South African Reserve Bank Governor on Quarterly Developments

Meeting report

South African Reserve Bank (SARB) Quarterly Bulletin: Briefing
Mr Tito Mboweni, Governor, South African Reserve Bank, introduced the delegation representing the Bank (SARB). They were Mr Brian Kahn, Senior Deputy Chief Economist, Ms Nombulelo Gumata, Economist (Research), Ms Samantha Henkeman, Media & Research Assistant and Mr Fannie Phakola, Senior Manager for Politics and Legislatures.

Mr Brian Kahn, Senior Deputy Chief Economist, SARB, briefed the Committee on the quarterly bulletin presentation. Under the heading of recent international economic developments, Mr Kahn reported that slowing economic growth was noted. The July 2008 World Economic Outlook Update showed that global economic growth was expected to moderate from 5% in 2007 to 4.1% in 2008 and to 3.9% in 2009.

Inflation in advanced economies was projected to accelerate in 2008, but ease in 2009 against the backdrop of slowing demand and a projected stabilisation in commodity prices. In the emerging and developing economies the increase in inflation was expected to be widespread and more pronounced than its more advanced counterparts.

Many monetary policy-makers were faced with two main conflicting challenges to monetary policy during recent months. The manifestation of these challenges varied across different countries, which in part explained the different monetary policy reactions. Annual consumer price inflation (CPI) accelerated in most of the Southern African Development Community (SADC) countries over the past few months, as food and energy prices continued to rise. Nevertheless, the recent decline in the price of oil may relieve some of the inflationary pressures. International prices of key South African export commodities had also declined considerably. The recent decrease in the price of gold was recorded as the international price of crude oil declined. This reduced the demand for gold as a hedge against inflation.

In the recent domestic economic developments, the domestic economy regained momentum in the second quarter of 2008, due to strong growth in the primary and secondary sectors. There was a rebound in the real gross domestic product, and real gross domestic expenditure contracted in the second quarter. Growth in real final consumption expenditure by households continued to slow, along with a moderation in the growth of real disposable income of households. The economy had seen a slowing accumulation of household debt and the ratio of debt to disposable income had declined. Real final consumption expenditure by general government had contracted in the second quarter, and there was a moderation in growth of real gross fixed-capital formation. Since March 2007, the composite leading business indicator had displayed a moderate downward trend. The unemployment rate decreased to a 10-year low and wage settlements had inched higher, partly reflecting rising inflation. The producer price index (PPI) surged to its highest level in almost 22 years and CPIX inflation (CPI less mortgage rates) breached the upper limit of the inflation target range for the sixteenth consecutive month, in July 2008. As a ratio of GDP, the current account deficit narrowed from 8,9% to 7,3% in the second quarter of 2008. The volume of exports increased over the same period – largely on account of domestic producers who had stepped up production levels after the lower production that emanated from the domestic power shortages early in 2008.

Net portfolio and other investment capital inflows were the major contributors to the surplus on the financial account. The accumulation of gold and foreign exchange reserves continued in the first eight months of 2008 and a surplus of R 5,7 billion was recorded in the second quarter of 2008. The exchange rate of the rand strengthened during the second quarter of 2008, following a significant decline during the first quarter. Growth in the money supply continued to ease in the first seven months of 2008. Growth in the banks’ total loans and advances also moderated. The money-market rates moved sideways from June 2008, as some market participants anticipated an end to the monetary policy tightening cycle. Share prices retreated from a record high. The deceleration in the rate of change in house prices turned into an absolute decline, and their projection for the medium term was that a modest financial surplus in the public sector would make way for moderate deficits.

The longer term domestic economic developments – from 1998 to 2008 – were then discussed. Mr Kahn commented that despite challenges, interest rates had been less volatile since the adoption of formal inflation targeting. Economic growth had also been more stable in recent years. The ratio of gross fixed capital formation to gross domestic product continued to increase. Mr Kahn reported that by gradually accumulating foreign reserves, the SARB had greatly improved the country’s international liquidity position.

Mr Kahn noted that the challenges in the future would be to guide inflation back to within the target range, maintain price and financial stability and create a conducive environment for the continued increase in capital formation, improvement in productivity, and real growth in the economy.

Mr Mboweni commented that the South African economy was strong in the long term and that people needed to see what had been achieved in the last ten years. The graphs that were tabled would tell a good story to counter negative opinions that the economy was a disaster. He specifically noted the change in the reserve position. In 1998, South Africa had a negative reserve position, and the current positive balance was a major achievement.

Discussions
Dr D George (DA) remarked that some countries were loosening their monetary policy stance to stimulate their economies as they slowed down. He asked if the SARB would tighten their position if the South Africa economy did not moderate.

Mr Mboweni responded that the inflationary picture, even when the price of food and fuel were excluded, was still showing the interest rate running into 7%. The argument attributing this to exogenous shocks therefore did not hold. This time was being informally called the “post securitisation period”. Nobody wanted securitised assets. Some central banks were sitting with assets that no one wanted to buy. Another name that was being used in financial circles was the “post investment banking period”, as previous investment banking institutions were applying to become deposit-taking institutions.

Mr S Marais (DA) referred to the information on gross fixed capital formation and the fairly buoyant level South Africa still had, and asked what was its relation to the 2010 construction projects.

Mr Kahn responded that it was difficult to disentangle capital investment projects from the 2010 World Cup. The focus here was on the completion date of some of the projects. Some of these projects would be completed sooner, and others, such as transport (including investment in rail, roads and ports) would amount to much more infrastructure development after 2010. Some projects would be completed before that date but the broader infrastructure development would continue afterwards. This was not a simple case where investment would simply end after 2010.

Mr Marais referred to the re-basing of the formula for the CPI and the revised basket of goods. This would come into effect from January or February of 2009. He pointed out that this change had stirred much debate and controversy, and he asked how this would influence the repo rate adjustments of the future.

Mr Mboweni replied that the simulations indicated that inflation would still be higher than expected and would only come back into the target band in the second quarter of 2010.

Mr Marais referred to the growth of the economy on the demand side, and the imbalance with the supply side. Household debt had increased, as well as the debt service cost. The disposable income of households had gone down. The production price index (PPI) had risen, while the cost of imports had gone down. He asked the extent to which South Africa was prepared for broad based supply side economic growth in the future. 

Mr Mboweni agreed that broad-based supply-side structural changes were needed and might also lift up the potential output of the economy. This would also preferably be centred on the government, labour and technology. Despite the slowdown in the global economy, South Africa’s economic growth had reached, or was close to its potential. This was not a bad performance, given the current circumstances.

Dr George noted the effect of the global credit crunch on banks. He said that South African banks appeared to be less affected, and asked if the SARB knew the extent of exposure and how it would know this.

Mr B Mnguni (ANC) queried South Africa's resilience to the global crisis. He asked what the risk was in the market, taking into account the exposure of the domestic banking sector.

Mr Mboweni responded that the banking sector was relatively unaffected. The international franchises of the big domestic banks may be somewhat exposed, but at the Johannesburg centre they were not. He noted that South Africa could possibly thank exchange controls for this position.

Mr Mnguni noted that there was an outcry in the USA to a policy change. He asked what risk South Africa was facing from the USA, taking into account the current account deficit, as this was seen as a risk by outside investors.

Mr Mboweni made a few general comments. He stated that there was a need to look at the growth in the rate of increase in prices. The graphs showed that South Africa might be going into negative territory soon, so the high interest rate argument did not hold. SARB were effectively running the risk that the real interest rate would be negative, which would not be good for investment. What was of greater concern to him was the instability in the global financial markets. The US sub-prime market, in particular, was getting worse. The USA Federal Reserve had to intervene in the money market in order to facilitate the continued existence of the inter-bank market and this was probably not the last of such interventions.

Mr K Moloto (ANC) asked what lessons South Africa could learn from the USA financial crisis. He specifically wanted comment on the use of the “lender of last resort” and “moral hazard” principles.

Mr Mboweni responded that the issues of moral hazard and lender of last resort were textbook questions that had been challenged to their core. The question now was what central banks should do to keep the banking system working. Banks had run out of traditional collateral and central banks had to make judgments in order to keep the financial system going. With reference to the Bear-Stearns rescue, he added that these issues were practical, and not academic.

Mr Moloto pointed that the bond yield was an important indicator of an investment's performance, and asked what the trends were with current bond yields.

Mr Kahn responded that in 2007 there was an upward shift in the inflation expectations, which was somewhat reflected in the bond yield. By the beginning of 2008 there was a large jump in inflation expectations and this was generally seen until mid-2008. From mid-2008, there had been a moderation in this expectation and by late 2009 the SARB expected that inflation would be coming down.

Mr Moloto asked about the financing of the current account deficit. He indicated that this might border on a policy issue, and he would assume that it was getting expensive to finance the deficit and that the inter-bank lending rate had also gone up.

Mr Mboweni responded that the real issue was whether South Africa was investing sufficiently abroad in order to receive dividends, and whether there was more outflow than inflow of funds. The trade account was a clear indicator that South Africa was not exporting as much as it should in order to offset the deficit. This was the main contributor to the current account deficit. South Africa therefore needed to invest more abroad (to earn dividends), export more (to earn foreign currency) and buy more South African goods (to boost the domestic economy).

Ms N Mokoto (ANC) referred to the outflow of investment and asked how large the impact of this was.

Mr Mboweni responded that non-residents were currently the net sellers of bonds and equity. Given the global situation, the tendency of investors was to withdraw investments in more risky emerging markets and move to the traditional areas of more confidence in developed markets. The mood in the markets changed from time to time and it was important for people to support the central banks as they tried to stabilise the global financial system.

Mr M Johnson (ANC) asked for clarity on the issue of wage settlements, specifically the sustainability of these when inflation was higher than the rate of increases and when wages did not keep up with inflation.

Mr Kahn responded that inflation exceeded the average rate of the increases in wage settlements. There were also differences in sectors that would reflect higher or lower increases. The question was whether that was sustainable, and whether a further increase could be expected in 2009. These were negotiated once a year and there were also multi-year agreements to consider. It was possible that even if inflation came down, it may not make a difference. In 2002 inflation went up and wage settlements had lagged behind inflation. South African may see this kind of response again. He added that it was expected that there would soon be pressure from unions for higher wage settlements, but whether they would exceed inflation remained to be seen.

Mr Johnson asked if the SARB had contact with Congress of South African Trade Unions (COSATU) and the South African Communist Party (SACP) to keep them informed of developments. He thought it very unfair that such important information did not reach these organisations.

Mr Mboweni responded that the SARB took this issue very seriously and this could be seen in their monetary policy forums, where everyone was welcome to express their views. Some individual stakeholders had chosen not to attend, but at times of the announcement they were the ones who would shout the loudest. The central bank continued to seek interaction. There was in fact a Monetary Policy Committee (MPC) member allocated to every province and these members were tasked with using this opportunity to understand the real economic dynamics of the provinces.

Ms J Fubbs (ANC) referred to the rise in the relative price of food and the cost or electricity relative to the decline in output. On the housing front, the Governor had cautioned against speculative investment. This advice was not heeded, leading to current problems. The reality was that many more people had bought houses and, given the need to repay mortgages together with the increases in the prices of food, fuel and electricity, the money situation had become tighter and people were using less credit. This showed that some of the issues the SARB had highlighted had been met. She asked for Mr Mboweni’s thoughts on the situation where people were faced with fairly significant hurdles, and asked what the Governor would say to the people of South Africa.

Mr Mboweni replied that on the issue of household debt and expenditure, monetary policy had achieved its goal, but the purpose of monetary policy was still focused on inflation staying within the target band. The SARB’s key focus was the impact of monetary policy on the inflation. He referred the Committee to slide 34 on the levels of CPIX inflation and the repurchase rate. He pointed out the SARB’s concern with the intersection of the two indicators. A hard line monetarist might say that the repo rate was too low, but the overall evidence was that the stance was working quite well.

Mr Moloto asked what the monetary policy sought to address, and whether it was possible that this could contradict the national developmental objectives. He further wanted to know how the two could be reconciled.

Mr Mboweni responded that government was within its rights to say that South Africa would have an inflation-targeting approach. The SARB had decided to target the 3% to 6% band of CPIX inflation. It was the responsibility of all to contribute what they could to that goal. He did, however, want to ensure that there was no confusion. The SARB was the central bank, and it was akin to the Industrial Development Trust, Independent Development Corporation or the Departments of Agriculture or Trade and Industry. The central bank was responsible for monetary policy, to contribute to low inflation. It was important to note that growth and development did not take place under circumstances of high inflation. Once this was achieved, the monetary conditions would be more accommodating. The growth of the middle class was also important, to generally contribute to further growth of the economy. The SARB could not take the blame for people who had been irresponsible. People must take heed of the budget constraints and live within their means. The interest rate condition was relevant to the point that it tried to contain inflation.

Ms Nombulelo Gumata, Economist (Research), SARB supported that view and pointed out that this had to be viewed in terms of the data. High inflation was not an advantage. Furthermore, high inflation was not necessarily the result of a high interest rate. This was a matter of strategic change, and the indicators showed that South Africa was on the right track, especially with regard to gross capital formation.

Mr Moloto asked what positive aspects arose from this experience.

Mr Mboweni responded that some good might come of these institutions becoming deposit taking banks again. It seemed that the investment bankers had got ahead of themselves and were selling assets that were not formally regulated. As deposit-taking institutions they could now be formally regulated, which would bring discipline. The change would force accountability, and there would be improved determinations of affordability to the clients of the banks. The question was that if regulators did not understand what was being traded, then why would they allow such trade. The cost of this transformation was quite substantial. The proposed bail-out fund would amount to $700 billion in order to stabilise the US economy. This was indicative of the very bad situation.

Mr Mnguni took the point that the central bank was happy with the banks and their level of exposure to the sub-prime market, and also noted the previous point that banks could not do much with the securitised assets. He asked if banks still had the right to take on such derivatives if doing so might pose a risk to financial stability.

Mr Mboweni responded that the prevailing global view on securitised assets was that these items needed to be brought back on to the balance sheet.

Mr Marais requested the delegation's thoughts on the possible reduction of the repo rate. He noted the continued funding of the current account deficit and wondered to what extent this would compromise the price differential, and therefore South Africa's competitive edge. He also asked if the MPC considered the underlying inflation rate when they looked at the repo rate.

Mr Mboweni responded that the underlying inflation was important for monetary policy decision-making. When the SARB stripped out the price effect of food and fuel, the underlying inflation rate was still above the 7% mark, indicating that something had to be done.

Mr N Singh (IFP) referred to the submarine procurement mentioned in the presentation under government consumption. He asked how that could be classified as government consumption, and also if there were other such cases.

Mr Kahn responded that this was a convention of the National Accounts system of the International Monetary Fund, to which South Africa subscribed. Military equipment was seen as consumption expenditure, and was not regarded as investment or capital expenditure as there was no return. The rationale was that military equipment could not be deemed as machines that produced products. Their inherent purpose was to eventually be destroyed or damaged in warfare.

Mr Singh noted the recent readjustments of the Fitch ratings of certain banks, and asked what effect this may have on the economy.

Mr Mboweni replied that rating agencies looked into the performance of institutions but recently these agencies had lost face and few took them seriously any more. For this reason, he did not think there would be much impact from the FirstRand Fitch rating downgrade.

Mr Moloto asked what other methods could be invoked before the central bank used the lender of last resort option.

Mr Mboweni responded that even though the central bank was seen as the lender of last resort, it must not be the lender of last resort for the foolish actions of private bankers. Private banks must stay true to the principle of good management.  A central bank faced a difficulty here, had to make judgments on the actions to be taken in a crisis, and would be held accountable for its reaction to a crisis. The notion of moral hazard, being theoretical, went out of the window very quickly. This was reflected in the current trend towards nationalisation. It was happening in the USA and the UK. Dogma did not help and there was a need to be practical. Banks were accepting unconventional assets as collateral (such as student loans). The experience in South Africa was that the liquidity problems of banks took them out of the system. They had to carefully assess whether a bank was insolvent or merely had temporary liquidity problems, when deciding on a course of action.

The first portion of the meeting was adjourned. The second portion of the report will be available shortly.