Briefing by Governor of SA Reserve Bank

Meeting report

FINANCE PORTFOLIO COMMITTEE
31 August 2000
BRIEFING BY THE GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK

Relevant Documents
Statement of the Monetary Policy Committee: 19 May 2000
Statement of the Monetary Policy Committee: 15 June 2000
Statement of the Monetary Policy Committee: 11 August 2000
Current International Economic Conditions
Domestic Economic Developments

Website: www.resbank.co.za

SUMMARY
The Governor of the South African Reserve Bank gave a wide-ranging briefing on the South African economic situation, looking at both the international and the domestic economic situation. A major element of the discussion with the Committee was the fact that despite a good international economic climate and some good economic fundamentals in South Africa, investors remain reluctant to invest in South Africa. The Governor considered this as mainly a sentiment issue. The Governor also defended the Reserve Bank's inflation policy, insisting on the importance of meeting its targets.

MINUTES
Gov Mboweni indicated that he welcomed the chance to interact with the Committee and that he took it as an indication that the independence of the South African Reserve Bank was being taken seriously. He indicated that the presentation would begin with discussions of the economic situation, proceed on to some policy issues like suggestions of unnecessarily high interest rates, and include a chance to familiarise members with inflation-targeting models. Dr X P Guma would do the part of the presentation on the international economic situation and that Mr B L de Jager would speak to the domestic economic situation.

International Economic Situation
Dr X P Guma, Advisor to the Governor, provided an overview of the world economic situation. He indicated that economic prospects were bright and that there was a positive employment situation with good growth supported by higher labour productivity. He presented a number of graphs and referred to the following:
- United States: satisfactory employment, good productivity providing momentum for sustainable growth, inflation based mainly on energy prices with the rest low and stabilising, rapid growth in M3 money supply without inflation because of an expanding real economy, some concerns about current account deficit
- Japan: an end to the recession, falling unemployment
- Europe: falling unemployment, strong expansion in economic activity, inflation possibly stabilising at 2,5% (noting that in Europe, any rise in inflation above 2% is considered unacceptable)
- United Kingdom: real GDP growth, declining unemployment, continuing current account deficit but still financeable
- emerging Asian economies: remarkable recovery
- emerging Latin markets: also strong growth in most
- varying performances in southern Africa, with inflation a mixed bag of up to 300% in Angola but relatively stable prices in other countries

Gov Mboweni commented that large amounts of money are being sucked into the United States to finance its current account deficit and that this has major implications for emerging markets. He noted that the United States continues to experience technology-driven growth and that, for the sake of the world, he hoped this continued. He noted that the Japanese central bank had abandoned its zero interest rate policy and that, although the government was not particularly happy, the central bank had taken a stand. International oil prices continue to be an issue (with a change from $9 when he became Governor in 1998 to $34 and rising today). He noted as well the interesting phenomenon that Asia has low inflation and high growth, whereas southern Africa has high inflation and low growth, and urged those wanting to be more lax on inflation to look at the numbers.

Discussion on International Economic Situation
Mr Andrew (DP) commented on the high quality and clarity of the presentation. He described it as containing good news inasmuch as the world was doing pretty well but bad news insofar as these positive numbers elsewhere could affect South Africa's access to foreign direct investment. He asked what lessons the international experience gave for South Africa aside from the one just mentioned in terms of getting foreign direct investment and higher growth.

Gov Mboweni indicated that this was essentially the issue on which he wanted to provoke discussion: to find the missing ingredient for South Africa. He noted that investments generally do not go to a highly inflationary environment. He stated that Mexico was an exception because of NAFTA. He also stated that a major concern is the huge current account deficit in the United States, which has implications in terms of funds not flowing in South Africa's direction.

Dr Woods (IFP) indicated that he had been ready to mention the Mexico exception. He also asked about the remarkable change in Japan's GDP, with a 16% quarter-on-quarter growth rate, and whether the presenter could give any insights on that.

Dr Guma indicated that there was much dispute on the recovery in Japan and whether it was in fact at the claimed level. He stated that it might be closer to 4%. He also stated that it had arisen largely from the construction area.

Dr Woods challenged this explanation, saying that a claim that the growth arose from a labour-intensive sector like construction was inconsistent with Japan's unemployment statistics.

Gov Mboweni indicated that there were serious disputes on the data. Large bankruptcies like that of the department store Sogo were having major effects in Japan, although it was possible that the economy was gaining efficiencies somewhere. In any event, there were many things on which data was needed.

Domestic Economic Situation
Mr B de Jager, Head of the Economic Research and Statistics Review Department, addressed the domestic economic situation with reference to graphs. The principal aspects that he mentioned were:
- income generation in different sectors: moderate declines in agriculture, mining struggling because of problems in the coal industry and in gold prices with platinum unable to fully counteract these, the electric sector rising, an accelerating pace of construction, expansions in communications because of cellular telephones, improvements in the financial sector, continuing prudence in government expenditure
- slowdowns in spending on durables and semi-durables with non-durables remaining firm
- a moderate increase in spending by government after a long period of decline
- strengthening in private investment and savings, but contributions to increased aggregate domestic investment largely from decreases in government dissavings
- lack of employment growth in formal sectors but some growth in service industries and informal economy (1998 unemployment = 25%, October 1999 = 23%)
- slowdowns in remuneration improvement and increases in production meaning stable unit labour costs
- accelerating inflation but largely from exogenous random shocks in oil and food items (inflation just 6,7% up from 6,5% a year ago if these excluded)
- decline in current account balance: concerns that export volumes not on rising trend, only slight increase in value of imports
- net outflow of capital from South Africa in financial account / capital balance of payments, declines in holdings of gold and foreign reserves as this exceeded surplus on current account
- slowdown in M3 money supply over the last twelve months
- active stock and bond markets with slight declines in volumes, increase in value of real estate transactions

Gov Mboweni made the following points:
- Noting the inflation target of three to six percent, recent data indicated that South Africa was going in the wrong direction, with Consumer Price Index (CPI) growth headed to eight percent. He stated that although decisions are not made on the basis of the latest published data, one cannot afford to ignore such data either. The inflation target was based on an index that included energy prices, which would unfortunately make the target difficult to achieve. But, other things being equal, on the Reserve Bank's models, inflation would begin to come down toward 2002.
- Statistics South Africa needs to keep investigating unemployment and that it unfortunately seems that new entrants into the labour market are being absorbed very slowly.
- It is a positive sign that household debt as a percentage of income is falling, which showed that households are financing purchases from disposable income.

Gov Mboweni returned to the issue of the missing link for investment in South Africa. He stated that the data showed that capital formation was a bigger problem than thought even if the macroeconomic indicators were generally good. He stated that the missing link could be the 'sentiment' issue.

He mentioned the problem of macroeconomic divergence in southern Africa and indicated that work was needed in the region. He stated that many investors did not know the geography well and did not know the difference between Sierra Leone and Johannesburg and that having guns on the streets did little to help. He stated that South Africa has to get its house in order and deal with sentiment issues.

He told the story of recent discussions at a conference in Geneva in which he had to explain first the situation in Zimbabwe that keeps coming up everywhere, then explain South Africa's programs to deal with AIDS, then answer questions about poverty in South Africa. He stated that the presence of too many negatives can give rise to a 'perception' issue even where there is no 'numbers' issue. He stated that he realised the impact of his statements in potentially costing the country money, but he said that he wanted to provoke discussion.

Discussion on the Domestic Economic Situation
Mr Feinstein (ANC) observed that politics was driving sentiments more than economics was. He added to the geography issue by telling the story of a recent phone call from a friend in London who asked if Sierra Leone borders only Zimbabwe or both Zimbabwe and South Africa. He asked if the Governor would consider elaborating on a comment he had made about "structural factors" being part of the missing elixir.

Gov Mboweni explained that this was a code word used among central bank governors. He stated that if the government was going to restructure public enterprises, it needed an implementation process; if it was committed to undoing things he had previously done in the labour market, perhaps it should do so; if it was committed to trade reform, it needed to do it; if it wished to do land reform, there needed to be results. Gov Mboweni said that he would get in trouble if he commented further and that he would not want the executive to talk about monetary policy. Thus, he said that he would unpack the code this much but no more.

Mr Andrew (DP) said again that he appreciated the high-quality presentation. He noted that he would like statistics on net reserves as well as gross reserves in future. He also commented that he agreed entirely that a myriad of factors affect perceptions, some of which are rational and others of which are irrational. He stated that an investor's risk-reward calculation must always take account of special considerations that might threaten the whole investment. He added that South Africans must be careful about blaming too much on the geography problem, as Latin America and Southeast Asia are succeeding in spite of facing a similar problem. He said that it was clearly true that it was desirable for the region to do better. He wondered if there could be serious research on the perceptions of South Africa by those who do and do not invest in South Africa.

Mr Andrew (DP) also asked whether Gov Mboweni had any view as an economist on the desirable level for household savings. Noting that most increase in savings in South Africa had come from a reduction in government dissaving, he asked if there was any serious analysis on why corporations were not saving more.

Mr de Jager stated that his division was in the process of finalising a study for submission to the Board of the Reserve Bank on savings issues and that it hoped to release the study shortly thereafter. Gov Mboweni indicated that the Board has recognised it as a serious issue and is dealing with it. From international best practice, he indicated that an appropriate aggregate savings rate would be 25 to 27%. Dr Guma added that it is the aggregate savings rate that is the benchmark and that where it comes from is not important, so it is not possible to talk about an optimal household debt level in isolation.

Mr Andrew (DP) asked why South Africa is not achieving the desirable level in aggregate. He asked if there might be international comparisons that could help explain this. Gov Mboweni stated that he was "tempted to discuss" the matter with the Minister of Finance and that there were possible links with the tax rate. He stated that he had had a recent personal experience with saving money and found out just how much tax there can be. He recounted a recent story of the president of the European central bank complaining about how interest on his overdraft was 13% in Germany and 6% in Holland. When the president of the Swiss national bank asked him why he had an overdraft, he said that it was tax-deductible in Holland.

Gov Mboweni reiterated that South Africa's inflation was coming largely from energy and food prices and that the trend was in the wrong direction according to the latest numbers. He added a plea for responsibility in reporting what he was saying. He knew both what he said and what people said he said could cost the country money, so he urged reporters not to rush off with wild stories.

Dr Rabie (NNP) noted that the price of oil could go to $40 and have more impact on inflation. He suggested that this would be a short-term impact that would work out in the medium term.

An ANC committee member noted that in 1996, South Africa seemed to have a good balance of GDP growth, general government spending, and reasonable unemployment. She asked if South Africa now has the balance right.

Gov Mboweni replied that 1996 was a year with a mood and context much different from today. All the fundamentals have been right in recent years: a lot of government waste has been cleaned up, which should help generate confidence; there has been a period of macroeconomic stability; the government is contributing to this by reducing dissaving; and much work has been done on macroeconomic stabilisation. He said that in 1996, preparations for the cellular phone network were taking place.

Mr de Jager added that in 1996, there were big projects going on with steel, aluminium, and the Saldhana project. Also the unification of exchange rates in 1995 brought an inward movement of mainly portfolio capital. Dr Guma added that the recession bottomed out in 1994/95 and that an acceleration after that was attenuated by international financial crises, so it was important not to look at 1996 in isolation.

Ms Taljaard (DP) asked if there could be a debate on the measure of inflation rather than on the bandwidth of the inflation target without facing international consequences.

Gov Mboweni noted that he would have a lot to say on this debate. He noted that the European Central Bank, Brazil, and Mexico all use headline inflation. As to the international repercussions if South Africa debated it, he said the problem would be in changing a target before the end of the period. He suggested debating this matter later so that it would not mean that South Africa was missing its targets. Changing the measure of some number partway through to make things easier for the country is no solution.

Ms Taljaard (DP) asked about tacit correlations between labour productivity and current account deficits and any empirical research on it. Gov Mboweni stated that there was no direct correlation but that major benefits accrue to labour productivity and that it helps draw in investment to the United States.

Dr Guma added that the issue is how to get some capital directed to one's country and stated that there was no capital shortage in East Asia.

Mr Ramgobin (ANC) noted that South Africans have billions of rand invested abroad and that this is a vote of non-confidence in their country. He said that in order to build a democratic society on the ashes of apartheid, South Africans need to stick together and avoid this kind of destructive disengagement.

Gov Mboweni disagreed and cited examples of South African companies that have invested abroad. He referred to South African Breweries, one of the largest beer companies in the world, but one which needed access to international markets to grow. To do so, it needed to improve its capital base and to go to London. It is no evidence of pulling out that it has located itself in London. The major investors are still here. There is no lack of confidence here but just an international expansion. He referred to the timber company, Sappi, which has a primary listing in Johannesburg and secondary listings in London and New York. It is a contrasting example because 54% of its investors are from outside South Africa, yet it keeps its primary listing here. Even if Anglo-American listed in London, its mines would still be in South Africa but only it might want to expand as an international company. One has to look not just at perceptions but at realities - so it may not be fair to say there is a massive outflow of capital.

An ANC member asked what it is that investors, who usually like risk, do not like about the risk in South Africa. Gov Mboweni said that if the risks far outweigh the potential benefits, investors will stay away.

Mr Feinstein (ANC) asked about the MPC (Monetary Policy Committee) statement of 11 August and the key variables in the decision-making.

Gov Mboweni replied that "a sangoma" had said from the models that the economy had reached the upper limit on the CPI and should come down as indicated. He said that the idea of the policy was to sit out the tight situation. He said that some suggested reducing the repost rate but that inflation was heading in the wrong direction. He said that he hoped to come back and discuss the acceptable level of real interest rates some day, as it was presently 6,5% and he wondered why some thought this too high.

Mr Mofokeng (ANC) asked about the sharp decline in the number of transactions on the bond market and what this signified. Mr de Jager indicated that there had been a decline in value, then the price had started to rise on the back of lower turnovers, so there was a lower yield. He stated that the turnover in the number and value of bonds traded meant the interest rate had actually declined. The Chair noted that non-residents had been net sellers of bonds, and she wondered if there might have been an underlying change in sentiments. Mr de Jager agreed that the problem was essentially a change in sentiment.

Mr Andrew (DP) asked if there was an intention to have an inflation target for 2003. Gov Mboweni said there was probably such an intention but he did not want to be accused of misleading the Committee if this changed. He noted that it was still under discussion. He also stated that he did not want to make any extra announcements because each announcement had repercussions. He noted that this matter would be up for discussion in his meeting with the Minister.

The Chair asked about the formation of gross fixed capital and noted negative statistics for parastatal agents and for government. She asked in what the government can invest. Gov Mboweni indicated that there had been increases in fixed capital expenditures since 1996 but that in one year, 1999, there had been major investments by South African Airways and that such investments cannot be sustained all the time, so there had been a decline. Mr de Jager stated that parastatals (those companies owned partially or wholly by the government) would buy equipment, buildings, machines, vehicles, and other capital. Governments could buy these same assets, but government capital would be dominated by construction works and such infrastructure as roads and hospitals. The Chair asked if this would include public housing. Mr de Jager stated that houses owned by the government were included.

The Chair noted that the 1995 graph seemed to be a rather singular exception and asked why there was a trough there. Gov Mboweni indicated that he could not give an immediate answer. The Chair asked for a disaggregation of the statistics to be communicated in written form.

Ms Taljaard (DP) asked if the acquisition of planes under lease, such as the new 737s, is still capital formation. Mr de Jager stated that those under lease are not included as capital.

Mr Andrew (DP) noted that the Committee had never expressed a view on inflation targeting and suggested that it had no influence if it could not participate in this process before an announcement. The Chair indicated that she agreed and that the Committee should look at that during the budget process. Mr Andrew (DP) suggested that that would already be too late. The Chair suggested engaging on this at another point and thanked the member for drawing it to her attention. The Chair noted generally the importance of considering the formal protocols for interactions between the Parliament and the Reserve Bank.

Gov Mboweni indicated that it was unlikely that any major new data would come out prior to his 19 September meeting with the Committee and asked the Committee what they would be interested in discussing at that meeting. He suggested institutional issues about the bank. The Chair said that it would be useful to get an overview of the Reserve Bank as an institution and that there might be some economic issues; she asked members to let her know in a timely fashion.

Mr Andrew (DP) stated that he would be interested in the bank's progress on modelling and in the Governor's thoughts on the approaching IMF / World Bank meetings. The Chair stated that these were good ideas.

The Chair thanked the Governor for a very clear presentation and noted that Governor Mboweni would appear again on 19 September, followed by a panel of economists discussing South Africa's economy on 20 September.