SA Reserve Bank Governor & Remuneration Committee Meeting

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Finance Standing Committee

26 March 2007
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Meeting report

FINANCE PORTFOLIO COMMITTEE AND JOINT BUDGET COMMITTEE: JOINT MEETING
27 March 2007
SA RESERVE BANK GOVERNOR & REMUNERATION COMMITTEE MEETING

Chairperson:
Mr N Nene (ANC)

Documents handed out:
SA Reserve Bank (SARB) presentation on the Quarterly Bulletin
SARB Quarterly Bulletin March 2007 No 243

SUMMARY
The global economic growth remained robust in 2006, but moderated during the second half of the year. Its forecast remained favourable notwithstanding the high and volatile price of crude oil. The generally tighter monetary policy bias had helped to contain inflation expectations. The Southern African Development Community (SADC) countries' inflationary trends remained mixed and ranged between 6% and about 1 700% per cent in Zimbabwe. The main factor causing volatility in the CPIX in the last year had been the oil prices but more recently it was food prices. The global economy had continued to be robust with growth in the main concentrated in China, India and Europe. Global inflation had remained fairly under control. There continued to be major concerns around oil prices at plus or minus $60 per barrel. The price was still on the upside. A number of central banks around the world (including Japan) had tightened monetary policies.

Despite the often repeated quest for higher growth rate, South Africa's economy was growing at higher rate. People should tell "the growth story" and not present it as if the economy was not growing. In terms of the SARB's technical analysis, it seemed that SA might be slightly above trend growth. This meant that SA might experience inflationary pressure unless some structural changes were made in the economy. The trend was assumed to be about 4, 5%.

There had been a strong increase in the production price index rising to 9, 8% in January. The CPIX was showing an upward bias and was 5, 3 % in January 2007. The important figure on the balance of payment was the deficit on current account of the balance of payment. That deficit was 7, 8% in the fourth quarter of 2006. There were some exceptional items that led to this (amongst others the 140% increase in oil imports that had partly to do with the restocking after the refurbishment of facilities). The 7, 8% deficit in fourth quarter was now historic. The important figure for 2006 was the 6,4 % current account deficit and this was easily financed by capital inflows. The Bank had been able to continue to strengthen its foreign reserves. The latest figures showed that inflows into the bond and share market were around R14 billion. This was impressive and helping finance the current account.

The situation in Zimbabwe was difficult. The solutions to the economic difficulties were not technical. It was impossible for Central Bank in Zimbabwe to resolve the inflation problem unless the fiscal policy position changed. One of the major contributing factors to the inflation was a very large budget deficit in that country. The Central Bank could do as much as it wanted but it would not be able to control the situation. The general economic situation was difficult because there were major constraints on the production side of economy. The constraints were not technical but political in the main.

Members raised a number of questions that included:
- What role SADC was playing to rescue the situation in Zimbabwe. SADC countries would suffer should Zimbabwe go down.
- Whether SARB had made a study on global warming. Global warming had an effect on agriculture.
- Whether the oil imports could contribute to further widening of the current account deficit.
- What was the strategy for investing the reserves.
- Whether SARB would consider allowing the public to see the minutes of the MPC.
- What were the key structural changes that had to be done to prevent inflationary pressures.
- What was the reason for the volatility of the Rand?
- What was the singe biggest factor driving food prices other than the price of oil.

MINUTES

The Chairperson welcomed everyone to the meeting. The Committee had not yet considered the December 2006 Quarterly Bulletin due to time constraints.

South African Reserve Bank Quarterly Bulletin (March 2007) Presentation
Mr Tito Mboweni (Governor) and Mr Brian Kahn (Senior Deputy Head: Research Department) attended the meeting. Mr Kahn made the presentation (see documents attached). The global economic growth remained robust in 2006, but moderated during the second half of the year. The global economic outlook remained favourable notwithstanding the high and volatile price of crude oil. The generally tighter monetary policy bias had helped to contain inflation expectations. The Southern African Development Community (SADC) countries' inflationary trends remained mixed and ranged between 6% and about 1 700% per cent in Zimbabwe. Real final consumption expenditure by households increased alongside sustained growth in real disposable income on households. Household debt as a percentage of households' disposable income continued to rise.

He said that production price inflation had lost some of its upward momentum while the CPIX had remained within the inflation target range since September 2003. The main factor causing volatility in the CPIX in the last year had been the oil prices but more recently it was the food prices. The deficit on the current account had widened significantly during the fourth quarter of 2006 mainly as a result of large (140%) increase in the volumes of oil imports. Imports for the year as a whole increase by 20% and exports by 6%. This had contributed to the widening of the balance of payment deficit. Nevertheless, there was a strong increase in capital inflows. The financial account to Gross Domestic Product measured about 8, 2% and more than covered the deficit on the current account. It had allowed the Bank to increase the level of foreign exchange reserves which were US$26, 3 as at the end of February 2007.

Mr Kahn said that the exchange rate of the rand had recovered during the fourth quarter from the recession that took place around June 2006. Money supply (MC) increased by over 20% for much of last year. Credit extended to the private sector continued to increase at a strong rate. Short-term interest rates had followed the changes in the repurchase rate. The repurchase rate had been rising. The long-term rates as reflected in the bond market had shown a different behaviour. The rates were between seven and seven and a half percent. The rate increased quite significantly in June, as there were perceptions of higher inflation threats. The rate had been coming down quite significantly since August 2006 partly as a result of improved inflation expectations and the shortage of bonds in the market due to government's fiscal policies. Share prices had receded from late February 2007 led by a decline in the Chinese share market. The house price increases seemed to have regained the momentum towards the end of 2006.

With regard to fiscal policy and government expenditure, he said that the government had budgeted for a small surplus for the current fiscal year. This was reflected in the non-finance public sector borrowing requirement which showed a negative borrowing requirement.

Mr Mboweni said that the global economy had continued to be robust with growth in the main concentrated in China, India and Europe. It seemed that Germany, in particular, was contributing significantly to the economy and this could in part be the effect of the 2006 World Cup. He hoped that the same would happen in SA after the 2010 World Cup. Global inflation had remained fairly under control. This was important for SA because global inflation also impacted on the country. There continued to be major concerns around oil prices at plus or minus $60 per barrel. The price was still on the upside. A number of central banks around the world (including Japan) had tightened monetary policies. Europe had been tightening monetary policies much to the dislike of politicians in Europe, particularly those facing elections. The SADC had continued to experience very good performance. Impressive growth was in Mozambique, Botswana and Angola. He hoped that Mozambique would be able to come out of the difficulties it was experiencing now so that the growth would not be unnecessarily subdued. Inflation in region was generally under control and below 10% except in one country where it was around 1700% per annum. Despite the often repeated quest for higher growth rate, the SA economy was growing at higher rate. People should tell the growth story and not present it as if the economy was not growing. It terms of the SARB's technical analysis, it seemed that SA might be slightly above trend growth. This meant that SA might experience inflationary pressure unless some structural changes were made in the economy. The trend was assumed to be about 4, 5%.

He said that the Bank was concerned about poor performance in agriculture and had asked its researchers department to look into this. If agriculture was to be excluded GDP growth would have been above 6%. There was some sideways movement in terms of mining production. This was slightly difficult to explain given that commodity prices were fairly strong. There had been a number of work disruptions in the platinum sector that could account for the unimpressive growth in mining sector.

Mr Mboweni said that household spending was still strong and household debts as percentage of disposable income was fairly significant. Many people would be in difficulties if the interest cycle was to be on the upside. There had been a strong increase in the production price index rising to 9, 8% in January. The CPIX was showing an upward bias and was 5, 3 % in January 2007. The important figure on the balance of payment was the deficit on current account of the balance of payment. That deficit was 7, 8% in the fourth quarter (Q4) of 2006. There were some exceptional items that led to this (amongst others the 140% increase in oil imports that had partly to do with the restocking after the refurbishment of facilities). The importation of capital goods was very important. South Africa was in the middle of a major construction boom and many companies were restocking and taking advantage of the conditions. The 7, 8% deficit in Q4 was now historic. The important figure for 2006 was the 6,4 % current account deficit and this was easily financed by capital inflows. The Bank had been able to continue to strengthen its foreign reserves. The latest figures showed that inflows into the bond and share market were around R14 billion. This was impressive and helping finance the current account.

There were some market volatilities towards the end of February and the beginning of March particularly in the financial market. The question was why this was the case. A number of explanations were being given. The first was that the Shanghi Stock Market had declined by 9% around 27 February 2007. This had raised concerns about whether the Chinese economy was over-heated and was going to decline significantly. There were concerns that maybe the Chinese Central Bank was going to tighten monetary policy further and introduce capital gains tax on shares in the Chinese market. The Chinese Central Bank thought that the explanations were not full and could not help one understand what had happened in the market. The second was around concerns raised after some retired central banker in the US had suggested that there was a possibility that the US could see a recession by year-end. This had caused a lot of concerns amongst investors. The US market was very important and any notion of recess caused markets to be very jittery.

Thirdly, there were concerns around the sub-prime lending markets in the US. This market was seen as the riskier component of the mortgage market in the US. The concerns were about reported loses that some of the institutions involved in the sub-prime lending market were experiencing. There were people who wanted to enter into the mortgage market but were seen as riskier by commercial banks. Commercial banks were unwillingly to provide mortgage bonds to them with the consequence that other mortgage participants approached the sub-prime players offering them mortgages. The mortgages would be accumulated and sold to commercial banks. The rates that the sub-prime lenders had to pay were much higher that they would have been had they approached banks directly.

The fourth reason was that the central bank in Japan had begun to increase interest rates and had (on 21 February 2007) increased the rate by 25 basis points. Japan had experienced a longer period of zero interest rates for a while. People in the market had borrowed from Japan and invested the funds in those markets with higher interest rates. When Japan increased the interest rates borrowers and the market felt that maybe the interest rate differentials would disappear over time. They panicked into unwinding the positions they had taken before because they had to pay interest of borrowed funds. The Yen appreciated against almost all currencies when this began to happen and this affected emerging markets including SA.

Discussion
Mr S Asiya (ANC) said that it was good that there was an improvement in the SADC. The country that had very high inflation figure was Zimbabwe. He asked what role the SADC was playing to rescue the situation in Zimbabwe. SADC countries would suffer should Zimbabwe go down. The bad performance in agriculture would affect people on the ground. He asked if the SARB had made a study on global warming. Global warming had an effect on agriculture.

Mr Mboweni replied that the situation in Zimbabwe was difficult. The solutions to the economic difficulties were not technical. It was impossible for Central Bank in Zimbabwe to resolve the inflation problem unless the fiscal policy position changed. One of the major contributing factors to the inflation was a very large budget deficit that obtained in that country. The Central Bank could do as much as it wanted but it would not be able to control the situation. The general economic situation was difficult because there were major constraints on the production side of economy (agriculture, manufacturing and mining. The constraints were not technical but political in the main. The SARB was hoping and praying that policy makers in Zimbabwe would adopt policies that would be of assistance to the Central Bank of Zimbabwe. The SARB had a standby facility for Zimbabwe. It was fully secured and the Central Bank used it when it wanted to make payments particularly in SA. The facility was squared off at the end of every year and they had never defaulted. The SARB and its colleagues in Zimbabwe had tried to engage in economic policy discussion to see what they could do collectively to help. The attempts were frustrated by other constraints.

He said that the Bank had not done any study on agriculture and global warming. It read and analysed research that was made public by those who were better informed on the issue. He was hesitant to put the poor performance of agriculture in SA at the doorstep of global warming. There was no doubt that the country was experiencing some difficult climatic changes but one should check if these were typical cycles that the country went through. There was much more that should be looked into hence the Bank had asked for research on this.

Mr I Davidson (DA) said that during the last meeting with the Governor, Dr I van Dyk (DA) had referred to monthly policy interest rates as a fairly blunt instrument to reign-in inflation. The Governor had dismissed this and had suggested that one could look to increasing reserves and deposit requirements for banks. It seemed that the Governor had changed his tune. He asked for an explanation on the change. The Committee had taken a trip to America and the Chairman of the Federal Reserves had spoken eloquently in support of the minutes of the equivalent of the South African Monetary Policy Committee (MPC) being made available to the public. He asked is the Reserve Bank would consider allowing the public to see the minutes of the MPC. The Governor had referred to South Africa growing above the trend line and said that this could have inflationary consequences unless there were structural changes. He asked what were the key structural changes that had to be done.

Mr Mboweni replied that perhaps he had added confusion into the situation. He said that the point that he was trying to make was about an attempt at making it more expensive for banks to make loans. They would feel some pinch when they embarked on reckless lending. The Reserve Bank and not commercial banks would make more money following the increase in the reserve requirement. Commercial banks might pass the costs on to borrowers. He had raised the issue publicly and discussed it with commercial banks indicating that reckless lending should come to a stop. There was some degree of madness because an institutions would give a consumer two credit cards and indicate that the consumer could use one card to pay debts on the other once the first had been exhausted. It was absolute madness because people accumulated more debt in the process. People would end up with informal moneylenders who charged very high interest rates. Banks had responded to the possibility of increased reserve requirement by signing code of good of good conduct in extending loans or credit. The Bank might be forced to increase the reserve requirement should nothing change in the market.

He was glad that the Committee had visited the Federal Open Market Committee (FOMC). The FOMC released a very short statement after its meeting indicating their decisions. The statement was followed by a detailed account of the reasons for their decision two weeks after the meeting. The statement also indicated how members of the Committee had voted. The MPC did not vote but took decisions by consensus. The statement that Bank of England, for instance, would publish was the minute was the same statement that the SARB issued the same afternoon after its meeting. The SARB was more advance in that it issued a detailed statement after the meeting of the MPC.

Mr Mboweni was convinced that there would be a higher growth should SA implement the programme of action outlined about two years ago by the President. Issues that had to be addressed included telephony costs, rail and harbour networks and research and development. There should be fair competition in the economy.

Mr A Moloto (ANC) said that the Governor had raised concerns around increases in advances or loans given to households. The Governor had said that he would increase the reserve requirement for banks. He asked if this would be a sustainable policy instrument in the long term. Would it not lead to a credit crunch? The private sector would require loans for capital expenditure. Would there be no impact on domestic output? The Bank had accumulated impressive reserves. He asked what was the strategy for investing the reserves. The Bank had signed a Memorandum of Understanding (MOU) on the management of reserves and inflation targeting. He asked if the MOU dealt with reserve accumulation strategy and the investment philosophy. There had been illiquid conditions in the local foreign exchange market later in 2006 and there were jitters in the market. He asked what were the conditions that led to the illiquid conditions and whether the measures announced by the Minister of Finance in relation to the Johannesburg Stock Exchange would bear any fruit.

Mr Mboweni replied that the increase in the reserve requirement would not lead to a credit crunch. There might be a temporary period of adjustment and some sanity coming into the picture at a later stage. He could not foresee any credit crunch. There was an impressive growth in the foreign exchange reserves and this had necessitated a review of the management of reserves. This was done in consultation with National Treasury. The reserves were invested through accredited international banks. The banks were allocated quotas and the Reserve Bank paid management fees. The reserves were invested in all classes of markets but not in hedge funds. Commercial banks were discouraged from investing in derivatives. SARB had started a lending programme which was bringing good returns. It lent scripts through one of banks in New York to people who needed security to enter into business. A fee was charged for using the scripts. The SARB was charged with the management of reserves but it was only fair that Treasury was consulted. Treasury had no veto right. The Bank also had an internally managed portfolio. With respect to liquidity in the market, he said that the interesting thing was that the average turnover was still about $14 billion. SA was affected like anybody else.

Mr L Johnson (ANC) focused on the impact of oil in the economy. The Business Report had reported that there would be imports of barrels of refined oil. He asked if the imports could contribute to further widening of the current account deficit.

Mr Mboweni replied that SA was not self sufficient in relation to oil and had to import it. The volumes imported depended on the demand. The current demand pattern was on the upside. He was of the view that what was seen in fourth quarter was a bit outside the norm. The Bank would continue to discuss the issue with the Department of Minerals and Energy. There would be major challenges if the situation that prevailed in the fourth quarter last year was to continue. He hoped that he was correct in saying that what happened in that quarter was outside the norm. The oil market was difficult to understand because there was no shortage of supply. Things changed depending on geo-political factors.

Mr B Mnguni (ANC) referred to the securitization of bonds and asked at what stage the SARB could intervene in the process. A budget surplus was good in relation to inflation for ordinary people. It meant that the government would not borrow much and that more money would be available for people to borrow. There was a tendency to invest in emerging markets. Most currencies were stable whereas the SA currency was very volatile. What could be the reason for the volatility?

Mr Mboweni replied that the securitization by banks was a good thing. It was an indication of the maturity of the markets. It tended to bring new players in to the market and banks used it to clean their books. The SA currency was not the only one that was volatile but the magnitude of volatility was different. The Rand and the New Zealand Dollar moved a lot in terms of losing out. The Rand tended to move more than other currencies.

Ms J Fubbs (ANC) referred to food prices and inflation. Although there had been stabilisation internationally, food prices in SA had continued to rise over the years. She asked the Governor to identify, other than oil, the singe biggest factor driving the prices. There was an improvement in the manufacturing sector of the economy. He asked if this referred to vehicles. How much was the reliance on the sale of vehicles?

Mr Mboweni replied that he was not only referring to vehicles but to the broad manufacturing output. Manufacturing was highly sensitive to the exchange rate.

Mr Y Bhamjee (ANC) wondered what was the role of the Portfolio Committee in relation to the Reserve Bank. The role was not to clear the mist in relation to what the Bank was doing. There was a need to take the Committee's role to a higher level. The Committee should engage the Governor in order to understand its oversight role. In future SA might have a Governor who was not so passionate about Parliament.

Mr Mboweni replied that he would love a discussion on the accountability of Bank to Parliament. It terms of the current situation the Bank was compelled by law to submit annual reports and financial statements to Parliament. It reported on its conduct in relation to monetary policy and general operations of the bank. The annual report served as a basis for discussion. He said that he had never been invited to come and discuss the annual reports in Parliament. There was a need to strengthen existing mechanisms. Parliament could also decide to establish special Committee for banking and related financial issues.

Presentation by the Remuneration Committee of the Reserve Bank
Prof. Raymond Parsons and Prof. Mahavishnu Padayachee attended the meeting. The Committee was briefed on the proposed salary adjustments for the executives of the bank. The briefing document was only handed to Members of the Committee. The package for the Governor would be around R3 million and the Deputy Governors would receive around R2, 4 million.

Discussion
Mr Mnguni asked why there were incentives for the Governor and his deputies but not for the staff.

Prof. Padayachee replied that there were no incentives for the Governor and his deputies. Incentives applied only to the staff of the bank. Staff referred to everybody below the level of Executive General Manager. There was no performance bonus incentive for executives.

Mr Bhamjee asked if the R3 million was the full package.

Prof. Padayachee replied that the real move was in relation of Deputy Governors whose salaries would increase from about R1, 6 million to R2, 4 million. The total package for the Governor would be R3 million.

Mr Asiya asked what the Committee was expected to do in relation to the information given.

Prof. Padayachee replied that the recommendations had not yet been implemented. A copy of the recommendations was given to the Minister of Finance for his consideration. It was up to the Committee to indicate if it wanted similar interactions with the Remuneration Committee (REMCO) in future. REMCO would welcome any comments that the Portfolio Committee would make.

Prof. Parsons replied that the bank had been trying to see how it could widen and deepen the degree of transparency that it had in relation to monetary policy and issues of governance. REMCO felt that it should break new ground in sharing its thinking on the personnel and remuneration issues. The answer to the question was captured in the answer by the Governor on the interaction of the Bank and Parliament.

Mr Asiya recommended that the Committee should look at its role in relation to the Bank. The question was whether the presentation was for information purposes only or made so that the Committee could recommend to the House whether or not it should approve the proposal.

The meeting was adjourned.

 

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