Meeting with Governor of South African Reserve Bank

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Finance Standing Committee

25 September 2003
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Meeting report

FINANCE PORTFOLIO COMMITTEE
26 September 2003
MEETING WITH GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK

Acting Chairperson:
Mr Mnguni (ANC)

Documents handed out:
Presentation by the South African Reserve Bank

Reserve Bank website

SUMMARY
The Reserve Bank briefed members on the latest economic developments that had played a big role in the current South African monetary policy. Members asked questions about the exchange rate, the buying of dollars and overall global economic activities.

MINUTES
The South African Reserve Bank was represented by Mr Tito Mboweni (Governor) and Mr Brian Kahn (Senior Deputy Chief Economist) who did the presentation (see document).

Discussion
Mr Moloto (ANC) asked why the manufacturing sector had a negative growth over the first six months of this year.

Mr Nene (ANC) referred to slide 37 on the balance of the current account and wanted to know to what extent the recovery of our currency attributed to the scenario.

Ms Joemat (ANC) referred to slide 29 on non-agricultural employment and slide 32 on non-agricultural labour productivity. She enquired why the employment went up but the productivity down.

Mr Khan replied that the domestic demand for manufacturing production has remained relatively firm which is a positive. What is concerning is the fact that the production side has been declining. Part of that downturn has been in the mining sector, particularly the gold mining sector which has seen a steady decline over the years. In recent months the downturn has been seen in the manufacturing sector, particularly that part of the sector that has been producing for exports. An important reason for this is the weak state of the international economy. SA exports a fair amount to the Euro area and that region was very subdued in the last quarter. The trade figures for the last couple of months have shown a much stronger export performance. The SARB is hopeful that as the world economy picks up, SA export volumes will also pick up. They would argue that the state of the world economy has a bigger impact on the export volumes than the exchange rate.

Mr Mboweni (Governor: South African Reserve Bank) added that we live in an open, highly integrated economy. If one was to summarize the key challenges facing the South African economy now, one would naturally come to the conclusion that the poor state of global demand is having a far greater impact on the performance of the South Africa economy than maybe we have seen in years. This has to do with the high level of integration of the South Africa economy into the global one. The poor state of the global economy will have an impact on SA's major exports, minerals and mineral products, and also on other manufacturing and agricultural products. Coupled to that the international balances in exchange rates regimes have changed a bit. That should impact on the levels of competitiveness to the South Africa exports. The consequence of this is that the performance of the global economy is of absolute importance to the South Africa economy. It will have an important bearing on what is happening in the clothing and textile sector, particularly the export side. It will have a bearing on what is happening in the mining industry, particularly the gold mining industry. Down the line it will also have an important impact on the automobile sector.

He continued that we are currently waiting for a substantial recovery of the global economy. This will have a rebalancing effect on the exchange rate and inflation. The second issue is that it is quite clear that the world economy relies heavily on the performance of the United States economy. Whether one likes it or not that is life. The US economy has become the key engine of economic growth. The poor performance by the US economy has dragged down the global economy. Europe is not doing well at all. The European economy is actually in poor shape. Their growth levels are very low. When such a large economy under-performs it doesn't make a good contribution to the global picture. On the other hand there is Japan whose growth is also insufficient to support the global economy when the US is doing badly. These are the three main sectors in the global economy. For global growth to improve, the US economy has to pick up. At the meeting of the governors of central banks, which happens every two months in Basel, the general impression that they had arrived at was that there were some promising underlying trends for a possible pick-up in economic performance in the fourth quarter and a bit of momentum beginning to build up in the first quarter of 2004. 2004 should see global growth improving. US tax cuts which put $30 billion back into the peoples' pockets, should improve consumer demand and spending. That should help to stimulate economic performance.
Although the Governor said that he did not like to say this but he thinks that military expenditure is likely to pick up as they retool and resupply. Generally we should be seeing improvements in the global economy.

The Europeans are having a bit of a problem with the growth and stability as far as meeting the budget deficits are concerned. France and Germany are beginning to overshoot their budget targets and hopefully that amount which they exceed their targets with would be used to invest in some productive activities to help the European economy to move a bit, or at least to encourage consumers to spend a little bit.

If we look at the South African economy in this global context we should not be too hard on ourselves that we are only growing at about 1.5%. The state of the global economy is subdued and we are doing much better than Europe. The mandate of the central bank is to focus on inflation (slides 35 and 36). There is no danger at the moment of imported inflation in the South African economy, because the inflation is on the low side in the world economy. That coupled with the significant recovery of the exchange rate of the Rand should mean that import prices should be fairly contained. He is however very concerned about the decision of the OPEC countries to cut oil production by 90.000 barrels a day. This led to a temporary spike in the oil prices which is an important energy source for South Africa and we are dependant mostly on imports. Increases in oil prices have a direct inflational impact. Europe is moving into their winter and therefore the demand for energy will be much higher and therefore the prices should be higher.

The inflation picture in South Africa has improved. Slide 35 shows that the all-goods production prices show a dramatic decline from where they were in the last quarter of 2001. This is good news and means that the inflation picture in the country is improving quite radically. The SARB will remain vigilant to reach their inflation target of 3 - 6% (currently 6.3%).

Dr Woods (IFP) commented that Parliament's point of departure on oversight is their interest in how the economy is performing and especially the role of monetary policy in economic growth. He added that they have to compliment the SARB on some of their achievements, but that the SARB has its detractors. It is important that Parliament put these questions to him. The one issue is interest rates which even though they came down in absolute terms are still pretty high in relative terms. Real interest rates are still about 5% above inflation. The criticism there is that the SARB are too cautious in comparison to how overseas countries manage their interest rate policies. It was suggested that the recent meeting of the Monetary Policy Committee was simply a correction to their over-cautiousness. This leads onto the point he made last time, which the governor does not enjoy, that SARB's restrictive monetary policies are driven almost with a single-minded pursuit of the inflation target as opposed to the Greenspan approach which looks at a broader approach to risk management of monetary policy.

The other area of criticism is the value of the Rand which in part is fed by the high interest rates. He recognises that the argument of the poor performance of the global economy is true. However he wondered if the governor is not playing down other factors that are paying a role. The role of the exchange rate on our economy is significant, whether it is the world economy situation or our value of the Rand situation - they are both part of the supply and demand. Our exports have not done too well in the last year. They have affected the balance of payments negatively and the reserves are also not looking too good. One is vulnerable in the international markets when one has no reserves, particularly when looking at the international crisis on the monetary front. One of the criticisms on the value of the Rand is that people are suggesting that the governor speaks the Rand up by saying it is under valued. He added that this is a tricky issue for the governor to speak publicly on and therefore he would not push him on this issue. Generally the world and industrialised countries are going for weaker exchange rate policies.

Dr Koornhof referred to the Monetary Policy Statement of 20 March 2003. There it was stated that with the recovery of the Rand, the Reserve Bank has on occasions taken the opportunity to purchase dollars for the reserves on a moderate scale. You qualified it as "these operations are in no way directed at seeking to influence a particular level of the Rand whose value will continue to be set by the market." Would the SARB consider gradually buying dollars in the market? His second question asked if administered prices influence the inflation target in any way.

Ms Mabe complimented the Governor on the inflation levels and asked what will sustain this target and ensure that we do not go above the 6% level? She also asked how he sees SA's economic performance in the near future.

Mr Mboweni replied that the issues that Dr. Woods had raised were very important as were all issues that members of this committee raise. On the question on interest rates and how monetary policy is conducted in South Africa, in comparison to the UK and US, this is a very complex process. First of all you have to ask what the purpose is of moving interest rates in other directions. Interest rates are changed depending on a detailed analysis of what the underlying inflation trends are in the economy, where they are in respect to the inflation target, what are the underlying trends telling them and particularly what is happening with unit labour costs, what is happening to the oil price, what is happening with the import component of prices plus a lot of other factors that they take into account.

The actions taken by the SARB last year have begun to show some results. Of course there is also a place for luck in monetary policy. You need luck, the gift of the gods. We are lucky that the oil prices did not overshoot above $330 per barrel for most part of this year. Luck was on our side since we can not control the oil price. Secondly there were no floods or massive droughts in the country except for certain parts of the Limpopo province. In the Western Cape the rain was delayed but eventually it came. Again we were lucky.

The structural balances in the global economy resulted in a situation whereby our currency recovered somewhat. Again if developments in the world economy were different the recovery might not have happened. The weakness of the US$ contributed a lot. A number of factors were in our favour. Given the overall balance of circumstances, the Monetary Policy Committee decides where to go.

Economics is not just an abstract science. It is a science about human behaviour, about whether you go and buy and sell or produce. It is interaction between human beings. The inflation expectations of the producers and buyers are very important. Once you conquer inflation expectations on the downside, part of the war against inflation is won. Inflation in the UK and the US are low so they can afford the kind of interest rates they have. South Africa still faces a big problem. We still have not achieved our target. We cannot afford to be gambling and careless. He stressed that when criticisms are fair he does take them into account. Economic developments do not wait for the meetings of the Monetary Policy Committee. That is why it is so important for the SARB not to become too straight jacketed in their approach. If and when the SARB notices that there is movement in the economy that requires analysis and action the central bank should be free to meet. That was the reason for the latest unscheduled meeting.

On buying dollars he explained that whenever the opportunity arises, the SARB do purchase dollars in the market. The policy is called creaming off. The intention is not to affect the level of the exchange rate but it is part of the prudent management of the reserves situation. One of their achievements was the elimination of the Net Open Forward Position (NOFP). This means that the country is beginning to build positive reserves. About administered prices he said that he has given up on that. He has been talking about it for the last five years and people do not care about it. Therefore he has given up on it. Government or public sector-influenced price increases are not taking account of the inflation target. Maybe he should write a letter to the president and see if he can do something about it. On the prospects for the economy he said that we should see the economy picking up in the first half of next year so that for the year as a whole we could still see the economy growing at 2.5 - 3%. A lot will depend on what happens with global economic developments. 3% is not enough but the SARB does not really spend a lot of time working through the projections of growth. They prefer to leave the forecasting of national growth to the National Treasury. They do that on a regular basis.

Dr Conroy (NNP) enquired after the effect of the stronger Rand, due to its detrimental effect it has on exports, on the balance of payments. What influence will this have on the tax revenue next year?

Prof Turok (ANC) remarked that in the governor's reference to the global economy that China was not mentioned. He had just returned from a study tour on economic reforms in China. He was very impressed at the rate of production, exports and the way they manage the economy. The fixed exchange rate is seen by the Chinese as a very important element in their growth. He asked for comment on fixed exchange rates.

Mr Mboweni replied that the solution is about a much more fairer and equitable global trading system. The Chinese are having a lot of difficulty in defending their fixed exchange rate system. There is a lot of pressure to have a flexible exchange rate. The governor reiterated that he definitely does not favour a fixed exchange rate system. A floating exchange rate system is working and we should be improving it further with a fair, equitable trading environment than with a system that is based on artificial structural impediments. With the fixed exchange rate, it might not be long before things change dramatically and they might find the cost of adjustments very high. He thanked members for their support and interactions.

The meeting was adjourned.

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