Economic Performance and Outlook: South African Reserve Bank briefing

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Finance Standing Committee

18 February 2020
Chairperson: Mr M Maswanganyi (ANC); Mr Y Carrim (ANC, KwaZulu-Natal)
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Meeting Summary

The Finance Committees of the National Assembly and National Council of Provinces (NCOP) held a joint meeting to receive a briefing by the Governor of the South African Reserve Bank (SARB) and other officials on the Bank’s monetary policy.

They were told that lower inflation had created space for the two recent interest rate cuts, and that the Bank projected a further repo rate cut in late  2020 from the current 6.25  percent.

Inflation was expected to remain near a target midpoint of 4.5 percent for three years. It was on track for its longest ever period inside the target range. The inflation rate for poorer households had now dropped below the headline inflation rate. 

South Africa's weak economic growth of 0.4 percent in 2019 was well below a long-run average of 3.3 percent, and was “disconnected” from the average world growth rate of 3.0 percent. Confidence in the economy was “very subdued.” 

There was upward pressure on interest rates as a result of higher risk perceptions about South Africa. Financial markets were already pricing South African bonds as below investment grade.

The Bank confirmed that it would like to dispose of its 50 percent shareholding in African Bank. It would have no objection to the government using African Bank as a nucleus for a proposed state-owned bank. 

Committee Members expressed concerns about the country’s debt to gross domestic product (GDP) ratio and the effects of a downgrade to its sovereign debt ratings. They were told a downgrade would have a negative effect on commercial banks. However, stress tests had indicated that the banks would be resilient to any significant change in borrowing costs.

Members were told that the economy was underperforming and not achieving its potential growth. However, investment levels were better than what was generally believed.

Meeting report

SA Reserve Bank briefing

Co-chairperson Maswanganyi welcomed the delegation from the SA Reserve Bank (SARB), and invited the Governor, Mr Lesetja Kganyago, to start the briefing.

Mr Kganyago said the global economy was going through a difficult time. The economics profession was trying to comprehend how much damage would be done by the coronavirus outbreak in China. There was no doubt that it would cause a significant economic slowdown in China, and this would affect the countries that traded with China. He asked Dr Chris Loewald, head of economic research, SARB, to give an overview of monetary policy.

Dr Loewald told the Committee that lower inflation had created space for interest rate cuts in July 2019, and in January 2020. The SARB’s economic model currently projected a second rate cut in late 2020 from the current 6.25 percent.

Inflation was expected to remain near a target midpoint of 4.5 percent for 2020, 2021 and 2022. It was on track for its longest ever period inside the target range. The inflation rate for poorer households had now dropped below headline inflation after reaching a peak of nine per cent in 2016. South Africa’s inflation rate was still quite high when compared with the 2.9 percent average of its peers among developing countries. Government-affected prices, such as fuel and electricity charges and “sin taxes,” were rising relatively fast. 

South Africa’s economic growth of 0.4 percent in 2019 was weak and below a long-run average of 3.3 percent. It was “disconnected” from the average world growth rate of 3.0 percent. This was unusual, as there was usually a much closer correlation.

Confidence in the economy was “very subdued.”  The Bureau for Economic Research (BER) consumer confidence index was at minus-7, while its business confidence index was at 26. Unemployment was rising. While the number of people employed had grown at an average of 156 700 a year, this had not kept pace with the size of the work force, which grew by an average of 373 500 new entrants a year.

Household incomes were growing, “but sluggishly,” and there were “some signs of life” in household credit growth. Household consumption remained high relative to GDP. For the eight-year period measured in 2016, it was 62.1 percent of GDP.

Investment had been a bit more resilient than people tended to think, but it should have been higher. Public sector investment had tapered off, but private sector investment was holding steady. 

Imports remained high, but exports had not been as high as had been expected. While many other economies had expanded their exports in the wake of the global financial crisis, South Africa had not. This was somewhat surprising, as commodity prices had remained high.

Weaknesses in export sectors were related to problems such as electricity shortages. These constraints were likely to keep growth low. In 2019, the electricity availability factor had been 66.9 percent. This was very low by historical standards, and was likely to remain low for some time.

Dr Leowald said the economy had consistently failed to achieve its potential growth, resulting in an “output gap.”

South Africa had over recent years entered a period of stagflation, where there was a widening gap between inflation and a low growth rate. The SARB had tried to ease that constraint by “talking inflation down,” to create space for interest rate cuts. 

A lingering problem was upward pressure on interest rates as a result of a higher risk measure applied to South Africa by the Emerging Market Bond Index.  One reason for this was an increase in South Africa’s debt as a percentage of GDP. South Africa continued to run a relatively large current account deficit by borrowing from the rest of the world. A small trade surplus was outweighed by interest payments abroad.

 The markets were already pricing South African bonds as below investment grade. However, global conditions were helping South Africa. World interest rates were unusually low. This meant interest rates on marketable debt were not as high as they would otherwise be.

Discussion

Mr W Aucamp (DA, Northern Cape) said too little was being done to create economic growth. The SARB, as the protector of the country’s financial stability, should tell the government that issues such as expropriation of land without compensation, and calls for the nationalisation of the SARB, were threats to investment. “Everyone knows that the Kaizer has no clothes,” he said. When would the SARB “have the guts to tell Kaizer it’s not working?”

Mr D Ryder (DA, Gauteng) asked how South Africa’s debt to GDP ratio compared to other countries. He believed it was out of line. There were growing concerns about a credit rating downgrade. Did the SARB’s forecasts take this possibility into account? What impact would a downgrade have on the balance sheets of South African banks? Would they have a lower appetite for risk? What would the role of a proposed state bank be?  Was there really a need for it?

Dr Dion George (DA) said his information was that businesses trading with China were already feeling the impact of the coronavirus outbreak there. There was a need to consider ways of mitigating the impact. Fundamental changes were needed if the economy was to grow. How certain was the SARB that it could protect South Africa’s currency as the economy deteriorated?

Ms P Abraham (ANC) asked what the SARB could do about wealthy people who hid their taxable income. How could fighting corruption help save the economy? If the economy had the potential to produce more, why was it not doing so?

Mr F Shivambu (EFF) said it was “foolish” to say that land expropriation would limit growth. It was on state-owned land that investments in industrial development zones were made. There was also no scientific basis for saying that removing private shareholders from the SARB would discourage investment. Ninety percent of the world's central banks did not have private shareholders.

Mr Shivambu referred to the SARB’s announcement that it intended to dispose of its 50 percent shareholding in African Bank. He suggested that African Bank could become the nucleus for a state-owned bank.

Mr I Morolong (ANC) said there was general concern that the country’s debt to GDP ratio was out of control. What would an acceptable ratio be? What effect would the coronavirus outbreak have on imports and exports? The Bank was suggesting that investment was more resilient than generally believed.  Why had this not been given more space in the media?

SARB’s response

Mr Kganyago responded to questions about economic growth. He said it was wrong to say that higher growth led to higher investment. It was higher investment that led to higher growth, and thus to more jobs. There had to be investment in physical assets, people and technology. There had to be an environment that was conducive to investment.  At one time, public sector investment had been fairly strong. Currently, given the state of the fiscus, public sector investment was not going to be a key driver of investment.  The private sector was the driver and it was important to maintain business confidence.  “A former US Treasury Secretary used to say that sorting out sentiment is the cheapest form of economic stimulus.”

On threats facing the economy, Mr Kganyago said South Africa was “externally vulnerable,” because the country was living beyond its means. It was running twin deficits by spending more than was generated by taxes, resulting in a fiscal deficit. The deficit was funded by raising debt which had to be serviced.

There was a shortage of savings, which were not sufficient to cover investment of around 18 percent of GDP. The difference between what was saved and what was invested led to a current account deficit, which led to borrowing from foreigners.  In 2010, foreign debt servicing costs were 0.4 percent of GDP. This had risen to 1.5 percent by 2018.

South Africa was vulnerable to a drop in foreign capital flows or a credit rating downgrade which would raise the cost of borrowing for the government, and therefore everyone else.  Foreigners calculated their returns in foreign currency, which could lead to a depreciation of the rand and higher inflation. If this happened, the SARB was duty bound to protect the value of the currency by containing inflation.

Mr Kganyago asked Bank officials accompanying him to respond to other questions.

Mr Kuben Naidoo, Deputy Governor, SARB, confirmed that the Bank would like to exit from its 50 percent shareholding in African Bank. Although it was not unusual for a central bank to come to the rescue of a failing bank in this manner, there was an inherent contradiction between owning the bank and regulating it. Government was free to put in a bid if they wanted to use African Bank as the genesis of a state bank.  The SARB would have no objection from a shareholding perspective. However, as a regulator, the SARB would have to adjudicate in the granting of a licence.

Mr Kganyago added that the agreement between the SARB and African Bank included a “tag-along” provision that if one shareholder sold shares, the others were entitled to sell a proportionate number of shares. At this stage, the Bank was not calling for bids for its shares, but for a transaction adviser to determine the appropriate way to exit its shareholding.

Mr Naidoo said a ratings downgrade would have a negative effect on banks. About 11 percent of the bonds on their balance sheets were government bonds. A downgrade might result in an increase in the bond yield and a reduction in the price, with negative implications for their balance sheets. Stress tests had indicated that the banks would, however, be resilient to any significant change in borrowing costs.

On combating illicit financial flows, Mr Naidoo said there was a new era of cooperation between the Reserve Bank and other agencies such as the SA Revenue Service (SARS), the Financial Intelligence Centre (FIC), the Hawks priority crime investigation unit, and the National Prosecuting Authority (NPA).

There were some “long-run reasons” for South Africa’s weak economic growth. Some related to the apartheid era. These were the quality of the skills of the workforce; the fact that poor people lived far from their places of work; and the concentrated, oligopolistic nature of many sectors of the economy.

Shorter term issues were the low savings rate, long distances from international markets and poor infrastructure, particularly on the African continent. There were also energy and skills constraints. It had been estimated that there were half a million high-skilled vacancies in the economy.  For every high-skilled person employed, two to four lower-skilled jobs were created. “If you were to import half a million skilled workers, you would create between one and two million low-skilled jobs, literally overnight,” Mr Naidoo said.

Some tax rates were high relative to South Africa’s competitors, and long-term borrowing costs for businesses were high, reducing competitiveness. Issues of policy certainty still bedevilled investment in some areas.

Mr Loewald said it was extremely difficult at this stage to form a clear view of the economic impact of the coronavirus. So far, oil prices had fallen sharply and the gold price had gone up. With commodity prices staying relatively high, there had been a short-term benefit to South Africa’s terms of trade. However, the long term impact could be very negative as the demand for commodities declined. 

While the Bank did not specifically factor a possible credit downgrade into its economic modelling, the models did factor in how the market was already pricing in the likelihood of a downgrade.

On the issue of achieving stronger growth, he referred members to the Spencer Commission report, which compared growth and development in various countries. A conclusion was that small economies should be open to global markets and the importation of knowledge from the rest of the world.

Ms Pamela Mjandana, head economist, SARB, outlined how South Africa compared to other emerging markets: On average, emerging markets were expected to grow at 4.5 percent between 2020 and 2021. In sub-Saharan Africa, the figure was expected to be 3.5 percent. South Africa’s projected growth was between 1.2 and 1.9 per cent. Inflation in emerging market countries was between two and four percent at the moment. South Africa’s headline inflation was projected to be 4.5  percent in 2022.

On the question of debt to GDP ratios, Ms Mjadana said there was no “magic number.” It depended on the growth and revenue of a country.  However, there were certain principles. Borrowing for consumption was not recommended, because it would not be possible to pay off that debt. Borrowing should rather be for revenue-generating activities which would boost long-term productivity. South Africa had set a target of a “comfortable” level of debt to GDP of around 60 percent. This was also the target set by the Southern African Development Community (SADEC).

Ms Mjadana referred the Committee to an assessment released by the Bank the previous November, which outlined risks to financial stability. These included weak growth, the government's “deteriorating debt matrices,” and the fragility of state-owned enterprises.

On the question of whether fighting corruption would contribute to economic growth, Ms Mjadana said the main question was at what point corruption became “macro-critical.” The question to be asked was to what extent government spending contributed to economic growth - the “fiscal multiplier” effect of every one rand spent. The Bank had found that the numbers were low, and sometimes negative. “That means that we are paying for inefficiency to some extent,” she said.

In his final remarks, Mr Kganyago pointed out that the Reserve Bank’s role in maintaining financial stability was secondary to its primary mandate to protect the value of the currency. On the SADEC debt to GDP target, he said it was the result of a move by the Association of African Central Banks to align economic indicators in different regions of the continent. It was part of a “long journey” to achieve macroeconomic convergence, and underpin the African Free Trade Agreement.

The co-chairs made concluding remarks.

Mr Maswanganyi said economic growth should be inclusive and not be achieved at the expense of the previously marginalised majority of people. Transformation of the financial sector was very important. A balance had to be struck between the needs of South Africa and the demands made by outside investors. Moves to deregulate the economy had not resulted in foreign investors coming to the country. Retrenchments were increasing, and even state-owned enterprises were threatening to lay off people.

Mr Carrim emphasised the issue of corruption. He suggested that the Reserve Bank, in its quarterly briefings to Parliament, should include reports on what was being done to reduce illicit financial flows.

The meeting was adjourned.
 

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