Meeting with Governor of South African Reserve Bank

Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEES: JOINT MEETING
20 August 2004
MEETING WITH GOVERNOR OF SOUTH AFRICAN RESERVE BANK

Chairpersons: Dr R Davies (ANC, NA); Mr T Ralane (ANC) [NCOP]

Relevant documents
Statement of Monetary Policy Committee - 12 August 2004
Presentation on monetary policy models and forecasting
Presentation on recent economic developments

SUMMARY
The South African Reserve Bank conducted presentations on the models it had used to forecast the inflation rate and recent economic developments. During the discussion Members sought clarity on:
· the impact of the relatively high interest rate in South Africa on the current relatively high exchange rate and monetary policy;
· the impact of the revision of the CPIX basket on SARB forecast models,
· appropriate level of the exchange rate,
· whether SARB has had specific discussions with Treasury on the difference of opinion on the exchange rate,
· how much emphasis SARB places on the impact that its decisions on rate cuts would have on growth and employment.
· statements by economists that SARB has taken a cautionary position in leaving the interest rate as it was
· whether the recent march by the National Union of Mineworkers (NUM) on the SARB building had an impact on its decision to drop the repo rate by 0.5%
· the reason for the increase in imported oil from 30 million to 60 million barrels.

MINUTES
Introduction by Chairperson
The Chair welcomed all to the first meeting of this Parliament with the Governor of the South African Reserve Bank (SARB), and congratulated the Governor on the renewal of his contract.

Introductory remarks by Governor of the South African Reserve Bank
Mr T Mboweni, Governor of the South African Reserve Bank (SARB), stated that he should, in typical African style, also reciprocate the good wishes shown to him by the Committee and congratulate Members on their election and re-election to Parliament. He stated that he looked forward to a good working relationship over the next 5 years.

He noted that the first presentation would provide an overview of the SARB models and the focussing techniques used to give it guidance and direction, although they were not the only factors that determined monetary policy. In fact they played a very small part, and were about as influential as weather forecasts. He stated that there will be a slight deviation from the norm in some of the scenarios that were considered at the August 2004 Monetary Policy Committee (MPC) would also be outlined.

The second presentation would involve an abridged version of the data that was presented to the MPC, so that Members could be made aware of some of the issues considered that might have influenced the way the MPC saw the economy and the prospects for inflation.

Models and Forecasting: briefing by SARB
Dr M Smal, SARB Deputy Head of Research: Macro Models, conducted the presentation (document attached) on the models used by SARB in forecasting the inflation rate and monetary policy.

Discussion
The Chair drew attention to the revised Philips curve model referred to by Dr Smal which measured price inflation and output gap, whereas the classic Philips curve model involved a trade-off at least in the short-term between inflation and employment. He sought clarity on the assumption underlying the revised model.

Dr Smal responded that the standard Philips curve was being employed and thus the basic theory applied. Different variables were also used, as identified in the literature. There was no long-term trade off between inflation and output.

The Chair sought clarity on the estimation of the impact of the relatively high interest rate in South Africa on the current relatively high exchange rate.

Mr Mboweni replied that there was no doubt that where there was interest rate differentials between two countries, the bargain-hunters or the yield seekers will try and take advantage of the situation. They would want to borrow in the low interest rate environment and invest in the high interest rate environment in order to take advantage of the differential. There were very short-term investments and were unlikely to remain in a particular position. It did have an impact on the exchange rate, but its influence was exaggerated. The largest players in the supply and demand of foreign exchange in South Africa were the exporters and importers. At times when the exchange rate fluctuated either the importers or exporters would be panicked into the market and could cause serious movement. He stated that he had requested SARB's research division to identify just how much of this was in real dollar terms.

Ms R Taljaard (DA) [NA] sought clarity on the relationship between the revision of the CPIX basket by Statistics South Africa and the impact of that process on the re-basing and re-weighting process within the CPIX basket on the models. She asked whether this process has already been taken into account on the modeling that has been done.

Dr Smal responded that all forms of data revision necessitated starting the modeling process again from scratch. This was a continuous process and it was for this reason that SARB stated that modeling and forecasting was undertaken constantly.

Mr Mboweni added that the revisions have not yet been published.

Dr M Mnyande, SARB Head of Research, stated that SARB had communicated with Statistics South Africa with regard to the revision, and this was thus not a problem.

Mr Mboweni stated that the key assumptions made by SARB were mostly around the Organization for Economic Co-operation Development (OECD) growth forecasts, international commodity prices, the repo rate and the oil prices. A full list could be provided to Members. New information which was reliable and of a good quality allowed SARB to improve its focus and its own results, but if it made the situation worse SARB would then simply change its mind. At the moment SARB was quite happy with its focus.

He stated that SARB's focus continued to be inflation targeting and the continued need for the rate to remain within the set target range. The Constitution stated furthermore that SARB would do this as part of its contribution to sustainable growth and development. There was thus no contradiction between inflation targeting and balanced economic growth and development. Low inflation should contribute to a better monetary set-up in the country, and hopefully this should contribute to better levels of demand, higher output and higher employment creation.

Dr Small added that the administered prices were also assumed, but there were taken from the disaggregated model.

Ms J Fubbs (ANC) [NA] stated the presentation indicated that the increase in the 2003/2004 fixed capital formation was probably due to the purchase of aircrafts. She suggested that it would be useful to remove those once-off factors from the fixed capital formation, in order to sketch the trend.

Mr Mboweni replied that this question would be dealt with in the second presentation. He stated that the aircrafts were exceptional and temporary items because, if it became a permanent feature, the current account deficit on the balance of payments would become worse.

Recent economic developments - briefing by SARB
Dr M Mnyande, SARB Head of Research, conducted the briefing which outlined the presentations made to the MPC on the international development, national economic trends, financial and fiscal developments in the economy, the national accounts statistics, labour and price development, the external accounts, monetary aggregate and the market trends as well as the monetary policy decisions.

In response to Ms Fubbs' questioned, Dr Mnyande replied that, with regard to the fixed capital formation for 2003/2004, the most important purchase was the oil that was imported in the second quarter. They were far above the normal import rate of 30 million barrels of oil, as a total of 60 million barrels were purchased. If these extraordinary items were removed, the trade balance remained at the same level as it was in first quarter. The consequence was that the current account of the balance of payments grew to about R49b.

Discussion
Mr Mboweni commented that this was Dr Mnyande's maiden speech in Parliament. He added that he has always found his interactions with this Committee over the last 5 years to be insightful and beneficial, and that he felt he could always rely on the Committee "when the chips are down".

Mr K Moloto (ANC) [NA] stated that some economic commentators had reported that many of the factors that would have an impact on inflation have not changed at all, and that SARB has taken a cautionary position in leaving the interest rate as it was. He requested the Governor of SARB to respond to this.

Ms Taljaard asked SARB to explain its decision to opt for a risk cut considering the formidable list of risk factors on the upside.

Mr Mboweni responded to these two questions by stating that this was a question that has assumed some importance not least because of a number of economists who had got it wrong, and they have now complained that SARB was unpredictable, was difficult to read, was bowing to political pressure and so on. Implicit in this complaint was "Governor, you must do as we tell you and not as you see the situation", which was absolute arrogance. SARB has always interpreted its mandate to respond to possible future developments in inflation and to take decisions which would ensure that inflation stayed within the target range. This was its mandate.

The MPC statement released on 12 August 2004 made some very important statements that were ignored, such as "the inflation outcome during the first six months of 2004 was more favourable than had been thought to be the case at the previous meeting of the Monetary Policy Committee". This was a very important statement as it quite clearly indicated that the inflation rate would stay within the target range at least into 2005, and possibly 2006. As stated earlier, these models were not cast in stone but instead provided SARB with an indication of the possible future paths.

In addition to this SARB conducted analyses as to how exactly the majority of the members of the MPC feel about the inflation prospects going forward. It also took into account some of the possible risks which include exchange rates, the possible deterioration of the current account, the possibility of global inflation picking up a little bit, the concern regarding unit labour costs, rising domestic demand and finally the risks of the growing oil price. The Governor stated that despite all this SARB was of the opinion that other beneficial factors to the inflation outlook were good.

It was on this basis of a really good possible inflation outcome that SARB took the decision. It was a judgement call at the end of the day. He encouraged Members to look at the MPC statement in detail as they would then see the justification for the expenditure, and urged them not to be influenced by those economists who "complained a lot" when they did not get it right.

Ms Taljaard stated that the exchange rate factor fundamentally was one of the keys here, and in the last month contradictory statements were given by the Governor and the Minister of Finance on the appropriate level of the exchange rate. She asked SARB to indicate whether it has had specific discussions with Treasury on the exchange rate and their difference of opinion.

Mr Mboweni replied that he was not sure how substantive this issue was. He had read about this issue in Business Day. If one had read the Business Day over the past five years carefully regarding the relationship between Treasury and SARB, it had attempted to ensure a conflict between the two. It even sought to do so right up to the last minute before his re-appointment, which it had opposed.

Apparently the Business Day reported that Minister Manuel had said that some companies were suffering as a result of the exchange rate and that South Africa needed a competitive exchange rate. Mr Mboweni pointed out however that in the latest MPC statement (document attached) he had stated that "this sharp rise in the average exchange rate of the rand has distorted the planning of many enterprises in the country and has had a serious negative impact on international price competitiveness with the resultant stress being witnessed in the export earnings of manufacturing and mining companies". Clearly "all of us who know how to read" would see that there is no different between this statement and the sentiments expressed by the Minister yet Business Day saw the difference which, as he stated earlier, it has been doing for the last five years. He said that he was thus not particularly bothered by the Business Day's statement.

Ms Taljaard noted that the Democratic Alliance welcomed the rate cut.

The Chair stated that the other side was that a large number of commentators and interest groups applauded the decision, and the Chair allied himself with this camp. People did this because the risks on inflation were slight, but a number of people wanted to go further and state that it was also good for the real economy because it would lower the costs of investing and also possibly have a beneficial effect on the overly high exchange rate. He asked SARB to indicate just how much emphasis it places on the impact that rate cuts would have on growth, employment and so on.

Mr Mboweni responded that SARB's interpretation was that its mandate currently read "the primary objective of SARB is to protect the value of the currency in the interest of sustainable growth and development". However this could equally be replaced with "the primary objective of SARB is price stability in the interest of sustainable growth and development" and, once this was done, the next logical thing to do would be inflation targeting. Once the framework on inflation targeting was decided on in order to understand the constitutional mandate, the next step would be to identify the inflation rate that would be compatible in the interests of sustainable and balanced growth and development. Government has come to the conclusion that this translated into a CPIX between 6 and 3 percent.

The question then arose that when one has an inflation target range, one should focus much energy on hitting the mid point of the target, or whether one should be satisfied with 3% or 6%. He stated that this involved a long and interesting debate, and proposed that it not be engaged in now. This matter could perhaps be considered further by the Committee when it deals with the South African Reserve Bank Amendment Bill.

He stated that quite clearly SARB would not now be expected to check whether the level of inflation was compatible with a list of development indicators, this was not SARB's job. SARB hoped that when it brought the inflation rate within the proper target range, this would enable others to do their jobs properly in the interest of growth and development so that it was not only the responsibility of SARB. The Minister would have an official idea whether 3-6% was a sustainable growth rate.

Ms R Joemat (ANC) [NA} stated that the Banks Supervision Report had indicated that credit card expenditure had grown from R2,3b to R17b over the last year which was an increase of 15%. She sought clarity on the effect this had on the inflation rate.

Mr Mboweni replied that SARB would not look at the actual level of credit card purchases, but rather at the totality of the factors which include the upward and downward risks to inflation, and the balance. SARB was not unduly concerned by this, although he was not sure what the Registrar of Banks position was on the matter.

Mr T Vezi (IFP) [NA} asked SARB to share any suggestions for Parliament to address the unacceptable unemployment rate.

Mr Mboweni responded that he would not want to answer this question, as other more appropriately positioned government departments would have better informed answers.

Mr B Mnguni (ANC) [NA] stated that the drop in the repo rate by 0.5% was welcomed as it provided relief to the workers and the gold industry in particular. He asked whether the recent march by the National Union of Mineworkers (NUM) on the SARB building had had an impact on this decision.

Mr Mboweni replied that NUM suggested that three things should be done to lower the level of the exchange rate: firstly they thought interest rates should be reduced, secondly that exchange controls should be abolished and thirdly that SARB should buy dollars in the market. He stated that it was a remarkable march and he welcomed it, as they had done absolutely nothing wrong as they were very disciplined, civil and respectful.

An important matter in the memorandum handed over by NUM was overlooked, and it was something that had not happened since 1994. It was the first time that the trade union movement, in fact its biggest trade union, called for the abolition of the exchange rate. This was a groundbreaking policy development in South Africa because the trade union movement has always been opposed to any notion of the removal of exchange control. Secondly, the trade union movement in the form of NUM did not oppose inflation targeting, and this has never happened over the past five years. This was a major leap forward which should have been recognised by these analysts. Thirdly, he had explained to NUM that SARB was buying American dollars when market conditions allowed. In fact since 1999 SARB had bought in excess of $32b, which was a huge amount of money. This was especially significant in view of the fact that South Africa had moved from a position of being $23b in the red, and was now in a positive position of $12b.

He stated that SARB was independent not only from government, but also from the markets, economic commentators, NUM and all others. SARB was free to pursue its objectives independently without fear or favour. Many businesses and institutions have complained that the exchange rate was affecting their investments, to which the Governor replied "well bad luck, bru, face the real world".

Mr Mnguni asked SARB to explain the reason behind the increase in the amount of oil imported from 30 million to 60 million barrels.

Mr Mboweni responded that SARB had no certainty as to where the oil price will end up, but there were clearly a number of factors at the moment that were making the market rather jittery. The first and most important factor was the situation in Iraq and problems with securing the oil supply from Iraq. The second problem was jitteriness around stability or suggestions that instability might be starting in Saudi Arabia, which was the largest oil supplier. This caused uncertainty in the future markets. The last problem was the usual issue of global demand and supply of oil. Market players felt that perhaps the supply might not be sufficient to meet the demand, and this resulted in jitteriness.

SARB's position on the rise in the inflation rate in response to the oil price, was that there was nothing it could do about that. But if SARB noted that the first round impact on inflation was beginning to spread out to second-round effects, it would then become concerned.

Ms Taljaard stated that the concern was that the extraordinary items actually ran over a period of procurement which ran until 2012 in respect of the most expensive items, which were the Hawks and the Griphons and not the Corvettes and the submarines. There would thus be a trend on the current account in respect of this acquisition in particular which will run till 2012, and questioned whether they could thus be viewed as extraordinary items.

Ms Fubbs asked SARB to indicate the kind of percentage drop in administered prices that would be needed to see significant change in the three scenarios referred to by Dr Small in her presentation.

Dr Smal responded that it is important to distinguish between a relative price change and a sustainable price change when looking at the oil price. Clearly when the oil price moves to a higher level there was a once-off price effect and within a year that effect would work itself out, so that it no longer fed through into an inflationary effect. She stated that she could not answer the question fully without working out fully all the inter-linkages, but the direct impact of administered prices in the overall CPIX basket amounted to 25% of all administered prices. Petrol prices comprised 5%, and half of those were probably levies etc. Thus irrespective of the oil price that 50% will remain the same. If it continued to rise there would be direct impact with second-round effects.

Mr Mboweni added that Statistics South Africa had been looking at providing an easy-to-understand list of items which can be classified as having administered prices, and this would surely be dealt with by the Minister in due course. At the moment SARB made no distinction between administered and regulated prices.

Ms Taljaard referred to the continued volatility of the exchange rate and asked SARB to indicate whether it was concerned with both the speed and extent to which the interest rate decision immediately impacted on the currency. She asked SARB to indicate its views on the volatility of the currency and the policy decisions that could be taken to reduce its volatility.

Mr Mboweni responded that for SARB's monetary policy formulation purposes, it hoped to see a stable exchange rate. But what would bring about a stable exchange rate was anyone's guess. Any policy decisions that need to be taken to ensure this must be supported. However he would express no specific view about any specific policy, since this fell outside his mandate.

Concluding remarks
Mr Ralane thanked Mr Mboweni and his delegation for their valued input. Mr Mboweni thanked the Committee for the opportunity, and looked forward to future interaction with the Committee.

The meeting was adjourned.