NWU School of Business and Governance

Launch

Policy Uncertainty Index

4Q2015

Johannesburg

Embargoed until noon on

Monday 1st February 2016

Contents

EXECUTIVE SUMMARY............................................................................................................................1

1. INTRODUCTION ................................................................................................................................... 4

2. RECENT DEVELOPMENTS IN ASSESSING POLICY UNCERTAINTY ......................................................... 5

3. TOWARDS A QUARTERLY POLICY UNCERTAINTY INDEX FOR SOUTH AFRICA - HOW DOES IT FIT

TOGETHER? ............................................................................................................................................. 6

4. COMPILING THE PUI FOR THE FOURTH QUARTER OF 2015 ............................................................... 7

5. PUI RESULTS FOR 4Q2015 -WHAT DOES IT SAY? ................................................................................ 8

6. NARRATIVE ON FACTORS INFLUENCING THE 4Q2015 PUI ................................................................. 8

6.1. The global economy ..................................................................................................................... 8

6.2. Policy uncertainty in SA is not new .............................................................................................. 9

6.3. The MTBPS and the MPC ............................................................................................................. 9

6.4. Credit-rating agencies ................................................................................................................ 10

6.5. Removal of former Finance Minister Nene ................................................................................ 10

7. LOOKING AHEAD ............................................................................................................................... 10

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EXECUTIVE SUMMARY

Policy uncertainty is not a new phenomenon. Yet it is certainly featuring more prominently

in the global conversation about why certain countries with clear potential are delivering

lacklustre economic performance and facing diminishing growth prospects. South Africa is

one such underperforming country, which has prompted a slew of opinions regarding the

extent to which growing policy uncertainty in the country has unnerved investors and

suppressed business activity.

Uncertainty should not be confused with risk. While risk poses challenges and carries the

chance of an undesirable outcome, there is usually sufficient information to be able to

determine the likelihood of such an outcome. With uncertainty, there is an information

vacuum, which can lead to haphazard decision-making or simply inertia. Although policy

certainty is not a panacea for all economic ills, an uncertain policy environment can be a

serious economic inhibitor.

In recent years, so as to better understand and manage the effects of policy uncertainty on

their economies, countries such as the United States, United Kingdom, Germany, France,

India and China have devised ways of measuring such uncertainty, using a range of indices.

To enable South Africa to follow this important global trend, the North-West University

School of Business and Governance (NWU-SBG) and the School of Economics have joined

forces to develop a ‘Policy Uncertainty Index’ which will help to throw light on the effects of

an opaque policy environment on macro-economic performance, and how political and

social agendas have influenced the policy-making process in the country. Under the

chairmanship of Prof Raymond Parsons from the NWU-SBG, the NWU team spent much of

2015 interrogating the policy uncertainty models used elsewhere in the world, adapting

various elements to South African circumstances, and then conducting a series of trial runs

using a new, tailored design.

The South African Policy Uncertainty Index (PUI) has three underlying components: (i) the

frequency of references to policy-related economic uncertainty in leading SA publications;

(ii) expert opinions drawn from a cohort of leading private sector economists; and (iii)

responses from a BER survey of manufacturers regarding whether the political climate is a

constraint to doing business. From the average of these various inputs, an aggregate PUI is

then determined. The Index was compiled on a trial basis for the period July, August and

September 2015 to provide a base level of 50. An increase beyond 50 would reflect greater

policy uncertainty while a decrease below 50 would reflect less policy uncertainty. The PUI

being launched today covers 4Q2015.

The real value in the PUI lies in its ability to reflect people’s collective sentiment about the

policy environment over a period of time, which will inevitably be influenced by a medley of

local and international decisions and events. Given the enormity of South Africa’s economic

growth and development challenges, nothing less than a responsive and coherent policy

framework will do. The PUI is well-placed to reinforce this urgent imperative.

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‘I am pleased to be able to welcome the compilation and release from the NWU's School of

Business and Governance (SBG) of South Africa's first Policy Uncertainty Index (PUI). NWU has

prided itself on promoting applied research in various key spheres and the development of the

PUI by the NWU SBG represents a vital addition to our understanding of the socio-economic

and business environment. It fills an important gap in the range of statistical indices upon

which decision-makers in both the public and private sectors must base their assessment of

economic trends in this country. I congratulate the SBG team on the pioneering work done to

mobilise the necessary international and domestic research in order to produce a highly

relevant new economic index for South Africa.’

Prof Dan Kgwadi

Vice-Chancellor

North-West University

‘I greatly welcome this collaborative effort between the NWU Schools of Business and

Economics respectively to create an index that seeks to measure policy uncertainty in SA. It is

an important piece of research which bridges economic theory with the needs of the business

world in ways that can promote our understanding of a constantly changing economic

universe. I look forward to seeing how trends in the PUI unfold over time and what the

messages will be for decision-makers in the public and private sectors alike.'

Prof Susan Visser

Vice-Rector: Research and Planning

North-West University

'I welcome this collaborative effort by a team of academic economists. It is important that

applied research links the theories of political economy with the practice of policies and

policymaking. South Africa faces significant challenges that we can only address when

academics become involved in the community. I want to commend them on this initiative.'

Ulrich Joubert

Independent Consultant

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‘While economists are generally in agreement that high levels of policy uncertainty are bad for

investment and economic growth, there is much less agreement on how uncertainty should be

measured. This is especially true in a country like SA where the appropriateness of current

economic policy is highly contested and where it is often necessary to distinguish between

what government and the ruling party say and what is actually done. Based on similar indices in

other countries, the NWU-SBG-PUI attempts to apply empirical rigour to measuring policy

uncertainty and changes therein over time. It will provide a welcome tool to aid our

understanding of the SA economy and business environment. The launch of the PUI should be

applauded by all those seeking more rapid economic growth and job creation in SA.’

Prof Gavin Keeton

Department of Economics and Economic History

Rhodes University

'South Africa has faced considerable policy uncertainty in recent years with adverse

consequences for capital formation and asset markets. I welcome the research by a group of

prominent economists who aim to give us a systematic measurement of policy uncertainty. I

commend them for this initiative and look forward to seeing the index.'

Prof Stan Du Plessis

Dean: Faculty of Economic and Management Sciences

Stellenbosch University

‘Policy uncertainty and its impact on economic stability is receiving increasing attention

globally as a phenomenon needing deeper analysis in both academic and applied economic

circles. The current economic challenges facing South Africa have again emphasized the

importance of policy certainty or the lack thereof. I welcome the efforts made by my academic

colleagues at NWU to design a Policy Uncertainty Index for the country. I trust that such an

Index will help us all to better understand the crucial role of policy uncertainty in the economic

performance of South Africa.’

Prof Elsabe Loots

Dean: Faculty of Economic and Management Sciences

University of Pretoria

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NWU-SBG POLICY UNCERTAINTY INDEX (PUI)

1. INTRODUCTION

The role of policy uncertainty has loomed large in much of the recent economic debate in SA. It is seen to have important implications for business confidence and the investment climate in the country. Hardly any recent economic assessment or media release from international or local financial institutions, business lobbies, economic analysts, financial journalists or credit rating agencies appears without the inclusion of the words 'policy uncertainty' occurring in them. The design of a policy uncertainty index for SA has nonetheless been spurred not only by economic circumstances in the country, but also by the increasing academic and policy interest globally around the cause, effect, measurement and definition of policy uncertainty.

There have been many manifestations of policy uncertainty in SA over the years. The institutional setting and policy making environment clearly influence the extent to which negative shocks and developments lead to bad outcomes and tough policy challenges. It seemed that the time had arrived to craft a more accurate measurement of this recurrent factor in SA's economic outlook. A deeper understanding of how uncertainty 'shocks' affect the SA economy helps policy makers to assess how future shocks will impact markets and business. The outcome of this research will now be made regularly available to hopefully fill a gap in our monitoring of the economic environment.

The issue of uncertainty in an economy and its consequences have had a long and distinguished recognition in the history of economic thought and policy. If outcomes occur with a probability that cannot even be estimated, the decision maker, whether in the private or public sector, faces uncertainty. This meaning is originally attributed to Professor Frank Knight, and is sometimes referred to as 'Knightian uncertainty'. While policy uncertainty is multi-faceted and often hard to measure at a practical level, Knight's work must be regarded as the original conceptual departure point for developing a focus about uncertainty in economic affairs.

Professor Knight's 1921 seminal book 'Risk, Uncertainty and Profit' therefore contains the definition of uncertainty as it is understood in economics today:

'The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known (either through calculation a priori or from statistics of past experiences), while in the case of uncertainty this is not true, the reason being that the situation dealt with is in a high degree unique'.

Thus, according to Knight, risk applies to situations where we do not know the outcome of a given situation, but can accurately calculate the odds. Uncertainty, on the other hand, is where we cannot know all the information we need in order to set accurate odds in the first place. It is essential to distinguish between risk and uncertainty.

In a nutshell, therefore, the more an event is subject to unforeseeable or unpredictable contingencies, the greater the uncertainty. The theory of investment under uncertainty implies that political or policy uncertainty may simultaneously increase volatility and reduce

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output, and there is considerable empirical data to reinforce this. Certainty is not necessarily a cure for all economic ills, but uncertainty has proved to be a serious economic inhibitor. Even a weak policy that is certain is preferable to open-ended uncertainty.

2. RECENT DEVELOPMENTS IN ASSESSING POLICY UNCERTAINTY

In recent years the study of this phenomenon globally has led to new measures of economic policy uncertainty in countries such as the US, Canada, UK, Germany, France, Italy, Spain, China, India and Japan. All these economies measure policy uncertainty in one way or another. 'To manage it you have to measure it' is the mantra. As these indices have developed, the emphasis has been on the events and policy matters that account for large changes in policy-related economic uncertainty.

To enable SA to join a global trend in this regard, the North-West University School of Business and Governance (NWU-SBG), in conjunction with the NWU School of Economics, has drawn heavily on international experience in general and the work of American scholars like Professors Steven Davis, Scott Baker and Nick Bloom in particular in shaping this initiative. We have been strongly guided by their previous research. The above academic research now offers a new dynamic measure of economic policy uncertainty especially in the US, and the US model (which is published monthly) has been extended to several other countries.

Its use in practice in recent years has yielded important results. Interesting correlations have been found of the policy uncertainty index with economic outcomes. Empirically it shows that when economic policy uncertainty is strongly present in the environment, it indeed lowers investment, employment and output. High levels of such policy uncertainty inhibit meaningful investment and consumption. Elevated policy uncertainty in many countries contributes to sluggish growth. Economic policy uncertainty then has actual consequences for the economy. Policy uncertainty has therefore gained a stronger profile in modern economic analysis.

Research suggests that uncertainty is very different across economies. Developing countries seem to have about one-third more macro-economic uncertainty than developed countries. Low-income countries in regions like Africa and South America understandably tend to show more volatile growth rates, exchange rates and stock markets.

A growing body of international data reveals that uncertainty is counter-cyclical: rising in recessions and declining in booms. Uncertainty can even become a catalyst of systemic risk. The role of uncertainty as a key factor in the economic outlook of a country thus needs to be specifically captured through an assessment of the effects of policy uncertainty on firm-level and macro-economic performance, as well as understanding the political, economic and social forces behind policy uncertainty as it appears in various economies. Policy uncertainty can be unpacked either as an impulse or driving force, or in amplifying and propagating other 'shocks' (e.g. the 2008 financial crisis), together with their impact on business and consumer confidence.

Following the American research group above, what do we want to broadly capture in SA's Policy Uncertainty Index (PUI)? Is it uncertainty –

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About who will make economic policy decisions?

About what economic policy action decision-makers will take, and when?

About economic effects of policy actions - past, present and future?

About the level of coherence and coordination in policy?

Induced by policy inaction or failure to implement?

Related to national security matters and other policy matters not mainly economic in character?

In capturing these questions the countries that have developed appropriate indices to measure policy uncertainty have used various relevant proxy statistics to do so. Proxy indicators can range from volatility on the Stock Exchange to fluctuations in the exchange rate. But an increasing number of national policy uncertainty indices are also (or in some cases solely) constructed on the basis of analysis of news reporting of newspaper articles referring to 'policy uncertainty'.

Derived from the US model, this requires enumerating the newspaper articles containing terms like uncertainty, economic or economy, or a group of other policy-relevant terms, and these then become an important driver of trends in the indices. The global evidence suggests that the news-based index has considerable advantages over other generally-used means known so far. All this is thus made possible by scanning for keywords that include terms relating to uncertainty and policy in some capacity.

Apart from the references to policy-related economic uncertainty in the printed media, the basic US index is composed of two other elements. The second element is the amount of the federal tax code that had the potential to expire and generate uncertainty. The third element is the amount of economic forecaster disagreement about government spending and inflation. The US data suggests that a reasonable measure of economic policy uncertainty can be captured in the index which, while not perfect, is sufficiently rigorous to match up with what the average analyst or person would call 'policy uncertainty'.

3. TOWARDS A QUARTERLY POLICY UNCERTAINTY INDEX FOR SOUTH AFRICA - HOW DOES IT FIT TOGETHER?

Against this background, the NWU group spent several months last year looking at global experience and practice in assessing policy uncertainty and deciding what would be the most appropriate way to measure it in SA . The challenge has been to craft a PUI suitable for SA. A small task team under the chairmanship of Professor Raymond Parsons, of the NWU School of Business and Governance (NWU-SBG), interrogated the policy uncertainty models elsewhere, adapted them to SA circumstances and conducted trial runs during the course of 2015.

The SA PUI hence now consists of three underlying components:

(1) a news-based index using the frequency of references to policy-related economic uncertainty in leading SA publications

(2) expert opinion from a cohort of leading economists

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(3) data from the BER survey of manufacturers who were asked whether the political/policy climate acts as a constraint to doing business

The PUI will be calculated quarterly and is intended to be published in January, April, July and October of each year. The index therefore was compiled over the period July, August and September 2015 to provide the base level of 50 for the PUI from now on. An increase beyond 50 reflects heightened policy uncertainty; a decline means reduced uncertainty.

4. COMPILING THE PUI FOR THE FOURTH QUARTER OF 2015

4.1. To quantify media reporting of policy uncertainty, press clippings were sourced from the top 20 publications in SA. Keywords were specified along with the term ‘policy’. Some keywords are shown in Table 1.

Table 1: Some keywords used to source the press clippings

Uncertainty Volatility Policy Regulation

Inflation Interest rate Rand Oil price

Recession Credit rating Consumer confidence

Business confidence

Investor confidence Taxes Electricity Service delivery

Protest action Corruption Strike action Constitutional amendment

Expropriation

4.2. To assess ‘uncertainty’ among economists, we conducted a survey among a group of

private sector economists in SA. They were asked whether they think the level of policy

uncertainty, and uncertainty for foreign investors, domestic investors and consumers, has

increased, decreased or stayed the same. They were also asked whether they thought

politics has become more uncertain, less uncertain, or stayed the same. About 25

economists have so far elected to participate on an anonymous basis and we intend to

enlarge the group in future.

4.3. To use the data collected by the BER for their business confidence index on the political

climate as a constraint on doing business.

The aggregate PUI is then compiled at this stage as a simple average of the three inputs.

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5. PUI RESULTS FOR 4Q2015 - WHAT DOES IT SAY?

The aggregate PUI for the quarterly period October to December 2015 is therefore the

average of:

news-based uncertainty

economists' views on uncertainty

manufacturers' views on political/policy constraints

This gives an average PUI of 55.4.

Although this is the first PUI to be published, it does represent a spike in policy uncertainty in

the 4Q2015 over the previous base quarter. The value of the PUI as a proxy for economic

policy uncertainty will lie in tracking changes in policy uncertainty over time, and as the

index settles down in the period ahead and builds a track record. The 4Q2015 PUI outcome

can nonetheless be supported by a credible explanatory narrative for what happened in that

quarter (see (6) below).

6. NARRATIVE ON FACTORS INFLUENCING THE 4Q2015 PUI

As this is the first PUI to be released, it is necessary to briefly review some of the factors

explaining the 4Q2015 trend in the PUI and to set an initial context, not all of which will be

repeated in future. The narrative includes the following –

6.1 . The global economy

The PUI has been introduced at a time when the global economy is less supportive of the

domestic economy. Like many other small open economies that benefit from the positive

effects of globalisation, SA has become vulnerable to its negative consequences. China's

economic slowdown, the sharp decline in commodity prices and a growing risk aversion

among global investors has gnawed away at SA's growth prospects, adding new

uncertainties and posing fresh challenges to government and the private sector alike. Yet

although no country today is immune from unpredictable surges and swells in the global

economy, several emerging economies have been able to ride the waves with more

resilience and less vulnerability than SA.

Most countries can do little about the drivers of international economic uncertainty but

every effort should be made to keep uncertainty caused by domestic policy to a minimum.

Global economic uncertainty emphasises the need to reduce domestic uncertainty through

factors that are under national control. Many studies of economic policy have suggested

that it does not need policy miracles to produce good results. If major policies are

predictable and headed in the right directions, economic performance is likely to be quite

successful. Economies are then also in a better position to manage global 'shocks' or

uncertainties when these arise.

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It is therefore important to note a recent statement from the Presidency (23 January 2016)

stressing that Team SA in Davos had been ‘assuring investors of policy certainty and

economic stability.... President Zuma emphasised SA's commitment to policy certainty....’

6.2. Policy uncertainty in SA is not new

The challenges of a lack of policy coherence and growing policy uncertainty did not only

emerge in the 4Q2015; they have developed over a period of years. The issue of policy

uncertainty is not new in SA, although the PUI is the first serious attempt to measure it.

There have been bouts of uncertainty in recent years, some of which have come from single

departments and some traceable to pieces of legislation that have come from different

departments, with seemingly contradictory provisions. Examples of the extent to which the

regulatory framework is shown to have imposed heavy costs and uncertainty on the

economy, especially small business, are too numerous to mention here. 'Policy uncertainty'

has also risen in the list of major obstacles to doing business in SA, as reflected in the recent

World Economic Forum's latest Global Competitiveness Index.

Other surveys indicate that this has had a negative impact on investor confidence and on

private fixed investment. Uncertainty about future growth prospects correlates with other

observations, such as the abnormally-large amount of cash sitting on corporate balance

sheets, the reluctance of firms to employ and consumers' hesitancy to spend. Although the

official commitment to the NDP since 2012 was intended to provide certainty about the

socio-economic road ahead, the NDP has not been sufficiently visible or tangibly

implemented. Several measures, such as those on land reform and nuclear power, are also

perceived to be in direct conflict with it. There has thus been a cumulative process in recent

years which has instead persistently aggravated the lack of coherence and level of

uncertainty in policy-making, despite the existence of the NDP.

6.3. The MTBPS and the MPC

Two other events of importance to economic perceptions in 4Q2015 were (a) the Medium

Term Budget Policy Statement (MTBPS) and (b) the November 2015 meeting of the MPC.

These generally provided definite economic signals.

The MTBPS conveyed a clear and realistic message about SA's public finances and the

challenges that would face the main Budget in February 2016 if growth prospects could not

be improved. It was cast within a predictable fiscal framework but economic circumstances

changed late in 4Q2015. A potential source of future policy uncertainty could now still lie in

the field of taxation. Not only is there the prospect of taxes being raised to balance the 2016

Budget, but there are also decisions to be taken on the tax reform recommendations of the

Davis Tax committee, including those relating to carbon tax. The combined impact of these

tax issues may intensify policy uncertainty in the near future.

On monetary policy the MPC announced a further 25 basis points rise in local interest rates

in 4Q2015. While the increase was modest, many businesspeople nonetheless viewed the

increase as signalling a rising interest rate cycle in 2016 and consequent higher borrowing

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costs, reinforced by what the US Fed decided about US rates in December 2015. Monetary

policy has been largely predictable as the latest MPC statement of 28 January 2016 also

reflects.

6.4. Credit-rating agencies

Another event in early December 2015 was the overall negative assessments by the key

rating agencies of SA's investment grading, ranging from putting SA just one notch above

'junk' status to reducing the outlook for SA to negative. These signals could not be ignored.

Even though the credit agencies did not converge on a single assessment, the underlying

message was clear that SA needed to get its economic house in order, or it might face a

downgrade to 'junk' ranking later. One agency also emphasised what it saw as a 'credibility

gap' between policies espoused and measures actually implemented - and hence a source of

uncertainty for decision-makers.

6.5. Removal of former Finance Minister Nene

Then there was the unexpected removal in mid-December 2015 of Minister Nene as

Minister of Finance and his replacement initially by David van Rooyen, and then

subsequently by reappointed Pravin Gordhan after a huge public outcry and severe

disruption in financial and other markets. Policy uncertainty escalated. Although the return

of Minister Gordhan has now fortunately partly assuaged the markets and business, trust

and confidence still need to be fully restored.

The one single event in 4Q2015 that in retrospect inevitably seems to have been the major

cause of the spike in the PUI in the last quarter of 2015 was the economic 'shock' and

market disruption that followed the unexpected removal of former Minister Nene from the

Finance portfolio. It was an event that put additional stress on an already weakened and

vulnerable economy, where there still remains residual policy uncertainty.

7. LOOKING AHEAD

It remains important to turn negative perceptions about the SA economy around and to

reduce policy uncertainty in 2016. Given its true economic potential as outlined in the NDP,

there is no reason why SA should be satisfied with the prospect of a growth rate of less than

1% in the foreseeable future. While the challenges facing SA are multi-faceted an immediate

overriding one now is how to avoid the country’s investment rating being reduced to 'junk'

class this year. Standard and Poor have recently issued a second warning in less than two

months, saying that the bailout of state-owned enterprises along with weak economic

growth, would see SA miss its fiscal targets. If this happens, it would compel the

government to borrow more or raise taxes to close the gap. Hence the significance of the

Budget ‘message’ this month.

Both the State-of-the-Nation Address and the Budget Speech this month must be dedicated

to saying the right things that will reduce uncertainty and boost confidence. These are

excellent opportunities to redefine the road ahead and to find the common ground on which

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SA can unite to tackle its socio-economic challenges. And to succeed in this requires a

rallying point, an overarching framework within which policies and projects will be actively

implemented with agreed points of reference, without having to go back entirely to the

drawing board.

Together with the overall NDP, the Medium-Term Strategic Framework that exists for its

implementation up to 2019, as well as Operation Phakisa, SA already has some half-forged

tools and processes with which to mobilise the nation more successfully. The original

mandate given to Minister Radebe in the Presidency to ensure that existing and new

legislation is compliant with the NDP must be tangibly implemented. This should be

reinforced through appropriate processes that allow this mandate to be enforced in a

transparent and effective way.

The corrosive effects of policy uncertainty need to be reversed if the PUI is to fall rather

than rise in future. Anxiety about the future remains a major driver of SA's economic

performance. SA will not break out of its current 'low growth trap' unless it brings new

thinking and strong leadership to bear soon on what urgently needs to be done to build a

bigger, stronger and better economy.

1st February 2016

North-West University School of Business and Governance

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Source: http://www.policyuncertainty.com/

Source: Bloom (2015). Does policy uncertainty matter?

Uncertainty barometer

Monthly US economic PUI

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Source: http://www.policyuncertainty.com/

Source: http://www.policyuncertainty.com/

Monthly Indian economic PUI

Monthly Chinese economic PUI

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Source: http://www.policyuncertainty.com/

Source: http://www.policyuncertainty.com/

Monthly Canadian economic PUI

Monthly European economic PUI