Meeting with Governor of South African Reserve Bank; Development Bank of Southern Africa Annual Report.

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Finance Standing Committee

24 September 2002
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Meeting report

FINANCE PORTFOLIO COMMITTEE; FINANCE SELECT COMMITTEE: JOINT MEETING
25 September 2002
MEETING WITH GOVERNOR OF SOUTH AFRICAN RESERVE BANK; DEVELOPMENT BANK OF SOUTHERN AFRICA ANNUAL REPORT

Joint Chairpersons: Ms B Hogan (ANC) and Ms Q D Mahlangu (ANC)

Relevant documents:
Presentation by the South African Reserve Bank
Statement of the Monetary Policy Committee: 2002-09-12 (Appendix 1)
Development Bank of Southern Africa Annual Report to Finance Committees
Part 1
Part 2
Part 3

Reserve Bank website:
http://www.resbank.co.za/
DBSA website:
http://www.dbsa.org/

SUMMARY
The Governor of the South African Reserve Bank, Mr Tito Mboweni supplied Parliament with his quarterly report. Most of the discussion surrounded the practice of inflation targeting and the factors that influenced the current inflation level. It was also emphasised that the South African economy is growing strongly across all the sectors.

The Development Bank of Southern Africa provided Parliament with their annual report. The bank's new vision and long term strategy for the next five years was announced. The DBSA will focus on becoming the leading change agent for socio-economic development in the region through sustainable development.

MINUTES
Dr Smal, Deputy Chief Economist of the South African Reserve Bank (SARB) presented the SARB's quarterly report (see presentation). Before starting the presentation Dr Smal gave an overview of the contents.

She said that the global economy impacts on the South African economy. World economic growth is slow but should pick up momentum in 2003. She stressed that current indications are that inflation is rising internationally.

She emphasised that the South African economy is showing strong growth in all its sectors, outperforming global growth. She added that the inflation rate hike was meant to control inflation next year also and not just aimed at the current problems.

Discussion
Ms Taljaard (DP) mentioned the impact of the depreciation of the Rand. She asked the Governor, Mr Mboweni, whether he is concerned that there might be a secondary round of rising inflation. She also said that the inflation target would probably not be met. She asked Mr Mboweni on his perceptions on this issue and to comment on the credibility of the bank.

Mr Mboweni answered that one of the concerns at the central bank is the growing threat that inflation pressures might become widespread. If that happens it would cause great difficulties for the economy. He referred to the Statement of the Monetary Policy Committee on 12 September 2002 where a study showed that the country's inflationary expectations were very high.

Mr Mboweni commented that inflation targeting itself is not under threat, but that the target itself is under threat if no action is taken. He added that the 2003 target is 3% - 6% and the 2004 target is 3% - 5%. He said that the forecast would not be changed. He stressed that when they conduct monetary policy currently they have 2003/4 in mind and not 2002. Decisions for 2002 have long been made and will be proven wrong or right at the end of the period. Forecasts are about what will happen in 18-24 months and not next month. He reiterated that the SARB's position on inflation is to remain vigilant and that the SARB is worried about oil prices going up on account of the threat of war. They are hoping for a peaceful resolution to the crisis.

Mr Moloto (ANC) commented that it is clear that there are exogenous factors influencing inflation over which there is no control and that there are indigenous factors that South Africa can to an extent control. He then asked whether there is a concerted effort by the SARB to keep administered prices.

Mr Mboweni replied that a man can only do so much to make people more aware of inflation. He often stressed the important role of the Government in combating inflation. He has had meetings with various ministers, directors general and other Government departments but that the meetings were poorly attended. Those that he did meet understood the importance of the matter. On administered prices he said that nobody was suggesting artificial prices. Administered prices are not under the control of the SARB and he continues to appeal to his colleagues in the Government to assist with this problem.

Dr Koornhof (UDM) remarked that it had been three months since the committee last saw Mr Mboweni. He reminded the Governor of remarks he had made regarding there being no buy-in on inflation targeting. He asked what role SARB should play to achieve this buy-in. He enquired about any advertising sprees.

Mr Mboweni answered that he could tell the committee a lot of stories about all his meetings with churches, farmers and all kinds of business people about inflation, pyramid schemes and micro-lending amongst other matters. He said that the awareness campaign from SARB is ongoing. Recent public interest, because of the rise of inflation, is a good thing. The public is discussing the issue and SARB is aiming at the broadest possible discussion. The trade unions have not yet become part of the discussion and he feels they have an important role to play in the success of this country. SARB is also looking at organising a conference on inflation targeting with business, churches, media, parliament, trade unions and other interested parties. He also had regular meetings with the financial editors in South Africa.

Mr Nguni (ANC) asked the Governor on SARB's position regarding the target point or range inflation measures.

Ms Joemat (ANC) enquired about the major causes for the rise in inflation apart from the rise in food prices and energy costs.

Mr Mboweni reminded the committee that the targeting is done by the Treasury. It is the sole decision of the Government. He emphasised that Government must align its processes to help reach the target. A point target with a one point leeway is the same as a point range and that the approach is the same. All central banks use interest rates to combat inflation. He challenged anyone that says differently to come and show alternatives.

Mr Nene (ANC) asked for clarity on the issue of monetary accommodation.

Mr Mboweni replied that if South Africans sit around and let monetary accommodation continue, we will have bigger problems.

Ms Mabe (ANC) said that inflation targeting should be the responsibility of SARB, Government and the private sector. She emphasised that with the rising food prices, the poor are hit the hardest. She wanted to know what the buy-in was from the private sector.

Mr Mboweni reiterated that SARB is constantly in discussion with all the sectors. He added that the futures market was a culprit. He added that the bank has commissioned a study on the rise in food prices.

Dr Woods (IFP) commented that by reading the SARB report he does not really understand the causes of inflation. Inflation statistics given were superficial and that the committee would like to know more about the makings and trends that influence inflation. He called on the SARB to be more investigative and in particular look at the relation between food prices and the poor.

Mr Mboweni referred Dr Woods to a comprehensive report released by StatsSA on these issues. He said that the question now is what drove these outcomes. He agreed that they need more investigation on defining the chain of factors and/or occurrences.

Mr Lekgoro (ANC) asked about the possible exclusion of food and oil price from the CPIX. He wondered whether that would be a good measure.

Mr Mboweni recommended an article in Finance Week of 25 September titled 'Lessons of Greenspan'. He said the temptation to exclude certain factors is there as this would paint a prettier picture. The Governor felt he would rather confront problems and deal with them. He added that encouraging a strong consumer movement is important since it is lacking currently.

Dr Rabie (NNP) commented on the sharp decline of the Rand versus the dollar in the last financial year. He asked the Governor on his forecast for this year

Ms Mahlangu (ANC) asked for clarity on slide 23 in the presentation on household debt as percentage of household disposable income. She wanted to know whether micro-lending was included in the statistic. She also asked the governor to comment on banks not wanting to lend to the poor. Her last question was based on remarks in the media that the markets were not so pleased with Mr Schroeder's victory in the German election. She said she found it difficult to come to terms with markets influencing governments.

According to Mr Mboweni, markets are made up of very powerful institutions. There is more money in the big firms than all the GDPs of developing countries. The markets do determine political outcomes in countries and he used Brazil as an example where recently the markets had a huge impact on a candidate's economic policies. He also referred to the conditions of IMF loans. Often the loans are on condition of certain economic policies being implemented. Markets are traditionally conservative. Mr Schroeder's coalition with an environmentalist (green) party, whose support grew in the election, does not sit well with the German markets.

The Governor emphasised that part of the Rand's weakness is political economy problems. He mentioned regional perceptions of Zimbabwe as one of those factors that could negatively influence the Rand. He explained the cycle of connectivity between Zimbabwean farmers and their South African counterparts and farmers in the south-east of England. Those very important farmers in the south-east have strong links with the financial centre in London. That is how Zimbabwe's problems become South African problems. He added that the Zimbabwean land reform is right, but that the managing of it is wrong. There were international fears that South Africa might become a second Zimbabwe in 20 years time. All these factors are damaging the currency and putting pressure on the exchange rate. He also referred to non-residents dumping South African bonds and other shares. The Governor however did think that the prospects for the Rand are very good.

On household debt Mr Mboweni commented that the decline to 53% is welcome. That means that households are financing their expenditures from income and not debt. The figure is still too high. He added that is very difficult to get accurate figures on micro-lending. Mr Mboweni emphasised that he is satisfied that it is not true that banks are not lending to the poor. He conceded that it is difficult for the banks to lend money just to anybody. This creates the gap for micro-lending.

Mr Mboweni ended by saying that he would like to appear more often brfore the committee as there were a lot of issues that he would like to discuss more fully.

Ms Hogan (ANC) told the Governor that the committee is going to the United Kingdom to look at the possibility of a single financial regulator and also the relationship between parliament and the central bank.

Mr Mboweni suggested that they not go to the UK - since its model was not best practice.

Development Bank of Southern Africa (DBSA)
Mr J Naidoo (Chairperson of the DBSA board) noted that the DBSA had examined its mandate for the next five years and wanted to become the leading change agent for socio-economic development in southern Africa.

He emphasised their transformation to a Knowledge Bank and partnerships with local authorities who cannot sustain themselves. The DBSA has essentially refocused itself. They are hoping that NEPAD will attract investment in the region and that it is an important platform for the DBSA. They see themselves as a key vehicle with expertise and a very good credit rating. Mr Naidoo told the committee that 14% of the world's population lives in Africa of which 40% live on less than $1 a day. 70% of AIDS sufferers in the world live in sub-Saharan Africa.

Mr Naidoo also explained that the DBSA has begun a development fund which started with R80 million and they have just added R80 million more. The fund is to be used for capacity building at local economic levels.

Mr De Villiers Botha (Executive Manager Operations DBSA) echoed the chairperson's sentiments that the DBSA is in very sound condition. He said that they are ready to respond to challenges facing the region (see accompanying documents).

Discussion
Dr Woods (IFP) congratulated the DBSA on their encouraging presentation and on the state of their institution. He was pleased with their performance over the last year and commented that he would like to see more details in the DBSA Performance Overview in the presentation. He wanted to see more information than just the amount of jobs created.

Mr Naidoo felt that these were important issues that his board has raised with management. He said that they are looking at a strategic planning session about this.

Mr M Gantsho (Managing Director and Chief Executive DBSA) added that the advice is well taken. He agreed that there is a need for clear development outcome results. He explained that the details are in the annual report, although they are not easy to find. They will highlight that for future reference.

Ms Taljaard (DP) spoke about the demand for technical support for local government that is going to increase dramatically. She wondered whether the DBSA's strategic thinking included this. She also asked about the progress made in discussions with Treasury and SARS on tax exemption.

Mr Naidoo replied that technical assistance has been identified as a great need. He added that technical assistance on risk management is going to be crucial for local authorities. He again mentioned the Development Fund and added that the Fund is available as an agency for the Government to use.

Mr Gantsho commented on their tax status. He said that they are waiting for SARS and the National Treasury to come back to them with proposals.

Dr Koornhof (UDM) commented on loan approvals by the DBSA. He said that the largest part of public sector financing was for municipal services infrastructure. He asked whether they foresee this ratio remaining the same or changing over time. The DBSA was asked to comment on the increasing ratio of operating costs to income since 1999.

Mr Moloto (ANC) wanted to know why the DBSA shows bias towards Gauteng in its allocation of loans. Why did they receive such a big proportion of the loans?

Mr Naidoo replied that these are issues that are being looked at by the board. There are practical reasons for the allocation of loans to the different provinces. Capacity of institutions to borrow money and apply it are just some of the important factors looked at. Gauteng has three of the biggest metros in the country. The DBSA has a responsibility to invest in sustainable projects. He added that the Development fund is specifically looking at increasing investments in the KwaZulu-Natal, Eastern Cape, Limpopo, North West and Free State provinces.

Mr Gantsho commented on the cost to income ratio. Their ratio is very low compared to other banks and other international development organisations. He added that new accounting methods contribute to the figure of 27,7%. Using the old methods, the figure would go down to 24% which is the same as the 2001 level.

Mr De V Botha said you have to see the provincial figures in context. Big projects, for example, that run over a couple of years are added to this year's financial report. That means the figures are not a good indicator of the amounts per province. He believes that the current trend will change as household infrastructure needs change.

Ms Mahlangu (ANC) congratulated the DBSA on their good work. She asked about debt situations of municipalities and also about partnerships or co-ordination between government agencies and the DBSA.

Mr Gantsho replied that they have consolidated debt at local authority level. They are experiencing no problems with the repaying of loans. He added that they work closely together with the Department of Local Government.

Mr Kolweni (ANC) wanted to know how street vendors can access loans from the DBSA.

Mr De V Botha said that local authorities and NGOs are responsible for street vendors. They cannot approach the DBSA. Individuals are not allowed to approach the bank.

Mr Nguni (ANC) enquired about the level of community participation and their access to funds.

Mr Naidoo commented that the information presented on the DBSA demonstrated its impact on sustainable development. It also demonstrated its commitment to the bank's 'Quantum Leap'. He said that they give expertise to all their local authority partners and that they insist that everything be quantified in terms that they can monitor. The DBSA is trying to empower people to become sustainable in an enterprise.

Mr Gantsho added that the DBSA is a wholesale institution that advises all their clients. The DBSA focuses on infrastructure development while other development organisations focus on other issues.

Ms Taljaard referred to the Private Sector Investments Business Unit on p.26 of the Annual Report 2002 of the DBSA. She questioned the productivity of two specific projects, namely their involvement in the Second Fixed Line Telecommunications Operator and a hotel development in the Seychelles. Ms Taljaard wanted to know whether these projects are productive and whether they are judgement calls.

Mr Gantsho thanked the member for her useful comment. He stressed that economic and financial sustainability are very important factors when considering an investment. He again emphasised that the DBSA is looking to invest in projects that are sustainable and productive.

Ms Hogan thanked them for their presentation and adjourned the meeting.

Appendix 1
2002-09-12: Statement of the Monetary Policy Committee
Issued by Mr T.T. Mboweni, Governor of the South African Reserve Bank, after a meeting of the Monetary Policy Committee in Pretoria.

The year-on-year increase in the consumer price index for metropolitan and other urban areas, excluding the influence of mortgage interest cost (CPIX), increased from 5,8 per cent in September 2001 to 9,9 per cent in July 2002. The acceleration in the quarter-to-quarter CPIX inflation rate was even more pronounced from an annualised rate of only 3,8 per cent in the second quarter of 2001 to 11,5 per cent in the second quarter of 2002. The twelve-month rate of increase in the all-goods production price index also rose from 7,8 per cent in September 2001 to the high level of 15,2 per cent in July 2002.

This increase in inflationary pressures arose largely because of the sharp downward movement in the value of the rand in the last quarter of 2001. In addition, the international price of oil increased from a monthly average of about US$19 per barrel in December 2001 to nearly US$26 per barrel in July 2002. The depreciation in the external value of the rand at first mainly influenced food prices. From the beginning of 2002 the rise in prices became more widespread and inflationary expectations began to increase. When excluding food price changes, CPIX inflation picked up from a year-on-year level of 5,4 per cent in December 2001 to 7,8 per cent in July 2002. Containment of these price increases, including administered prices, is essential to reduce inflation. This requires a concerted effort by all concerned.

The continued increase in year-on-year production price inflation indicates that consumer price inflation will rise further in the coming months because there is normally a lag of approximately 2 months before production price increases affect consumer prices. Although the quarter-to-quarter rate of increase in production prices declined somewhat in the second quarter of 2002, it is still very high at a seasonally adjusted and annualised level of 14,2 per cent. Moreover, this slowdown can to a large extent be attributed to a strengthening of the rand in the first five months of 2002. By contrast, the price of domestically produced manufactured goods continued to increase at annualised rates in excess of 20 per cent in the first two quarters of 2002.

Taking these developments into consideration, it is not surprising that inflationary expectations have increased significantly despite efforts by the Reserve Bank to curtail price increases. According to the expectations survey of the Bureau for Economic Research of the University of Stellenbosch done for the Reserve Bank, respondents expect CPIX inflation to amount to 7½ per cent in 2003 and then to decline only slightly to 7,0 per cent in 2004. At these levels, inflation expectations are well above the upper level of the inflation target range, but they moderate over time.

Nominal unit labour cost rose from 2,9 per cent in 2000 to 4,8 per cent in 2001 and 6,4 per cent in the year to March 2002. Faster growth in nominal unit labour cost is usually associated with higher consumer price inflation. According to survey results obtained from NMG-Levy Consultants and Actuaries, the average annual rate of wage settlements in the first half of 2002 amounted to about 7,5 per cent, i.e. wage increases did not accelerate in the first six months of the year. Recent wage settlement rates announced in the media are, however, considerably higher. This implies that if labour productivity does not increase commensurately, there could be further upward pressure on consumer prices.

Another factor that could lead to increased inflationary pressures is the decline in the nominal effective exchange rate of the rand of 11½ per cent from the end of May 2002 to the end of August. This weakness of the exchange rate coincided with a reduction in the holdings of domestic securities by non-residents, amounting to nearly R12 billion in July and August, which almost neutralised the net purchases of securities by non-residents in the first six months of the year. This probably reflected concerns about problems in emerging markets, including Zimbabwe. Although the draft mining charter is not government policy it was nonetheless perceived negatively by foreign and domestic investors, particularly in an environment of heightened risk aversion to emerging-market assets following the crisis in Argentina and fears of a debt default in Brazil.

The developments that have so far led to higher inflation are therefore mainly exogeneous or cost-push factors, which cannot be directly influenced by changes in the level of short-term interest rates. At present there are no signs of excess spending or production capacity constraints, while fiscal discipline has been maintained by the authorities. It is, however, always important to take into consideration that cost-push and excess monetary demand factors are interacting elements or different aspects of the same process, rather than totally separate causes of different processes. Autonomous cost-push or exogeneous factors cannot on their own lead to an inflationary process if they are not accommodated by a monetary expansion. When autonomous price increases occur without increases in the money supply, bank credit extension and inflationary expectations, such increases are self-terminating. But when they are supported by accommodating monetary developments, inflationary pressures will become self-perpetuating.

As already indicated, inflationary expectations are already very high. Moreover, growth over twelve months in the broadly defined money supply (M3) amounted to 17,4 per cent in July 2002. Although this growth rate was lower than the 20,6 per cent recorded in May 2002, the reduction was to a large extent due to increased tax collections, which reduced the private sector's deposits with banks included in M3 while raising government deposits which do not form part of money supply. It is also true that a large part of this increase in M3 was the result of increases in long-term deposits, which are less likely to be related directly to aggregate nominal spending on goods and services. The narrower defined monetary aggregates, however, also rose significantly. To the extent that the deposits at banks could be used to purchase goods and services, they are an indication of possible spending that may exceed the economy's production potential in the future, and therefore create inflationary pressures.

The growth over twelve months in bank credit extended to the private sector slowed down moderately from a high level of 15,6 per cent in January 2002 to 11,7 per cent in July. Measured from quarter to quarter, growth in credit extension to the private sector fell from 19,6 per cent in the first quarter of 2002 to only 1,9 per cent in the second quarter. This considerably decreased rate of credit expansion was mainly the result of a reversal in the leads and lags in the payments for and receipts from foreign transactions. Earlier borrowing associated with these international trade transactions was mostly repaid in the second quarter when the external value of the rand strengthened. It therefore reflected a slower rate of credit extension to the corporate sector. Credit extended to households by banks hardly seems to have been affected by the increase in interest rates during 2002 and continued to rise rapidly.

In view of these accommodating monetary developments, the Monetary Policy Committee has decided to increase the repurchase rate by a further 100 basis points to 13,50 per cent with effect from 13 September 2002. It is expected that this will lead to similar adjustments in deposit and lending rates in the domestic market. Although this will mean that interest rates in South Africa have been increased by 4 percentage points from the beginning of the year, this will in fact bring the banks ' real prime overdraft rate back to approximately the level prevailing during the first few months of 2002. The banks' real twelve-month deposit rate before taxation will amount to only approximately 2 per cent if it is adjusted by this increase. The inflation-adjusted yield on long-term government bonds in July 2002 came to only 1,2 per cent.

Consequently, the level of interest rates cannot be regarded as a major factor which has had or will have a significant constraining effect on production growth. This statement is supported by the fact that domestic final demand has continued to grow strongly. Moreover, export volumes increased considerably in the second quarter of 2002, as part of the lagged effect of the depreciation of the rand. Export growth contributed to maintaining a surplus on the current account of the balance of payments, which alleviated the pressure on the exchange rate of the rand mainly arising from the recent portfolio capital outflow. Export increases should further assist the economy in the attainment of healthy growth levels, while the current increase in interest rates should bring the inflation rate to within the target range.

TT Mboweni
GOVERNOR

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