The great unwind and calls for reforms and structural change

IN this series of articles, Lazarus Shigwedha, Portfolio Manager at Investec Asset Management, looks at the reasons for the precarious state in which the Namibian economy finds itself, the need for structural change and sound policy decisions, and the tools at our disposal to shore up sustainable long-term growth.

Lazarus Shigwedha, Portfolio Manager at Investec Asset Management

Balance sheet recessions are the toughest to manage when they occur simultaneously with distressed debt conditions in the wider economy. During balance sheet recessions, asset values dissipate, while debt commitments become increasingly challenging to service.

As a nation, Namibia finds itself in this predicament, as over the last few years households have lived beyond their means. For as long as households can leverage wages that are growing ahead of inflation, living on credit is not an issue. But, as a nation we have pushed debt to unsustainable levels, therefore to service our debt commitments we must resort to asset redemptions. We are now having to unwind the excess built up over the last decade, the result of an extended expansionary fiscal policy and private sector credit extension growth that was way ahead of real GDP growth. In short, we printed too much money.

Asset redemptions in themselves result in a downward spiral, knocking consumer sentiment and investment confidence. Households are stretched: the Namibia financial stability report released in April 2019 indicates that non-performing loans (NPLs) in the local banking sector have increased to approximately 3.8% to N$3.5billion as at the end of 2018 from less than N$1 billion recorded at the start of 2014.

NPLs increased by 53% between 2017 and 2018. A closer look at the quality of banking sector mortgage exposure indicates that around 10% of all mortgage holders are now in arrears. Households are increasingly resorting to microlenders and short-term borrowing to live month to month. Outstanding micro loans and credit agreements now stack up to N$6.4billion compared to N$3.4billion in 2014; this segment of credit has compounded at a rate of double the growth of overall private sector credit extension between 2014 and 2018.

Usually, at this stage of the cycle, the slack in the economy is shored up by the combination of an expansionary fiscal and loose monetary policy. However, fiscal space does not currently exist for the government to boost the economy. The government is at the opposite end of fiscal policy, consolidating the budget. On the other hand, little help has come in the way of easing interest rates through monetary policy, which begs the question why the Monetary Policy Committee (MPC) of the Bank of Namibia has not come to the rescue?

The MPC seems comfortable with the current level of inflation at 4.5% and reserves at N$34.1billion, which translates into 5.4 months of import cover, enough to protect the peg of the Namibian Dollar to the Rand.

However, in our view the MPC has not provided enough communication as to why it has not adjusted the Repo rate lower from 6.75%, at which it has been since August 2017, particularly in light of the fact that the level of reserves and rate of inflation are not an issue. Furthermore, the local economy is contracting, with first quarter GDP growth reported at -1.9%. Both regional and global economic conditions have deteriorated – our largest trading partner, South Africa, recorded a -3.2% GDP growth in the first quarter and global institutions such as the International Monetary Fund (IMF) and the World Bank have downgraded global growth expectations for 2019 and 2020, including that of Namibia.

It is our view that monetary policy will be ineffective as a policy tool in resuscitating the local economy, because of the type of recession we are experiencing is a balance sheet recession.

During balance sheet recessions, households are more concerned with paying down their debt and increasing savings as quickly as possible rather than increasing consumption. Therefore, lower interest rates would not entice the uptake of credit but would certainly assist households in paying down their debts. Equally, during balance sheet recessions lenders are more concerned about managing the quality of their assets (managing their balance sheets) as opposed to growing incomes. The combined net effect of household deleveraging and financial sector reluctance to lend means that a significant portion of deposits do not re-enter the real economy. Rather financial institutions will park these deposits in treasuries.

As of the end of 2018 the banking sector had N$15.5 billion in treasury holdings compared to N$8.9billion in 2016 holdings in treasury bills grew by 32% per annum during 2017 and 2018. Therefore, there is an interruption in one of the key functions of a deposit taking financial institution, which is intermediation aimed at matching borrowers with lenders. This interruption results in a major leakage in incomes, which has deflationary implications for the economy. The resulting deflationary impact further perpetuates the balance sheet recession, causing a downward spiral that damages household sentiment and business confidence. The FNB house price index points to average prices having receded by 6.8% over the first quarter of this year. Residential property valuations are off 20-30% compared to their 2016 peak prices. Considering that houses in most cases are the largest component of household balance sheets, the lower values are a massive blow to consumer sentiment. Reported closures of mom and pop shops in the local media add further evidence to the leakages referred to above.

The solution to get the economy going again in a balance sheet recession is for government to step in with an expansionary fiscal policy, mopping up savings and expanding spending with the aim of stimulating the economy, at best to cushion the economy but ideally to expand growth. The goal is to increase incomes, thereby increasing the ability of households to service debt commitments and ultimately drive consumer demand and defeat asset deflation.

However, the ratio of total public debt to GDP is 45% and projected to peak above 50% over the current fiscal period according to the 2019/20 fiscal budget. Public debt service costs as a percentage of revenues have more than doubled since the 2014/15 fiscal period to approximately N$7billion. As a nation we now spend more than 10% of revenues on servicing interest payments. Elevated interest servicing costs means that there are less resources to invest in the productive capital formation. In short, government does not have the capacity to stimulate the economy through fiscal policy. This means we need to reform the economy and initiate structural changes to get the economy going again.

In the next article in this series, we explore the policy changes needed and pitfalls to avoid to shore up long-term, sustainable growth. The articles can be read in full at www.investecassetmanagement.com