economic recovery.
• The consequences of these actions could lead to a more unequal distribution of income as the poor would have less access to credit. In addition, the poor would bear the brunt of rising unemployment because of their lower skills profile. This could, in an extreme case, lead to social unrest (demonstrations, strikes).

The South African case
MFA believes that there are three economic forces working in South Africa’s favour that could mitigate the worst effects of the current economic crisis on the real economy.

The first of these forces is the fact that the rand exchange rate would act as a shock absorber, thereby making imports dearer and exports more competitive on world markets. This could benefit the export sector and mitigate the inevitable rise in unemployment.

Secondly, the fiscal situation in South Africa is fairly healthy and the current public capital investment programme could, to some extent, combat the expected rise in unemployment.

Finally, as in all recovery phases of the business cycle, interest rates play a key role. The consensus is that local interest rates could decline during 2009. Several financial economists have predicted that the first declines in local interest rates are expected by April 2009. This prognosis is based on the premise that inflation will start to fall during early 2009 and that the South African monetary authorities will apply a forward-looking policy, i.e. that they will anticipate this drop in inflation and act accordingly by lowering interest rates.

Source: Johan Snyman, MFA, October 13, 2008.

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