South African Reserve Bank on its June 2011 Quarterly Bulletin and Annual Economic Report
Dr Johan van den Heever Senior Deputy Chief Economist of SARB, stated that the past year had not been a bright year in the history of the world economy. Since 2008, the price of oil had caused inflation to drift higher, and caused economic policies to be tightened. There was a brief fall in the prices, but the prices subsequently shot back up very briskly. The past year saw increases in energy prices, and food prices, which fed into the inflation spiral taking purchasing power away from consumers. This had a negative impact globally. There was a perceived interest risk on bonds issued by a number of peripheral European countries like Greece. This had cast a cloud on economic advancements in Europe, which had significant negative implications for South Africa’s major export destinations.
The South African business cycle had coincided very much with G7 countries. The turning point in the business cycle for South Africa was in August 2009 and since September 2009, there had been an upswing in the cycle. First the Gross Domestic Product (GDP) had turned around, followed by employment. Unemployment was very high, at 25.7%. During the first quarter of 2011, general government consumption expenditure had increased a bit, with some military purchases included. There had been increases in fixed capital expenditure for the past four consecutive quarters. Household consumption expenditure had been growing quite solidly over the past seven quarters. This had been the backbone of the South African upswing so far. There had been quite a sustained and strong improvement in household consumption expenditure. The increase had been aligned with real disposable income. Consumption expenditure did not result in a higher indebtedness ratio. The debt level had declined quite a bit, relative to income but the interest payments on the debt had decreased significantly due to the lower interest rate environment. The increase in domestic expenditure was reflected in rising import volumes, but export volumes were slow to respond and the pace of recovery was weaker than that of both emerging market and advanced economies’ exports. The reasons for the weakness in export market were due to infrastructure bottlenecks, the lack of availability of electricity and relatively strong exchange rates. While export volumes have not been rising, the export values rose significantly due to favourable prices for commodities like energy, gold and platinum. This contributed to a narrowing of the balance on current account.
SARB had been increasing its holdings of foreign currency quite a bit, purchasing dollars in the market to a considerable extent, and increased foreign reserve holdings to over $50 billion USD from $8 billion USD in 2002. The increase in reserve holdings forced SARB to have to sterilise the currency to avoid flooding the market with rand liquidity. The exchange rate was currently stronger than where it was at the beginning of 2010 partly because of the high export commodity prices. With strengthening exchange rates, the inflation rate had declined quite a bit and there were currently inflation rates close to the midpoint of the range, if the volatile components like food and energy were stripped out, the result was a tame inflation rate, which was positive news for an “inflation targeting country” like South Africa.
Mr Vukani Mamba, SARB Head of Financial Analysis and Public Finance, stated that the South African economy had grown over the past 90 years, but in an uneven way as the production structure had changed considerably with deflation in the early years, and inflation in the later years of SARB.
Lower inflation had made it possible to maintain lower interest rates. Household debt levels were still very high so consumers were unable to present themselves successfully to lenders.
During the South East Asian crisis in 1998, there was a spike in inflation followed by monetary policy tightening and an increase in the repurchasing rate into the low 20s. Recently, during the global financial crisis in 2008-09, SARB aggressively lowered the repurchase rate resulting in the lowest repurchase rate in 30 years. Inflation in 2011 has increased due to higher commodity prices. SARB had not deemed it prudent to raise the repurchase rate that remains at 5.5%. The main consideration for keeping the repurchase rate unchanged in the face of rising inflation has been weak growth on the supply side of the economy. Most of the recovery had been on the spending side.
The 30-year low in interest rates had not sufficiently stimulated lending by banks. There had been several successive recessionary periods, which always coincided with a sustained drop in credit extensions by the banking sector. This phenomenon was explained by the demand for credit had been impaired by the fact that there were deep job losses and household debt levels were very high, so people could not present themselves successfully to lenders and obtain credit.
Production had not recovered sufficiently in the post-recovery phase; therefore the South African economy still had sufficient access to surplus production capacity and companies were not demanding credit to finance their production needs such as paying wages, electricity and buying inputs. This had restrained the appetite for credit from the corporate sector. On the supply side, banks did incur some higher than usual non-performing loans on their books and that required repair work on their balance sheets. Parliament had enacted the National Credit Act, which led banks to scrutinize those who came forward to borrow. The potential borrower’s ability to repay a loan was paramount in the minds of bankers.
When house prices were strong some consumers were able to re-mortgage their property and access extra credit from the banking institution. House prices collapsed in early 2009 and then recovered very strongly but that recovery lost momentum by the middle of 2010.
Healthy share prices were another support for spending. When share prices went up some shareholders sold their shares to finance consumption. There was a “runaway” in commodity prices in the 2006-2008 period. Households with shareholdings benefited from the commodity price boom. Companies linked to the resource sector also benefited and the Government benefited with elevated collection of revenues. However all gains collapsed at the height of the recession and there had been a recovery that was losing its momentum in the past few weeks.
The high international commodity prices and sovereign debt were a concern in today’s global economy. A recent consumer-led upswing in the South African economy had been observed. The hope was that it would inspire confidence for production to be stimulated. Employment creation was lacklustre, but hopefully a strong economic recovery would create jobs going forward.
Mr S Swart (ACDP) stated that it was disappointing that significant export volumes had been slow to respond and the pace of recovery was weaker than that of both emerging markets, and advanced economic exports. He asked if a reason could be provided for this and if it was related to productivity or competitiveness. What were the impacts of the downgraded credit rating in the United States and the sovereign debt crisis in Greece on our export markets, GDP growth and fiscal policy?
Dr Z Luyenge (ANC) asked what fiscal remedial measures were created to reduce the policy interest rate and to aggressively support domestic economic recovery? What were the tendencies in the past that sought to ensure sustainability of the economy?
Mr N Koornhof (COPE) stated that people saw the Rand as a risky investment, and had started to take their money out of the country. He asked SARB to comment on the concern that South Africa was seen as a risky environment when foreign markets were in jeopardy.
Regarding the changes in the level of employment, Ms Z Dlamini-Dubazaba (ANC), said that the levels were only reflected as far as 2010 n the presentation. She asked where the levels were situated now, and if the situation was still the same.
Ms Dlamini-Dubazaba asked what sectors contributed to the improvement in employment, and if the improvement in employment was relevant to the domestic product. Why was there so much repurchasing and was there really a need for this, given that currently there was a global financial crisis? What had led to the projection that by 2013/14 government fiscal balances might become robust. How tangible and achievable were these projections?
Mr D George (DA) said it was disappointing that the Governor was not present because a great deal had happened in the global economy over the past few days, which would have a significant impact on the South African economy. What were the views currently regarding turmoil in the international economy, and how was it going to impact on our economy, and how was the Bank responding to this new crisis? What had SARB done to look at the potential impact? Would a slide in our GDP growth impact on tax revenues and wealth?
Mr K Marais (DA) referred to export volumes, and asked what contributed to the narrowing of the gap in export volumes, was it predominantly commodities or commodity exports and furthermore did this create jobs? There was an increase in government deposits, what was the source of the deposits, where did they come from and what was the purpose for the deposits in the first place? Mortgage loans seemed to correlate with the implementation of the National Credit Act amid claims from consumers that banks had stringent lending policies. To what extent was it the banks, or this mechanism called the National Credit Act, that there was less lending by the banks and were there unintended consequences as a result of this?
Mr van den Heever spoke to export performance first and it said it had been relatively weak on the volume side within the current global context. The reasons for the weakness in our export volumes was actually not singular, as it was quite a number of things which happened at the same time, and had been impeding the volumes of our exports. To pin it down to just the exchange rates would definitely be wrong, but the strength of the exchange rate had created less of an incentive for exporters to run into new markets and to up their volumes. Productivity in general had been a problem, as the country was competing against other countries such as China - where productivity increases were quite dramatic - and in that process it was difficult to enter into new export markets and capture them. It did not help if one was constrained from the supply side by export infrastructure capacity, and this had been an unfortunate element of South Africa’s dispensation, where our ability to export and take advantage of commodity prices had been impaired by the capacity of our transport infrastructure to export greater volumes. So that had been quite an important impediment. Fortunately the government itself was actually addressing these structural bottlenecks through our parastatals and through the government itself. However to change the infrastructure took a long time. The plan of a pipeline and the expansion of our harbour took a lot of time unfortunately.
It was fortunate that the electricity bottleneck had not come to the fore this year. One would be safe to assume that exporters were a bit reluctant to commit to big capital expenditures to up their export capacity just at a time when electricity capacity was still not delivered on the ground as installed or ready. We should really not underestimate the importance of just our natural mix of export partners. It was most evident in Europe that the weakness in the economic crisis had been most severe. Because of that crisis, to have redirected our export destination, and recapture new export markets was a very difficult process. So for all these reasons our export volumes had not been good.
With reference to the problem of the weakness of our export volumes, the deficit on the current account was much smaller than before. The reason for that was twofold: Firstly the export prices had been very positive, there has been an excellent run up in prices of coal, platinum and gold, where gold had benefitted quite well from the uncertainty in the global environment. Hence uncertainty had actually increased export proceeds in nominal terms. The rand value accruing to South Africa had actually been rising well because of better prices, and not so much because of better volumes. Secondly, the reason that the deficit on the current account was smaller was that imports had been much lower. The imports of capital goods had not been that much, so on the import volume side we have had a reprieve, and on the export prices side, we have had a reprieve. For those reasons the deficit on the current accounts had narrowed quite well.
With regard to fiscal policy, if our export performance continued to be weak, there would have been an increase in the income injected into the economy and the proceeds from this; hence the fiscus would be reduced accordingly, and for those reasons it was very necessary that South Africa did its utmost to increase export capacity also in volume terms.
The volatility of the exchange rate was due to the fact that bankers obviously preferred a more orderly and gradual movement of the exchange rate, rather than a ‘jumpy’ exchange rate. The reasons remained unclear, as it was known that the foreign currency market would continue to jump up and down. But at least there were some risk management mechanisms which central banks and fiscal authorities could do to instill more confidence and reduce volatility in that market. What had been done in South Africa was to build up our foreign currency reserve position quite substantially. As was indicated previously, in the early 2000s South Africa had foreign currency reserve levels of $8 billion or there about. Currently the country had $50 billion or thereabout. This provided confidence as there was enough money in the kitty so if our imports/export balances really went in the wrong direction, we could happily continue to pay for imports and there was some reassurance coming from that side. The so-called ‘forward book’ of SARB had been gotten rid of, and it had actually been reversed so we now had ‘forward dollars coming in future’ rather than ‘forward dollars going out in future’. South Africa had demonstrated sustainable fiscal and monetary policies, hence investors did not see us as a risky destination. When circumstances were uncertain, foreign investors preferred the familiar and tended to avoid the unknown.
With regard to employment and output, Statistics South Africa had released further information, besides the graphs presented today, which showed the continued trend of the slow increase in employment numbers. But the bottom line was that in our re-employment upswing, right to when the economy went through really tough times, from 2009 to 2010, it had been the parastatals and the government that had been the best employment creators. This had underpinned the employment that existed, and that was one of the benefits of having had fiscal policies that allowed for the creation of employment.
The issue of government fiscal balances and the factors that would impact with regard to the years 2011, 2012 and 2013, 2014 and the future trajectory, should rather be put to the National Treasury when they presented to the Committee. But there had been an assumption that the economy would grow more robustly going forward. Currently the country had a consumption-led expenditure upswing that would increasingly turn more to fixed investment. The inventory cycle would also turn around, and the government would also spend more. Between all of those expenditures and from a healthier supply side, the road would pick up and more employment would be created, so that a number of multipliers would act and up the income. The deficit was just contained and narrowed slowly.
The current turmoil had a fairly heavy impact on expectations, business confidence and consumer confidence. It was expected that there would be resistance to enter into built ventures. The country was currently experiencing a consumer-led upswing, which was not heavily credit-dependent, and was a far more sustainable situation. The situation here was a consumer-led upswing in an environment of relatively low inflation, with generally healthy financial policies inside the country, which had given the assurance of a fairly strong financial system, with good measures in place. Despite some uncertainties, our domestic upswing would continue, and would take us forward, despite the international environment. One should also be happy about the higher uncertainty feeding the gold price, which had at least to some extent provided a positive impact for South Africa.
SARB had stuck to fairly prudent policies in the current turmoil. It had reduced interest rates quite a lot for the right reasons, and did not envisage bottleneck inflation. Low inflation settings allowed for low interest rates and with a bit of stimulation through that avenue, much could be achieved without risk, irresponsibility and promiscuity in monetary policy. And then on top of that while we were supported by the upswings in that way, we had gathered a lot of foreign currency reserves in this period. Reserve accumulation was demonstrated in the graph that reflected the rand value. The idea was to demonstrate the rand value of the reserves and also the rand value of the liquidity draining measures, which have been put in place by SARB. If the dollar value of the reserves, which were in rands, were considered, then the trend was unilaterally upward. This was because the rand has been strong against the dollar in recent years. The Reserve Repurchase Agreement was really just a money market instrument, where the Reserve Bank temporarily borrowed money typically from another bank. This was short-term borrowing from another bank, where the rand was used and a promise was secured to repay the rand in a few days, weeks or months in the future. Reserve Repurchase Agreements have been used very lightly, as a very small portion of our total intervention in order to get liquidity in the money market to the desired levels. What was more important was the Reserve Bank Debentures, where the government made deposits with SARB. As far as government deposits with the Reserve Bank were concerned, it was a bit of a mix where it came from. In the past the government did take money which was deposited with private sector banks, and redeposit with the Reserve Bank. In that process the private banks had less rands and SARB had more rands deposited with it, and the private banking sector’s stock of rands had been tightened a bit. But in order for the government to get those build-ups in deposits, it had to have expenditures fairly well aligned with what had been budgeted for. On the whole, the government had been fairly good in issuing its expenditure outcomes within allocated budgets. So the reason for the build up in deposits was not non-expenditure, but the government, in order to support the accumulation of foreign currency reserves, just had to rake in some tax money, and issue some government debt instruments, in order to be able to build up these deposits. Therefore it had cost money to accumulate reserves.
Mr Mamba responded that historically, South Africa had started in the 1990s as an economy with very high deficits to GDP and significant debt with regard to GDP. The National Treasury was tasked with the normalisation of the deficit from these high levels, and arrived at a time when a more expansionary approach was adopted, and made profound pronouncements about what was to become of fiscal policy going forward. In recollection, a statement was made to the effect that there was a need to look at fiscal balances with a view to avoid debt in future generations. It was noted that it was generally and broadly helpful for fiscal policy to be counter-cyclical. This meant that when the economy was doing well, with revenues coming in, spending should be maintained without peaks in movement. This would allow government spending to grow at a predictable rate, going forward. Money could therefore be kept for ‘rainy days’ if revenue was healthy, and the excitement to spend all of the money could be avoided. If a bumpy patch was reached in the economy, money could be spent to maintain favourable government spending. Counter-cyclicality also meant that when the economy was growing and revenue was coming in, it tended to create inflation, and when it created inflation, SARB would respond to inflationary pressures. And when the economy reached a slump, inflation normally followed downward, and when it came down, SARB would be ready to break down the interest and boost the economy.
The National Credit Act came into being at the height of the upswing in the economy, such that we have now experienced the first decline in economic activity since the National Credit Act was put into place. SARB was unable to make a concrete judgement, because it was currently waiting for a new upswing in economic activity, to see whether more credit extensions by banks was a result of the National Credit Act, or generally the economic conditions. For the health of the banking sector, it had to avoid a situation where its books would be overburdened with people unable to deal with debt. SARB would then give them the benefit of the doubt and see when the economy was in full swing and if production capacity was diminishing and then see if they would continue not to lend. SARB was of the opinion that as the economy recovered sufficiently, opportunities would be created for companies to borrow and fund working capital. The banks would be open as it would not be in their interest to lend.
The Chairperson asked what the propelling force was for growth in the period of the early Nineties.
Mr van den Heever replied that a debt standstill had occurred in the 1980s because South Africa had run up too much short term foreign debt due to financial sanctions, and there was lots of volatility in international markets. There was a lack of confidence and investment spending by the private sector fell substantially and things were very difficult at the time. This had put the economy into very severe recessionary conditions, round about 1985 to 1986. In response to that, the fiscal and monetary policies were eased quite a bit. Interest rates went down, and in August 1984 SARB raised the repo rates, which lead to the prime rate or lending rate of the banks going to 25%. In order then to start upping the economy again, interest rates were reduced quite quickly, and the prime lending rate went from 25% to something like 12% in two years in order to get some new life into to the economy. And in between that, the fiscal policy was also eased a little and this helped the economy to recover. At the same time the exchange rate was somewhat lower and generally the world was doing okay in the late 1980s. After three years of positive growth, the country got into a situation where our imports went up by a small amount, and because of financial sanctions we could not access national borrowing any further and had to curtail that upswing of the three years with fairly heavy policies. Monetary policy was curtailed and fiscal policy also became quite restrictive at that time. The negative growth rates also brought inflation down to single digits in early 1990s.
The Chairperson asked if a possibility existed, given what the United States had done, for a way to redirect short term capital inflow from emerging markets to emerging economies. What would the implications be to our stable currency?
Mr van den Heever responded that one should always be wary of the nominal interest rate on the one hand and the real interest rate on the other hand. The US had extremely low nominal interest rates and extremely low inflation. The repo rate of SARB was 5.5% currently, and the inflation rate was just slightly below that. So in real terms our interest rates were slightly positive currently, and actually working on forward looking inflation expectations rather than backward looking inflation measures. One found therefore that our real repo rate was very slightly negative. So we actually had a real interest rate which was pitched to the economic circumstances, with a big output gap, and generally fair inflation prospects which made it possible to bring interests as far as they had currently come. That however allowed us to be stuck with a nominal interest rate which was still a bit lower than in the US. One could not deny those investors who sought nominal returns and who were willing for a time to take some exchange rate risks. They then had the appetite for pursuing these countries where nominal interest rates were slightly higher than in the US or Europe. The US would have lower interests for longer. We should not be unduly concerned about this. There was a domestic savings shortfall and the need for money from other places in the world. Given the situation in this country where a savings shortfall existed, one had to be happy for the foreign money that reached our shores, because ultimately more investment, growth and employment was desired.
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