Monetary Policy Review
April 2017
South African Reserve Bank
Monetary Policy Review
April 2017
Monetary Policy Review April 2017
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ISSN: 1609-3194
Monetary Policy Review April 2017
Preface
The primary mandate of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. In addition, the SARB has a complementary mandate to oversee and maintain
financial stability.
Price stability helps to protect the purchasing power and living standards of all South Africans. It provides a favourable
environment for investment and job creation, and also helps to maintain and improve international competitiveness. The goal
of price stability is quantified by the setting of an inflation target by government after consultation with the SARB. The SARB
has operational independence. Monetary policy decisions are made by the SARB’s Monetary Policy Committee (MPC), which
is chaired by the Governor and includes the deputy governors as well as other senior officials of the SARB.
The MPC conducts monetary policy to keep inflation within a target range of 3–6%. This inflation targeting framework is
flexible, meaning that inflation may be temporarily outside the target range, under certain circumstances. The MPC takes
into account the time lags between policy adjustments and economic effects. This provides for interest rate smoothing over
the cycle, and contributes towards more stable economic growth. The decision of the MPC, together with a comprehensive
statement, is communicated at a media conference at the end of each meeting.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening public understanding of the objectives
and conduct of monetary policy. The MPR covers domestic and international developments that affect inflation and that
impact on the monetary policy stance. It is fundamentally a forward looking document which focuses on the outlook for the
South African economy, in contrast to the Quarterly Bulletin which records and explains recent economic developments.
The MPR is presented by senior officials of the SARB at monetary policy forums in various centres across South Africa in an
effort to develop a better understanding of monetary policy through direct interaction with stakeholders.
Monetary Policy Review April 2017
Contents


Boxes


Statements issued by Lesetja Kganyago, Governor of the South African Reserve Bank
Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review April 2017
Executive summary
South Africa’s macroeconomic imbalances have eased
somewhat, with household balance sheets as well as fiscal
and current account deficits all moving towards more
sustainable levels. Inflation is falling back within the target
range, and is expected to average 5.4% in 2018 and 5.5% in
2019. Meanwhile, gross domestic product (GDP) growth is
projected to pick up from 2016’s post-crisis low. The shortterm growth improvement largely reflects a recovery in the
primary sector (agriculture and mining). Over the medium
term, output is expected to benefit from renewed investment,
stronger household consumption and improved global growth.
Growth prospects, however, remain subdued, while inflation is
staying relatively high despite receding shocks.
The previous Monetary Policy Review (MPR), published in
October 2016, welcomed an improvement in global conditions.
This progress has mostly been sustained. Pessimism about
world growth has faded somewhat, with themes of secular
stagnation and ultra-low long term interest rates retreating in
favour of reflation and a degree of optimism. In the United States
(US), measures of policy uncertainty are elevated, yet volatility
is unusually low while equity markets are close to record highs.
Inflation is reverting to target levels following half a decade of
outcomes below 2%, and employment gains remain robust.
In this context, the US Federal Reserve (Fed) is moving with
a new resolve towards policy normalisation. Yet the prospect
of higher interest rates, which previously sent shockwaves
through financial markets, now seems to be inspiring more
confidence than fear. Meanwhile, policy stimulus in China
appears to have stabilised growth at relatively high levels. This
has allayed fears of a sharper slowdown and has breathed new
life into industrial commodities.
In this environment, South Africa’s terms of trade have
rebounded to a five-year high. The exchange rate has recovered
some ground: 2016 was the first year this decade in which the
rand was stronger in December than it had been in January.
These experiences have parallels across the emerging market
space, with peer countries including Brazil, Chile, Colombia
and Russia all experiencing stronger capital inflows and
currency appreciation. However, the rising tide is not lifting all
boats. In particular, Turkey (where macroeconomic imbalances
remain acute) and Mexico (which is especially vulnerable to US
policy risk) stand out as exceptions to the emerging market
trend.
As in 2013, investors appear to be differentiating between
emerging markets based on country specific characteristics.
South Africa has benefited from its improved economic
fundamentals. The current account deficit is likely to reach
3.2% of GDP this year, from 5.9% in 2013, reflecting a lower
external financing requirement. Fiscal consolidation has so far
reduced the fiscal deficit to 3.9% of GDP in 2016/17, from 4.4%
in 2013/14, and the debt to GDP ratio is expected to stabilise

* CPI for all urban areas
Sources: SARB and Stats SA
Percentage change on a year earlier
Targeted inflation* forecast

Inflation target range
* At seasonally adjusted annualised rates
Sources: SARB and Stats SA
Percentage change*
Real GDP


Indices: 1 January 2016 = 100
Jan
Mar
May
Jul
Sep
Nov
Jan
Mar

Emerging market currencies

JPM EM Currency Index

Turkish lira

Indonesian rupiah

Russian ruble

Mexican peso

Colombian peso
Sources: Bloomberg and SARB

South African rand

Indian rupee

Brazilian real

Chinese yuan

Hungarian forint

Monetary Policy Review April 2017

by 2018/19. Household debt stocks – which peaked at nearly
90% of disposable incomes in 2008 – are now back to 2006
levels, slightly above 70%. This suggests the hangover from
the pre-crisis debt boom may at last be fading. Inflation is
slowing and should be back within the target range during the
second quarter of 2017. These macroeconomic improvements
are complemented by other positive outcomes, ranging from
normalising rainfall patterns to a sharp reduction in the number
of work days lost to strikes. The combined effect is somewhat
better economic prospects over the medium term, potentially
reversing the trend of slower growth and rising inflation which
has dogged South Africa through the post-crisis period and
2016 in particular.
Overview of the policy stance
The repurchase (repo) rate has been stable at 7.0% for a year.
During this period, the medium-term inflation forecast, which is
the relevant time frame for monetary policy, has been similarly
stable. Indeed, the forecast for 2018 has stayed within a narrow
range of 5.4–5.5% at every Monetary Policy Committee (MPC)
meeting to date. The 2019 forecast, which became available
only for the March 2017 meeting, also shows inflation within the
target range, at 5.5%. The existing monetary policy settings are
therefore proving adequate to return inflation within the target
range over the policy horizon, of around 12–24 months.
This outlook is quite favourable compared to a year ago. It
nonetheless poses two sorts of policy problems. There are
risks to this forecast which, on balance, incline towards higher
inflation. Furthermore, projected inflation remains relatively
high, close to the top end of the 3–6% target range throughout
2018 and 2019.
The exchange rate is the biggest risk to the forecast trajectory.
The past year has seen sustained rand appreciation, breaking
a five-year depreciation trend. The currency has weakened
sharply on occasions during this period – for instance, following
the US election result – but it has made up its losses relatively
quickly. Furthermore, it has recently shrugged off US monetary
tightening, despite previous sensitivity to Fed moves. In late
March, however, it weakened abruptly following the Cabinet
reshuffle. In time this may be identified as a new turning point
for the currency, but at present the outlook is uncertain. The
latest forecast starts with the implied dollar/rand exchange rate
at about R13.40. That level is close to the actual rates prevailing
at the start of the second quarter, and well above the first
quarter strong point of about R12.30. The risk is that the rand
could follow a more depreciated path than expected, which
would, other things being equal, raise inflation.
The second problem is that, given the assumptions, forecast
inflation is still relatively high. Although headline is decelerating as
drought effects fade, underlying inflation remains elevated. Core
inflation reached a post-crisis high of 5.9% in December 2016,
and is likely to trend only moderately lower over the medium
Percentage change over four quarters

Changes to SARB CPI forecast*

March 2016

July 2016

November 2016

March 2017
* Dotted lines indicate forecasts
Sources: SARB and Stats SA

May 2016

September 2016

January 2017

Actual

Percentage change over four quarters
2000 2002 2004 2006 2008
2010 2012 2014 2016
BER average inflation expectations since 2000*

Two years ahead
* CPIX for metropolitan and other urban areas until the end of 2008;
CPI for all urban areas thereafter
Source: BER

Five years ahead

Monetary Policy Review April 2017
term, at no point falling below 5.0%. Furthermore, disinflation in
core is driven almost exclusively by goods prices responding to
exchange rate effects. Core goods inflation is projected at close
to 4% through 2018 and 2019. By contrast, services inflation is
much closer to 6% across the medium term.
An important aspect of the problem is the relatively high level of
inflation expectations. Surveyed expectations for 2018 have not
yet declined in line with the South African Reserve Bank’s (SARB)
forecast, remaining close to 6.0%. Furthermore, expectations
for the period five to ten years ahead, as derived from surveys,
market indicators or independent forecasts, all appear similarly
high, at or above the top end of the inflation target range.
While stable expectations were welcome so long as they were
resistant to higher inflation, their persistence becomes more
problematic as inflation falls. The fact that expectations seem
to be stuck close to 6.0% helps explain why inflation does
not slow more rapidly over the forecast period. The relevant
horizon for monetary policy now falls across 2018 and 2019.
When these years arrive, shocks to food and petrol prices are
expected to have dissipated. The exchange rate forecast for
this period is stable in real terms.1 Economic growth, while
slightly improved, will likely remain low, and employment is
anticipated to have declined. Yet inflation is still projected well
above the midpoint of the target range. Unfortunately, with
underlying inflation as well as inflation expectations pinned to
the upper-end of the target range, even small negative shocks
are likely to cause target breaches.
In recent years, policymakers have confronted the challenge
of rising inflation alongside slowing growth. The forecast now
shows some signs of improvement on both counts. Inflation
appears to be returning to target, while ‘green shoots’ of growth
have been visible following the disappointments of 2016.
Furthermore, smaller current account deficits are reducing
external financing requirements, while debt trajectories in
both the household and public sectors appear more clearly
sustainable. These developments have permitted a clearer
sense over the past three MPC meetings that additional policy
tightening may not be necessary.
Nonetheless, this fledgling recovery is vulnerable to shocks.
The expected degree of improvement for both growth and
inflation is modest at best. Forecast inflation and inflation
expectations remain relatively high, constraining prospects for
rate cuts. The economy is on a path back to full production,
but progress is expected to be gradual, with the output gap
effectively closed only by the end of 2019 despite sustained
monetary and fiscal support to growth. Furthermore, even at full
capacity the economy’s growth rate will remain unsatisfactory,
below historical averages and only slightly above the growth
rate of the population. Improving the long run potential of the
economy to grow requires reforms to boost investment and
improve the functioning of key markets, but such initiatives are
mostly outside the responsibilities of the central bank.

In fact, in the forecasting model the longer-run exchange rate does
not cause inflation but responds to it, with the nominal exchange rate
depreciating from its current starting point in line with inflation differentials.
Per cent
2009 2010

Date of forecast
4.5
5.0
5.5

South Africa’s five year ahead inflation forecast


Source: IMF

Percentage of potential GDP

Output gap with confidence bands

75%

25%
Source: SARB

50%

Output gap
-6
-4
-2

Per cent
2000 2002 2004 2006 2008 2010 2012 2014 2016
South Africa repurchase and prime rate

Repurchase rate
Source: SARB

Prime rate

Monetary Policy Review April 2017

Monetary policy continues to be supportive of the recovery.
Real interest rates remain low in historical perspective, thereby
contributing to demand and helping to close the output gap.
South Africa has been buffeted by severe inflation shocks since
the global financial crisis, including currency depreciation and
drought. To prevent a deterioration in inflation expectations,
policy accommodation has been somewhat reduced since
2014. With the appreciation of the exchange rate, weaker
growth last year and expected moderation in food prices, that
policy adjustment has appeared sufficient to return inflation to
within the upper part of the target range and to keep it there
across the forecast period. The outlook, however, is unusually
uncertain.

Monetary Policy Review April 2017
Overview of the world economy
Global growth is expected to improve from 2016’s post-crisis
low. A number of major emerging markets (Russia, Brazil,
Nigeria) are exiting recessions, while the largest (China and
India) appear capable of maintaining growth near current levels.
Major advanced economies are in a cylical upturn, with the US,
euro area and Japan all expected to close their output gaps
over the next few years. Meanwhile, inflation rates are generally
moving back towards targets, from being too high in some
emerging markets or too low in many advanced economies.
Despite these positive trends, the shape of the global recovery
remains unclear, due in particular to policy uncertainty in the
US, debt overhangs in China and persistent risks in Europe.
Advanced economies
Advanced economies are starting 2017 on a much stronger
footing than 2016, and arguably any period since the global
financial crisis. Industrial production is accelerating, drag from
inventories is receding, asset price growth has been vigorous
and household balance sheets are supporting stronger
domestic demand. The Purchasing Managers’ Index (PMI)
for the Group of Three (G3) economies has improved from
an average of just under 51 for the first half of 2016 to over
56 in February 2017, its highest level since 2011.2 Accordingly,
advanced economy growth is expected to reach 1.9% in 2017
and 2.0% in 2018, up from 1.6% in 2016.
The US economy should contribute significantly to this
acceleration, with growth in excess of 2.0% over the next
three years. The starting point is a good one. Employment
gains have been healthy, averaging 190 000 jobs per month
during 2016, and unemployment has fallen somewhat below
5.0% – reaching levels consistent with Fed estimates of the
long-run natural rate of unemployment. The new administration
has brought with it a sharp increase in policy uncertainty.
Nonetheless, financial markets have welcomed the prospect
of tax cuts, infrastructure expenditure and lighter financial
regulation. The Standard & Poor’s (S&P) 500 index and Dow
Jones industrial average have gained over 10% since the US
elections, achieving new highs in early March. Consumer and
small business confidence indicators have also picked up,
with various measures reaching their strongest levels in over a
decade. Growth forecasts have improved slightly: consensus
forecasts for 2017 and 2018 growth were revised up by 0.1
and 0.2 percentage points respectively in February 2017
compared with three months ago. Accordingly, the output
gap – which the Congressional Budget Office puts at around
-0.5% of potential GDP for 2016 – is likely to turn positive by
2018 as robust demand pushes growth above potential. These
developments indicate that the Fed will be able to proceed

The G3 PMI includes the US, euro area and Japan. It is weighted using an
average of 2014–2016 real GDP adjusted for purchasing power parity.
Forecast
Annual percentage change

World real GDP growth*

World real GDP
* Trade weighted based on South African exports. Projections are
based on the Global Projection Model
Sources: IMF and SARB

World output gap
-3
-2
-1

Percentage change over 12 months

US inflation

PCE price index
Source: US Bureau of Economic Analysis

Inflation target

Per cent
J M M J S N J M M J S N J M M J S N J M M J S N

Federal funds rate

Effective federal funds rate

17 November 2016
Sources: CME Group, Fed and SARB

1 November 2016

3 April 2017

Monetary Policy Review April 2017

with monetary policy normalisation, in line with its projections.
Both the Fed dot plots and market expectations indicate
three hikes in 2017, lifting the Fed funds rate to between
1.25 and 1.5%.
Other major advanced economies are also expected to close
output gaps over the next few years. Despite lower potential
growth, the degree of slack in the euro area and Japan is
approximately twice that in the US, reflecting a longer period of
underperformance.3 In the euro area, significant progress has
been made in lowering the unemployment rate, with the region
as a whole having added 4.6 million jobs since the first half of
2013. Yet wage growth remains muted, registering a nominal
increase of 1.3% in the third quarter of 2016 versus almost 3.0%
pre-crisis. The number of hours worked has also not recovered
to pre-crisis levels. Forecasts indicate growth of 1.6% in both
2017 and 2018, which should aid the labour market recovery.
In Japan, economic growth surprised on the upside in 2016,
supported by fiscal stimulus and stronger exports. Over the
next two years, Japan is expected to benefit from stronger
global demand and a relatively depreciated currency, as well
as continued fiscal stimulus. These should permit growth rates
of around 1%, slightly above that economy’s potential.
Emerging market economies
Emerging markets faced difficult conditions during 2016. Over
the first half of the year, the BRICS4 weighted PMI averaged
49.1, with only India’s manufacturing sector still expanding.
Prospects have since improved, with the PMI moving into
positive territory, reaching 51.1 in February 2017. In line with this
upward trend, the International Monetary Fund (IMF) expects
growth in emerging markets to reach 4.8% by 2018, from
4.1% in 2016.
Recessions in several major regional players are expected
to end soon. Brazilian output is projected to start growing
again towards the end of 2017, having contracted throughout
2015 and 2016. Russia’s economy is likely to return to growth
sooner, possibly from the beginning of 2017, having also shrunk
over the past two years. Nigeria slipped into recession at the
start of 2016 and should similarly be growing again sometime
this year. Better performance in these economies will be
replicated in their respective regions. Both Latin America and
the Commonwealth of Independent States are forecast to see
a return to growth in 2017, with the pace of expansion rising
over 2.0% by 2019. Sub-Saharan Africa is also expected to
accelerate from current lows, with growth picking up from
1.6% in 2016 to slightly over 4.0% by 2019.
The direction of growth in emerging Asia depends chiefly on
prospects for the two regional giants, China and India.

There is disagreement on the size of the Japanese output gap. The
International Monetary Fund estimate the output gap at -1.7% of potential
GDP in 2016, while the Bank of Japan and the Cabinet Office predict an
output gap of -0.3% and -0.5% respectively in 2016Q3. In contrast, the
Organisation for Economic Co-operation and Development estimates the
output gap at 0.5% in 2016. On balance, estimates suggest the output
gap is negative.

BRICS refers to Brazil, Russia, India, China and South Africa.
Indices

Manufacturing purchasing managers’ indices

G3 (GDP PPP weighted)

JPMorgan global manufacturing PMI
Sources: IMF, JPMorgan and SARB

BRICS (GDP PPP weighted)

Monetary Policy Review April 2017
Rebalancing in China should cause growth to slow towards
6.0% from 6.7% in 2016. India, by contrast, is expected to retain
its title as the fastest growing major economy, achieving growth
rates closer to 8.0% over the next two years. The net effect of
these trends is that emerging Asian growth decelerates slightly
from 6.5% in 2016 to approximately 6.3% over the next two
years, a rate sufficient for emerging Asia to remain the world’s
fastest growing region.
Improved inflation dynamics
Inflation dynamics are improving across most of the world’s
economies. In many cases, chiefly advanced economies,
this entails reflation following an extended period of price
stagnation. For a range of emerging markets, by contrast,
inflation is subsiding towards more desirable levels.
The reflation trend reflects higher energy and food costs
alongside improving growth. Producer prices for final demand
goods in the US moved from deflation for the better part of
2015 to growth of 2.2% in February 2017. In China and the
euro area, where producer price deflation dates back to
2012 and 2013 respectively, price changes have also turned
positive. Rising producer prices have already translated into
higher consumer prices in most advanced economies, moving
inflation closer to central bank targets. Advanced economy
consumer prices have risen from an average of 0.3% in 2015
to 1.5% in December 2016. The IMF projects that inflation in
advanced economies will reach 1.9% by 2018.
In some major economies, particularly the euro area and
Japan, stronger headline inflation has not been accompanied
by a rise in underlying inflation. In the euro area, core inflation
(which excludes food and energy) was 0.9% in February 2017,
retreating from a peak of 1.1% in October 2015. There is,
however, a wide dispersion in inflation rates, with Austria and
Belgium at 1.6%, the Netherlands and Germany at 1.3%, France
and Ireland at 0.2% and Greece at -0.4%. In Japan, consumer
inflation less fresh food remains in deflation, contracting by
0.2% on an annual basis in December 2016. Market indicators,
however, have started to show rising inflation expectations in
these economies, a necessary condition for a pick-up in core
inflation. The five-year, five-year forward inflation expectations
in the euro area and Japan have both risen by over 30 basis
points since September 2016. Signs of inflation in the euro
area, particularly in Germany, suggest that the onset of policy
normalisation may come sooner than currently anticipated.
In other major economies such as the US and China, by contrast,
core and headline are more closely connected. Core Personal
Consumption Expenditure (PCE) inflation in the US rose to
1.9% in February 2017 from a low of 1.4% in July 2015. Rising
core inflation is underpinned by accelerating average hourly
earnings. Inflation expectations – again as measured by fiveyear, five-year forward expectations – have made comparable
gains, rising to 2.4%. Survey-based measures of expectations
Per cent

Producer price inflation

US

China
Source: Haver Analytics

Japan

UK
-6
-4
-2

Euro area
Per cent

Five-year, five-year forward inflation swap rate

Euro area
Source: Bloomberg

Japan

US

Monetary Policy Review April 2017

have not followed this upward trend, but nonetheless remain
above 2%. In China, core inflation registered 1.8% in February
2017 from a low of 1.3% in February 2016. Higher inflation
represents rising producer prices and improving near-term
economic conditions due to policy stimulus.
Emerging markets as a whole are achieving disinflation despite
rising commodity prices. Average inflation has fallen from a
recent peak of 6.8% in January 2016 to 4.2% in December,
and IMF forecasts suggest it will stabilise close to these levels
(4.5% in 2017 and 4.4% in 2018). Disinflation has been driven
predominantly by policy adjustments and currency rebounds, as
well as fading supply shocks. Russia and Brazil are prominent
examples of these phenomena. In Brazil, headline inflation has
fallen from a peak of 10.7% in January 2016 to 4.8% in February
2017. In Russia, inflation has slowed from 16.9% in March 2015
to 4.6% in February 2017. Following substantial tightening during
the inflation upsurge (with the policy rate up by 700 basis points
in Brazil, and 1 150 in Russia) both these countries now have
space to ease, leading to rate cuts totalling 200 basis points in
Brazil and 725 basis points in Russia to date.
Heightened policy uncertainty
This relatively optimistic assessment of the global economic
outlook offered in this section confronts risks on at least three
fronts. First, the election of Donald Trump in the US has opened
space for abrupt and wide-ranging policy changes. In its first
months in office, the new administration has attempted travel
bans, withdrawn from the Trans-Pacific Partnership (TPP)5 and
challenged the fairness of exchange rate policies in Japan, the
euro area and China. These moves signal a more protectionist
approach to trade, potentially weakening an important driver
of global growth.
The new leadership in Washington has also proposed
substantial investments in infrastructure as well as tax cuts
for individuals and companies. The initial market responses
were positive, although implementation risks have recently
diluted this enthusiasm. Unlike trade restrictions, infrastructure
investment and tax cuts should improve potential growth in the
US and boost consumer expenditure, provided these policies
do not seriously compromise debt sustainability. President
Trump has also ordered a review of the Dodd-Frank Act,
the centrepiece of post-crisis financial reform, arguing that it
imposes excessive burdens on companies and stifles lending.
Looser financial regulation may well yield short term benefits,
but these gains should be set against the risks of large and
persistent costs from financial crises.

TPP is a multilateral trade deal between 12 countries including the US,
Canada, Mexico, Chile, Peru, Malaysia, Japan, Vietnam, Singapore,
Australia, New Zealand and Brunei. It was aimed at lowering tariffs and
improving economic relationships between member nations.
Index

Global economic policy uncertainty
Source: Baker, Bloom and Davis (2016)

Monetary Policy Review April 2017
The second front is the debt overhang in China. Policymakers
have chosen to maintain economic stability and higher growth
at the cost of worsening imbalances. Total social financing, a
broad measure of credit in the economy, has risen to 213%
of GDP in 2016 from close to 100% in 2010. Policymakers
have also used close to US$1 trillion of foreign reserves
since mid-2014 to stabilise the exchange rate. The near-term
consequences of policy stimulus are rising commodity prices
to the benefit of the relevant exporting countries. However, the
longer-term risks to growth are rising.
The third front is in Europe, where the ‘European project’ of
closer political and economic union remains in crisis. The
United Kingdom (UK) is in the process of negotiating the terms
of its exit from the European Union (EU) (so called Brexit).
The short term consequences have been relatively benign
to date, with consumer confidence and a more competitive
exchange rate sustaining demand in Britain, although sterling
depreciation is expected to produce a period of abovetarget inflation. The longer term consequences are likely to
be less favourable, particularly if investment suffers as firms
relocate to more attractive jurisdictions. For the remaining
parts of the EU, the economic spillovers from Brexit have
been minimal. The more serious implications may take the
form of demonstration effects, bolstering nationalist, populist
figures in other European countries. In this vein, the upcoming
French presidential elections might conceivably install an antieuro, anti-Brussels leader in Paris. Italy is another prominent
candidate for disruption, given the prospect of early elections
in the context of continued economic underperformance and
a troubled banking sector. Finally, Greece’s ongoing recession
and large debt burden is a persistent source of crisis summits
and policy dissension.
Conclusion
The global economy started 2017 on a stronger footing.
Growth prospects in several major economies are improving
and inflation is generally moving back towards target levels.
Animal spirits, which have been dormant since the global
financial crisis, appear to have revived. It is difficult to judge
whether the new optimism is justified by fundamentals and
risks. The policy direction in the US is uncertain but outcomes
across issues such as trade and financial regulation may well
prove negative for the global economy over the longer term.
Policy stimulus in China has stabilised growth and benefitted
commodity exporting economies, but at the cost of rapid
and potentially unproductive debt growth. There are multiple
flashpoints in Europe, including Brexit, French elections, the
Italian banking system and Greek debt. The forecast anticipates
a steady improvement in global growth over the medium term,
eliminating negative output gaps, but the risks to this forecast
are skewed to the downside.
Index
Indices: January 2012 = 100

Chinese economy and commodity prices

Iron ore (left-hand scale)

Coal (left-hand scale)

Chinese purchasing managers index
Source: Bloomberg

Monetary Policy Review April 2017

Overview of financial markets
Global financial conditions have been exceptionally calm lately.
Despite an unusually high degree of policy uncertainty, financial
markets have benefitted from expectations of more corporate
friendly US policies and economic stabilisation in China.
These global conditions, combined with signs of domestic
stabilisation, have supported prices of South African assets.
The changing relationship between
Fed tightening and risk assets
As highlighted in the world economy section of this MPR,
US economic conditions have made the Fed more confident of
reaching its dual goals of full employment and price stability.
Consequently, the Fed has raised rates twice in four months,
with both markets and the Fed’s own projections indicating two
more increases this year. Coupled with proposals by the newly
elected US administration for sizable tax cuts and a boost
to infrastructure spending, this has led to an upward shift of
the US yield curve. From around 1.6% in early October 2016,
the US 10-year yield rose to a high of 2.6% on 15 December,
before easing back in recent months.
In contrast with what happened during the ‘taper tantrum’ of
2013, the prospect of an upward adjustment in what is
essentially the world’s risk free rate is not proving detrimental
for riskier assets. For example, since the beginning of October
2016, the S&P 500 index of US equities has risen by close to
10%, while spreads of BBB and A-rated corporate debt over
US Treasuries have narrowed by 10–15 basis points.
The pattern has been the same outside the US. Global equities
have rallied, with the MSCI World Index gaining 7% and the
MSCI Emerging Market Index up 3%. Long-term bond yields
in Germany, Japan and the UK have risen by only 10–40 basis
points (although German yields benefitted from a perceived
rise in political risk within the single-currency bloc). Meanwhile,
emerging market debt has remained attractive to investors:
JP Morgan’s Emerging Markets Bond Index Plus (EMBI+) spread
has narrowed by about 70 basis points from early November
highs, reversing an earlier sell-off; its emerging local currency
market index (ELMI) has mirrored these developments.6
In foreign exchange markets, the dollar has appreciated
further. However, the additional gains in recent months have
been relatively limited. Whereas the Fed’s broad dollar index is
now 22% higher than it was at the start of 2014, it is only 1.1%
higher than it was at the start of November 2016. In turn, the
relatively moderate appreciation of the US dollar has enabled
emerging market currencies to recoup, on average, all of their
losses incurred in the immediate aftermath of the US election.
As of late March, the JPMorgan Emerging Market Currency
Index was slightly (0.5%) above its 1 November 2016 level.

The JPMorgan EMBI+ includes US dollar denominated debt (bonds or
loans), issued by emerging market sovereigns and tracks total returns for
actively traded external debt instruments in these markets.
Index

US volatility and policy uncertainty (news based)

VIX volatility index (left-hand scale)

Policy uncertainty index (news based)
Sources: Bloomberg and Economic Policy Uncertainty

Index
Index
Index
Oct
Nov

Dec
Jan
Feb
Mar
MSCI emerging market and world equity indices

MSCI EM Index (left-hand scale)

MSCI World Index
Source: Bloomberg


Yield to maturity (per cent)
Years to maturity
Treasury nominal coupon yield curves

October 2016
Source: Bloomberg

December 2016

March 2017


Monetary Policy Review April 2017
Economic fundamentals help explain this decoupling of rate
expectations and risk assets. Whereas in 2013 Fed tightening
could have been interpreted as premature, it is now more clearly
justified by an improved outlook for growth and inflation – with
a range of commentators even suggesting the Fed has fallen
behind the curve. Furthermore, the macroeconomic imbalances
which distinguished vulnerable emerging markets during the
‘taper tantrum’ have in most cases moderated. Finally, the
adverse scenarios which preoccupied financial markets earlier
in 2016 have not materialised. In particular, there has been no
aggressive devaluation of the Chinese renminbi. Furthermore, the
UK decision to leave the EU has not yet produced the negative
macroeconomic consequences which many observers feared,
although the terms of Brexit remain unknown. The conclusion
is that normalisation of US monetary policy is a more benign
prospect now than it was four years ago.
Mixed fortunes for South African assets
Local financial market developments have not followed a
consistent trend. Much of the past year was characterised
by more positive perceptions of South African assets in the
context of a favourable global environment. By contrast, the
trend has recently reversed following the cabinet reshuffle and
the subsequent credit ratings downgrade by S&P.
The South African rand initially out-performed most of its
emerging market peers. From January 2016 to mid-March
2017, it appreciated by 21.7% against the US dollar and 22.4%
on a trade-weighted basis. However, the currency resumed
its depreciating trend late in March as speculation mounted
that the Finance Minister would be replaced. The rand has
since become the worst performing currency compared to its
emerging market peers.
South African bonds have echoed the rand’s fortunes, starting
with a comparatively strong performance but finishing relatively
weakly. The yield on the benchmark R186 bond, maturing in
2026, stood at 8.5% at the start of March. By early April it
had breached the 9.0% level, while the spread over its US
equivalent had widened by 67 basis points.
The initial gains for South African assets reflected a more
positive turn in the South Africa investment narrative. This
was based on a range of factors, including a narrower current
account deficit, evidence of an upward turn in the economic
cycle and moderating inflation which supported real yields.
Furthermore, the 2017 Budget confirmed that consolidation
plans were ongoing despite the challenges of disappointing
revenue growth. However, some of the positive impact
from these earlier developments was eroded by the policy
uncertainty introduced by the reshuffle.
In contrast to both local bonds and the rand, South African
equities have tended to stagnate throughout the past year,
under-performing both global and emerging-market equity
indices. As of 3 April, the JSE Limited (JSE) All-Share Index
(Alsi) was 1.2% lower than on 1 October 2016, with a brief New
Year rally having proved short-lived. In part, the appreciation
of the rand has weighed on the equity market, in particular
Basis points
South Africa five-year CDS
J
M
M
J
S
N
J
M
M
J
S
N
J
M

South Africa credit default swap
Source: Bloomberg

Indices: 22 May 2013 = 100
EMBI+ spread and US corporate 10-year spread

US corporate 10-year spread

EMBI+ sovereign spread
Source: Bloomberg

Monetary Policy Review April 2017

shares of companies such as mining firms which generate
a large portion of profits overseas and which investors treat
as rand hedges. At the same time, investigations into alleged
colluding practices of banks in their foreign exchange trading
businesses have slightly depressed banking stocks.
Short term interest rates
Exchange rate developments have helped shape expectations
of future domestic policy rate movements. As of mid-March,
Bloomberg surveys of private sector economists indicated
interest rate cuts, with the average expectation for the repo
rate down by 25 basis points to 6.75% for the first quarter of
2018. Similarly, market indicators have until recently pointed to
lower rates. By mid-March forward rate agreements were fully
pricing in at least one repo rate reduction in 2018. Towards the
end of March, however, these measures moved back towards
no rate changes, in line with renewed rand depreciation, and
by early April had shifted to indicating approximately one more
repo rate increase within the next 12 months.
Significant risks threaten financial
market improvement
Both domestic and external risk factors could prompt a
correction in financial markets in coming quarters. In the US,
upside inflation surprises could force a faster pace of interest
rate hikes – especially if the new administration’s proposed
tax cuts provide a sizable boost to demand in an environment
of reduced slack. This could restore the link between Fed
tightening and weakness of riskier assets.
At the same time, overheating in segments of China’s economy
– especially the property market – may force authorities to
tighten policy more aggressively, with potentially negative
consequences for global market sentiment and commodity
prices. Finally, within European markets, elections in France and
Germany in 2017 may show a further rise in anti-EU sentiment.
While opinion polls currently do not point to the formation of
governments that support abandoning the euro, this risk could
at some point prove highly disruptive to the orderly functioning
of global financial markets.
On the domestic front, the biggest risk now stems from additional
rating downgrades, especially as S&P kept a negative outlook
on its sovereign ratings. While local currency ratings remain
investment grade at present, further downgrades (by one notch
from S&P and two notches from Moody’s) would see South
Africa excluded from the Citigroup World Government Bond
Index (WGBI).7 This would require some foreign investors to
sell their domestic bonds. Rising uncertainty about the future
direction of economic policy could prompt capital outflows in
anticipation of such downgrades. These outflows would, in
turn, raise borrowing costs and place the rand under renewed
downward pressure, potentially accelerating inflation.

Fitch ratings are not used for WGBI inclusion.
Indices: 1 September 2016 = 100
Sep
Oct

Nov
Dec

Jan
Feb
Mar
JSE All-Share, mining and banking indices

JSE Alsi

JSE Alsi (Banking)
Sources: Bloomberg and SARB

JSE Alsi (Mining)

Per cent

Repo rate expectations

Repo rate
Sources: Bloomberg and SARB

Bloomberg consensus forecast

Forward rate spread
Rand per US$
Forward rate spread and exchange rate of the rand

Rand against the US dollar (left-hand scale)

FRA spread (12*15 and 3*6)
Source: Bloomberg


Monetary Policy Review April 2017
Overview of the real economy
South African GDP growth has eased steadily over the past
five years. It is likely 2016 was the low point, with output
expanding just 0.3%, compared to 1.3% in 2015 and forecasts
of 1.2% in 2017, 1.7% in 2018 and 2.0% in 2019. The projected
improvement in growth over the medium term stems from a
mild recovery in investment as well as improved household
consumption, supported by smaller contributions from net
exports. Potential growth, the rate of expansion possible
without accelerating inflation, remains below 2.0% over the
medium term, well below historical averages.
Expenditure components* of real gross domestic product
Annual percentage change
Actual
Forecast
Components


Government consumption...

Percentage points contributions of expenditure components to growth in real
GDP are in italics
Sources: SARB and Stats SA
Low growth in context
Although recent fluctuations in South Africa’s growth rate have
stemmed from exogenous shocks, including drought, the
underlying trend remains very subdued. As noted in previous
MPRs, growth close to 1% compares unfavourably with longer
term South African growth averages of around 3%. It is also
distant from the National Development Plan aspiration of over 5%.
International comparisons provide another perspective on
South Africa’s weak growth. Although the pace of world
economic expansion slowed in the aftermath of the global
financial crisis, South Africa has decelerated more abruptly.
In the years preceding the crisis, South Africa ranked slightly
above the global median for growth. In both 2004 and 2005, for
instance, it was growing more rapidly than 54% of countries.
This ranking has slipped steadily after the crisis, with South
Africa falling into the bottom third of countries by 2014; in
2016 South Africa is projected to have outgrown just 15% of
countries. Global growth is anticipated to accelerate in 2017,
so South Africa’s own growth acceleration does not improve
its ranking.8

2016 and 2017 rankings are based on the SARB growth forecasts. The
IMF’s forecasts for South Africa are slightly lower.
Percentage points
Annual percentage change
2011 2012 2013 2014 2015 2016 2017 2018 2019
GDP and its expenditure contributors
Government consumption
Other
Household consumption
Sources: SARB and Stats SA
Net exports
Investment
GDP (left-hand scale)
Forecast
-3
-2
-1

-3
-2
-1

Percentage
South Africa percentage ranking and share of
countries growing faster/slower than SA
Share of countries growing faster than South Africa
Share of countries growing slower than South Africa
South Africa (percentage rank)
Sources: IMF, SARB and Stats SA

Forecast
Percentage change
Real GDP
Commodity countries
World
Sources: IMF, SARB and Stats SA

-2

South Africa
Monetary Policy Review April 2017

There are a range of factors underpinning South Africa’s postcrisis growth slowdown. Some are relatively deep-rooted,
such as household debt overhangs and declining commodity
prices. Others have intervened more unexpectedly, including
drought and shocks to confidence. The scale of South
Africa’s slowdown, both in absolute terms and relative to
other economies, demonstrates that these challenges have
been both severe and concentrated. It is also becoming
clearer, however, that the slowdown has helped effect a partial
rebalancing of the economy. In particular, fiscal consolidation,
household deleveraging and smaller current account deficits
provide a sounder foundation for future growth. Furthermore,
lower inflation will boost spending power and help moderate
long term borrowing costs.
The role of the primary sector
Extremely low growth in 2016 largely reflects underperformance
in the primary sector, with both agriculture and mining
contracting. Absent these shocks, growth in 2016 would
probably have been over 1%. In turn, a rebound in the primary
sector helps explain the growth acceleration anticipated for
2017. For agriculture, this is a result of rainfall normalising
following two years of drought across much of the country. The
agricultural sector (including forestry and fishing) is relatively
small – around 2% of the total economy – but it contracted
sharply in 2016, falling by 7.8%. Its recovery in 2017 is likely
to add around 0.3 percentage points directly to total growth
for the year. The mining sector is larger than the agricultural
sector, at around 7.0% of GDP. It shrank by 4.7% in 2016, but is
expected to rebound in 2017, growing more than 2%, supported
by inventory restocking and the uptick in commodity prices.
Its recovery should directly contribute about 0.2 percentage
points to annual growth.
Household consumption
Real household consumption growth has been mediocre
in historical perspective, averaging just over 1.0% for the
past three years, versus 3.4% on average since 1994. It has
nonetheless outpaced overall GDP growth in recent quarters
and is expected to do so again in 2017. This is mainly due
to ongoing real wage gains which are boosting disposable
income. Households will also benefit from declining inflation,
particularly for food and fuels. Furthermore, wealth effects
should become supportive later in the forecast period as asset
prices recover from a period of stagnation. By contrast, other
factors are constraining households. Tax increases announced
in the 2017 Budget will cut into disposable incomes.
Employment is projected to decline until the middle of 2019,
due to a difficult environment for job creation without sufficient
offsetting wage moderation. Finally, debt levels remain quite
high and households are expected to continue deleveraging.
The latest data indicate a slight downturn in debt service
costs, as a proportion of disposable income, reflecting stable
interest rates alongside declining debt burdens. Indeed, debt
Ratio
Ratio

Household debt and debt service costs

Household debt to disposable income (left-hand scale)

Debt service cost to disposable income
Source: SARB

Monetary Policy Review April 2017
stocks relative to incomes have now fallen to levels last seen
in early 2006. This development favours the long term financial
security of households and should, with time, support stronger
credit growth. Over the medium term, however, households
are unlikely to achieve debt or income levels adequate to drive
more rapid economic growth.
Household income levels
Annual percentage change
Actual
SARB forecast


Source: SARB
Investment
Investment was the worst performing component of GDP in
2016 – contracting by 3.9% over the year – and is forecast to lag
again in 2017, growing by just 0.2%. It is expected to rebound
in 2018 and 2019, becoming the fastest growing portion of
the economy.
The ongoing investment slump has two components. The first
is weak private sector investment. This is broadly explained
by a collapse in business confidence, which has been
subdued throughout the post crisis period but deteriorated
especially markedly in recent years. During this period, the
electricity constraint became binding with the advent of load
shedding. Business sentiment was further undermined by the
persistent threat of a sovereign credit ratings downgrade to
below investment grade, threatening both higher long term
borrowing costs and the reputational burden of ‘junk status’.
Finally, confidence suffered from acute political shocks, also
visible in indicators such as credit default swaps and surveybased indicators of policy uncertainty. The forecast implies a
recovery in confidence which strengthens private investment,
generating growth of 1.1% in 2018 and 1.4% in 2019. But that
recovery is far from assured.
The second component of the recent investment slump is an
unexpected contraction in public-sector investment. This was
mainly driven by state-owned companies (SOCs) (of which
Eskom and Transnet account for about 80%) which continue
to underspend and delay investment plans. For instance, in
2015/16 SOCs spent R20.9 billion less than what was expected
at the time of the 2015 Budget. However, the most recent
estimates indicate that there will be a return to growth in SOC
investment spending in nominal terms. Unfortunately, a portion
of higher spending will not translate into real gains given cost
overruns in a variety of projects. SOC spending is expected to
be slower over the forecast period, relative to recent years, as
corporations are at or near the end of major projects (such as
the Medupi and Kusile power plants).
Percentage change over four quarters
Index
Forecast
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Business confidence and real fixed investment
(private business)

RMB/BER Business Confidence Index (left-hand scale)

Real fixed investment by private business
Sources: RMB/BER and SARB


Percentage of GDP

2012 2014

Fixed investment

General government

Private business
Source: SARB

Public corporations

Total

Percentage change

2012 2014

Fixed investment growth

General government

Private business
Source: SARB

Public corporations

Total
-25
-15
-5

Monetary Policy Review April 2017

General government also contributed to the weakness of
public investment, registering slightly positive growth in 2016,
well below previous levels. This appears to reflect one-off
factors, including a base effect from 2015. It is not simply
explained by fiscal consolidation because investment budgets
have been protected (although at lower levels of government,
funds may nonetheless have been diverted into consumption).
General government investment is expected to pick up in 2017
and 2018, leading the overall recovery in public investment.
Investment (March 2017 forecast)
Percentage of GDP
Actual
SARB forecast


Private business enterprises....

Source: SARB
Government consumption and
fiscal dynamics
Perhaps unexpectedly, government consumption expenditure
was the fastest growing component of GDP in 2016, expanding
by 2.0%, up from just 0.5% in 2015. However, this uptick is
mostly explained by hiring for the 2016 local government
elections, and will therefore not be sustained. Accordingly,
government consumption is projected to moderate over
the forecast period, growing at a stable 1.0% between 2017
and 2019.
These growth rates are lower than they were in the early postcrisis years, owing to the fiscal consolidation programme
required to rein in public debt growth. They nonetheless entail
small positive contributions to overall GDP growth across the
forecast horizon, given that government spending continues to
rise in real terms. The implication is that fiscal policy remains
relatively supportive of demand. As a result, the main budget
deficit is expected to narrow slightly over the medium term
and a primary surplus is now only expected in 2018/19, one
year later than planned in the 2016 Budget. The debt peak is
now anticipated at nearly 53% of GDP in 2018/19 – versus,
for instance, the 2016 Budget forecast of 51% in 2017/18.
Estimates of the structural budget balance, which excludes
cyclical fluctuations in tax revenue and expenditure, suggest
the structural deficit is around 3% of GDP.
Percentage of GDP
2014/15 2015/16 2016/17 2017/18 2018/19 2019/20
Gross debt

MTBPS 2015

MTBPS 2016

Source: National Treasury

Budget 2016

Budget 2017

Forecast
Indices: 2010 = 100

South African terms of trade

November 2016 MPC
Source: SARB

March 2017 MPC

Percentage of GDP
Government balances

Main primary balance – 2017 Budget

Main primary balance – 2016 Budget

Main budget balance – 2017 Budget

Main budget balance – 2016 Budget
Source: National Treasury


Monetary Policy Review April 2017
Net exports and the balance
of payments
Net exports are expected to subtract from growth in 2017,
following a relatively strong 2016 performance. They recover
in 2018 and 2019, contributing approximately 0.3 percentage
points to growth in each year. Exports are likely to benefit
from stronger world growth as well as favourable commodity
prices. However, these factors are offset in the forecast by a
less depreciated outlook for the exchange rate, which limits
competitiveness, as well as higher imports from increased
investment (a category which tends to be import-intensive).
Current account* (March 2017 forecast)
Percentage of GDP
Actual
SARB forecast


Income and transfers

* September 2016 MPC forecasts in italics
Source: SARB
The balance on the current account was previously anticipated
to reach its narrowest point in the cycle during 2016. However,
current account narrowing is now projected to continue
into 2017, with the deficit reaching -3.2% of GDP this year.
Thereafter the deficit widens somewhat to -3.9% in 2018 and
-4.0% in 2019.
The improvement in the current account outlook is premised on
more favourable terms of trade, with the peak occurring in the
first quarter of this year. Prices for base metals and coal have
been very buoyant lately, but these gains are not expected to
persist over the forecast period as longer term fundamentals
start to outweigh the short term momentum in prices. By
contrast, precious metals are expected to trend modestly higher
as investors seek safe haven assets to hedge against policy
uncertainty and rising global inflation. Meanwhile, oil prices are
likely to be roughly stable at current levels. As a result, South
Africa’s terms of trade are expected to reach their highest level
in six years – and their second highest level on record – early in
2017, before trending moderately lower in 2018 and 2019.
In comparative perspective, it is unusual for a country to be
running a current account deficit of 3–4% of GDP with growth
under 1%. In South Africa, this is not simply a problem of
imports staying too high and exports too low. Rather, the
trade balance of the current account has adjusted significantly,
from around -2% of GDP in 2013 to 0.1% in 2016. Instead,
the persistent deficit on the current account is a consequence
US$ per ounce

Precious metals prices

Platinum
Sources: Bloomberg and SARB

Gold


Forecast
US$ per metric tonne

Industrial commodity prices

Coal
Sources: Bloomberg and SARB

Iron ore

Forecast
Percentage points
Percentage of GDP

Foreign debt of South Africa

Rand denominated debt

Total foreign debt (left-hand scale)
Source: SARB

Foreign-currency denominated debt

Monetary Policy Review April 2017

of the service, income and current transfers account, which
typically registers deficits in excess of 3% of GDP. (The average
since 2011 is -3.7% of GDP, with a standard deviation of
0.4 percentage points.) Although the services component of this
account has come into balance – roughly in line with the trade
account – current transfers have remained between -0.5% and
-1.0% of GDP, mostly due to Southern African Customs Union
(SACU) transfers. Furthermore, net interest payments under
the income account have been rising, reflecting the growth in
South Africa’s total foreign debt to around 40% of GDP, and
now stand at around 1.4% of GDP. The forecast anticipates
that the income and transfer payments deficit will persist
across the medium term at a little more than 3% of GDP. As
usual, the scale of the current account deficit therefore chiefly
reflects this component, even as swings in the trade account
explain most of the variations in the overall current account.
Potential growth and the output gap
Since the previous MPR, published in October 2016, potential
growth and the output gap appear to have been broadly
stable. There have been minor downward revisions of short
term potential, to a low of 1.3% for 2016, but the estimate for
2018 remains 1.5%. The output gap continues to be negative,
with most of the accumulated shortfall between potential and
actual output coming from late 2015 and 2016. The gap is
expected to widen slightly in 2017, given growth of 1.2% versus
potential of 1.4%. It then begins to narrow gradually over the
following two years, and is almost closed by the end of 2019.
Output gaps are unobservable. This makes them difficult
to quantify, and their interpretation is a perennial source of
controversy. At present, there is little or no evidence that the
economy is overheating. Manufacturing capacity utilisation is
close to historical averages. Credit growth is subdued, with
lending to households declining in real terms. Furthermore,
it is unlikely that potential growth will be revised much lower,
below even the growth rate of the population. Nonetheless,
the output gap may be overstated. To the extent that it reflects
primary sector weakness – recall that the current output gap
is almost entirely a legacy of the past year and a half, in which
the primary sector underperformed – it may be a poor guide
for monetary policy. (Because output in the primary sector is
strongly affected by sector specific factors, such as rainfall,
some central banks exclude it from their output gap estimates.9)
Furthermore, the output gap has been consistently wrong in
real time, with estimates changing after the fact by as much
as 4% of potential GDP. In recognition of this problem, the
SARB’s output gap estimates are reported with error bands
to convey uncertainty. Research to refine these estimates is
also ongoing.

See for instance Central Bank of Chile, 2015. ‘Potential GDP, the output
gap and inflation’, Monetary Policy Report p. 35.
Percentage of GDP
Percentage points

2006 2008

Services, income and transfer account components

Transfers

Other income

Dividends
Source: SARB

Services

Interest

SIT account (left-hand scale)


Percentage of production capacity

98 2000

08 2010 12

Manufacturing production capacity utilisation

Downward phase of the business
Sources: SARB and Stats SA

Utilisation of production capacity of total goods

Long-term average (1971-2016)

Percentage change

2009 2011

Real GDP, potential GDP and population growth

Population

Potential GDP
Sources: SARB and Stats SA
Forecast
-2
-1

Real GDP

Monetary Policy Review April 2017
Conclusion
Over the forecast period, which stretches to 2019, growth
is expected to improve slightly from 2016 lows. The largest
portion of this growth comes from household consumption,
with investment and net exports making positive contributions
in 2018 and 2019. Government consumption is projected to
grow marginally in all three forecast years, fiscal consolidation
notwithstanding. The economy’s fundamentals are becoming
less unstable, which helps explain why growth is accelerating
again. Growth is nonetheless weak by almost any standard.
Headline CPI inflation (per cent)
The output gap and inflation

Sources: SARB and Stats SA
-3
-2
-1

5 3

Output gap (percentage of potential GDP)
Trendline
Pass-through to inflation
The output gap and pass-through to inflation

Non-linear
Source: SARB

Linear
-4
-2


Box 1 An asymmetric Phillips Curve?

Fedderke, J and Liu, Y. 2016. ‘Inflation in South Africa: an assessment of
alternative inflation models’. SARB Working Paper 16(5).

Kabundi, A, Schaling, E and Some, M. 2016. ‘Estimating a time-varying
Phillips Curve for South Africa’. SARB Working Paper 16(5).
The Phillips Curve describes the relationship between inflation and
some measure of economic slack (originally unemployment, but often
the output gap). It is both one of the most foundational and most
contentious concepts in modern economics. In its Keynesian heyday,
it was interpreted as a trade-off. Policymakers were advised to
choose their preferred mix of the two variables, with more inflation
providing less unemployment and vice versa. The stagflationary
experiences of the 1970s, however, showed that rising inflation and
rising unemployment could go together. Meanwhile, the theoretical
underpinnings of the Phillips Curve were weakened by new arguments
that the trade-off should be temporary and unstable. Over time, price
and wage setters would incorporate expectations of rising inflation in
their demands. Prices would then rise with no change in output.
The literature on the South African Phillips Curve is simultaneously
extensive and inconclusive. Fedderke and Liu (2016) point out that for
all the interest in the subject, the relationship is hard to identify
empirically.1 There are also better predictors of inflation than the
output gap, especially wages. However, the relationship must exist in
some form if interest rate changes are to raise or lower demand and
therefore affect inflation. The problem is describing the relationship
accurately. Kabundi, Schaling and Some (2016) have provided one
important contribution by showing that the Phillips Curve in South
Africa is time-varying.2 The relationship was quite weak in the 1990s,
stronger in the 2000s, and weaker again after the global financial
crisis. More recent work provides a complementary insight:
the Phillips Curve in South Africa may be non-linear, with a much
stronger relationship when the economy is overheating than when it is
underperforming.
This asymmetric Philips Curve emerges from inflation data which have
been econometrically corrected for supply shocks (which would affect
prices independent of demand). Inflation responds strongly when the
output gap is positive, but less so when demand is weak and the
output gap is negative.
Monetary Policy Review April 2017

Percentage points
Per cent
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Direct impact of output gap on inflation based on
Phillips Curve specification

Non-linear
Sources: SARB and Stats SA

Linear

Headline CPI inflation


By ignoring this distinction, forecasts will tend to under-predict
inflation when the economy is operating above potential. Where
demand is already weak, forecasts will also underestimate the
policy adjustments required to reduce inflation. This last point
presents a difficult policy problem, because it implies a worse
disinflation/output trade-off. In such circumstances, policymakers
may prefer to rely more heavily on other transmission mechanisms,
especially communication, to achieve their inflation targets.
This does, however, require that policymakers have credibility,
meaning they should be seen as willing and able to meet their
targets over time.

Monetary Policy Review April 2017
Inflation developments
and outlook
Headline inflation is currently outside the 3-6% target range,
but is expected to moderate to 5.4% in 2018 and 5.5% in 2019.
Food and oil price shocks provided the nudge to inflation
which pushed it over 6%. Underlying inflation, however, has
been elevated, meaning even relatively small shocks would
have been sufficient to push inflation above the target range.
Core inflation is expected to decline from its peak in December
2016, benefitting from the more appreciated level of the
exchange rate. Services inflation nonetheless remains sticky
around 6%, in line with inflation expectations, which prevents
core from falling more markedly and keeps headline inflation in
the upper portion of the target range.
Food prices
Food and non-alcoholic beverages (NAB) inflation averaged
10.6% in 2016, versus a post-crisis average of 6.8%, contributing
1.6 percentage points to headline inflation. The peak came in
the final quarter of 2016, with prices rising 11.7% (slightly below
the 12.3% forecast published in the October 2016 MPR). Food
and NAB inflation is expected to average 7.4% this year, adding
1.3 percentage points to headline inflation (although this would
have been 1.1 percentage points with the previous consumer
price index weights), followed by 5.2% in 2018 and 5.5%
in 2019.
Weather conditions have improved across much of the
country. February was an exceptional rainfall month, with
South African dams regaining two years of losses in just a few
weeks. Early indications from government’s Crop Estimates
Committee suggests that the maize harvest will be 14.3 million
tons in 2017, back near the record levels achieved in 2014
and about double the 2016 harvest. The significant gap that
opened up between white and yellow maize prices from early
2015 has disappeared. Maize spot and futures prices have
both declined, with futures prices below current spot prices
and only rising again from later in the year. Wheat production
is also responding positively, rising to a five-year high. Lower
grain prices will benefit the bread and cereals component of
food and NAB inflation. Combined with the high base created
in 2016, inflation in this category will likely moderate to 1.1%
by the final quarter of 2017, before picking up to 4.8% in 2018.
While the large contributors to 2016 food inflation (fruit and
vegetables, and bread and cereals) moderate throughout 2017,
these disinflationary effects will be partially offset by a continued
rise in meat price inflation. Forecasts for this category have
shifted higher and later. The peak is now expected at 11.4%,
versus 9.1% in the October MPR, and is likely to be reached in
the third quarter rather than at the start of 2017.
Percentage change over 12 months (both scales)

Selected agricultural and producer prices
-10

-70

White maize

Yellow maize

Wheat

Agricultural producer prices (left-hand scale)
Sources: SAFEX, SARB and Stats SA

White maize futures

Yellow maize futures

Wheat futures

Forecast
Percentage points
Percentage change over 12 months

Meat inflation and its drivers

Dried, salted or smoked

Beef

Meat (left-hand scale)
Sources: SARB and Stats SA

Pork

Lamb

Poultry
-5

-5

Monetary Policy Review April 2017

Consumer food price inflation
Percentage change over 12 months, previous weights and September 2016 forecast in italics
Actual
Forecast
Actual
SARB forecast
Weight
2003-16

2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
Food and non-alcoholic
beverages................................. 17.24

Sources: SARB and Stats SA
Herd rebuilding has been singled out as a key driver of rising
meat prices, and beef inflation is indeed likely to sustain
meat price inflation over the forecast period. In the near term,
however, poultry sector dynamics have also become important.
Poultry inflation was unusually low for most of 2016, chiefly
due to competition from imports. Yet it began to accelerate
late in the year, reaching 12.4% in February 2017, from 1.7% in
September 2016. There are two factors underlying this shift. The
first is an outbreak of avian influenza in Europe, which has cut
off supply from seven of the 10 countries which export poultry
products to South Africa. The second and more significant is
changes to brining regulations imposed by the Department of
Agriculture, Forestry and Fisheries in October 2016. The new
rules reduce the amount of salt water that may be injected into
frozen chicken. Although this could be interpreted as a quality
improvement rather than a price increase, it is nonetheless
measured as inflation in the CPI.10
World food prices, denominated in US dollars, have begun to
rise again following an extended period of deflation. The change
in trend is broad-based, with positive price changes in all five
of the broad food categories. In part, this reversal is explained
by higher oil prices which have raised producer input costs.
Sector-specific conditions are also contributing; for instance, the
world’s largest exporter of sugar, Brazil, has experienced poor
crops. Although world food price projections have been marked
up in the latest forecast, price pressures are expected to remain
quite weak given substantial inventories of staple commodities,
including many grains, as well as relatively low input costs.
10 Under the new regulations, a given portion of chicken will contain less
saltwater but may also cost more per gram. The change in the price of the
portion is treated as inflation, although strictly speaking the consumer is
getting more chicken.
US$ per barrel

Evolution of Brent crude oil price forecasts

Actual

March 2016

March 2017
Sources: Bloomberg and SARB

May 2015

September 2016

Monetary Policy Review April 2017
Box 2 Reweighting and rebasing the consumer price
index – implications for the forecast

The intuition here is that when an item with an index value of 200
increases by 5%, that lifts the index 10 points to 210. The same
5% increase for an item with an index value of 100 adds just 5 points.
Assuming both items have an equal weight in the CPI, the first item
will have twice the impact on headline, compared to the second, in
calculating the final inflation outcome. Yet both inflated by the same
5%. Periodic rebasing keeps such distortions small.
Statistics South Africa (Stats SA) has recently completed a routine
reweighting and rebasing of the consumer price index (CPI). This box
describes how these adjustments are likely to affect headline inflation.
To quantify the direction and magnitude of the changes, the revised
weights and bases were applied to an earlier forecast. The results
suggest that there is a small net downward shift in overall CPI of
roughly 0.1 percentage points for both 2017 and 2018. The 2017
changes are mostly explained by reweighting (particularly the lower
weights of electricity and petrol). By contrast, the 2018 effects are
almost entirely due to rebasing.
Reweighting means aligning the CPI basket with the latest consumer
expenditure patterns (in this case, based on data from the 2014/15
Living Conditions Survey). This entails adjusting the shares of existing
items as well as updating product coverage. For instance, in this latest
update, stamps and DVDs were removed from the index, while instant
noodles were added.
Rebasing means adjusting all the indices in the CPI basket to a new
base period, in this case making December 2016 equal to 100. This
is required because different sub-indices increase at a faster (or
slower) pace than the overall index. As a result, some sub-indices
might end up contributing more to headline inflation than would be
justified by their respective weights.1 These distortions can be
controlled by periodic rebasing to a single starting point.
Administered price inflation is lower given changes to electricity and
fuel. Electricity inflation continues to be relatively high, but whereas
between 2008 and 2012 this increased the share of electricity in
household expenditure, consumers have now cut back. As a result,
electricity’s share has fallen to 3.75%, versus 4.13% in 2012 and
1.68% in 2008. The forecast is also slightly lowered by a smaller
weight for fuel, which has fallen from 5.68% in 2012 to 4.58% in 2016.
Food inflation is raising the forecast, given a larger weight for food as a
whole (from 15.4% of the basket to 17.2%) as well as changing weights
within the food category. Meat, which was already experiencing
relatively high inflation, now has a larger weight (up by 0.9 percentage
points, from 4.6% of the total 2012 basket to 5.5% of the 2016 basket).
By contrast, bread and cereals, which have been disinflating, now have
a smaller weight (falling from 3.6% to 3.2% of the total).
The weight of services in the basket is 1.2 percentage points higher.
Both housing services and recreation and culture have been revised
up, by 0.66 and 1.07 percentage points respectively. By contrast,
weights have been reduced for major services categories like medical
health insurance (-0.38%), education (-0.42%), and restaurants and
hotels (-0.41%). The reweighting effects on the inflation trajectory are
slightly positive, but these are overwhelmed by rebasing effects.
The net result is that underlying inflation is lower by 0.13 and
0.15 percentage points in 2017 and 2018 respectively.
Percentage points
Percentage change over 12 months

Food inflation

New base

Food (December 2012 = 100) (left-hand scale)

Food (new weights, December 2016 = 100) (left-hand scale)
Sources: SARB and Stats SA

New weights


Percentage points
Percentage change over 12 months

Headline consumer inflation

New base

Headline (December 2012 = 100) (left-hand scale)

Headline (new weights, December 2016 = 100) (left-hand scale)
Sources: SARB and Stats SA

New weights

Percentage points
Percentage change over 12 months

Core inflation inflation

New base

Underlying (December 2012 = 100) (left-hand scale)

Underlying (new weights, December 2016 = 100) (left-hand scale)
Sources: SARB and Stats SA

New weights

Monetary Policy Review April 2017

Fuel prices
Brent crude oil climbed to US$57 per barrel in January,
escaping the US$30 to US$50 range in which it had
traded since August 2015. This shift was triggered by the
announcement of production cuts by the Organization of the
Petroleum Exporting Countries (OPEC) as well as some nonOPEC countries, including Russia. The decision to reduce
output marked a change of strategy by traditional producers,
which had previously sought to defend market share by
maintaining supply and using low prices to squeeze out
marginal producers. Yet new rivals, chiefly shale producers
in North America, proved unexpectedly resilient, prompting
OPEC countries to re-assess.
Although production cuts were effective in pushing prices
close to US$60 per barrel, they have since subsided to nearer
US$50. There is a plausible case they will stay quite low. OPEC
production cuts have typically not been implemented in full
over time, as there are strong incentives to free-ride on others’
efforts and enforcement mechanisms are relatively weak.
Furthermore, North American producers have increased
production in response to higher prices, limiting the overall
reduction in supply. The oil price assumption used in the
forecast is US$60 for 2017 and US$62 for 2018, but the lower
level of prevailing prices suggests a risk this may be too high.
The change in local petrol prices has been greater than the gains
in world oil prices, owing to increases in the various domestic
cost factors that make up slightly more than half of the final
petrol price, as well as international refinery margins and other
costs such as freight and insurance. The total fuel price change
in the forecast is 127 cents per litre between September 2016
and April 2017. Of this, just 27 cents reflects the international
oil price portion of the local price. The balance is split roughly
60:40 between domestic taxes and margins (mainly for higher
fuel and road accident fund levies) and international refinery
margins and other costs. Over the forecast period, fuel price
inflation is projected at 7.8%, 6.9% and 6.0% in 2017, 2018 and
2019 respectively.
Electricity prices
Although the multi-year pricing agreements are intended to
make electricity prices more predictable, they remain complex
and difficult to forecast. The National Energy Regulator of
South Africa has approved Eskom tariff increases of 2.2%
for the financial year 2017/18. This number is unusually low
given the Regulatory Clearing Account (RCA) adjustment,
which compensates for excess payments to Eskom in
2016/17; without this RCA adjustment, tariff increases would
be 8%. The regulator has given Eskom permission to apply
for a higher increase should the approved 2.2% threaten its
financial sustainability, and it is possible that a higher figure will
be granted, especially given that the Year 2 and Year 3 RCA
applications by Eskom have not yet been processed. Given
the uncertainties around Eskom’s tariff increase, the SARB still
Million barrels per day

US and world oil production changes from 2012 to 2018*

World
* Includes crude oil, shale oil, oil sands and natural gas liquids, but
excludes biofuels and ethanol
Sources: BP, Energy Information Administration and SARB

United States

Forecast
Rand per litre
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Fuel price inflation

Petrol price
Sources: Department of Energy

Diesel price

Cent per kilowatt-hour
Gigawatt hours

Electricity consumption and prices

Electricity consumption (left-hand scale)

Electricity price
Sources: Eskom and Stats SA

Monetary Policy Review April 2017
assumes CPI electricity inflation of 7.7% for 2017 and 8% for
both 2018 and 2019. Even if the 2.2% increase goes ahead,
however, final prices faced by consumers are likely to rise by
a larger magnitude – perhaps closer to 5% – due to municipal
pricing decisions.
Core inflation
Core inflation is anticipated to trend downwards from its
December 2016 high of 5.9%, averaging 5.4% in 2017, 5.2%
in 2018 and 5.3% in 2019. This slight moderation in core is
due to lower inflation in the core goods component, which is
projected to benefit from rand appreciation. Vehicle inflation,
for instance, is expected to fall from 7.6% in 2016 to just 3.8% in
2018, with its overall contribution to headline inflation forecast
to drop from 0.5 percentage points in 2016 to 0.2 percentage
points in 2018. Core nonetheless remains relatively elevated
due to sticky services inflation, which is unlikely to depart from
the upper end of the inflation target range.
The outlook for core inflation is broadly unchanged from
the October 2016 MPR, recording an improvement of just
0.1 percentage points for each of the first two forecast years.
The stability of the core forecast, despite continued exchange
rate appreciation, is explained by offsetting increases in other
factors, particularly medical insurance and rentals and owners’
equivalent rent.
Targeted inflation (March 2017 forecast)
Percentage change over 12 months, previous weights and September 2016 forecasts in italics
Actual
Forecast
Actual
SARB forecast
Weight
2003-16

2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
Targeted inflation....................... 100.00

Core inflation*............................ 74.43

Insurance................................. 10.06

* CPI excluding food, non-alcoholic beverages, fuel and electricity
Sources: SARB and Stats SA
Forecast
Percentage change over 12 months

Core inflation and its components

Services
Sources: SARB and Stats SA

Total core

Core goods

Monetary Policy Review April 2017

Although service price inflation has been stable close to 6%, in
line with inflation expectations and the upper end of the target
range, key service sub-categories have experienced inflation
well above this level for an extended period of time. In particular,
inflation in the insurance and education categories has
averaged 7% and 8.4% respectively between 2003 and 2016,
compared to average headline inflation of 5.9%. Education
inflation was briefly lower in 2016 following the decision to
temporarily freeze tertiary tuition fees, but renewed increases
will shift it back towards 8% by March 2017 and it is likely to
stay close to these levels over the rest of the forecast period.
Insurance inflation is expected to remain similarly elevated.
Employment, remuneration
and unit labour costs
Wages and salaries are a continued source of inflationary
pressure in South Africa. Increases in remuneration tend to
be generous, at least for the upper deciles of income earners
whose compensation accounts for the major portion of the total
South African wage bill. This is due to the structure of labour
market institutions as well as skills shortages, both of which
bolster the negotiating power of this segment of the workforce.
To some extent, the resulting price pressure is contained by
off-setting factors: productivity growth, labour shedding and
profit compression. Yet some portion also feeds into inflation.
In the context of weakening growth and rising unemployment,
real wage growth might have been expected to stagnate.
Nonetheless, the available data show continued real gains
from 2011 onwards. The Andrew Levy wage settlement rate
and the mean growth rate of wages and salaries in South
Africa, derived from the Quarterly Employment Survey, have
both remained elevated, averaging close to 8% over this
period. After deducting average labour productivity growth of
1.2%, unit labour cost (ULC) growth has been 6.8%, above the
upper bound of the inflation target.
ULC growth likely reached its post-crisis peak in 2016 at 7.5%,
mainly due to the productivity loss implicit in very weak output
growth. Over the forecast period, ULC growth is projected to
moderate to 5.7% by 2018, its lowest level in over a decade,
with average salaries growing at 8.1% and productivity growth
at 2.1%. The deceleration in ULCs is premised on improved
GDP outcomes and – much less desirably – job losses.
Without these developments, ULC growth could surprise on
the upside, lifting core inflation.11
Exchange rates
In a small open economy like South Africa, import prices are
another key driver of inflation. One aspect of these prices is
international wholesale prices; the other crucial determinant is
the exchange rate. Over the past year, the rand has benefitted
the inflation forecast. It has recovered from a weak position in
in January 2016, and by March 2017 was back at mid-2013
11 This discussion refers to the ULC measure used in the forecast, which
differs from that published in the Quarterly Bulletin. The forecast uses
economy-wide remuneration, whereas the Quarterly Bulletin measure
covers only the formal, non-agricultural sector.
Percentage change over 12 months

Vehicle prices at producer and consumer level

Vehicle PPI inflation
Sources: SARB and Stats SA
-5

Vehicle CPI inflation
Forecast
Annual percentage change
Percentage points
Unit labour cost and its components

Productivity (left-hand scale)

Average salaries (left-hand scale)

Andrew Levy average salaries
Sources: Andrew Levy Employment Publications and SARB

Unit labour cost

Real wages
Forecast
-5

-5

Monetary Policy Review April 2017
levels against the euro and sterling, and at mid-2015 levels
against the US dollar. This rand recovery reflected several
complementary factors, including improved macroeconomic
fundamentals in South Africa, diminished political uncertainty
and reduced global risk aversion. The appreciation trend
has at times been interrupted by shocks, including the Brexit
referendum and the US elections. In each of these episodes,
however, the rand has subsequently rebounded, returning to
its appreciation trend.
The outlook for the exchange rate remains uncertain. The rand
could appreciate further, supported perhaps by commodity
prices and better domestic growth and confidence. Yet it
might well weaken again, given several domestic or foreign
factors. On balance, the risk to the exchange rate is that it will
depreciate in the near term in response to increased political
uncertainty, potentially accelerating inflation.
The exchange rate assumption used in the forecast is
predicated on a simple convention: the real exchange rate is
held constant at around the starting point shortly preceding
the MPC meeting – allowing sufficient time for the modelling
team to prepare the forecast – with the nominal exchange rate
then adjusting across the forecast horizon in line with inflation
differentials. This practice has in recent meetings tended to
make the exchange rate used in the forecast somewhat weaker
than the one prevailing at the time of the policy decision. It
has also left the exchange rate in each subsequent meeting
somewhat more favourable than the one used before. The
fact that this has not produced larger variations between the
different forecasts points to offsetting factors, but also the
fact that pass-through to inflation remains quite low. Applying
an exchange rate shock to the latest version of the core
econometric model yields a response of only about 0.15 in the
peak quarter. Furthermore, historically, pass-through has been
weaker in appreciation phases than during depreciations.12
Inflation expectations
In a flexible inflation targeting framework, inflation is permitted
to depart temporarily from target in the event of shocks.
Inflation expectations help policymakers judge whether such
shocks will in fact prove temporary. If inflation expectations are
well anchored in the right place, shocks should pass out of
the year-on-year comparisons after 12 months and inflation
will revert to target. However, if medium term expectations
change in line with current inflation, or if they are anchored
at an inappropriate level, then wages and prices are likley to
respond and inflation will not return to its desired rate without
some form of monetary policy response.
There are several available measures of inflation expectations
in South Africa. One of the most frequently consulted is the
Bureau for Economic Research’s (BER) survey, which collects
the views of union leaders, business people and financial
12 Karoro, T D, Aziakpono, M J and Cattaneo, N. 2009. ‘Exchange rate
pass-through to import prices in South Africa: Is there asymmetry?’ South
African Journal of Economics, 77(3): 380-398.
Forecast
Percentage points
Percentage change over four quarters
2011 2012 2013 2014

2017 2018 2019
Contribution to headline inflation

Import price contribution

Output gap contribution

Unit labour cost contribution

Headline CPI (left-hand scale)
-2
-1

-2
-1

Sources: SARB and Stats SA
Indices: 2010 = 100

Evolution of the real effective exchange rate assumptions

July 2016

November 2016

March 2017
Source: SARB

September 2016

January 2017

Actual
Stronger rand = higher

Per cent

2016 2017
Survey-based inflation expectations*

Current year

Two years ahead

Inflation target range
* Total, combining expectations of labour, business and analysts
Source: BER

One year ahead

Five years ahead

Monetary Policy Review April 2017

analysts. According to this survey, aggregate expectations for
one, two and five years ahead are clustered around the top of
the target range, varying between 5.7% and 6.2%. The analyst
component of the survey shows expectations somewhat lower
in the medium term, at 5.4% and 5.5% in 2018 and 2019, which
is in line with the SARB forecast. (These expectations are also
echoed in the Reuter’s survey of analysts, for which many of
the contributors are the same.) Arguably, the expectations of
business people in the BER survey are the best available guide
to price-setting behaviour. These expectations are higher and
have also been more stable than those of analysts; they are
currently at 6.4% and 6.3% for 2018 and 2019.
Break-even inflation rates, a market based measure of inflation
expectations, have improved from levels approaching 8% in
early January 2016, trending back towards 6%. Break-even
rates cannot be strictly compared to inflation surveys as
they also price in risks of inflation surprises (an inflation risk
premium). Furthermore, they are also sensitive to market
idiosyncrasies affecting the underlying instruments from which
break-even rates are calculated. Nonetheless, they reflect
inflation expectations for long time periods, five to ten years,
over which shocks should be expected to even out. The fact
that break-evens remain close to or above the target therefore
suggests the same interpretation attached to the BER survey:
that expectations are sticky close to, or above, the top end of
the 3–6% target range.
Conclusion
Headline inflation is falling back below 6% following an
extended breach of the inflation target. The forecast indicates
it will remain within the upper portion of the target range across
the medium term. The decline in inflation reflects stabilising
food and petrol prices as well as currency appreciation.
Yet the persistence of inflation above global and emerging
market averages speaks to wage and price rigidities, which
are fed by elevated inflation expectations. While the stability
of expectations has been reassuring in the context of abovetarget inflation, it would be preferable for expectations to be
anchored more centrally within the inflation target range.
Per cent

2016 2017
Survey-based inflation expectations of business

Current year

Two years ahead

Inflation target range
Source: BER

One year ahead

Five years ahead

Per cent

Break-even inflation rates

Five year
Source: Bloomberg

Ten year


Monetary Policy Review April 2017
Box 3 Comparing the accuracy of CPI forecasts

Currently between 12 and 14 institutions and economists participate on a regular basis in supplying Reuters with quarterly economic
forecasts of consumer price inflation. Reuters forecast contributors change over time in terms of who participates and how often they do
so. It is important therefore to discard those forecasters that do not have a significant track record (taken as less than 30 forecasts over the
periods chosen) or contribute sporadically.

The average forecast error (AFE) and the root mean square error (RMSE) are used to evaluate the forecasts. The AFE measures projection
bias in terms of systematic over- or underestimation. The RMSE is a measure of the standard deviation or magnitude of the errors.

The average value of the RMSEs has decreased by a significant factor – from 3.2% points during the first period to 0.7% points during
the second period.
Economic forecasts are critical inputs into the monetary policymaking process. To test the quality of forecasts and to build credibility, the
best practice among central banks is to conduct routine accuracy assessments and publish the results. Accordingly, previous Monetary
Policy Reviews have contained boxes on the growth and headline inflation forecasts (e.g. in April 2016) the core forecast (October 2016)
as well as the fan charts (June 2015).
The usual standard for evaluating the forecasts is to compare them with observed outcomes. An alternative would be to contrast performance
with that of other institutions. This is helpful as a yardstick for success: even forecasts which proved close to outcomes and were not biased
in a particular direction would need improving if rival forecasts performed better. Furthermore, a large forecasting error is less embarrassing if
it is shared by other forecasters. For instance, it was wrong but not unreasonable for 2013 forecasts to miss the collapse in the world oil price
and therefore overstate headline inflation.
In this box, the South African Reserve Bank (SARB) forecasts are compared with those provided by other organisations to Reuters.1 These
forecasts are divided into two periods, one up to and including the crisis (2003Q3 to 2009Q4) and the other post-crisis (2010Q1 to
2016Q4). The accuracy tests consider both the size and bias of projection errors.2
The error statistics reveal that the SARB is most accurate over all forecast horizons for the pre-crisis period, but all forecasters are less
accurate in this period compared to the next because of the large shock to inflation during 2007 and 2008. In period 2, although all the
forecasts improve, the SARB’s ranking worsens somewhat.3 In particular, the SARB’s forecast six quarters ahead slips to 10th place out
of 14, whereas in all other cases the SARB forecast ranks either first or second. The size of the error remains quite small, however.
RMSE 1 quarter ahead
Size of forecast errors
* Size of worst RMSE 6 quarters ahead in Period 1 = 5.7
Sources: Reuters and SARB

SARB core model

Reuters mean

RMSE 4 quarters ahead
Period 1
SARB core model

Reuters mean

RMSE 6 quarters ahead
SARB core model

Reuters mean

11*

RMSE 1 quarter ahead

SARB core model

Reuters mean

RMSE 4 quarters ahead
Period 2

SARB core model

Reuters mean

RMSE 6 quarters ahead

Reuters mean

SARB core model

*
Monetary Policy Review April 2017

AFE 1 quarter ahead
Forecast error bias
* Size of worst AFEs 6 quarters ahead in Period 1 = -2.1 and -4.0
Sources: Reuters and SARB
-2
-1

SARB core model

Reuters mean

AFE 4 quarters ahead
Period 1
-2
-1

SARB core model
Reuters mean

AFE 6 quarters ahead
-2
-1

11*
12*

SARB core model
Reuters mean

AFE 1 quarter ahead
-2
-1

SARB core model

Reuters mean

AFE 4 quarters ahead
Period 2
-2
-1

Reuters mean

SARB core model

AFE 6 quarters ahead
-2
-1

SARB core model
Reuters mean

*
*
Average forecast errors then show that both the SARB core model and the Reuters’ average are relatively unbiased across the two time periods
and also for forecasts of different durations. A number of private sector forecasters recorded fairly large negative errors both four and six quarters
ahead in period 1, but this mainly indicates significant underestimation of the inflation spike during 2007 and 2008.
One interpretation of these findings is that economists have improved their forecasting ability. Another is that inflation has become more
stable and therefore simpler to predict. More inflation stability, in turn, may be a better indicator of luck and the achievements of monetary
policy than of forecasting quality.

Monetary Policy Review April 2017
Summary
The assessment of South Africa’s economic outlook depends,
to some extent, on the perspective adopted. From an earlier
starting position, perhaps 2011, the combination of growth
under 2% for the foreseeable future and inflation either at or
above the top of the target range looks very disappointing.
From a more recent vantage point, accelerating growth, with
inflation falling back into the target range, marks a welcome
improvement. This comparison highlights the extent of
the economic deterioration experienced in recent years,
culminating in 2016’s stagflation.
Reaching this low point required a variety of adverse
developments. Global growth slowed steadily from 2011
onwards, reaching a new post-crisis low in 2016. Furthermore,
South Africa suffered from greater exposure to the parts of
the global economy that slowed most markedly (the euro
area, China) than those that recovered more rapidly (the US).
Commodity prices weakened, prompting a steady decline in
South Africa’s terms of trade between 2011 and 2016. World
capital flows also became somewhat more discriminating as
the US Fed moved away from quantitative easing towards policy
normalisation, increasing pressure on borrower countries.
These problems were compounded by a series of domestic
shocks. Labour disputes disrupted production in several key
sectors. Electricity shortages became acute in 2014 and
2015, and although load shedding has since been avoided,
electricity production remains below early 2015 levels. The
drought in 2016 was one of the worst in South African history.
Policy uncertainty also intensified, with various proxies for this
variable peaking late in 2015 and early 2016. In this context,
consumer and business confidence weakened to levels last
seen during the global financial crisis.
This combination of shocks posed difficult policy challenges.
One was developing a realistic assessment of the economy’s
potential. In the immediate post-crisis years, expectations were
that GDP growth would soon revert to levels of 3% or higher.
This outlook motivated large budget deficits and provided
assurance that higher debt levels would be manageable
when growth rebounded. Instead, growth failed to recover
and estimates of potential slipped to around 1.5%, putting
government debt dynamics on a less sound trajectory.
For monetary policy, lower estimates of potential growth largely
closed output gaps, implying reduced scope for demand
stimulus. Meanwhile, inflation dynamics were deteriorating,
given repeated supply shocks on top of stubbornly high
services inflation. Furthermore, persistent exchange rate
depreciation fuelled a steady rise in underlying inflation, helping
drive core from the bottom to the top of the 3–6% target range.
As a question of policy, rand depreciation has improved the
economy’s competitiveness and helped to absorb shocks,
especially the decline in commodity prices. Yet the depreciation
trend was also a symptom of deeper problems, including an
Percentage of GDP
Forecast
Main budget balance
Source: National Treasury


Percentage of GDP
Forecast
Current account balance
Source: SARB


Monetary Policy Review April 2017

unsustainably large current account deficit. In this context, the
inflation forecasts began pointing to sustained target breaches.
Furthermore, with inflation expectations already precariously
positioned close to or above 6%, the risks to the medium term
inflation forecast were becoming excessive.
Macroeconomic policy reached a turning point in early 2014.
Monetary policy embarked on a tightening cycle, and at
around the same time fiscal policymakers began setting out a
consolidation agenda to stabilise debt relative to GDP. These
policy adjustments reduced the degree of stimulus provided
to the economy, contributing to macroeconomic rebalancing.
Since then, global conditions have improved and some
domestic shocks, like drought, have abated. These factors
underpin some economic recovery over the forecast period.
Growth is expected to rise towards 2% by 2019, closing the
output gap. Inflation should be back within the target range
by the second quarter of 2017 and is projected to remain
there until the end of the forecast period. As such, the policy
rate trajectory may now have stabilised. However, forecast
inflation is still relatively elevated, remaining above 5% for 2018
and 2019, and inflation expectations are uncomfortably close
to 6%. This limits the scope for rate cuts. Furthermore, the
risks are that inflation will be higher, and growth will be worse,
than currently projected, owing in part to a recent spike in
uncertainty. The much-needed improvement envisioned by
the forecast may therefore not materialise.
Forecast
Indices: 2015 Q1 = 100

Real and potential GDP

Real GDP

Real potential GDP (old 2013 method)
Source: SARB

Real potential GDP

Monetary Policy Review April 2017
Statement of the Monetary Policy Committee
24 November 2016
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Headline consumer price inflation declined to within the
target range of 3–6% in August, in line with the expectations
of the South African Reserve Bank (SARB). Nevertheless,
higher inflation outcomes are forecast in the near term
before a sustained return to within the target range during
2017. While domestic economic growth prospects appear
more favourable following the positive surprise in the second
quarter of this year, the outlook remains constrained against
a backdrop of weak domestic fixed investment and low
levels of business and consumer confidence.
Since the previous meeting of the Monetary Policy
Committee (MPC), the global economic and political
landscape
has
changed
significantly
following
the
presidential election in the United States (US). The high
degree of uncertainty surrounding the economic policies of
the new administration is expected to persist for some time,
creating a more challenging and volatile environment for
emerging markets in particular. Higher US long bond yields,
along with expectations of a tighter stance of monetary
policy by the US Federal Reserve (Fed) than previously
expected, have contributed to the reversal of the recent
positive sentiment towards emerging markets. The prospect
of rising protectionism and its implications for world trade
are also a concern.
These developments have also affected capital flows to
South Africa, with implications for the rand and bond yields.
Domestic growth and inflation dynamics have remained
more or less in line with expectations, but risks to the
inflation outlook have increased moderately.
The year-on-year inflation rate, as measured by the consumer
price index (CPI) for all urban areas, measured 6.1% and
6.4% in September and October respectively, compared
with 5.9% in August. The October outcome was marginally
above the forecast of the SARB. Food price inflation
accelerated further to a recent high of 12.0%, with the
category of food and non-alcoholic beverages contributing
1.8 percentage points to the overall inflation outcome. Goods
price inflation measured 7.1% in October, up from 6.6% in
September, with non-durable goods inflation increasing to
7.6%. Services price inflation increased from 5.6% to 5.8%.
The SARB’s measure of core inflation – which excludes
food, fuel and electricity – measured 5.7%, up from 5.6%.
Producer price inflation for final manufactured goods
measured 6.6% in September and October, down
from 7.2% in August. The main contributor to the
October outcome was the category of food products,
beverages and tobacco products, which contributed
4.0 percentage points and reflects the continued impact of
the drought on food prices.
The latest inflation forecast of the SARB is broadly
unchanged over the forecast period, despite a moderate
upward adjustment to the food price forecast in the later
quarters. The annual averages are unchanged at 6.4% for
2016 and 5.8% and 5.5% respectively in the coming two
years. Inflation is expected to peak at 6.6% in the fourth
quarter of this year, marginally lower than in the previous
forecast, with a sustained return to within the target range
still expected to occur during the second quarter of 2017.
The higher food price assumption is offset by a slightly more
appreciated exchange rate assumption.
Core inflation is expected to average 0.1 percentage points
less in each year of the forecast period compared with the
previous forecast, at 5.6% this year and 5.5% and 5.2% in
2017 and 2018 respectively. Core inflation is expected to
remain within the target range over the forecast period, with
a peak of 5.8% in the final quarter of this year.
The annual inflation expectations of economic analysts, as
reflected in the Reuters Econometer survey conducted in
November, are broadly unchanged since September and
are similar to those of the SARB. The median forecast for
the current and next two years are 6.3%, 5.8% and 5.6%
respectively. Bond market expectations implicit in the
break-even inflation rates, i.e. the yield differential between
conventional government bonds and inflation-linked bonds,
increased in the wake of the recent depreciation of the
rand. They remain above the upper end of the inflation
target range.
The global outlook became increasingly uncertain during
the year following the decision of the United Kingdom
(UK) to leave the European Union and the outcome of the
US presidential election. While the new policy direction
in the US is still unclear, the markets have interpreted the
outcome as being positive for US growth in the short run,
with commitments to tax cuts and higher fiscal spending on
infrastructure. These policies are expected to result in higher
growth and inflation, particularly against the backdrop of an
increasingly tight labour market. Nevertheless, the timing
and extent of the expenditure boost is highly uncertain at
this stage.
While an increase in infrastructure expenditure could be
positive for commodity prices, other aspects of the possible
new policy direction are likely to have an adverse effect
on emerging markets. These include a possibly more
Monetary Policy Review April 2017

aggressive tightening of US monetary policy in response
to higher inflation and growth, which could also reduce the
multiplier effect of the fiscal expansion. Together with the
recent sharp increase in US long bond yields, the possibility
of such actions has led to a reversal of capital flows to
emerging markets, reminiscent of the market reaction to
the so-called US taper tantrum in 2013. The impact on
emerging market currencies and bond markets, including
in South Africa, is already evident. Given the high degree
of uncertainty, the financial markets may have overreacted.
A further concern for emerging markets is the potential
change of trade policies that may impact on existing trade
treaties, as well as unilateral increases in tariff protection
in the US. The outlook for emerging markets has therefore
become more uncertain. The lingering concerns about the
sustainability of the recovery in the Chinese economy have
been revived by the possibility of tariff increases on Chinese
exports. Countries with strong direct trade links with the US,
in particular Mexico, are most vulnerable to increased trade
barriers. A more protectionist US stance could reinforce the
already slow growth of global trade.
The short-term fallout of the Brexit vote on the UK economy
has been limited to date, in part due to the accommodative
monetary policy response. The longer-term impact remains
unclear as the terms of withdrawal are still to be negotiated
and there are concerns that a delay in clarity could undermine
investment. The eurozone is expected to continue with
its slow but steady recovery, and the Japanese economy
continues to battle with deflation.
Global inflation remains generally benign. Since the previous
meeting of the MPC, a number of countries have loosened
monetary policy. Expansionary policies are expected to
persist in the eurozone, Japan and the UK, despite emerging
inflation pressures in the latter. By contrast, a persistence of
significant outflows from emerging markets in response to
the possibility of a tighter US monetary policy stance could
pose challenges for monetary policies in a number of these
economies.
These new global developments have impacted on the
domestic bond and foreign exchange markets. The rand
appreciated steadily from the middle of October in response
to some positive domestic developments as well as inflows
from a large mergers and acquisitions transaction. The
currency was trading at around R13.20 against the US dollar
just before the elections. It then reached its weakest point
of R14.60 against the US dollar in the wake of the surprise
outcome, before recovering somewhat. Domestic long
bond yields (R186) initially spiked by about 60 basis points,
but the increase has since moderated to about 25 basis
points. Since the previous meeting of the MPC, the rand
has depreciated by about 5.7% against the US dollar and
by about 1.1% on a trade-weighted basis.
The rand is expected to remain sensitive to changes in the
stance of US monetary policy. A US rate increase is generally
expected in December and probably largely priced in, but
of greater significance for the rand will be the signals from
the Federal Open Market Committee (FOMC) regarding
the trajectory of future increases. The rand will also remain
sensitive to the sovereign ratings announcements due later
this month and early in December.
On the positive side, the rand has been given support by
the generally improved trade account in recent months.
However, the deficit on the current account of the balance of
payments is expected to have widened in the third quarter
of this year.
The financing of the deficit may become more challenging
should the recent significant non-resident sales of bonds
and equities persist. During October and on a month-todate basis, non-residents have been net sellers of domestic
bonds and equities to the value of R42.7 billion and
R19.7 billion respectively.
The domestic economic growth outlook remains subdued,
although the low point of the cycle appears to be behind
us. The SARB’s forecast remains unchanged at 0.4% for
2016 and 1.2% and 1.6% respectively for the next two
years. While the estimate for potential real gross domestic
product (GDP) growth was revised down marginally to
1.3%, rising to 1.5% by 2018, the output gap is expected
to remain negative over the forecast period. The SARB’s
composite leading business cycle indicator improved in
August and September, continuing a recent generally
positive albeit gradual upward trend.
Available monthly data suggest that growth in the third
quarter is likely to be positive but well below the rate
recorded in the second quarter. The mining sector
contributed positively to GDP growth in the quarter. The
physical volume of manufacturing output declined despite
a positive month-to-month outcome in September. The
Barclays Purchasing Managers’ Index (PMI), which declined
further in October, has remained below the neutral 50 index
point level for three consecutive months. The weak trends in
manufacturing are consistent with the continued low levels
of business confidence despite a moderate improvement
in the third quarter. More positively, the services sector is
expected to sustain its positive growth rate, with the tourism
sector being particularly buoyant.
Consumption expenditure by households remains subdued,
with declining retail trade sales and static wholesale trade
sales in the third quarter of this year. Although new motor
vehicle sales increased sharply on a month-to-month basis
in October, a sizeable proportion of this is attributed to car
rental companies; challenging conditions in the new vehicle
sector persist.

Monetary Policy Review April 2017
Consumers continue to face a number of constraints.
Employment growth is particularly weak. Household debt
levels, while moderating, are still elevated. And wealth
effects are muted amid stagnant equity and residential
property markets. Furthermore, growth in credit extension
to households remains subdued.
The slow growth in household disposable incomes is also
reflected in a gradual decline in wage growth, with growth
in nominal remuneration per worker declining to 5.8% in
the second quarter. When an adjustment is made for the
increase in labour productivity, growth over four quarters
in nominal unit labour costs measured 5.1% in the second
quarter. The Andrew Levy Employment Publications survey
reports an average wage settlement rate in collective
bargaining agreements of 7.5% in the first three quarters of
the year and 7.1% in the third quarter. This may be indicative
of wage settlements becoming more sensitive to the
persistently high unemployment rates.
According to the Medium Term Budget Policy Statement
(MTBPS) released in October, fiscal consolidation is set
to continue at a measured pace. A moderate degree of
slippage is expected in the near term, as tax receipts are
negatively affected by the economic slowdown. In order
to prevent an excessive widening of the fiscal deficit, the
MTBPS proposes a reduction in the expenditure ceiling
and tax increases, to be announced in February. A revised
deficit of 3.4% of GDP is expected in the current fiscal year,
steadily narrowing to 2.5% of GDP in the 2019/20 fiscal year.
Food price inflation remains a significant driver of inflation.
It remains sensitive to the continuing drought. While food
price inflation is still expected to moderate from early 2017,
the pace of decline is expected to be slower than previously
forecast. This has led to an upward revision to the food
price assumption in the forecast during the outer quarters in
particular. The change is mainly due to the delayed impact
of meat prices, which are now expected to peak only in
early 2018 as farmers rebuild their herds during 2017.
Brent crude oil prices reached a year-high of US$52 per barrel
in early October following the decision of the Organization
of the Oil Exporting Countries (OPEC) to curtail production.
Since then, prices have declined following doubts about the
prospects for an agreement on the distribution of production
cuts across the cartel. Some price volatility is expected in the
short run as negotiations on production cuts continue. The
SARB’s forecast maintains the assumption of a moderate
upward trajectory of international oil prices over the forecast
period. The domestic price of 93 octane petrol increased by
a cumulative 88 cents per litre in October and November,
with almost all of the increase due to higher international
product prices. The current over-recovery indicates that,
should current trends persist, about half of that increase
could be reversed in December.
The MPC is of the view that a high degree of uncertainty
surrounds the nature and timing of possible policy changes
emanating from significant developments in the global
economic environment. This elevated uncertainty creates
a more challenging environment especially for emerging
markets, as evidenced in the recent changed pattern of
capital flows. Financial markets are thus likely to remain
volatile for some time.
Since the previous meeting of the MPC, the inflation forecast
has remained largely unchanged. Whereas the risks to the
inflation forecast were previously assessed to be more or less
balanced, the MPC now assesses the risks to be moderately
to the upside. This is mainly due to the possible impact of
adverse global developments on the exchange rate. The risk
of domestically generated shocks to the exchange rate also
remains. Nevertheless, despite its high degree of volatility, the
rand has displayed relative resilience in the face of numerous
shocks over the past year.
The domestic growth outlook is unchanged and remains
constrained against the backdrop of weak business and
consumer confidence. The risks to the growth forecast
are assessed to be broadly balanced. Domestic demand
pressures remain weak, and consumers are expected to
remain under pressure for some time.
The MPC has accordingly decided to keep the repurchase
rate unchanged at 7.0% per annum. The decision was
unanimous.
The MPC remains concerned that the inflation trajectory
is uncomfortably close to the upper end of the target
range. Furthermore, the uncertain environment and
moderately higher risks to the inflation outlook require
continued vigilance. While the MPC retains the view that we
may be close to the end of the hiking cycle, this position
may be reassessed should the upside risks transpire.
Monetary Policy Review April 2017

Summary of assumptions: Monetary Policy Committee
meeting on 24 November 2016*
1. Foreign-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign-sector assumptions and domestic-sector assumptions, see pages 48 and 49.

Monetary Policy Review April 2017
Forecast results (annual)
Per cent
Actual
Forecast


(-4.0)
(-4.2)

The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Forecast results (quarterly)
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Meeting on 24 November 2016
Monetary Policy Review April 2017

Statement of the Monetary Policy Committee
24 January 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee
(MPC), the near-term inflation outlook has deteriorated, but
the longer-term outlook is more or less unchanged. The
expected inflation profile has been negatively affected by
higher international oil prices and a persistence in elevated
food price inflation despite improved rainfall in many of the
drought-stricken regions. At the same time, the rand has
displayed some resilience. While some of the key risks to
the rand appear to have subsided for now, they could reemerge at any stage.
Global growth prospects are mixed amid policy uncertainty,
primarily in the United States (US) and the United Kingdom
(UK). The domestic growth outlook remains challenging,
although a modest improvement is expected over the
forecast period.
The year-on-year inflation rate as measured by the consumer
price index (CPI) for all urban areas measured 6.8% in
December, up from 6.6% in November. The December
outcome surprised on the upside relative to the South
African Reserve Bank’s (SARB) forecast and the market
consensus expectation of 6.5%. The main sources of this
surprise included food prices, housing rentals, recreation
and culture, and restaurants and hotels. Food price inflation
remained elevated at 12.0% in December, matching the
recent high recorded in October 2016. The contribution
of the category of food and non-alcoholic beverages to
the overall inflation outcome has remained unchanged at
1.8 percentage points for the past three months. Goods
price inflation measured 7.8% in December, up from
7.7% in November, while services price inflation increased
from 5.6% to 5.9%. The SARB’s measure of core inflation,
which excludes food, fuel and electricity measured
5.9%, up from 5.7%.
Producer price inflation for final manufactured goods
measured 6.9% in November, compared with 6.6% in
October. The main contributor to the November outcome
was the category of food products, beverages and tobacco
products which contributed 3.9 percentage points.
The inflation forecast of the SARB has deteriorated since
the previous meeting of the MPC. Headline inflation is
now expected to only return to within the target range
during the final quarter of 2017, and to average 6.2% for
the year, compared with 5.8% in the previous forecast.
The forecast for 2018 is more or less unchanged at an
average of 5.5%. The peak of the forecast remains at 6.6%,
which was recorded in the final quarter of 2016, and this
level is now expected to persist in the first quarter of 2017.
This deterioration is mainly due to changed assumptions
regarding international oil prices, the domestic fuel prices
and the outlook for food prices, which more than offset the
more favourable exchange rate assumption.
By contrast, the forecast for core inflation is unchanged,
averaging 5.5% and 5.2% in 2017 and 2018 respectively.
Inflation expectations as reflected in the survey conducted
by the Bureau for Economic Research (BER) during the
fourth quarter of 2016 showed average inflation expectations
for 2017, declining from 6.0% in the third quarter to 5.8%.
The same outcome is expected for 2018 as well as for fiveyear inflation expectations. Despite the slight moderation,
expectations remain more or less anchored at the upper
end of the target range, but with a narrower divergence
between the different groups of respondents than is usually
the case. The expectations of these groups ranged from
5.6% to 6.0% for 2017, and from 5.4% to 6.0% for 2018. The
outcome may have been distorted by the marked decline of
0.6 percentage points for the trade union respondents.
The median annual inflation expectations of market analysts
as reflected in the Reuters Econometer survey are relatively
unchanged at 5.8% and 5.5% for 2017 and 2018. Bond
market expectations implicit in the break-even inflation
rates have declined across all maturities since the previous
meeting, though they remain above the target range.
The global economic outlook remains uncertain, despite
increased optimism regarding US growth following the
US presidential elections. There is still a great deal of
uncertainty regarding the policies of the new administration,
particularly with respect to the size of the promised fiscal
stimulus. While some of the initial optimism has since been
tempered somewhat, US growth is expected to be relatively
strong, but with some downside risks posed by a stronger
dollar. Uncertainty also persists regarding the prospects
for the UK economy, as the terms of the disengagement
from the European Union (EU) are unlikely to be resolved
for some time. The steady but slow growth recovery in the
eurozone is expected to continue, but upcoming elections
in a number of countries could pose risks to the outlook,
alongside ongoing concerns about the prospects for the
Italian economy.
The outlook for emerging markets is also unclear, given
conflicting developments. Commodity prices, especially
industrial commodities, have risen in recent months, but
protectionist threats from the US, if carried through, could
undermine world trade and have an adverse effect on

Monetary Policy Review April 2017
emerging markets in particular. These countries are also
highly dependent on Chinese growth, which is expected
to remain above the 6% level. However, given the creditdriven nature of recent Chinese growth, there are fears of an
unsustainable credit bubble which could expose financial
sector vulnerabilities and undermine the growth outlook.
There are tentative signs of global inflation edging up as fears
of deflation recede amid higher energy and food prices.
As expected, the US Federal Reserve tightened monetary
policy in December and signalled further increases to
come. However, the pace of increase is still expected to be
relatively moderate amid a highly uncertain economic policy
environment. Both the European Central Bank (ECB) and the
Bank of Japan have maintained their highly accommodative
policy stances. This divergence between the advanced
economies is likely to persist for some time.
The rand has displayed a degree of resilience since the
previous meeting of the MPC, having traded in a relatively
narrow range of between R14.22 and R13.46 against
the US dollar. Since the previous meeting, the rand has
appreciated by 5.6% against the US dollar and by 4.2% on
a trade-weighted basis. The rand was positively impacted
by the decisions of the ratings agencies not to downgrade
the sovereign foreign credit rating to sub-investment grade,
although this remains a risk in the coming months. The
limited response of the rand exchange rate to the increase in
the US policy rate in mid-December suggests that the move
had been largely priced in. A gradual pace of tightening is
expected in the US, with the rand vulnerable to any upside
surprises in this respect.
The rand has been positively affected by the improvement
in the terms of trade, following the recent modest increase
in commodity prices. Although the overall current account
deficit is expected to narrow over the forecast period, it
remains relatively wide. In line with the recent improved
capital flows to emerging economy bond markets, nonresidents have been net buyers of South African bonds
since the beginning of the year, while equity net sales have
continued. This follows persistent net sales of both bonds
and equities during the last three months of 2016.
The domestic growth outlook remains weak and more or
less unchanged since the previous meeting of the MPC.
The SARB expects growth to have averaged 0.4% in
2016, although recent monthly data for the fourth quarter
suggest that there may be a downside risk to this forecast.
The forecast for 2017 has been revised down marginally to
1.1% (from 1.2%), and remains unchanged at 1.6% for 2018.
This improved outlook relative to 2016 is consistent with the
recent upward trend in the composite leading indicator of
the SARB. By contrast, the Rand Merchant Bank (RMB)/
BER Business Confidence Index declined again in the fourth
quarter, following a recovery in the previous quarter. Much
of this decline was driven by the new vehicle sector.
The recent monthly data paint a bleak picture for the fourth
quarter of 2016. Mining production, which had improved in
the second and third quarters, contracted in both October
and November. However, improved commodity prices are
expected to help the sector in the coming months. The
manufacturing sector recorded low but positive growth in
November, following a month-to-month decline in October.
The Barclays Purchasing Managers’ Index (PMI) declined
further in December and recorded its fifth consecutive
month below the neutral 50 level.
The low level of business confidence is reflected in the
continued, but slower, contraction in real gross fixed capital
formation. Gross fixed investment has contracted for four
consecutive quarters, particularly in the private sector. This
has contributed to the persistent labour market weakness,
with
formal
non-agricultural
employment
(excluding
temporary
election-related
employment)
remaining
unchanged in the year to the third quarter of 2016. The
official unemployment rate increased to 27.1%, its highest
level since the inception of the Quarterly Labour Force
Survey in 2008.
Wage growth appears to be responding to the weak labour
market environment. Year-on-year nominal wage growth per
worker moderated for a fifth consecutive quarter in the third
quarter of 2016, down to 5.8%. Following a small decline
in labour productivity growth, nominal unit labour costs in
the formal non-agricultural sector increased to 5.7%. The
slower nominal wage growth per worker is consistent with
the lower wage settlement rates reported by Andrew Levy
Employment Publications.
Household consumption expenditure data paint a mixed
picture. Growth in household consumption expenditure
accelerated to 2.6% in the third quarter despite a further
contraction in durable goods consumption. Real retail
trade sales declined in October, but increased markedly
in November on a month-to-month basis. By contrast,
wholesale trade sales contracted in both months. Domestic
new vehicle sales remained subdued following further
declines in the final quarter of last year.
Notwithstanding some improvement, consumers remain
under pressure and consumer confidence remains low,
as indicated in the sharp contraction in the First National
Bank (FNB)/BER Consumer Confidence Index in the fourth
quarter. Households remain highly indebted despite a further
moderation in the debt ratio and the subdued housing and
equity markets have contributed to an absence of strong
wealth effects. Slower wage growth along with stagnant
employment growth and expected tax increases in the
forthcoming budget are also likely to dampen consumption
expenditure.
A further constraint to consumption expenditure growth
has been the weak credit extension to the private sector,
which, at 4.5% in November, was the lowest year-on-year
Monetary Policy Review April 2017

growth since late 2010. While growth in credit extension
to the household sector was particularly subdued, that to
the corporate sector also moderated in the second half of
2016. The strongest decline was seen in mortgage credit
extension for commercial property.
Food price inflation is expected to decline following good
rainfall in parts of the country. Spot prices for both maize
and wheat have declined significantly, and a markedly higher
maize crop is expected this year. However, the impact on
prices at the consumer level are yet to be felt, with meat prices
likely to lag other food price categories as farmers restock
their herds. Although the SARB’s inflation forecast assumes
that food price inflation has more or less peaked, the pace
of moderation is expected to be slower than in the previous
forecast. Food price inflation is now expected to average
7.0% during 2017, compared with 6.5% previously. Food
price disinflation is expected to be constrained or delayed by
higher fuel costs and a rising trend in global food prices.
Brent crude oil prices increased by over 20% to almost
US$60 per barrel, in response to the Organization of the
Petroleum Exporting Countries (OPEC)-brokered agreement
to restrict production. Prices have since moderated to current
levels of around US$55 per barrel. The sustainability of this
agreement and its longer-term impact on prices is uncertain,
given the possibility of offsetting developments. A number
of oil producers were exempt from the agreement; there are
incentives and scope for cartel members to exceed their
quotas; and US shale producers have already increased
production in response to higher prices. These factors are
likely to constrain oil price increases. While the SARB’s oil
price assumption has been revised up, the trajectory is
relatively flat. Despite the stronger rand exchange rate, the
domestic price of 93 octane petrol increased by 50 cents
per litre in January and a further increase can be expected
in February.
The MPC has noted the marked deterioration in the inflation
forecast since the previous meeting, as well as the extension
of the expected breach of the upper level of the target
range by a further two quarters. Inflation is now expected
to return to within the target range in the final quarter of
2017. While this is a cause for concern, the main drivers
of this deterioration are supply side shocks, in particular oil
and food prices. The increase in the international oil price is
not expected to be a start of a new oil price spiral. Various
supply side factors are expected to constrain oil prices
going forward in the absence of any major global political
risks that would threaten production. While the food price
forecast has been adversely affected by higher input costs,
a steady decline in food price inflation is still expected.
The more favourable rand exchange rate has been an
important factor in offsetting some of the negative impacts
of these developments. Despite a turbulent second half of
2016, both domestically and globally, the rand has been
relatively resilient. Furthermore, the current level of the rand is
stronger than that implicit in the forecast, and pass-through
to inflation continues to be relatively muted. Nevertheless it
remains vulnerable to both domestic and external shocks.
As always, the approach of the MPC is to look through
the first-round effects of exogenous shocks, but remain
focused on the possible emergence of second-round
effects, which could require a policy response. At this stage,
the longer-term trajectory over the relevant policy horizon is
unchanged, as is the forecast for core inflation. In particular,
the MPC will take note of possible changes in the longerterm inflation expectations, which had shown tentative
signs of moderation in the fourth quarter of 2016. The MPC
assesses the risks to the inflation outlook to be moderately
on the upside.
The domestic growth outlook has remained largely
unchanged despite a possible weaker outcome in the fourth
quarter of 2016. While some improvement is anticipated over
the forecast period, growth is expected to remain below
potential. The risks to the growth forecast are assessed to
be broadly balanced. Growth prospects remain dependent
on uncertain but tentatively improving global conditions
and their impact on commodity prices. Domestically, some
improvement in agricultural production can be expected.
However, a significant improvement in growth prospects
requires the implementation of structural reforms which
could contribute to increased business and consumer
confidence.
In light of these developments and the assessment of the
balance of risks, the MPC has unanimously decided to keep
the repurchase rate unchanged at 7.0% per annum.
The MPC remains focused on the medium- to longer-term
inflation outlook, but the deterioration of the shorter-term
outlook requires increased vigilance. Furthermore, the MPC
remains concerned that the longer-term inflation trajectory
continues to be uncomfortably close to the upper end of the
target range. The MPC retains the view that we may be near
the end of the hiking cycle. However, should second-round
effects emerge that undermine the longer-term inflation
outlook, there may be a reassessment of this view.

Monetary Policy Review April 2017
Summary of assumptions: Monetary Policy Committee
meeting on 24 January 2017*
1. Foreign-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign-sector assumptions and domestic-sector assumptions, see pages 48 and 49.
Monetary Policy Review April 2017

Forecast results (annual)
Per cent
Actual
Forecast


(-3.8)
(-4.3)
(-4.4)
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Forecast results (quarterly)
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Meeting on 24 January 2017

Monetary Policy Review April 2017
Statement of the Monetary Policy Committee
30 March 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee
(MPC) the inflation outlook has improved. This was mainly
due to the further appreciation of the rand exchange rate
following the benign market reaction to the United States
Federal Reserve (US Fed) monetary policy tightening as well
as the significant narrowing of the domestic current account
deficit. A more positive growth outlook in the advanced
economies has also contributed to a more favourable
environment for emerging markets generally. However,
the recent heightened domestic political uncertainty has
reversed some of these exchange rate gains, and the risk of
further rand weakening overshadows the inflation outlook.
Domestic growth prospects remain constrained, although
the low point of the cycle is probably behind us. Demand
pressures are expected to remain weak amid low business
and consumer confidence
The year-on-year inflation rate as measured by the
consumer price index (CPI) for all urban areas moderated
to 6.3% in February, from 6.6% in January, in line with the
market consensus expectation. Food price inflation, which
measured 10.0%, moderated for the second consecutive
month following its recent peak of 12.0% in December.
The contribution of the category of food and non-alcoholic
beverages to the overall inflation outcome declined from
1.9 percentage points in January to 1.7 percentage points
in February. The South African Reserve Bank’s (SARB)
measure of core inflation, which excludes food, fuel and
electricity, measured 5.2%, down from 5.5%. This follows a
recent peak of 5.9% in December 2016.
Producer price inflation for final manufactured goods
measured 5.6% in February, compared with 5.9% in January.
The category of food products, beverages and tobacco
products decelerated for the sixth consecutive month to
8.4%, following its recent peak of 13.4% in August last year.
The inflation forecast of the SARB has improved, reversing
most of the deterioration seen at the previous meeting of
the MPC. Headline inflation is now expected to return to
within the target range during the second quarter of 2017,
compared with the fourth quarter previously, and to remain
within the range for the rest of the forecast period. CPI
inflation is expected to average 5.9% for the year, compared
with 6.2% in the previous forecast, while the forecast for
2018 has moderated from an average of 5.5% to 5.4%.
The forecast period has been extended to 2019, with an
expected average of 5.5% for the year.
This improvement is mainly due to a more appreciated
exchange rate assumption. Despite the recent depreciation,
the current level of the rand is still consistent with the exchange
rate assumption in the forecast. Although the international
oil price assumption remains unchanged, the exchange
rate is expected to lead to lower petrol price inflation and
is reflected in a downward revision to the assumption for
administered prices. This favourable trend is partially offset
by a slower pace of disinflation in food and non-alcoholic
beverages, driven by an expected acceleration in poultry
prices in particular. Food price inflation is now expected to
average 7.4% and 5.2% in 2017 and 2018, compared with
7.0% and 5.0% previously.
The forecast for core inflation is marginally lower than before,
at an average of 5.4% in 2017, and unchanged at 5.2% in
2018. An average core inflation of 5.3% is expected in 2019.
Inflation expectations as measured by the Bureau for
Economic Research (BER) show a deterioration over the
near-term in particular. The average expectation for 2017
has increased from 5.8% to 6.2%, with the largest upward
revisions coming from businesses and labour respondents.
The average expectation for 2018 increased marginally from
5.8% to 5.9%, while the expected inflation for 2019 is 6.0%.
By contrast, average inflation expectations over five years
declined by 0.1 percentage point to 5.7%.
Median inflation expectations of economic analysts, as
reflected in the Reuters Econometer survey conducted in
March, are more or less unchanged since January. Inflation
is expected to average 5.8% in 2017 and 5.5% and 5.4%
in the coming two years, roughly in line with the SARB’s
forecast. Inflation expectations implicit in the break-even
inflation rates (the yield differential between conventional
bonds and inflation linked bonds) had declined since the
previous meeting, but have since spiked following the recent
depreciation of the rand, and remain above the 6.0% level
for longer-dated maturities.
The global economy shows continued signs of a broadbased improvement. The growth outlook in the US remains
favourable with business confidence indices at high levels.
However, there is growing uncertainty about the timing and
size of the expected fiscal stimulus. Tax reform may take
longer than anticipated following the recent failure to repeal
the Affordable Care Act.
Monetary Policy Review April 2017

Growth prospects in Japan and Europe are also more
promising, with the Purchasing Manager’s Index (PMI)
reaching a six-year high in the euro area, led by the services
sectors in France and Germany. The extent to which the
sustainability of this improvement is dependent on the highly
accommodative monetary policy stance is still unclear.
The outlook for emerging markets is also more positive, in
part driven by the recovery in the advanced economies and
stronger demand in China. Firmer commodity prices have
also helped, but an oversupply of some commodities could
limit these gains.
Global inflation provides a mixed picture with the recent
decline in international oil prices threatening to reverse the
broad-based increases in headline inflation in the advanced
economies. Some inflation normalisation is evident in the US
and the euro area, but Japan is showing less momentum
in price and wage growth. Inflation in the United Kingdom
is expected to overshoot the target for some time, as the
economy adjusts to a weaker currency. Similarly, inflation
experiences in a number of emerging economies have
reflected divergent currency movements.
The US Fed raised its policy rate in March in response to the
stronger inflation trend and improved growth outlook. While
this action was widely expected, the gradual nature of the
expected interest rate cycle implicit in the forward guidance
surprised the markets. Policy rates are expected to remain at
low levels for some time in most of the advanced economies
until more favourable inflation and growth dynamics are
more firmly entrenched.
For the past few months the rand exchange rate has been
relatively resilient, along with a number of other emerging
market currencies. While most measures of emerging
market risk have narrowed over recent months, those for
South Africa have widened again over the past few days. The
rand has depreciated significantly in response to increased
domestic political uncertainty and the exchange rate has
re-emerged as an upside risk to the inflation outlook. Since
the previous meeting of the MPC, the rand has appreciated
by 3.9% against the US dollar, by 4.0% against the euro and
by 3.4% on a trade-weighted basis.
The prospect of US monetary policy tightening has been
seen as a risk to the exchange rate. However, the rand and
other peer currencies strengthened in response to the Fed
actions in March, indicative of revised market expectations
of a more moderate tightening cycle than that priced in.
The rand has also been underpinned by favourable terms of
trade trends. Furthermore, the improving trend of the deficit
on the current account of the balance of payments has
reduced the perceived vulnerability of the rand to possible
capital flow reversals. However, while significant adjustment
of the current account has occurred, the deficit is not
expected to remain at the level seen in the fourth quarter
of last year.
The domestic growth outlook remains weak following the
negative growth recorded in the fourth quarter of 2016. The
2016 annual gross domestic product (GDP) growth of 0.3%
is likely to have been the low point of the growth cycle, and
a mild recovery is expected over the forecast period. The
SARB’s forecast for GDP growth has been revised up by
0.1 percentage points in both 2017 and 2018, to 1.2% and
1.7%, with growth of 2.0% forecast for 2019. While growth is
still expected to be below estimated potential output growth
of around 1.4% in the near term, the output gap is expected
to narrow to some extent in the later part of the forecast
period. The more favourable growth outlook is consistent
with the SARB’s leading indicator of economic activity,
which has increased for six consecutive months.
The main drivers of growth are expected to be net exports
and positive, albeit weak, household consumption
expenditure growth. Some impetus is expected to come
from fixed capital formation in the outer period of the
forecast. At a sectoral level, the agricultural sector is
expected to return to positive growth following good rains
in a number of regions and improved maize crop estimates.
A modest recovery in the manufacturing sector is expected
following two consecutive months of the Absa PMI being
above the neutral 50 point level, while the mining sector is
forecast to respond to more favourable commodity prices.
Low growth in gross fixed capital formation remains a
downside risk to growth in the short term. In 2016 gross
fixed capital formation contracted for the first time since
2010, with the ratio of fixed capital formation to GDP
declining from 20.4% in 2015 to 19.6% in 2016. Private
sector investment remains particularly weak, having
contracted for five successive quarters. This is reflected in
the Rand Merchant Bank (RMB)/BER Business Confidence
Index which increased marginally in the first quarter of 2017,
but at 40 index points remains well below the neutral level of
50. The BER Manufacturing survey shows a sharp decline in
expected capital investment over the next 12 months, with
the political climate cited as the main reason.
The constrained growth outlook does not bode well for
employment creation in the economy. According to the
Quarterly Labour Force Survey, employment increased by
0.3% while the number of unemployed grew by 11.3% in the
fourth quarter of 2016, compared to the fourth quarter of
2015. This resulted in an increase in the unemployment rate
by 2.0 percentage points to 26.5%.
Consumption expenditure by households, which grew
by 0.8% in 2016, remains subdued amid low consumer
confidence. While growth of 2.2% was recorded in both of
the final two quarters of 2016, negative retail and wholesale
trade sales growth in December and January underscore
the likely persistence of this weakness. New vehicle sales
continued to decline in February, although exports increased
significantly.

Monetary Policy Review April 2017
These trends are expected to persist as the impact of a
higher tax burden, low employment growth and weak
wealth effects take their toll on consumption expenditure.
In addition, credit extension by banks to the private sector
continues to grow at low rates, particularly to households,
amid a further decline in the household debt to disposable
income ratio. Expenditure will be supported to some extent
by positive but moderate real income growth.
Fiscal policy as outlined in the recent budget remains
committed to a steady pace of deficit reduction over the next
three years. Lower tax revenues relative to budget – partly a
consequence of slower economic growth – have resulted in
a shortfall to be filled by a combination of lower expenditure
growth, increased fuel levies and other excise duties, and a
number of tax changes. These include limited compensation
for fiscal drag and a higher marginal tax bracket for highincome earners. The tax increases are expected to act as
a drag on household consumption expenditure, particularly
for middle and upper income earners.
International oil prices have declined following increased oil
inventories and weak compliance with the Organization of
the Petroleum Exporting Countries (OPEC)-brokered deal
to restrict output, and an increase in shale gas production
in the US. Although Brent crude oil prices increased by
about 10% in the wake of this agreement, these gains have
been largely reversed, with oil prices back in the region of
US$50 per barrel for the past three weeks. The impact on
the domestic petrol price will be evident in April, when a
reduction is expected, despite the 39 cent increase in the
Road Accident Fund and fuel levies provided for in the
February budget.
Since the previous MPC meeting the inflation outlook has
improved. However, the risk to the inflation forecast has
been affected by the reaction of the exchange rate to the
current elevated levels of political uncertainty. At current
levels of around R13.00 against the US dollar, the exchange
rate is still moderately stronger than the level implied in the
exchange rate assumption in the forecast. However, the
rand is likely to react further to unfolding developments until
a greater degree of certainty and confidence is restored.
The possibility of significant overshooting of the exchange
rate in the short run also cannot be ruled out. As always, the
MPC will attempt to ‘look through’ short term fluctuations
and focus on longer term trends in its policy settings.
The MPC remains concerned about the elevated level of
inflation expectations. While the near-term reversal was
not unexpected, given the deterioration of the short-term
inflation outlook in January, the longer term expectations
remain anchored uncomfortably at the upper end of the
target range.
Not all the inflation risk factors are on the upside. The
deterioration in the forecast at the previous meeting was
partly due to a higher international oil price assumption.
This assumption has not been adjusted to reflect the recent
market developments. There is a downside risk to this
assumption, given the possibility of these more moderate
trends persisting.
A further downside risk comes from electricity price
increases, which could turn out to be lower than the
8.0% currently in the forecast from mid-2017. The final
price determination by the energy regulator is yet to be
announced.
Overall, the MPC assesses the risk to the inflation outlook to
be moderately on the upside, mainly due to the high degree
of exchange rate uncertainty.
The MPC sees no evidence of significant demand
pressures impacting on inflation. The growth outlook
remains disappointing, and the MPC is concerned that
increased political uncertainty could impact negatively on
private sector investment and household consumption
expenditure, and further undermine employment growth.
The risks to the growth outlook are therefore assessed to
be on the downside.
In light of these developments, the MPC has decided to
keep the repurchase rate unchanged at 7.0% per annum.
Five members preferred an unchanged stance and one
member preferred a 25 basis point reduction.
The MPC is of the view that we may have reached the end
of the tightening cycle. However, the Committee would like
to see a more sustained improvement in the inflation outlook
before reducing rates. This assessment may, however,
change if the inflation outlook and the risks to the outlook
deteriorate.
Monetary Policy Review April 2017

Summary of assumptions: Monetary Policy Committee
meeting on 30 March 2017*
1. Foreign-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign-sector assumptions and domestic-sector assumptions, see pages 48 and 49.

Monetary Policy Review April 2017
Forecast results (annual)
Per cent
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Forecast results (quarterly)
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Meeting on 30 March 2017
Monetary Policy Review April 2017

Foreign-sector assumptions
1. Trading partner gross domestic product (GDP) growth
is determined broadly via the International Monetary
Fund’s (IMF) Global Projection Model (GPM), which is
then adjusted to aggregate the GDP growth rates of
South Africa’s major trading partners on a trade-weighted
basis. Individual projections are done for the four largest
trading partners (euro area, China, the United States
(US) and Japan), while the remaining trading partners
are grouped into three regions: Emerging Asia (excluding
China), Latin America and the Rest of Countries bloc.
The assumption takes account of country specific
‘consensus’ forecasts as well as IMF regional growth
prospects.
2. The commodity price index is a weighted aggregate
price index of the major South African export commodities
based on 2010 prices. The composite index represents
the total of the individual commodity prices multiplied
by their smoothed export weights. Commodity price
prospects generally remain commensurate with global
liquidity as well as commodity demand/supply pressures
as reflected by the pace of growth in the trading partner
countries.
3. The Brent crude oil price is expressed in US dollars
per barrel. The assumption incorporates the analysis
of factors of supply, demand (using global growth
expectations) and inventories of oil (of all grades) as
well as the expectations of the US Energy Information
Administration (EIA), the Organization of the Petroleum
Exporting Countries (OPEC) and Reuters.
4. World food prices are the composite food price index
of the United Nations Food and Agriculture Organization
(FAO) in US dollars. It is weighted via average export
shares and represents the monthly change in the
international prices of a basket of five food commodity
price indices (cereals, vegetable oil, dairy, meat and
sugar). World food price prospects incorporate selected
global institution forecasts for food prices as well as
imbalances from the anticipated trend in international
food supplies relative to expected food demand
pressures.
5. International wholesale prices refers to a weighted
aggregate of the producer price indices of South
Africa’s major trading partners, as per the South African
Reserve Bank’s (SARB) official real effective exchange
rate calculation. Although individual country consumer
price index (CPI) forecasts provide a good indication for
international wholesale price pressures, the key drivers
for the assumed trend in global wholesale inflation are oil
and food prices as well as expected demand pressures
emanating from the trends in the output gaps of the major
trading partner countries. Other institutional forecasts
for international wholesale prices are also considered.
6. Real effective exchange rate is the nominal effective
exchange rate of the rand deflated by the producer price
differential between South Africa and an aggregate of
its trading partner counties (as reflected in the SARB
Quarterly Bulletin). Although the nominal rate is a
weighted average of South Africa’s 20 largest trading
partners, particular focus is placed on the rand outlook
against the US dollar, euro, Chinese yuan, UK pound
and the Japanese yen. The assumed trend in the real
effective exchange rate remains constant from the latest
available quarterly average over the projection period.
However, due to the time delay for the calculation of
the real effective exchange rate, the most recent trend
in the nominal effective exchange rate is adjusted with
the assumed trend for the domestic and foreign price
differential for the current quarter. This may result in a
technical annual adjustment over the current and next
forecast year that differs from zero.

Monetary Policy Review April 2017
Domestic-sector assumptions
1. Government consumption expenditure (real) is broadly
based on the most recent National Treasury budget
projections. However, since these projections take place
twice yearly, the most recent actual data points also play
a significant role in the assumptions process.
2. Administered prices represent the total of the regulated
and non-regulated administered prices as reflected by
Statistics South Africa (Stats SA). Their weight in the
CPI basket is 18.48% (16.17% from January 2017) and
the assumed trend over the forecast period is largely
determined by the expected pace of growth in petrol
prices, electricity tariffs, school fees, water and other
municipal assessment rates.

Petrol price is an administered price and comprises
5.68% (4.58% from January 2017) of the CPI basket. The
basic fuel price (which currently accounts for roughly
half the petrol price), is determined by the exchange rate
and the price of petrol quoted in US dollars at refined
petroleum centres in the Mediterranean area, the Arab
Gulf and Singapore. The remainder of the petrol price
is made up of wholesale and retail margins as well as
the fuel levy and contributions to the road accident fund
(RAF). Since most taxes and retail margins are changed
once a year, the assumed trajectory of the petrol price
largely reflects the anticipated trend in oil prices and the
exchange rate.

Electricity price is an administered price measured at
the municipal level with a weight of 4.13% (3.75% from
January 2017) in the headline CPI basket. Electricity
price adjustments generally take place in the months of
July and August of each year, and the assumed pace of
increase over the forecast period reflects the multi-year
price determination (MYPD) agreement between Eskom
and the National Energy Regulator of South Africa
(NERSA) with a slight adjustment for measurement at
municipal level.
3. The pace of potential growth is derived from the
SARB’s semi-structural potential output model. The
measurement accounts for the impact of the financial
cycle on real economic activity and introduces economic
structure via the relationship between potential output
and capacity utilisation in the manufacturing sector
(SARB, Working Paper Series, WP/14/08).
4. The repurchase rate (repo rate) is the official monetary
policy instrument and represents the interest rate at
which banks borrow money from the SARB. Although
the rate is held constant over the forecast period, this
assumption is relaxed in alternative scenarios where for
instance the policy rate responds to deviations of output
from its potential and the gap between future inflation
and the inflation target, that is, via a stylised ‘Taylor rule’;
one that is based on market expectations of the future
path of the policy rate; and other paths as requested.
Monetary Policy Review April 2017

Glossary
Advanced economies: Advanced economies are countries
with high levels of gross domestic product per capita. These
countries are sometimes described as industrialised. With
further growth, however, they have tended to diversify, with
particular emphasis on services sectors.
Balance of payments: This is a record of transactions
between the home country and the rest of the world over a
specific period of time. It includes the current and financial
accounts. See also ‘current account’ below.
Budget deficit: A budget deficit indicates the extent to which
government expenditure exceeds government revenue (a
budget surplus occurs when revenue exceeds expenditure).
Business and consumer confidence: These are economic
indicators that measure the state of optimism about the
economy and its prospects among business managers and
consumers.
Commodity prices: Commodities can refer to energy,
agriculture, metals and minerals. Major South Africanproduced commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication
of aggregate price changes in the domestic economy. The
index is calculated using a number of categories forming
a representative set of goods and services bought by
consumers.
Core inflation: Core generally refers to underlying inflation,
excluding volatile elements (e.g. food and energy prices).
The SARB’s forecasts and discussions refer to headline CPI
excluding food, non-alcoholic beverages, fuel and electricity
prices.
Crude oil price: This is the US dollar price per barrel of
unrefined oil (Brent crude refers to unrefined North Sea oil).
Current account: The current account of the balance of
payments consists of net exports (exports less imports)
in the trade account, as well as the services, income and
current transfer account.
Emerging markets: Emerging markets are countries with
low to middle income per capita. They are advancing rapidly
and are integrating with global (product and capital) markets.
Exchange rate depreciation (appreciation): Exchange rate
depreciation (appreciation) refers to a decrease (increase) in
the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange
rate changes on domestic inflation (i.e. the percentage
change in domestic CPI due to a change in the exchange
rate). Changes in the exchange rate affect import prices,
which in turn affect domestic consumer prices and inflation.
Flexible inflation targeting: This refers to inflation-targeting
regimes that consider changes in inflation and other variables
affecting the real economy in the short term. Under strict
inflation targeting only inflation matters, but flexible inflationtargeting takes into account other variables, such as output.
Forecast horizon: This is the future period over which the
SARB generates its forecasts, typically between two and
three years.
Gross domestic product (GDP): GDP is the total market
value of all goods and services produced in a country. It
includes total consumption expenditure, capital formation,
government consumption expenditure and the value of
exports less the value of imports.
Gross fixed capital formation (investment): The value of
acquisitions of capital goods (e.g. machinery, equipment
and buildings) by firms, adjusted for disposals, constitutes
gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers
to CPI for all urban areas that is released monthly by
Statistics South Africa. Headline CPI is a measure of price
levels in all urban areas. The 12-month percentage change
in headline CPI is referred to as ‘headline CPI inflation’ and
reflects changes in the cost of living. This is the official
inflation measure for South Africa.
Household consumption: This is the amount of money
spent by households on consumer goods and services.
Inflation (growth) outlook: This outlook refers to the evolution
of future inflation (growth) over the forecast horizon.
Inflation targeting: This is a monetary policy framework
used by central banks to steer actual inflation towards an
inflation target level or range.
Median: This is a statistical term used to describe the
observed number that separates ordered observations in half.
Monetary policy normalisation: This refers to the unwinding
of unusually accommodative monetary policies. It could
also mean adjusting the economy’s policy rate towards its
real neutral policy rate.
Nominal effective exchange rate (NEER): A NEER is an
index that expresses the value of a country’s currency
relative to a basket of other (trading partner) currencies. An
increase (decrease) in the effective exchange rate indicates
a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted
average exchange rate of the rand is calculated against
20 currencies. The weights of the five major currencies
are as follows: euro (29.26%), Chinese yuan (20.54%),
US dollar (13.72%), Japanese yen (6.03%) and the British
pound (5.82%). Index: 2010 = 100. See ‘Real effective
exchange rate’.

Monetary Policy Review April 2017
Output gap/potential growth: Potential growth is the
rate of GDP growth that could theoretically be achieved
if all productive assets in the economy were employed
in a stable inflation environment. The output gap is the
difference between actual growth and potential growth,
which accumulates over time. If this is negative, then the
economy is viewed to be underperforming and demand
pressures on inflation are low. If the output gap is positive,
the economy is viewed to be overheating and demand
pressures are inflationary.
Producer price index (PPI): This index measures changes
in the prices of goods at the factory gate. Stats SA currently
produces five different indices that measure price changes
at different stages of production. Headline PPI is the index
for final manufactured goods. PPI measures indicate
potential pressure on consumer prices.
Productivity: Productivity indicates the amount of goods
and services produced in relation to the resources utilised
in the form of labour and capital.
Purchasing power parity (PPP): PPP is based on the law
of one price, assuming that in the long run, exchange rates
will adjust so that purchasing power across countries is
approximately the same. It is often used to make crosscountry comparisons without the distortionary impact of
volatile spot exchange rates.
Real effective exchange rate (REER): The REER is the
NEER adjusted for inflation differentials between South
Africa and its main trading partners. See ‘Nominal effective
exchange rate’.
Repurchase (repo) rate: This is the policy rate that is set
by the Monetary Policy Committee (MPC). It is the rate that
commercial banks pay to borrow money from the SARB.
Real repo rate: This is the nominal repo rate, as set by the
MPC, adjusted for expected inflation.
Taper tantrum: The term ‘taper tantrum’ is widely used
to describe the strong reaction of global financial markets
to comments by the US Federal Reserve (Fed) chairman
in May 2013 that the Fed would likely start to reduce (or
‘taper’) the pace of its asset purchases later that year.
Terms of trade: This refers to the ratio of export prices to
import prices.
Unit labour costs: A unit labour cost is the labour cost to
produce one ‘unit’ of output. This is calculated as the total
wages and salaries in the non-agricultural sector divided by
the real value added at basic prices in the non-agricultural
sector of the economy.
Monetary Policy Review April 2017

Abbreviations
AFE
average forecast error
Alsi
All-Share Index
BER
Bureau for Economic Research
BIS
Bank for International Settlements
BRICS
Brazil, Russia, India, China and South Africa
CAD
current account deficit
CDS
credit default swap
CPI
consumer price index
CPIX
consumer price index for metropolitan
and other urban areas, excluding the
interest cost on mortgage bonds
ECB
European Central Bank
EIA
Energy Information Administration
ELMI
Emerging Local Markets Index
EMBI+
JPMorgan Emerging Market Bond Index Plus
EU
European Union
FAO
Food and Agriculture Organization
FNB
First National Bank
Fed
United States Federal Reserve
FOMC
Federal Open Market Committee
G3
Group of Three
GDP
gross domestic product
IMF
International Monetary Fund
MPC
Monetary Policy Committee
MPR
Monetary Policy Review
MTBPS
Medium Term Budget Policy Statement
MYPD
multi-year price determination
NAB
non-alcoholic beverages
NERSA
National Energy Regulator of South Africa
OPEC
Organization of the Petroleum
Exporting Countries
PCE
Personal Consumption Expenditure
PMI
Purchasing Managers’ Index
PPI
producer price index
RCA
Regulatory Clearing Account
REER
real effective exchange rate
repo (rate) repurchase (rate)
RMB
Rand Merchant Bank
RMSE
root mean square error
S&P
Standard and Poor’s
SACU
Southern African Customs Union
SARB
South African Reserve Bank
SOCs
state-owned companies
Stats SA
Statistics South Africa
TPP
Trans-Pacific Partnership
UK
United Kingdom
ULC
unit labour cost
US
United States
WGBI
World Government Bond Index