Meeting with Governor of South Africa Reserve Bank

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Finance Standing Committee

23 June 2003
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Meeting Summary

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Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEES: JOINT MEETING
24 June 2003
MEETING WITH GOVERNOR OF SOUTH AFRICA RESERVE BANK

Chairperson:
Ms B Hogan (ANC)
Co-Chairperson:
Ms Mahlangu (ANC) [NCOP]

Documents handed out:
SARB Presentation to Portfolio and Select Committee on Finance
Monetary Policy Statement

SUMMARY
The South African Reserve Bank presented its quarterly report which highlighted the recent international and national economic trends.

Overall inflation is continuing to decrease; the latest figure is 7.7%. The inflation targets of below 6% should be reached by 2004, all things remaining the same. The most significant achievement in the past few years was found in the net open forward position of the Reserve Bank, which has changed from an oversold position to a positive position of $0.7b (US). This has helped the Reserve Bank with the debt rating agencies. It was also reported that the economy has slowed down in terms of domestic output. There has been an increase in nominal remuneration labour costs, coupled with a decrease in labour production, which concerned the Bank.

MINUTES
South African Reserve Bank briefing

Mr Tito Mboweni, Governor of the South African Reserve Bank, thanked the Committees for the invitation and noted that the presentation would be based upon recent economic developments.

Dr E. van der Merwe (Chief Economist and Head of Research Department) discussed the recent international and national economic developments according to the presentation document (see above).

International economy
The international oil price increased substantially at the end of last year due to the strike in Venezuela and uncertainty surrounding the war in Iraq. The price has recently gone down, as it is now around $26 (US) per barrel.

Generally, there is a slowing down in the world economy. According to real gross domestic product the world economy is projected to grow from 3.6% in 2002 to 3.8% in 2003. Developing countries are doing very well in terms of growth as the projections indicate an increase from 5.4% to 5.8%. Global inflation is expected to remain low. He noted that deflation is currently occurring in Japan and that levels of inflation still remain high in Africa compared to the rest of the world.

He then detailed the recent trends in the economy of the United States. There was an increase in real gross domestic product in the first quarter of this year, and many people believe that the economy will show better growth in the later half of this year. The American unemployment rate is 6%, with an increasing trend.

Japan has had positive growth in the last four quarters, but at a declining rate. Unemployment has remained at around 5 ½ %. Their consumer prices have been decreasing, as the economy has been in a deflationary period since 1998. This is a very important indicator of the structural difficulties they have been experiencing, with large budget deficits and problems with their banking sector.

The Euro area has shown no growth in the last quarter. They are also battling with structural problems, specifically in Germany. They are struggling with inflexible labour markets and an ageing population. They use defined benefit pension plans. In the near future they will have problems with the financing of these schemes. Their unemployment rate is close to 9%.

The United Kingdom's economy has been doing exceptionally well. Their real GDP growth is now decreasing, as they are experiencing the effects of the global decline in productivity. Unemployment is slightly above 3%. The UK is one of the few countries which showed an increase in consumer prices, which is now at 3.1% which is above their target of 2.5%. This inflationary tendency in their economy may be the reason why did not change their official rate.

Inflation rates in the SADC countries are relatively low, with the exceptions of Zimbabwe and Angola.

South African economy
There has been a slow-down in the growth of the real gross domestic product. There was 1.5% growth in the first quarter of 2003. This slow down was not solely due to the 3% decline in the agricultural sector; there was a more general down turn in economic activity. There were also declines in the mining and manufacturing output. There was a minor slow down in real gross domestic expenditure, which was 3.5% in the first quarter; this is still very high. The growth in disposable income has come down to 2.6%; this is related to the high inflation and the poor performance of the agricultural sector. Despite this slowdown, people were still spending money by increasing their debt. The ratio of household debt to disposable income increased significantly from 51% in the fourth quarter of 2002 to 53% in the first quarter of 2003.

Gross savings as a percentage of gross domestic product weakened somewhat to 16%, this can be attributed to weaker savings by the general government, and households increasing their use of credit.

The unemployment rate is very high at 30.5% (one in three), which remains the major problem of South Africa. The Bank is concerned that there has been an increase in the average nominal remuneration per worker, while there has been a decrease in the level of labour productivity.

Overall inflation is continuing to decrease; the latest figure is 7.7%. The inflation targets of below 6% should be reached by 2004, all things remaining the same.

The most significant achievements in the past few years was found in the net open forward position of the Reserve Bank, which has changed from an oversold position to a positive position of $0.7b (US). This has helped the Reserve Bank with the debt rating agencies.

The Rand has strengthened by 27.2% on a weighted average basis and has appreciated by 49.7% against the US dollar.

The government finances are doing exceptionally with their deficit. However, no firm conclusions can be drawn from the data, as it is too early in the fiscal year.

In conclusion, the economy can be summarised as having slowed down in the domestic output. This was not due to a slow down in domestic final demand but mainly from the changes in exports, probably effected by the appreciation of the Rand. The nominal remuneration labour cost and the recent increase in money supply should be looked at carefully. Government Finances are doing very well.

Discussion
Dr G Woods (IFP) asked if the Reserve Bank has become a little obsessive about the inflation target and if their policy has become too reactive. He wondered what factors the Bank considered when deciding about interest rate policy.

Mr Mboweni responded that the Bank was a little obsessed with meeting the inflation targets because the government has said that they must achieve these targets within the specified time period. Also, the Bank has had some bad experiences with not having achieved these targets in the past. He did not want to be part of a failing exercise. He felt that "conservative" was a better word than "obsessive". There is nothing in economic theory or practice that says the task of a central bank is to reduce interest rates. A central bank must operate according to its mandate, and as of now their mandate is to achieve the inflation targets during the specified time period.

The major issues taken into account when determining interest rate policy were elaborated on in the presentation. To re-highlight some, they look at the current CPIX (consumer price index minus the mortgage costs) outcome. At the time of the last Monetary Policy Committee (MPC) meeting the figures were 8.5% for March and 7.7% for May. This figure helps them to make a projection for the future. They also look at production prices. Normally, there is a three-month gap between changes in production prices and an impact on consumer prices. Another factor is the unit labour costs, which are very significant. He expressed his frustrations with explaining this concept. They were not saying that there should be no wage increases, just that there must be a relationship between pay increases and productivity. If you get this relationship wrong then the increases in unit labour costs will have an impact on prices, as it immediately impacts the cost of production.

Monetary growth, credit extension, oil prices, and the current account of the balance of payments give them an indication of the likely inflationary trends. These are some of the issues that they look at, and on a balance they need to make a judgement based on their analysis, the state of the current state of the economy, and what the projections are for the next 18-20 months. Inflation targeting relies to a large extent on the sophistication and the reliability of econometric focusing models.

The second to last item on the agenda of the MPC meeting is a presentation by the econometricians of the model projections. The Macro model team approaches the MPC about a month or so before the MPC meeting to discuss assumptions that they must work into the model, so that they may have a focus. Since this is the focus that the MPC will use to make decisions, it is very important that they be involved in the assumptions building process. They use the baseline results of those assumptions to project what the CPIX outcomes will be. They then make further assumptions, for example, the oil price dramatically increasing over the next year, then use them to make alternative outcomes. This process gives them a comprehensive view of what the conservative, the worst-case and best-case outcomes could be. Then they have a discussion about what each member of the MPC feels about the situation of the CPIX outcomes. At this stage, the Governor insists that each member of the MPC state his or her views about the monetary policy. There is an interaction between the technical aspects (the models, etc) with the sound judgement of the MPC members. Everything must be agreed upon by consensus and eventually they compromise and find each other.

A question was asked how have the revised figures from STATS SA helped to reach our monetary policy decisions? Mr Mboweni replied that the revisions should be welcomed by everyone. They indicate that in fact they have been getting inflation lower, which is very good. His observations of the behaviour of the MPC members at the last meeting was that whether the figures had been revised or not they would probably have opted to cut the repo rates. The revised figures may have influenced the magnitude of the repo rate cut, but that was not given as one of the reasons. The natural behaviour of the CPIX inflation demonstrates that the turning point of the unrevised figures is more or less the same as that of the revised figures.

Ms R Talijaard (DA) asked to narrow the focus with respect to the CPIX review. The Minister had announced the CPIX review approximately a year ago. She wondered if the Bank had any opinion about the composition of the CPIX basket, as there have been quite a number of criticisms from at least one private sector economist as to whether it is an accurate indicator of inflation. This opens up questions about the broader question of the disparities that exist between the CPIX and the PPI (production price index).

On the issue of STATS SA faulty statistics, she commented that if you look at the inflationary pressures that remain, for example the unit labour costs and wage settlements, they were based on faulty statistics. One of the consequences of this is the continued pressure that exists on wages that were set with incorrect figures at the base of the wage settlements. These ongoing issues still need to be addressed, as they continue to apply pressure. She wondered what the Bank's view was on this subject.

She then discussed the Net open forward position, which relates to the issue of STATS SA. The euro bond issue was primarily used in the net open forward position being brought down to zero. She wondered how the issues with respect to the problematic data had impacted on this.

Mr Mboweni responded that the substantial point was the composition of the CPIX basket and their view on whether there were any elements distorting the picture. The South African Reserve Bank is okay with the way the CPIX is composed at the moment. The key issue is that it is the consumer price index minus the mortgage costs. They have removed the mortgage costs because they are directly influenced by monetary policy. The CPIX is a comprehensive view of the inflation picture in the country and they are happy with it. They are careful not to be regularly tampering with the decisions they have made when there is no substantial evidence to prove that there is anything wrong with the process. The CPIX is a very tough measure used mostly by the British and themselves. The European Central Bank uses a straight harmonised index. He added that he was unaware with what was happening with the ministerial review.

In response to Ms Tajiaard's second concern regard faulty statistics, he acknowledged that there were consequences to this all around. He did not want to go into detail about some of those consequences, as it may awaken sleeping dogs.

With the euro bond issue, ordinarily the Treasury would have done a prospectus, used to talk to the potential investors and in this prospectus there would have been a number of issues raised, including publication of statistics which would relate to macro-economic issues, inflation etc. In this prospectus there is probably going to find that the inflation figures used were unrevised. However, the revised figures do not fundamentally change the picture.

Just before the launching of the euro the net open forward position had come down to $0.8b (US). This was partly due to the decision taken at the beginning of the year to purchase small amounts of extra dollars that they could find in the market for purposes of expunging the NOFP and more importantly to build the reserves position. One of the sources of vulnerability for the South African currency has been in the position of the NOFP and the fact that the reserves position is much smaller than expected. They were able to capitalise on 1.25b euros, which translated handsomely into dollars, and allowed them to expunge the negative NOFP. They must not be too excited, as if the Treasury decided to pay one of their dollar loans, they may need to use the positive NOFP position.

Mr K Moloto (ANC) asked why the South African Reserve Bank would be concerned about the widening gap between the South African interest rates and those of our trading partners. The conditions and challenges that we face are quite different (see document "Statement of the Monetary Policy Committee 5.1"). Secondly, what are the main factors that lead to the sharp decline labour productivity.

Mr Mboweni noted that they were just indicating that if South Africa stayed where they were in terms of interest rates, and there was a general decline in international interest rates, the gap would become ridiculous. The question has a lot of market implications, which he suggested he could discuss later.

Regarding the reasons for the sharp decline in labour productivity from about 2000, he did not have an answer. He commented that low productivity has to do with the number of employees that a company may have, as well as better utilisation of technology and remuneration of the workers. For example, if there is an increase in the remuneration of the employees and an increase in the number of employees, the level of productivity is likely to come down. If the remuneration of the worker is stable and the number of employees decreases, the level of productivity will increase.

Mr van der Merwe added that there was a slow decrease in the number of employees, followed by an increase in 2002. This change around resulted in an immediate decrease in labour productivity. The second factor was the slow down in production, as there were more people producing the same goods. Therefore with the same number of people you were producing less, which indicates that labour production is going down.

Mr B Mnguni (ANC) asked the Governor what challenges are posed by the changes of interest rates and inflation. Theoretically, when interest rates are lowered or inflation is lowered, unemployment increases. What challenges does that pose on you when you are supposed to drop interest rates and inflation rates. Additionally, Mr Mnguni questioned the impact that the Stats SA revised figures have had on the economy in general.

The Governor asked Mr Mnguni to repeat the question.

Mr Mnguni stated that when you look at the economy generally, in the UK, you find unemployment increases, inflation goes down and GDP goes down. In the USA, you find that GDP decreases, unemployment increases and inflation goes down. Is that the type of ratio that is constantly true? If interest rates go up, you seem to sacrifice unemployment with inflation and GDP. Mr Mnguni wanted to know what challenges this poses to the country since it wishes to fight unemployment and, at the same time, keep inflation rates low.

The Governor understood the question and stated that they could have a long theoretical discussion on the topic. The growth performance in a number of countries has been poor and sluggish. In the USA growth is very sluggish, but inflation is low. You have low growth, low inflation scenario. That is why the issue has concerned the central banks around the world. You see a similar situation beginning to emerge where inflation is very low in some of the Asian countries and growth is not picking up as expected. In the Euro area, inflation is relatively low, but some of the economies are in serious trouble. The German and French economies are in very serious trouble. Low inflation and low growth is a scenario that central bankers do not like. Where there is low growth, one should expect that there is low employment. South Africa is in a completely different situation. The South African situation is one of high inflation, low growth, and high unemployment. It is a bit of a zigzag situation. In fact it would be wrong not to mention that the country is still above the inflation target. South Africa is 1,7% above the upper level for the inflation target. That should be kept in perspective.

Dr EA Conroy (NNP) [Gauteng] asked whether the Governor or the bank would be prepared to venture a guess as to what the cost of Stats SA's erroneous CPIX calculation had on the consumer in terms of unnecessary paid interest on bonds and financing cost on cars and other luxury items.

The Governor answered that the South African Reserve Bank is not prepared to guess the cost of the error of Stats SA. It would be a pointless exercise for SARB. He hoped the Committee would forgive the Stats SA officials. They made a human error and explained the background of the error. They have been honest people.

Dr GW Koornhof (UDM) stated that it is the first time since the Governor has been reporting to the Committee that a positive net open position has been reported. The Committee should congratulate him on reaching this target. He stated that the priority should be to build South African reserves in the coming years. He asked the Governor to elaborate on this priority. In the last week, a major bank has made some comments on the balance of payments in the current account and they have scaled down the projections considerably in the medium term. The Governor has referred to the deficit in the first quarter, of the balance of payment current account. He asked him to indicate what may be the direction that the current account may take in the foreseeable future.

The Governor addressed the issue of the private bank that made some guesses as to the likely development of the current account or the balance of payments might be going forward. According to the historic behaviour of the balance of payment, it is difficult to tell where the likely developments will be. The Governor would be happy to assume that the deficit shown on the current account is not going to be a permanent feature. Particularly if some improvements taking place in the trade accounts are realised. As our companies readjust their own exports, performance, and competitiveness there should be an improvement. If South Africa avoids a situation of becoming too import intensive, things might balance out better in the future. The behaviour on the services transfer and the income account is not as worrying as it used to be as you can see from graph 36 of the report. The graph does not indicate any serious difference in behaviour. There is not much to worry about.

The Governor explained that the problem experienced was in the trade account. Things have been choppy. There are years where we have had three quarters of deficits and one quarter positive. Some years there has been a balance, a deficit, and a positive current account. For 2002 there were three quarters positive and one quarter deficit. The record is quite choppy. The Governor refused to make serious conclusions. The most important point from a technical view is that the current account deficit, which is less than 3% of GDP, is nothing to worry about provided that there is some inflows into the economy. So far there is an influx from bonds and shares and the money market sector. South Africa is not in the same position as the USA, whose current account deficit is so huge that it is impossible to know what they will do about it.

In terms of building reserves, SARB would like to build reserves so that when clients would like to have access to other currencies, SARB would be in a position to supply them. The major client of SARB is the South African government. There are also embassies that are served by SARB. The other reason for reserves is so that SARB can demonstrate to the market that the bank has reserves for any possible rainy day in the future. There could be disasters and other developments that will require sufficient foreign exchange. SARB would like to build reserves so that other markets can see that SARB has reserves. Other markets can sometimes take positions against SARB based on the fact that the reserves are insufficient. It will take some time to build up the reserves.

The Chair stated that there is a deficit in the balance and financial accounts.

The Governor responded that the deficit is very small.

Dr Van der Merwe explained that there was a deficit in the first quarter. However, the net purchases on the bond exchange and the stock exchange have turned around since May. There seems to be inflows now. There has been about a R10 billion swing in those statistics during April and May. He stated that the figures indicate that there has been an inflow in the second quarter in the financial account.

Ms QD Mahlangu (ANC) [Gauteng] asked a question relating to the household debt as a percentage of household disposable income. While the Producer Price Index is coming down, consumers are not benefiting in terms of the rate they are paying for goods and services. Will this be ascribed to that kind of phenomenon? If not, why does the analysis show that household debt has recently increased as a percentage of household disposable income. It was decreasing, but it is now increasing. Finally, she stated that in the presentation made by Mr M Schussler (20 June), the Committee was told that a lot of South Africans are in debt. This analysis has been a source of concern to the Committee.

The Governor explained that in 1998, when the household debt as a percentage of disposable income was around 61%, people learned that in that with high interest rates, they would get into more and more trouble. People, therefore, tried to scale down, pay off their debts, and begin to structure consumption expenditure based on current income. The graph shows that between 1998 and 2002 the percentage of household debt to household income decreased significantly.

Since the low point, people began to understand that as inflation was coming down, there would be a lag before interest rates came down, and there was still a bit of pent-up demand. They therefore decided that they could afford some more debt. This is a trend, however, that should be discouraged. This analysis also shows that households are not feeling any pinch of the interest rates. The fact that they are willing to accumulate debt, might indicate that interest rates are not as biting as some people might think they are. If interest rates are biting, this situation should be avoided.

The graph that explains what is happening to the real estate market relates an important story (Graph 54). Basically, a straight line can be drawn from the end of 2001 to the present, which shows that the real estate market is quite buoyant. There is a lot of activity going on in the real estate market. Interest rates might have been a bit biting, but the situation is not as bad as some may have thought. The other graph displays that the number of insolvency's is not as high, which is contrary to what Mr Schussler was saying the other day. SARB examines information concerning insolvency's every fortnight. The information, unfortunately, was not brought to the meeting. It shows that the number of insolvency's is down. If interest rates are exorbitantly high, the number of insolvency's would be high, but they are not.

The Chair stated that Mr Schussler only related the figures concerning the debt of individuals.

The Governor stated that his figure included businesses, which gives a more complete picture.

The Chair explained that Mr Schussler's figures only related individuals because his research was meant to examine the indebtedness of individual households.

The Governor asked to see the submission so that he could offer some comment on it. Insolvency's of entrepreneurs is not as high as one would have thought in the present situation. There are a number of indications that give a contrary picture to what one would have thought.

With regard to the question of household debt as a percentage of household disposable income, the Governor stated that it is a figure that SARB is concerned about. SARB does not think it bodes well for the economy if people are financing current expenditure by taking on too much debt.

Mr M Tarr (ANC) asked if SARB has a view on a band within which the exchange rate should be, because this of interest to exporters and importers alike. There are stories of people who have been hurt recently because they were planning on the exchange rate being different than what it is. He asked if SARB had a view on this.

The Governor answered that SARB does not have a band or level at which it would like to see the exchange rate. SARB does want to see a strong rand. SARB would like to see the rand much stronger than it is now because the pass through effect into inflation of a recovering exchange rate is good. That is why production prices are coming down and why CPIX is coming down.

The Governor explained that the exporters have got themselves into a lousy corner and are trying to blame everybody else for their lousy planning. SARB had a meeting with one of the leading South African mining houses. They were trying to explain the trouble that they got themselves into. When asked how they got into trouble, they explained that they examined the inflation differentials between South Africa and the United States and on the basis of that, projected the depreciation of the currency in the coming period. They therefore planned their rand earnings on the basis of that depreciated exchange rate based on the inflation rate just between the South Africa and the US. They informed SARB that the situation has turned out to be the other way around.

Therefore, he continued, some of the expansion programmes that were had totalling about R20 billion are now under threat. Moreover, the existing jobs are under threat. The Governor informed the delegates from the mining house that he had met with the Cape Chamber of Commerce and Industries and they related the same story concerning the clothing industry. Everybody seems to have figured the exchange rate projections incorrectly and subsequently planned poorly. The Governor said that he advised that they fire their planning officer because the notion that the rand is just a one-way bet is wrong.

The Governor explained that in fact, the biggest speculators in the currency market are the exporters and importers. Exporters decide to hold onto their dollar earnings much longer than they are supposed to by law. That will influence the exchange rate. They hope it will weaken more the rand more, so that by the time they bring in their dollar earnings, they get more rand through speculation. This is the nature of the market. The importers will also come into the market when they think they will pay less for their dollar. In addition, some other funds may enter into the market that exacerbate some of the moves. While SARB should listen to what the exporters and importers are saying, they also should listen to what SARB is saying. SARB has no intention of weakening the rand. That must be clear to everyone. SARB has absolutely no intention of weakening the rand, for as long as the Governor remains in that capacity.

Dr GG Woods (IFP) raised two issues. Firstly, the CPI and the CPIX gap is extraordinarily wide at the moment. In fact, if the figures that come out on PPI tomorrow are down in the region of 2,7%, then CPIX could be three times. If the theory of the three to six months lag is applied and looked at in conjunction with the fact that the country is in an inflationary slowdown, it would seem unrealistic that CPIX could come down to that level. Does this present the possibility that the economy could overshoot the inflationary target in coming down. The economy could overshoot the inflation target if the PPI is the serious indicator which it is normally assumed to be. He asked what could explain the large size of the CPI/PPI gap beyond retailer's fat margins.

The second issue raised by Dr Woods, concerned the bank's projections on the currency. With falling interest rates, one would expect foreign speculators sentiments to be towards the rand. The rand was considered by the bank to be one of the main drivers of inflation and it should be working the other way around. He was interested in SARB's view on the rand.

Dr Van der Merwe answered that the lag of two to three month between the CPI and PPI is simply the turning point. The lag does not necessarily mean that the two rates will coincide after two to three months. The reason is that composition of the two indices is completely different. The PPI only includes the goods, while services is also included in the CPI. Services account for roughly 40% of the total of the CPI. Therefore, 40% of the prices in the CPI are not included in the PPI. The PPI is only the production prices of goods in South Africa. The other reason for the difference is that the import component becomes very important in the PPI. Imports in the PPI, at the moment, account for 27%. More than a quarter of the PPI is reflected by the prices of imports as they come into the country. With the appreciation of the rand one would expect the PPI to come down very quickly, whereas in the CPI it would be reflected with a lag. Imported prices do not directly come in into the CPI. It comes in an indirect manner where the prices of consumers are affected. The indices are completely different. They do not necessarily have to reflect the same sort of changes in their rates of growth over time. In the past, the turning points have coincided quite nicely. The PPI normally leads to a turning point in the CPI.

The Governor added another observation. That is, once production prices have begun to go up and the pass through effect has happened to consumer prices, PPI starts to come down. He suspected that the pass through effect into lower prices is much slower than the pass through into higher prices. There is a stickiness that occurs in the consumer prices.

With regard to the possibility of overshooting or undershooting the inflation target, the Governor stated that if the behaviour of the PPI might indicate the likely behaviour of the CPIX, there is not any evidence that suggests the possibility of undershooting. Based on historical experience of how the consumer prices tend to behave despite the behaviour of the PPI, there is no likelihood of the economy going below 2% of CPIX next year. The model projections also indicate that the inflationary figure will be somewhere around the midpoint. The economy might be around the midpoint of the inflation target, which would be fine.

The Governor explained that for the midpoint to be reached, all things would need to remain the same. In other words, oil prices would have to remain where they are or come down. Unit labour cost would have to remain the same or, in fact, come down. The exchange rate would have to remain the same or maybe recover another five percent against the US Dollar. If those factors remain the same and administer prices also behave accordingly, then the inflation target should be reached. The Governor indicated that he was tired of talking about administer prices. No one listens, so he would not talk about them anymore. If all the aforementioned factors go in the right direction, the inflation figure should be around the midpoint, but not below. If things do not turn out right, the risk is that the inflationary figure will be slightly above the 6%. That would be the result of many factors going wrong at the same time.

The Governor explained the challenge that emerging market economies find themselves in when they decide on inflation targeting, particularly those emerging market economies that have flexible exchange rates. In addition, if the exchange rate has a major influence on the emerging market economy's price formation system, then the challenge faced is quite big because it means that there is a flexible exchange rate over which there is no control. The exchange rate then determines, quite significantly, the inflation outcome. In that scenario, there are a lot of difficulties. Some of these difficulties are evident in South Africa where the exchange rate has a major influence on the outcome of prices. It puts South Africa in a situation where a strong rand will always be preferable because the economy cannot afford to have a weak rand from an inflation point of view. A strong rand is necessary to support the inflation targeting objective. That begins to contradict all kinds of other objectives. The Governor thought he should mention that in passing, without saying other things that he is not supposed to say.

Mr KA Moloto (ANC) asked whether the Governor had any interaction with the Zimbabwean central bank. What type of assistance and advice is the Governor giving to the Zimbabwean central bank? There are a number of huge problems in that country which need a lot of attention and assistance.

The Zimbabwean central bank and SARB has a central bank to central bank relationship. Central banks are very interesting institutions. Where things might seem to be collapsing all around, central banks maintain very good central bank to central bank relationships because at the end of the fighting, at the end of the war, the central bank is necessary to get things going for the financial system. Records are needed as to who did what, when, with who. Within SARB, one can find the records of the transactions that happened during the Apartheid period with central banks. SARB maintains a good relationship with the central bank of Zimbabwe, which has discussed some experiences with SARB from time to time. The banks co-operate through the committee of central bank governors. They have a lot of highly technical people at the central bank of Zimbabwe. They have very good people. The current political crisis there is complicating the work of our colleagues in a very big way. They remain in our minds and in our prayers.

The Governor explained an arrangement between SARB and the Zimbabwean reserve bank whereby South Africa has an overdraft facility for the reserve bank of Zimbabwe. It is a very small amount, less than R100 million. That overdraft facility is backed up by very viable collateral, i.e. South African land bank deals. Many years ago, during the Rhodesian days, the Rhodesian government acquired a significant portfolio of land bank deals which serve as very good collateral. SARB uses the land bank deals as collateral to back up the overdraft facility. Since the Governor has been with SARB, Zimbabwe has never defaulted on that facility. It is always paid. Incidentally, in going through the financial accounts of the reserve bank, the Governor found that until last year, SARB had an overdraft facility for Portugal. He wondered why Portugal was in the books. While he has not found a good answer, the Governor thought it was appropriate to speculate that overdraft facility has to do with the Cabora Basa scheme and the development of Mozambique.

Ms Mahlangu stated that part of what she was going to ask was answered when the Governor dealt with the exporters that choose to keep their dollars with the hope of converting them to rand in a later stage. She asked about the situation of the individuals who keep dollars in their pockets. She related a story about a man who said that he went on holiday with a lot of traveller's cheques with him and he did not change them at the time because he thought the rand was going to depreciate further. Now that the rand has strengthened, he does not know what to do. He said it was a lot of money. When one leaves the country and returns, within a particular period of time that person must convert his foreign currency to rand. Many people, however, hold onto their foreign currency. She asked what could be done with such individuals. Whenever such individuals wait to convert their currency to rand, it has an implication to the rand and the strength of the rand.

The Governor responded that this practice is illegal to the extent that they keep the foreign exchange with them. He quipped that people were not supposed to help build the reserves of the country by keeping their dollars under the mattress. It would be of greater assistance if they brought them back to the banking system. It is illegal, actually, to hold onto the foreign currency. Human beings are very complicated economic agents. At the level of individuals, the impact of the change would be very small. It is the behaviour of the large institution and the large companies that will have an impact to move the exchange rate. The Governor advised individuals who return from overseas to go to the bank and exchange foreign currency for rand.

In the case of exchange control regulations, there are set number of days during which an individual has to exchange foreign currency in order for the money to be counted into the overall foreign reserves position of the country. However, it is the big institutions that are absolutely critical. The Governor hoped that one day South Africa will reach a point in terms of exchange control position where it no longer matters whether individuals keep a dollar account here at home or they do not. For individuals it does not really matter, but over a period of time, hopefully it can be the same thing as going to Switzerland. You keep your Swiss francs when you come in, when you go out, you change them or decide not to change them and so on. It really should not matter over a long period of time because there is no way in which SARB could know that a citizen has ten US dollars at home. Inspectors will not be sent into houses to investigate.

The Governor asked Ms Taljaard if he has answered her question.

Ms Taljaard responded that she had many more questions but there is not enough time.

The Governor asked if he sufficiently answered concerning the Zimbabwean collateral.

Ms Taljaard responded that she would be far more interested to know about the transactions. She stated that if she had the access and scrutiny the Governor possesses she would be interested in reading about the transactions between the respective government entities.

The Governor answered that there is not much to scrutinise. He did not believe such information is confidential. It is a basic legal agreement, e.g. We the Zimbabwean central bank hereby accept that we have access to this facility, and so on. The agreement is signed by the lawyers and deputy governors. Zimbabwe will use that facility to pay a number of things. The monetary amount is small and it will be used for things such as electricity. The good thing about having Zimbabwe as a client is that they have never defaulted on their account.

Mr Mnugni stated that it is one of the bank's co-functions to strive for financial and price stability. He elaborated on the issue of business people planning on the current exchange rate with the view that perhaps the rand will depreciate or appreciate in the future. Will that not in the long run or the short run have a negative impact on the credibility of the bank? Additionally, Mr Mnguni noted that countries such as Lesotho and Swaziland have currencies that are tied to the rand. One can enter Lesotho and Swaziland and buy anything with the rand, but in South Africa one cannot buy anything with Lesotho currency. Are the central banks inside this region thinking of introducing a singly currency such as in the Euro zone?

The Governor responded regarding the exchange rate fluctuations and the impact on financial stability and the planning by the private sector. It is important to maintain financial stability. It is important for stable conditions in the financial sector, banking, financial markets and so on. But, SARB cannot be held responsible for fluctuations in the financial markets. Through the management of monetary policy SARB attempts to create conditions which might have a positive impact on the financial market. But sometimes the financial markets will behave in ways which are difficult to read because they respond to other known economic factors. There are many of those factors which in the past four years or so SARB has discussed with the Committee.

SARB is responsible for supervising and regulating the banks, which is another contribution to add to the stability of the financial sector. SARB is concerned about the financial stability of the country, and will do what is possible to contribute towards that. If SARB had its way, the exchange rate would not be characterised by such volatility as it is from time to time. SARB would prefer an exchange rate that has low volatility and is fairly stable, but is on the stronger side.

With regard to the Common Monetary Area (CMA), there is a firm agreement in place between South Africa, Lesotho, Swaziland, and Namibia to constitute the CMA. The CMA basically has a common currency - the rand - which is accepted in all of these countries. But in South Africa, the other currencies are not accepted. In reality, SARB's Bloemfontein branch in the Free State does a lot of processing of the Maluti because in the towns in the boarder areas people tend to accept Maluti. When a farmer in that area is approached and offered Maluti for a head of cattle, he will take the Maluti. In those areas it does not matter whether you have rand or Maluti, people accept them. The bank ends up having to process the currency and to tender the Maluti to Lesotho. The same thing is true of Swaziland. Strictly speaking, people should be locked up for using the wrong currency, but it happens. The practice gives one a clue about economic processes and people's thinking about the different countries. In Swaziland, South African currency is not appropriately legal tender, but in practice it is. De facto it is, de jure it is not.

Discussions with the other central bank governors from the CMA have been held concerning whether they can play a role in the determination of monetary policy in South Africa. This is being discussed because immediately after the monetary policy committee makes a decision on its monetary policy stance, the central banks in the CMA immediately have to adjust their repo rates or their bank rates. In a sense, monetary policy is being determined in South Africa for the entire CMA, which is undemocratic. Decisions are made for people who do not have the opportunity to participate in the decision making process. It is not democratic. SARB, for its part, clearly states that it is making monetary policy for South Africa. It so happens that there is a larger impact to SARB's decisions.

The governors of the respective CMA banks have been discussing what role they can play in the monetary policy committee. The answer is that they cannot play any role because SARB is making monetary policy for South Africa, not for anybody else. But they argue that there is an agreement between South Africa and themselves that constitutes the CMA. SARB responds that there is nothing about monetary policy in that agreement. Although this is true, this process is not fair. It is undemocratic for SARB to sit in Pretoria and make monetary policy decisions that affect other countries.

The answer to the problem is political; it is not, strictly speaking, an economic problem. SARB has agreed to do some research on the feasibility of a common central bank for South Africa, Lesotho, Swaziland, and Namibia. If the political leadership were to accept the concept of a common central bank, then such a bank could be modelled after the European central bank. All of the governors could constitute a monetary policy committee for the entire area. It would necessitate the rearranging of payment systems and banking laws. Other activities would have to be rationalised and put together into a single central bank. It is not a bad idea to have a single central bank, but a single central bank for the SADC region is already being discussed. If it is feasible to start with a common monetary area, it is not a bad idea. Politically, the Governor did not think it will sell.

The Chair thanked the Governor for an interesting address and thanked the members for their questions. The Chair stated that the Committee looked forward the last engagement with the Governor in September before the Parliament changes.

The Governor said thank you and that he was looking forward to the last engagement.

The meeting was adjourned.

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