South African Reserve Bank: briefing

Meeting report

FINANCE PORTFOLIO COMMITTEE
21 October 2005
SOUTH AFRICAN RESERVE BANK: BRIEFING

Chairperson: Mr N Nene (ANC)

Document handed out:
Presentation by the South African Reserve Bank

South African Reserve Bank website: www.sarb.co.za

SUMMARY
The South African Reserve Bank briefed the Committee on recent economic developments on international, as well as national fronts. The briefing focused largely on the escalation of the oil price, growth and employment trends, exchange and interest rate tendencies and inflationary performance. Regarding the domestic economy, specific consideration was given to household debt, household debt service ratios and savings ratios. In his contribution, Dr Tito Mboweni indicated that inflationary pressures were on the rise. Members’ questioned monetary policy interventions on a number of fronts, with Members of the Opposition showing particular concern on the possibility and timing of an interest rate hike.

MINUTES
The South African Reserve Bank (Reserve Bank) was represented by Dr Tito Mboweni (Reserve Bank Governor) and Dr Johann van den Heever (Reserve Bank Review, Statistics and Research Department Senior Deputy Head).

Briefing by the Reserve Bank: Dr Johan van den Heever
In terms of the international economy, Dr van den Heever pointed out that the slight recent decline in the international oil price — a decisive variable in monetary policy — from the August 2005 record-high of US$70 should be seen against the background of the various minor price-dips that punctuated the general increase over the last four years. With core inflation well contained, the recent comparative boost to USA headline inflation (3.6% in the 2005 third quarter) was due to rising energy prices. The latest figures indicated USA real gross domestic product (GDP) growth of 3.3%, and unemployment rates of between 5% and 5.5%. Key global central bank interest rate changes indicated neither an upward, nor a downward interest rates phase.

The global economic growth rate for 2004, and the forecasted figures for 2005 and 2006, was at the 4.3% to 5.1% level, with the corresponding figures for Africa only marginally higher. This boded well for South African exports and economic growth. Global inflation was forecasted to remain below 4% until 2006. First semester GDP growth for Japan seemed promising and there was hope for structural improvement over previous years, given low unemployment rates and the improved containment of negative core inflation. Growth in the Euro area was uninspiring (under 1.5% during the first semester of 2005), but unemployment was declining (8.6% in August 2005) and the interest rate had remained at 2% since mid-2003.

Inflation in the SADC region was declining (7.8% in 2004). Angola (98.3%), Zambia (21.5%) and Zimbabwe (350%) remained the outliers.

In terms of the South African economy, Doctor van den Heever pointed out that after a slow start, total real GDP growth in South Africa accelerated to 5% in the second quarter, with fluctuations in manufacturing output largely being responsible for this. Real gross domestic expenditure and household expenditure in particular, was favoured by favourable interest rates, rising levels of disposable income and rising consumer confidence. High levels of household debt (62% in the second quarter of 2005) were justified in that much of it funded real estate acquisitions. Household debt service ratios (6.5% of household income) remained stable.

Spikes in the otherwise stable real gross domestic final demand at the end of both 2003 and 2004 was fuelled by major government military acquisitions. The gross savings ratio (13.5% in the second quarter) remained an area of caution, since it was not adequate to benefit fixed capital formation. Core inflation had remained within the 3% to 6% target band for 24 months. Rising housing and energy costs saw headline inflation standing at 3.9% (August 2005). The official unemployment rate stood at 26.5%.

Briefing by the Reserve Bank: Dr Tito Mboweni
Dr Mboweni stated that the growth in employment by around 84 000 jobs in the second quarter of 2005 bore testimony to the fact that robust growth of the South African economy created jobs. He emphasised the success of the Reserve Bank in exercising its core mandate of maintaining inflation targets. This had created opportunities for the Reserve Bank to introduce significant monetary stimuli, such as the current interest rate, which was the lowest since 1980. However, inflationary pressures were building up in the economy and the current level of monetary accommodation could not be maintained indefinitely. Household debt should therefore be seen as an issue of concern.

Though the balance of payments was an important issue, there were no indications of a crisis in the near future. Despite the significant deficit (3.4% of GDP in the second quarter), there were sufficient inflows of capital to finance the deficit. Newer generations of economists within the Reserve Bank regarded this as sufficient for a globalised economy to stave off the pressure to hike interest rates.

One of the biggest current threats to the global economy was the consistent stubborn increase in oil prices. The pattern of escalation was not the same as the oil price shocks of the 1970s and 1980s, and fuel prices at the pumps would escalate gradually, but consistently. This would impact on inflation at some point. A feature of this trend was the increased transfer of wealth from oil importing countries to oil exporting countries. This could neutralise much of the recent debt relief given to poorer countries by the G8.

Dr Mboweni expressed his confusion at why the market had doubted the Organisation of Petroleum Exporting Countries (OPEC) when it had stated that it could meet the global demand comfortably. Pessimists argued that the oil-producing countries had insufficient capacity to bring forth sufficient supplies since investment in oil extracting had been insignificant. Geopolitical concerns also still had an effect. Of late, concerns over the refining capacity in the USA predominated. Supply was reportedly constrained since the last refinery had been built in 1976, while recent hurricanes had brought major damage to refineries on the Gulf of Mexico. Dr Mboweni argued that none of these factors were new or unpredictable, and was therefore surprised at the influence they had had on the market.

Discussion
Mr K Moloto (ANC) asked what the drivers were for the significant and widening difference between goods inflation and services inflation. He also wanted to know whether South Africa had yet experienced the full impact of the rising oil prices, or whether there would be a delayed effect.

Dr Mboweni replied that services inflation was higher, in short, because of higher administer prices. Intervention in this regard was the prerogative of the public authorities. Under-recovery because of higher oil prices was passed on to the consumer as soon as it became untenable. Further than this, it was difficult to say how long it took for the full effects to filter through the economy.

Mr B Mnguni (ANC) asked whether there was any correlation between non-agricultural employment (graph 30) and non-agricultural labour productivity (graph 33) trends. He asked for the Reserve Bank Governor’s opinion on what would constitute a healthy current account and balance of payments position should the current level of capital inflows prove not to be sustainable.

Dr van den Heever responded in the affirmative regarding the suggested correlation between non-agricultural employment and non-agricultural labour productivity. To some extent, the way in which productivity was measured informed this correlation, as it simply divided output by the total number of people employed.

Dr Mboweni expressed his personal view that South Africa should not focus on a single strategy for growth, such as import substitution or export promotion. The aim should be an open and highly integrated economy. He did, however, believe it strange that South Africa imported products such as shaving razors and leather.

Dr Mboweni felt it somewhat pessimistic to be overtly concerned over the level of capital inflows vis-à-vis capital inflow levels, given the current macro-economic environment and framework, and interventions planned by the South African government.

Dr M van Dyk (DA) asked which monetary policy shortcomings could be addressed to edge current growth rates closer to the six percent target. He questioned whether South Africa displayed acceptable levels of fixed investment and what was envisaged in this regard. An indication was asked from Dr Mboweni on how far South Africa had to go before gathering inflationary pressures would force the hand of the Reserve Bank on interest rates and other monetary policy instruments. Finally, Dr van Dyk was asked what effects were aimed for with the exchange rate, and what kind of interventions were envisaged with regards to achieve these effects.

Dr Mboweni stated that the role of monetary policy was mainly to manage inflation in a holistic manner that would benefit economic growth and employment creation. He felt that the current monetary policy stance was appropriate, that it supported growth and that the process was as open and transparent as could be expected.

Dr van Dyk asked for a direct indication on when the interest rate would be altered.

Dr Mboweni explained that the Monetary Policy Committee would be meeting in December and decisions regarding the interest rate would be taken then. He did not envision anyone arguing for a cut in interest rates, but claimed no knowledge on the position that might otherwise be taken. The Monetary Policy Committee was determined not to allow second-round pass-through effects of the higher oil price, and this would be the decisive factor. Further monetary accommodation could therefore suffer as a result.

Dr Mboweni expressed his disapproval of fixed or artificially manipulated exchange rates for the purpose of meeting growth targets. Past attempts to manipulate the exchange rate had cost the Reserve Bank billions of rands with only minimal success. Currently, this option was obviated by the fact that South Africa’s US$20 billion reserve would be relatively ineffective in a daily foreign exchange market with a turnover of US$11 billion. Also, there lay a danger in artificially manipulating a currency in a certain direction, in that it might not be possible to return it to a "normal" level thereafter. Should the market be deemed to overreact in any direction or on any basis, the Reserve Bank would communicate this as effectively as it could.

Dr Mboweni did not feel that the current exchange rate inhibited growth. Current levels of monetary accommodation were also not deemed negative, given that they did seem to fuel capital investment.

Mr I Davids (DA) asked Dr Mboweni to unpack the probability of an interest rate hike before Christmas in the light of a more flexible inflation targeting approach. Secondly, he enquired as to the measures employed by the Reserve Bank to encourage saving. Finally, he asked for the Governor’s position on the further liberalisation of foreign exchange controls.

Dr Mboweni confirmed that the Reserve Bank was pursuing inflation targeting in a flexible manner. This did not signify a willingness to accommodate inflation, but rather a desire to pursue inflation targets in a manner that took growth and unemployment concerns into account as well. The Reserve Bank had to be proactive in this regard. Therefore, should the Reserve Bank observe negative first-round inflationary responses to the escalating oil prices, it should act. Dr Mboweni did declare himself biased towards the use of monetary policy to pre-empt the irrational escalation of prices not substantially informed by energy costs. Activity in this regard had already begun in Canada, the USA and England.

Dr Mboweni declined to comment on possible interventions with regard to savings-levels, as it was deemed to be the terrain of the Minister of Finance. The Minister was also due to make his medium term budget statement, and this would deal with the question of foreign exchange liberalisation.

Mr Y Bhamjee (ANC) asked whether the Reserve Bank’s thinking was informed by home-based and/ or home-trained economists, or whether it was informed by thinking from abroad.

Dr Mboweni stated that Dr van den Heever was a graduate of the University of Pretoria (UP) and had an econometrics background. The previous Chief Economist of the Reserve Bank was trained at the then University of Potchefstroom, conducted his PhD research on water and damns in South Africa, and only entered the field of monetary economics later in his career. A few of the Reserve Bank economists were from the University of Stellenbosch (US) and some had done their PhDs with the University of South Africa (UNISA). Most of the modelling experts at the Reserve Bank hailed from the UP, and to a lesser extent, the US, with one having graduated from the University of the Free State. Academic rivalry was thus healthy within the Reserve Bank echelons. Some of the newer economists were recruited from Rhodes University and the Universities of KwaZulu-Natal and Cape Town, and some had been trained at universities in the USA and the UK. Some economists were also drawn from the research component of the broad democratic movement.

The meeting was adjourned.