State of the Economy: South African Reserve Bank briefing

Meeting report

The State of the Economy: South African Reserve Bank (SARB) presentation
Chairperson’s Opening Remarks
The Chairperson stated that the Committees’ first interaction with the Governor of the Reserve Bank, was a demonstration that the Committees did not view Parliament as just a democratic institution through which the voices of the people could be heard, but also as a forum where the Reserve Bank, as an important institution and a player in regulating the economy of the country, could find support from an independent institution that echoed the voice of the electorate. He thanked the Reserve Bank for its approach of engagement on a number of issues, and its willingness to assist the Committee on its path for positive development in regard to the analysis of what Parliament should do. This presentation should be seen as the beginning of a process, which Parliament would need to complete.

SARB Governor’s presentation
Ms Gill Marcus, Governor, South African Reserve Bank, said that the approach taken by the South African Reserve Bank (SARB or the Bank), was that its responsibility lay not in commenting on the Budget per se, but rather in looking at the economic framework within which this had taken place, so that when the Committee evaluated what was being proposed as the Budget, it would have the domestic and global context as a background.

The Governor noted that a global context must be used, because what happened in the world was critical to the choices that could be made and the possibilities for action. In essence the international economy was recovering and a large part of the focus in this crisis had been in the developed world, with the impact being described as a global recession of enormous proportions. Economic activity was recovering and the International Monetary Fund (IMF) had raised its outlook for the potential for the world to grow. The world economy was recovering faster than had been anticipated, and there was therefore improvement in the secondary and tertiary sectors. The various short-term indicators, certainly in South Africa, had come out of the recession reasonably rapidly.

The Governor said that what had been observed as a consequence of this global recession, both in the developed world and in South Africa, was a very serious fall-off in employment. For example in the United States (US), the formal employment was around 10%, with expectations dependent upon how growth occurred in the US, and whether this would rise to 11% by the end of this year. What comprised one number in one country was not necessarily the same as what comprised another. If one looked at the wider definition in the US, unemployment stood at about 18%, but that would include people who had been discouraged from seeking employment, or who had full-time jobs, but were working part-time. South Africa had lost about 900 000 jobs by the wider definition, which included the informal sector. When this was compared with other unemployment, it was not clear whether the unemployment being compared and the impact on the different economies in the wider or narrow definition were included. Hence assumptions could not just be made that these matched. Without a doubt the recession had had a huge impact on employment in most countries; some with a lag - like the United Kingdom (UK) and Europe - where there had been a situation of “job hoarding”, where people and companies have tried to retain their workers with a contract, and where there might not have been formal agreements in this regard. Part of their retention had meant that workers had agreed to have no increases.

In essence, the situation looked better with signs of recovery, but the signals and data indicated that this was a very serious situation. If there was recovery, it was seen as slow and over the medium-term, rather than a very quick recovery around the developed world.

Ms Marcus gave some examples of fiscal balances. The US, in 2007, had a deficit of 2.8% that had risen in 2009 to 11.2%. The debt to Gross Domestic Product (GDP) ratio in the US in 2007 was at 62%, and was expected to be 92% in 2010. In Japan, the fiscal balance was 2.5% in 2007, which was also their deficit, but in 2009 it had risen to 7.4%. If one looked at their debt to GDP ratio, it was 188% in 2007, and in 2010 it was expected to be 227% of GDP. South Africa was at about 40% of GDP. This was a very good figure because South Africa had had very low international borrowing. One of the lessons of the crisis was that if a country was in a difficult stage around deficits and GDP debt ratios, there was very little room to manoeuvre when a crisis came. South Africa had moved from a surplus into a deficit situation, and could therefore work its way back down from the deficit. Secondly, its debt to GDP numbers were good.

This situation was different from the Households’ Disposable income, which had moved from about 80% to about 79%. South African individuals still showed a high indebtedness. By way of example, Greece’s fiscal deficit moved from 3.7% in 2007 to 13% in 2009. This situation was very similar to Ireland and the US. Italy, in the same category, had a debt ratio of 123%. These figures indicated a lot of challenges and a lot of common purpose that needed to be developed by the countries, to come out of the crises.

With regard to the stimulus packages, if one looked at the estimates at the moment, the total global fiscal package had been about 3.2% of world GDP, and over US $ 2 trillion. A huge amount of money had been poured into stimulus packages. The biggest number of all had been in China, who had put almost 7% of its GDP into a stimulus package of $580 billion dollars. China had recovered quickly, with a growth expectation of 10%, but at the cost of a huge stimulus package. The US had expanded the stimulus package from $800 billion to over $2 trillion.

Recent Domestic Economic Developments
Dr Monde Mnyande, Advisor to the Governor and Chief Economist: SARB, briefed the Committees on the domestic side of the economy and noted the improvement of the South African economy in the third quarter of 2009, due to positive growth and real value added by the secondary and tertiary sectors of the economy. On the expenditure side of the economy, he said that real gross domestic expenditure had contracted at a slower pace in the third quarter of 2009. The demand side short-term indicators suggested that there would also be an improvement in domestic expenditure. The real consumption expenditure by households had contracted further as disposal income continued to decline. The ratio of household debt to disposable income had remained at an elevated level, which was seen as meaningful, and could be attributed to the decline in the interest rate over the past year. He noted that this was the lowest ratio recorded since the third quarter of 2006, which signalled a greater affordability of credit among households. After robust performance seen since 2003, the fixed capital formation recorded a marginal decline in the second quarter, due to a decline in the capital economy. He said that consumer confidence had increased in the final quarter of 2009, alongside increased business confidence (see attached document.)

Financial Market developments: presentation
Mr Daniel Mminele, Deputy Governor, SARB, said that developments in financial markets and financial market conditions had continued to improve since the difficult period from which the country had emerged. The rates in the US were used as a proxy for international interest rates, and a comparison with South Africa showed that a wide gap remained between the two countries with regard to short-term interest rates. Currently market participants expected a broadly sideways movement in short-term interest rates. The money-market situation in South Africa had been stable throughout the international crisis. There was no need for the SARB to extend special loans to banks or to step up its operations of providing liquidity to the banking sector. With regard to the turnover in the domestic bond market, he reported that 2009 was slower than 2008, both in terms of the value of bonds traded, as well as with reference to the number of transactions. The number of shares traded on the Johannesburg Stock Exchange (JSE) was strongly affected by global financial prices, and there had been a recovery in share prices which was reflected in turnover values. (See attached document)

Monetary Policy developments: presentation
Mr Brian Kahn, Advisor to the Governor, SARB, briefed the Committee on the developments in monetary policy, and stated that producer price deflation had turned to inflation in December 2009. The targeted measure of inflation had moderated to within the inflation target range in October and November, before accelerating again in December, while administered price inflation accelerated considerably despite a drop in petrol prices. He outlined the main points of the Monetary Policy Commission (MPC) statements for the Committee, and emphasised that demand-side pressure on inflation had been persistently weak but posed no significant upside risk to the inflation outlook. The outlook for food price inflation was favourable, despite higher food prices in international markets. International oil prices had risen from the lows in 2008, but this situation could change and depended on global recovery. Electricity price increases remained the single biggest risk to the inflation outlook. (See document)

Discussion
Dr Z Luyenge (ANC) asked about the role of National Treasury in the activities of the SARB because, from the Budget Speech and presentation of the SARB, it was clear that there was synergy. He asked further if there was a formal working relationship or interface between the two institutions.  

Ms Marcus replied that according to the Constitutional mandate and the South African Reserve Bank Act, provision was made for regular consultation with the Minister responsible for financial management and governance. The SARB had a range of interactions in place. Three sub-committees hade been created which were jointly chaired at senior level by deputy governors or senior officers, and a co-chair from the National Treasury. These committees looked at the inflation-targeting environment, macro-policy, financial stability, financial regulations and the environment around those areas. The three committees met regularly and also dealt with technical issues. The SARB did not have insight into the Budget, but did have insight into matters that affected both the Bank and the National Treasury. In addition to this, a monthly discussion process had been established between the Governor of the SARB and Finance Minister Gordhan. On another level, when meetings were held with economists, the National Treasury was also invited. The Bank tried to create openness about interactions and co-operation for a better understanding in working relationships. The Bank recognised that it was in many ways the economic hub of the data analysis, and it was able to present information in a composite way.

Dr Luyenge asked, given that 900 000 jobs were lost, whether there were any mechanisms in place by SARB side to assist in the process of identifying the main culprits who contributed to this situation, and whether these were in the private or the public sector.

Dr Mnyande said that there was a tendency to think that the Bank was not concerned about job losses, employment or growth. The Bank had always been concerned about growth, and the implications of growth on employment. One of the things the Bank did was to publish economic information and to disseminate the statistics and data that came from different sources. This was done by publishing a quarterly bulletin, which allowed the Bank to give facts to those statistics. These statistics would allow policy makers to apply their minds to the figures. With regard to employment, the private sector had started to see a declining trend in employment, and when corporate profits were reduced, jobs were shed. To ensure that a situation such as this was addressed, the Bank would provide the factual information so that that these issues could be debated. This would assist in shaping the policies consequential to what was actually happening in the economy.

Dr Luyenge noted recent media releases and asked whether any of the service providers for SARB were located outside the country as there might be issues of unscrupulous behaviour or conduct. He asked if there were any mechanisms in place on the part of the bank to prevent any improper utilisation of the institution for personal enrichment.

Ms Marcus responded that the SARB had a very clear budget and procurement processes in place. The Bank did have some service providers from abroad, primarily in the technology area, and many were from India; but as far as possible, it looked at what was happening domestically. It was unlikely that improper utilisation of foreigners to get themselves into lucrative contracts in the Bank could take place.

Mr B Mnguni (ANC) asked how the bank saw its role in public growth and job creation, given that these two issues were now part of its mandate.

Ms Marcus responded that these issues were considered when the Bank took decisions. Its mandate made very clear stipulations about matters like the exchange rates and labour markets, as these had to be taken into account. Part of this mandate encompassed a way of holding the Bank accountable in terms of people’s expectations and emphasising a flexible approach. It looked at the real economy and did not make extreme adjustments, which could result in a maximum negative effect on the economy. It emphasised flexibility and anchoring.

Mr Mnguni asked about the issue of the ‘impossible trinity’, and how the SARB intended to address this issue.

Mr Mminele replied that it was impossible to pursue the objectives referred to by the ‘impossible trinity’, and to achieve them equally, but it was important to try to strike a defensible balance so that the economy was served in such a manner that it could grow at its potential rate, or as close to that as was possible for sustainability.

Mr Mnguni raised concern about electricity increases, as some economists had indicated that the 25% increase in the petrol levy, would result in an approximate increase in the inflation rate by 0.88%. He asked if the SARB had taken this into consideration in its pronouncements.

Mr Kahn replied that he did not know if the petrol levy was specifically taken into consideration in the SARB forecast, but it would of course be added into the next forecast round. The petrol levy was, effectively, a once-off tax increase effectively, but because it was relatively small in percentage terms, the overall impact of that levy would also be relatively small. The actual increase that occurred at the time when this levy was applied would depend upon what was happening to the international oil price and the exchange rate. It could be in addition to a further increase in the usual monthly increases that were announced, or there could be a decrease, so there could be some off-setting effect, depending on international price trends and exchange rate trends. The actual levy of R0.25 would not have a material impact on the forecast, as it certainly would not have any impact on monetary policies.

Ms Z Dlamini-Dubuzana (ANC) said that the presentation stated that the rand exchange rate had remained a positive factor from an inflation perspective. This had created difficulty in defining the relationship between the effectiveness of the rand and the effect of inflation, which resulted in unemployment. She asked for an explanation regarding this matter and what the SARB was going to do about it.

Mr Mminele said that as far as the exchange rate was concerned, the key issue (which was more important than the absolute level) was the volatility of the exchange rate. While the Bank shared the view that excessive volatility in the exchange rate was unhelpful and was not conducive to proper planning in the real economy, it was important to carefully assess what the causes of such volatility were, and whether any strategies devised to deal with the volatility were likely to have success. The loss in volatility seen recently in the exchange rate was mostly driven by external factors, over which there was only limited control. It would be more useful to try to work with the trends and soften them, as part of the adjustment, rather than to fight them. The Bank would continue to work together with the National Treasury to try to explore how the volatility in the exchange rate could be addressed.

Mr Kahn added that from a monetary policy perspective, the Bank would prefer to have had a stable exchange rate. If the rand was appreciating, this would have helped to reduce prices, but if this was a consistent factor, then a constantly appreciating exchange rate would result, which was clearly not desirable for the country. From a broad inflation point of view, a stable and preferably competitive exchange rate was desirable. There had been some appreciation of the rand during the past years, so from the point of view of inflation outcomes, it did not mean that the rand had contributed to the decline in inflation. If the forecast was that the rand would depreciate quite significantly, then the inflation forecast would have needed to be adjusted in an upward direction. The Bank was fairly neutral on the exchange rate and did not see it providing an upside or downside risk in terms of the inflation outlook.
He stressed that unless there was price stability, the given exchange rate would not remain a competitive exchange rate. As the exchange rate depreciated, this would bring about increased domestic inflation. It was important to keep the perspective that what was important from an export point of view was the real exchange rate, or in other words, the inflation adjusted exchange rate. This underlined the importance of having a low rate of inflation, as one of the important factors in competitiveness was relative prices.

Mr M Swart (DA) said that the Governor had indicated a gradual recovery when outlining the international situation, but this situation was tenuous and risky, as South Africa was looking at a 40% debt to GDP ratio in the long term. This would place the country in a difficult situation if it had another crisis, as it was in the process of evaluating long term fiscal policy with a high deficit and without funds for an additional stimulus package. He asked the SARB to comment on this situation.

Ms Marcus said that, recognising that the different sectors of economy had different needs; the best way to deal with the fiscal deficit was to get the economy growing and look at how it was growing. The tools for a situation such as this had some relation to the ‘double-dip’ (economic stagnation), and what the implications of this were. The South African government as a whole had taken counter-cyclical measures with the objective of maintaining a growth path. South Africa had not cut expenditure, even though one of the tools available was to cut expenditure. It had adopted a policy of going for the deficit as part of the policy, to enable counter-cyclical measures to be implemented to stave off the work of the recession. Then as the country began to grow, the deficit could be addressed. If growth was better than expected, and revenue increased, in terms of an increase in the tax base, then the deficit question could be addressed effectively. South Africa did not have a systemic banking crisis but was hit by the outcome of that crisis. A large part of the developed world was hit by the crisis as a banking sector, and then the economy as well, which was why they were in such serious difficulty.

Mr Swart asked if the business cycle indicators could be updated. He asked what the implications were of the December figure, as the Committees were given the November figure, which was similar. He asked further if this indicated a positive growth path.

Dr Mnyande replied that the Bank concerned itself more with the trends than the month to month change in a particular variable. The trends seemed to suggest that economic recovery was definitely expected in 2010 and in 2011, and the likelihood existed for an improvement in economic activity. The SARB could not prescribe policy, but needed to ensure that there was debate about how the variables augured in terms of economic activity, and shaping a way forward in terms of recovery.

Dr M Oriani-Ambrosini (IFP) asked why interest was at its current rates. If medium and long-term growth were prioritised and if there was the belief that the other priorities like inflation stabilisation and proper exchange rates were a function of growth, then the interest rates should be cut, as this had happened elsewhere in the world. There should be a policy that targeted interest rates.

Mr Kahn said that it was important to note that the real interest rate was the nominal interest rate adjusted for inflation. Most industrial countries with low inflation had low interest rates, but in economies with relatively high inflation, interest rates were commensurately higher, because there had to be some adjustment for inflation. If expected inflation was subtracted from the nominal rate, the real interest rates would in fact be very low. If interest rates were looked at comparatively, nominal rates would be low because inflation rates were low.

Mr T Harris (DA) asked for the Governor’s opinion on a quotation in today’s Business Day newspaper which stated that: ‘we are talking about what influences decisions to invest and create jobs, the relevant rates are long term interest rates, but the Bank does not set long term interest rates, the market does’.

Mr Kahn responded that the long-term rates were some sort of average of expected future short-term rates and they did have an expected inflation component. So, even if the Bank lowered interest rates to negative levels in real terms, it would undoubtedly create inflation expectations, and the long-run rates would start to increase. The Bank did not set long-term rates but it did influence them. It was important to remember that long-term rates were the important rates for investment, as long-term investment decisions were based on long-term borrowing. The best influence the Bank could have on long-term investment was to create a below-the-inflation environment and to allow for lower long-term rates.  

Ms Marcus said that the Bank was very clear about not targeting a level of the exchange rate. Conditions changed all the time and the exchange rate was complex. It did have an impact and the Bank had to take it into account to see what these implications were. If the Bank had to target an interest rate it would have to take into account the data that existed and what was happening. The SARB did not have a view on what was an appropriate exchange rate.

Dr D George (DA) said that the National Treasury had estimated a growth rate of 2.3% and the Reserve Bank had estimated a growth rate of 2%. He asked what the Bank’s actual forecast was and why it was different to that of the National Treasury.

Ms Marcus said that the SARB used its own data for different views and different numbers. Historically, the National Treasury had been over-optimistic. In the fourth quarter, both numbers averaged at 3.2%, which meant that the economy had contracted for 2009 at 1.8%, and there was good growth and certainly a needful number for the fourth quarter. The 2% forecast of the Bank was very much aligned with the conditions. All sectors had reflected positively, the primary sector at 0.9%, the secondary sector at 8.1% and the tertiary sector at 2.3%, which were very positive indications.

Mr Kahn said there were different models as all private sector forecasters had different models, and would differ on the assumptions that were put into the models. There would always be the tendency that some could come up with slighter different outcomes, and this also depended on the timing of the forecast.

Dr George asked what was driving the process regarding shareholders, and if it was the shareholders themselves who wanted the Bank to be liquidated so that they could access the reserves of the Bank and therefore make a profit on the shares they bought.

The Governor said that the SARB was not an investment for profit. The Board of the SARB was a governance Board, not a policy board. It was unhealthy for any organisation with shareholders to have different objectives or to not have the interests of the organisation and its purpose at the heart of the way they acted. Everyone had the ability to purchase a maximum of 10 000 shares issued at R1.00 each. This did allow for the exercise of influence that would affect functioning and decision-making. Seven members could be voted on to the Board. The SARB would be looking at what it meant in terms of getting people on the Board as this could not impact on policy.

Dr George referred to the letter from the Minister of Finance, which had identified a target range of between 3 and 6%. For example the effect of the tariff increase from Eskom and the increase of the fuel levy would most probably drive up inflation, and theoretically no action would be taken. In an instance such as this, the rate would not be increased. He asked if the opposite scenario would also be true, that the rate would possibly theoretical be cut in order to try to stimulate growth in some way.

Ms Marcus noted, in regard to the letter, that matters were certainly more explicit and transparent now. The Bank was looking at integration in terms of industrial policy, and all of these things required different combinations. The point about industrial policy was that it represented the micro environment, and this was something that the Bank believed required urgent attention, because this was the area in which everything related to jobs was addressed.

Dr George asked if the SARB would be presenting some scenarios regarding the Eskom increases to assist people to understand the impact on the economy

Mr Kahn responded that, in regard to the expectations arising from the electricity tariffs and the different scenarios, he would like to state, firstly, that the Bank had no idea of what to expect from the electricity increase. It preferred to just keep the original increase from Eskom - of 25% - in the forecast, and hoped that any outcome that was announced tomorrow was not very far off that on the up-side. The Bank had had different scenarios presented to it by a macro-modeling team, so it was aware of what the implications were for inflation and the different possibilities. It was very easy to work out what the impact of this would be.  

Mr M Makhubela (COPE, Limpopo) asked if the Governor knew if the economy in South Africa could be saved, given the high rate of job losses, job insecurity and very slow recovery.

Ms Marcus said that South Africa had come out of a period of great difficulty extremely well, from both the financial sector and a real economy point of view, to emerge with these kinds of numbers. The challenge was to sustain it and be aware of what happened globally and how this would impact on the country.

Mr Harris asked if the Governor had responded to the letter she had received from the Minister of Finance.

The Governor responded that a response mandate existed and the Bank had a very good working relationship in relation to the letter from the Finance Minister.

Mr Harris asked for the definitions of the words ‘framework’ and ‘approach’ as used in the letter from the Minister of Finance. He asked how did ‘framework’ equal ‘approach’ and how ‘framework’ and ‘approach’ differed from the ‘mandate’ of the Bank.

The Governor responded that the mandate came from the Constitution. The Constitution clearly indicated the purpose of what was required. The framework was very much that the goals and targets were set by government, and the operational approach was where the bank exercised its independence on decisions, goals and targets as set by government. This created the framework, which was the 3% to 6%. It was SARB’s responsibility as to how to reach that. That framework was expanded in terms of the other issues that had been elaborated on, in the letter from the Minister. The approach that was taken was part of what was done at the operational level.

Mr Harris referred to the letter from the Minister of Finance in which it was stated that it was the responsibility of the Bank to make explanations to the public. He asked if there were any new mechanisms for how it would make these explanations. He asked further if a new mechanism was warranted if a situation arose where the Bank was going to miss the inflation target and had to write a letter to the Minister of Finance.

Mr Kahn responded that with regard to explanations to the public, there was never a requirement for the SARB to write a formal letter, but there was always a requirement that if the Bank went outside the target, then the reason for this should be explained, including how the Bank saw matters going forward. The exact mechanics of this process had never been explicitly set out, but the Bank had interpreted it as something it had to do in terms of its monetary policy statements. In each monetary policy committee meeting, the Bank explained where and how it saw inflation going forward, and gave a good indication of what its forecast was. If it was hit by shock, it had to explain how it was going to get back into the target range for inflation. The new mandate, in a sense, reinforced this by trying to underscore that flexibility and balance had to be taken into consideration.

The Governor said that the Bank was working on ways to improve its communications with the public. The Bank had monetary policy forums on a quarterly basis, both nationally and regionally, where everyone was invited to attend and ask questions. The SARB had embarked on a new outreach programme, to look at engagement across the board with all. The intention of this programme was to meet with people from all walks of life.

Mr Harris asked how the Bank would respond to monetary policy if the country had an ‘inflation shock’, and had to show due regard for the source of the inflation shock.

Mr Kahn said that the standard approach of the Bank, when hit by an inflation-shock, was to take a view of how that price increase had filtered through to the rest of the economy and caused generalised inflation, as those were the second-round effects which were taken into account. The problem was that it was much easier to deal with a one-off shock, but a multiple shock was a much more tricky situation because for the next three years there would be increases. The Bank would try to focus more on the second round effects than on trying to reverse something that was irreversible.

Dr Mnyande said it was important to distinguish between monetary policy framework and monetary policy goals. Academics, policy-makers and most central banks believed that the goal of monetary policy was price stability, and the SARB agreed with this goal. The Constitution clearly stated that the objective of the Bank was to protect the value of the currency in the interest of sustainable growth and development.


Mr B Mashile (ANC, Mpumalanga) said that the activities of the Reserve Bank seemed to have a serious impact on how ordinary people spent disposable income, and he asked how the work of the Reserve Bank was influenced by the lives of ordinary people.

Ms Marcus said that providing explanations to the public was closely related to the question of the impact of the SARB on ordinary people. There was no question about the fact that the Bank was aware that the decisions taken affected everybody, and therefore these decisions were not taken lightly. A lot of time was spent in discussions, elaborating and evaluating the different positions, and on what needed to be done about the situation.

The following questions were raised but not directly answered

Mr S Swart (ACDP) asked whether the now broadened flexible inflation-targeting mandate of the SARB gave it more flexibility to consider factors such as growth, employment, unemployment and the exchange rate. He asked how the SARB saw this broader mandate as some commentators had said that this amounted to an implicit rebuke by the National Treasury regarding monetary policy.

Dr George asked if, in regard to the fiscal framework, the Bank was looking into the potential risk of the phenomenon where debt - specifically that of the national government and parastatal borrowing - was increasing over time, which probably impacted on the liquidity within the banking system and the ability to borrow.

Mr Harris asked what the new system for flexible inflation targeting was called.

Mr Harris asked what the impact was of the ownership structure of the Reserve Bank on its operations.

Mr Mashile asked what the SARB expected regarding the tariff increases from Eskom, as these were a high risk for certain indicators.

Mr Harris asked if the SARB, given that Section 38 of the Reserve Bank Act referred to the average market price of shares of the Reserve Bank, believed that the average price of shares was the price of shares as they were currently traded, or whether this in fact was not the true market price because the market for shares was so illiquid.

The meeting was adjourned