Monetary Policy
Review
October 2012
Monetary Policy
Review
October 2012
Monetary Policy Review October 2012
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Monetary Policy Review October 2012
Preface
The primary mandate of the South African Reserve Bank (the Bank) is to achieve and maintain
price stability in the interest of balanced and sustainable economic growth. Low inflation helps
to protect the purchasing power and living standards of all South Africans. Price stability or low
inflation reduces uncertainty in the economy and provides a favourable environment for growth
and employment creation. The Bank additionally has a complementary mandate to oversee and
maintain financial stability.
Price stability is quantified by the setting of an inflation target range by government after
consultation with the Bank. The commitment is to pursue a continuous target of 3 to 6 per cent
for headline CPI inflation. The Bank conducts monetary policy within a flexible inflation-targeting
framework that allows for inflation to be temporarily outside the target range as a result of supply
shocks. The Monetary Policy Committee (MPC) takes into account a viable medium-term time
horizon for inflation to return to within the target range, considering the lags between policy
adjustments and economic effects. This provides for interest rate smoothing over the cycle, and
makes growth more sustained and consistent.
The Monetary Policy Review (MPR) is published twice a year, and is aimed at broadening the
understanding of the objectives and conduct of monetary policy. The MPR reviews domestic
and international developments that have impacted on inflation, and that motivate the monetary
policy stance. The MPR also provides an assessment of the outlook for, and the factors
determining inflation and the Bank’s forecast of the future path of inflation and economic
growth. The MPR is presented by senior officials of the Bank at Monetary Policy Forums (MPFs)
in various centres across South Africa to develop a better understanding of monetary policy
through interaction with stakeholders.
Monetary Policy Review October 2012
Contents
Monetary Policy Review


Statements issued by Gill Marcus, Governor of the South African Reserve Bank
Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Boxes


Figures


Monetary Policy Review October 2012


B1.1


Remuneration per worker, labour productivity and unit labour cost in the


B5.1 Trends in industrial production for South Africa, the United States,


B7.1


Tables


B7.1

Monetary Policy Review October 2012
Introduction
The previous MPR was published in May 2012 at a time of heightened uncertainty and deep
concern about the risks posed to the global and domestic economy from developments
unfolding in Europe and elsewhere. The global economic crisis has not eased appreciably since
then and global economic growth momentum has moderated. A slowdown in major emergingmarket economies (EMEs), in particular China and Brazil, has been prolonged by weaker-thanexpected growth in the United States (US) and sustained recession in many euro area countries
and the United Kingdom (UK).
This MPR marks a point where renewed efforts are being made by central banks in the US, the
euro area and Japan to moderate or reverse the deterioration in global economic conditions
and intensification of financial market tensions. These efforts are important steps forward,
but as ongoing turmoil suggests, are merely part of a long series of ameliorative steps that
still need to be taken. Improvements can be discerned in some key markets, such as in US
housing, but these instances of positive outcomes remain overshadowed by a range of policy
and co-ordination risks. As a result, market volatility remains high and negative spillovers to real
economic activity and confidence are likely to continue in coming months.
While emerging markets continue to provide upward impetus to global growth rates, prospects
have deteriorated in the face of weakening external demand. Global gross domestic product
(GDP) growth estimates have been revised downwards.
Subdued economic growth, weak demand and lower commodity prices have softened
inflationary pressures in many countries. The already relatively benign global inflation outlook
is expected to moderate further in 2013. However, supply-side shocks from higher food prices
and volatile international oil prices continue to pose a serious risk to the inflation outlook. A few
countries have cited concerns about near-term inflationary pressures.
Many central banks have kept policy rates unchanged at low levels. A significant number
of advanced and emerging economies have eased policy as growth fell off or implemented
additional unconventional measures, while only a few have tightened policy.
Both global and domestic factors have shaped the outlook for the South African economy.
Output in the primary sector in the first half of 2012 was volatile and growth in the secondary
sector weakened. Household consumption has moderated. Gross fixed capital formation grew
at a reasonable pace of 6,1 per cent, with greater impetus provided by government. Subdued
credit extension picked up speed in September. Employment levels increased up to the middle
of 2012, but industrial unrest in the mining sector suggests a worsening of prospects for the
third and fourth quarters of this year. The impact will be exacerbated if confidence weakens
significantly in other sectors of the economy.
Recent high-frequency data point to a moderation in domestic economic activity from the second
to third quarter of 2012. The Bank’s forecast for growth has been revised marginally downwards
over the three-year forecast period to 2014. The South African economy is expected to grow by
2,6 per cent in 2012 and 3,4 per cent in 2013. The probability of future growth and financial shocks
from global developments remains high and further risks are likely to be on the downside.
Headline consumer price inflation has been within the target range since May 2012. Better
inflation outcomes, easing food and petrol prices, and somewhat weaker growth prospects
shaped the decision by the MPC to adjust the repurchase rate down by 50 basis points at the
July 2012 MPC meeting.
The Bank’s inflation outlook, which had improved up to the July meeting of the MPC, suggests
a moderate re-acceleration of inflation over the short to medium term. Headline CPI inflation is
still expected to remain below the upper level of the target band, however, and should settle
down into a flat trajectory over the 2013–14 forecast period. Upside pressure in coming months
is expected to emanate from oil and food price increases, despite demand pressures remaining
relatively benign.
Monetary Policy Review October 2012

Slowing world growth, sustained capital investment, and higher dividend payments to nonresidents have contributed to a rapid but probably temporary widening in the current-account
deficit. At the same time, concerns over developments in the mining sector appear to be a
primary factor behind strong sales of South African equities by non-resident investors. Moody’s
Investors Service and Standard & Poor’s lowered South Africa’s credit rating in September 2012
and October respectively, citing rising political risk, slower economic growth and a weakening
in government finances as factors motivating the downgrades.
Having, on balance, depreciated significantly over recent months by 14 per cent, partly driven
by these factors, the exchange rate continues to pose risks to the inflation outlook. Domestic
risks include future wage developments, food prices and, on the downside, weaker confidence
and growth. The risks to the overall inflation forecast are assessed to be more or less balanced.
The MPR analyses the latest developments in inflation and the factors that affect inflation. It
reviews recent monetary policy developments, discusses the outlook for inflation, and presents
the growth and inflation forecast of the Bank. In addition, topical issues are addressed in boxes.
The first box reviews the drivers of, and outlook for, food price inflation in South Africa. The
second box reviews recent economic reforms in India. The third considers the importance of
oil and South Africa’s exposure to this commodity. The fourth box estimates the equilibrium
value of the real effective exchange rate of the rand. The fifth measures the size of international
spillovers to South Africa, the sixth quantifies the looming fiscal cliff in the US and the seventh
box provides an updated evaluation of the accuracy of the Bank’s inflation forecasts.
Recent developments in inflation
This section reviews recent trends in the main inflation indices and looks at the main factors
impacting on inflation in South Africa.
The evolution of inflation indicators
Headline consumer price inflation, the targeted inflation rate, has been within the target
range since May 2012 as a result of subdued global price inflation and weak domestic price
pressures. Headline inflation surprised on the downside as it decelerated to a short-term
low point of 4,9 per cent in July before ticking up to 5,0 per cent in August and 5,5 per
cent in September. International food prices, and domestic food and petrol prices rose and
remain volatile due to widespread drought and geopolitical factors respectively. The rate of
increase in electricity tariffs, however, moderated in 2012 as regulators agreed to a lower
increase for the year compared to what had been expected. Core inflation is expected to
remain well contained.
Targeted inflation
The year-on-year percentage change in the headline consumer price index (CPI) decelerated
markedly from 6,1 per cent in April 2012 to 4,9 per cent in July before increasing to 5,5 per cent
in September (Figure 1). Since May, headline CPI inflation has continuously been within the
inflation target range.
Slowing increases in the prices of goods have pulled down the overall inflation rate as goods
price inflation moderated from 6,3 per cent in April 2012 to 5,2 per cent in September. Within the
goods category, however, prices of non-durable goods have raised the headline inflation rate.
Prices of semi-durable goods rose by only 2,1 per cent over the twelve months to September,
while durable goods prices continued to fall over this period. Prices of durable goods declined
by 0,1 per cent in the year to September. Services inflation remained stable and within the target
range at just below 6 per cent from April 2012 to September.
A further breakdown of the price categories shows that housing and utilities, transport, and
food remain the three largest contributors to consumer price inflation as a result of relatively
rapid price increases and their weight in the index (Table 1). After considerable moderation in
these contributions from April to August 2012, there was a reversal in September.

Monetary Policy Review October 2012
Percentage change over 12 months

Figure 1
Consumer price inflation: Targeted inflation*
* CPIX for metropolitan and other urban areas until the end of 2008; CPI for all urban
areas thereafter
Source: Statistics South Africa

Table 1
Contributions to targeted inflation
Percentage change over 12 months* and percentage points

Weights
Apr
May
Jun
Jul
Aug
Sep

Of which:

Sources: Statistics South Africa and own calculations
Food prices
As seen in Table 1, food prices have been a primary driver – both up and down – of South Africa’s
consumer prices over the past year. The pass-through of international food prices into domestic
prices has been relatively strong for the 13 months leading up to June 2012, when it decelerated
to 6,0 per cent from the 9,1 per cent reached in April. Food price inflation further moderated to
5,1 per cent in August, before increasing to 6,1 per cent in September (Figure 2). Bread and cereals,
and meat prices in particular slowed sharply in July and August. This reversed in September when
bread and cereals prices increased by 6,9 per cent and meat prices by 7,7 per cent.
The downward trend in food prices appears to have been stopped by the unexpectedly severe
drought in the US that has had a significant impact on international food commodity prices. The
US has experienced the worst drought since the 1950s and agricultural production, especially
for maize and soya beans, has been severely affected. Dry conditions will also hurt spring wheat
production in Russia and Kazakhstan. Agricultural prices have risen significantly and remain
at elevated levels. These rose sharply during June and July before levelling off in August. The
result of the step change in prices already became visible in September and could continue to
be reflected in increased bread and cereals prices, and meat price rises in coming months. (See
Box 1 for drivers of, and outlook for, food price inflation in South Africa.)
Monetary Policy Review October 2012

Percentage change over 12 months
Figure 2
Targeted inflation* and food inflation
All food items
Vegetables
Bread and cereals
Targeted inflation measure
Meat
-10

* CPIX for metropolitan and other urban areas until the end of 2008; CPI for all urban areas thereafter
Source: Statistics South Africa

The international price increases have led to higher prices for local agricultural commodities,
with steep increases seen in June and July 2012. After falling by 27 per cent from late March
to early June, the price of white maize more than fully reversed the decline by rising by almost
41 per cent from June to July. The price rose from R1 972 per ton in June to R2 774 at the
end of July. It then stabilised at around R2 700 during August before moderating to a still-high
R2 450 in October (Figure 3).

Rand per ton
Rand per ton
Figure 3
Selected commodity prices


White maize SAFEX spot price
Wheat SAFEX spot price

Note: The top grey line is the import parity price and the bottom grey line is the export parity
price. These prices are the theoretical upper and lower bound prices for commodities.
Source: Grain South Africa

Monetary Policy Review October 2012
For now, the closeness of the domestic maize price to the export rather than the import parity
price augers well for domestic food inflation, but the sustainability of this situation depends on
the size of the local harvest.
Drought, low production levels, higher demand and quality concerns about wheat harvests
in Europe and the US have also impacted on local wheat prices. The price of wheat, which
remained close to import parity, rose by 27 per cent in June and July, from R2 865 per ton early
in June to R3 646 per ton in late July. Wheat prices have since levelled off at a high level last
experienced on occasion in the first half of 2011.
Petrol prices
Lower international oil prices led to a decrease in petrol prices during June and July 2012
(Figure 4). The price of 95 octane unleaded petrol in Gauteng fell by R1,40 per litre before almost
fully reversing in the months to October by R1,38 per litre to R12,20 per litre as a result of increased
oil prices and a slightly weaker exchange rate. Petrol price inflation slowed from 20 per cent in
April 2012 to 8,9 per cent in July before accelerating to 17,6 per cent in September.
Cents per litre
Cents per litre
Figure 4
South African petrol price

Exchange rate
Over (-)/Under (+) recovery
Movement in international product prices
Price change
Basic fuel price
Other levies
Fuel levy
Margin
Road Accident Fund
Gauteng price of 95 octane unleaded petrol


Source: Department of Energy
Contributions to the change in
the petrol price
Level
Core inflation
Core inflation remained well contained in 2012 (Figure 5) despite considerable food and petrol
price changes. When broader demand pressures remain modest, volatility in such prices may
have more muted effects on core measures than a sustained upward trend. Second-round
effects of the exogenous drivers of the inflation process have therefore remained moderate. This
Monetary Policy Review October 2012

can be seen in the various core measures, in particular the CPI excluding food, non-alcoholic
beverages, petrol and energy prices, which was the most stable, averaging 4,6 per cent from
April 2012 to September.
Percentage change over 12 months

* NAB: Non-alcoholic beverages
Source: Statistics South Africa
Figure 5
The effect of food, petrol and energy prices on

headline inflation
CPI excluding food and NAB* prices
CPI excluding food, NAB and petrol prices
Headline inflation
CPI excluding petrol prices
CPI excluding food, NAB, petrol and
energy prices

Administered prices
In contrast to core measures, administered price inflation as measured by the administered
price index (API) remained high and above the upper limit of the inflation target range between
April and September 2012. Twelve-month API did moderate considerably, by 4,1 percentage
points from 11,6 per cent in April to 7,5 per cent in July (Table 2) in line with a fall in the petrol
price contribution from 4,8 percentage points in April to 2,0 percentage points in July.

Table 2
Contributions to administered prices
Percentage change over 12 months* and percentage points
Weights

CPI
API
Apr
May
Jun
Jul
Aug
Sep

Regulated component

Unregulated component

Primary and secondary

Source: Statistics South Africa

Monetary Policy Review October 2012
The contribution of electricity also declined by 1,1 percentage points from April to July.
The revised tariff increase for electricity set out in March only appeared at the municipal
consumer level by August. Following the municipal adjustment, the contribution of electricity
to API increased to 1,8 percentage points in August and September. Thereafter, API rose to
9,8 per cent during September, boosted by the increase in petrol prices to a contribution of
4,1 percentage points.
Producer prices
The producer price index (PPI) measures the price changes of goods produced in South
Africa at the factory gate. Although the classification standard for the PPI and CPI differs,
some PPI categories such as food give an indication of forthcoming consumer price
pressures. The prices for domestic output moderated from 7,2 per cent in March 2012
to 4,2 per cent through to September – their lowest rate of increase since March 2010
(Figure 6). This outcome was in line with declining international commodity prices and was
accounted for by significant declines in mining and quarrying inflation from 6,6 per cent in
March to -0,1 per cent in September, and inflation in prices of products of petroleum
and coal from 19,1 per cent to 10,4 per cent over the same period but with a low of
5,6 per cent in July. Electricity price inflation moderated from 27,6 per cent to 13,3 per cent over
this period.
Percentage change over 12 months

Details regarding changes to the PPI in this period are documented in statistical release
P0142.1, February 2008, issued by Statistics South Africa
Source: Statistics South Africa
Figure 6
PPI for domestic output and imported commodities
Domestic output
Domestic output: Electricity
Imported commodities

-30
-20
-10

Inflation of imported commodities fell slightly more, from 9,9 per cent in March 2012 to
4,4 per cent in August, as crude petroleum, natural gas, and mining and quarrying inflation
decreased. It then increased sharply to 9,4 per cent as mining and quarrying more than doubled
to 25,1 per cent.
Food price inflation at the agricultural level continues to be volatile, with a low of 2,3 per cent
in May followed by a rise of 6,3 per cent in September (Figure 7). Food price inflation at the
manufacturing level fell to 7,7 per cent in June 2012 from 9,6 per cent in March before rising
to 10,1 per cent in September. These movements were driven mainly by changes in meat and
meat products, and grain mill and bakery products.
Monetary Policy Review October 2012

Percentage change over 12 months
Source: Statistics South Africa
Figure 7
Food prices in the PPI and CPI


PPI: Food at agricultural level
PPI: Food at manufacturing level

CPI: Food
Box 1:
The drivers of, and outlook for, food price inflation in South Africa
South Africa’s food price inflation has tended to rise and fall with a significant lag to movements
in international grain and food prices (Figure B1.1). This asynchronous adjustment to global
prices may reflect South Africa’s domestic food production conditions and lags in the transmission
of imported food prices into the wholesale and retail food industry. Food price inflation, with a
weight in CPI of 14,27 per cent, contributed 0,9 percentage points or 6,1 per cent, on average,
to targeted inflation in the twelve months to September 2012.
Percentage change over 12 months
Figure B1.1 Food price inflation
South Africa CPI: Food
FAO food price (right-hand scale)
FAO cereals prices (right-hand scale)
-5

Sources: Statistics South Africa and FAOSTAT

-50
-25

Globally, food prices increased sharply to high levels in the first half of 2008 and again from the
latter part of 2010 (Figure B1.2). The food price index of the Food and Agricultural Organization
(FAO) of the United Nations (a measure of change in the international price of a basket of food
commodities) was still high in September 2012 although 22 index points below the peak of
February 2011 and 9 index points lower than in September 2011.

Monetary Policy Review October 2012
International economic and policy developments
Monetary policy decisions are made on the basis of current and expected international
developments in the global economy. This section reviews medium-term developments, and
assesses the near-term outlook in terms of prospects, risks and uncertainties for inflation.
The price increases in 2012 have been driven by a range of factors, including supply
pressures caused by drought and rising international oil prices. Higher prices for maize, high
ethanol inventory levels and declining subsidies for ethanol appear to have taken some
steam out of demand for maize for energy production. In contrast, weather conditions are
impacting heavily on the US maize crop and wheat produced in Russia, leading to sharp
increases in international prices in recent months.
US dollar per barrel
Index: 2002–2004 = 100
Figure B1.2 Food and oil prices

FAO food price
Sources: Food and Agricultural Organization and Bloomberg
Price of Brent crude oil (right-hand scale)

Globally, agricultural commodities are mostly priced in US dollars and, together with movements
in the exchange rate of the rand and domestic production conditions, these factors largely
determine domestic prices. Currency weakness in recent months is likely to put upward pressure
on domestic food prices.
Local food production costs are also strongly influenced by oil prices. The FAO food price index
and the monthly price of Brent crude oil exhibit a strong correlation of more than 90 per cent
(Figure B1.2). The volatile and elevated price of crude oil affects food prices through transportation
costs; diesel for field crops and crude oil in fertilisers; and the reallocation of land use for biofuels.
In South Africa production costs have become more sensitive to changes in the crude oil price,
with the share of costs accounted for by fertilisers in the production of maize roughly almost
doubling from 1999/2000 to 2009/10. Other domestic cost–push pressures arise from high
electricity, and thus refrigeration costs and wage increases.
As a price taker in the global commodities markets, South Africa’s food prices are affected by
import and export parity prices. Exposure increases when buffer stocks are depleted due to bad
harvests or exports. When domestic agricultural production is supplemented through imports (as
in the case of wheat), prices gravitate higher towards import parity. However, most of the
products such as soya beans, sunflower seeds, sorghum and maize tend to trade closer to
export parity. At this point in time, South Africa’s final crop estimate for maize in 2011/12 looks
fairly robust.
Monetary Policy Review October 2012

International economic developments
The modest pace of the global recovery seen in early 2012 has slowed significantly. Economic
growth in all major economic centres, advanced and emerging markets has been lower than
expected. Fiscal austerity has dampened growth in Europe and negative spillovers from one
economy to another have been significant, resulting in a sharp slowdown in world trade and
reduced cross-border lending. Previously fast-growing emerging markets have also slowed
and policy levers have been eased to support growth. Recent monetary policy measures by
major central banks may help to put a floor under the current deceleration in global growth.
With uncertainty weighing on confidence and sentiment, the global economy continues to
expand at a very modest pace. Global real GDP is projected by the International Monetary Fund
(IMF) to slow from 3,8 per cent in 2011 to 3,3 per cent in 2012, revised down from 3,5 per cent
earlier in 2012. World growth in 2013 is expected to be marginally higher at 3,6 per cent. Table
3 shows the downward revisions over the year to forecasts for growth.
Table 3
IMF projections of world growth and inflation for 2012 and 2013*
Per cent
Real GDP
Consumer
prices

(3,5)
[3,5]
3,3
(4,1)
[3,9]

[1,4]
1,3
(2,0)
[1,9]

[2,0]
2,2
(2,4)
[2,3]

[2,4]
2,2
(1,7)
[1,5]

[-0,3]
-0,4
(0,9)
[0,7]

[0,2]
-0,4
(2,0)
[1,4]

[2,1]
1,9
(2,2)
[2,2]

[2,4]
2,1
(3,5)
[3,4]
3,0
2,2
2,4
Emerging-market and developing economies....
(5,7)
[5,6]
5,3
(6,0)
[5,9]

[5,4]
5,0
(5,3)
[5,3]

[2,6]
2,6
(3,4)
[3,3]

[1,9]
2,0
(2,9)
[2,8]

[4,1]
4,0
(4,1)
[4,1]

[7,1]
6,7
(7,9)
[7,5]

[8,0]
7,8
(8,8)
[8,5]

[6,1]
4,9
(7,3)
[6,5]

[5,5]
5,3
(3,7)
[3,7]

[3,4]
3,2
(4,1)
[4,2]
3,9
6,0
5,9
* IMF projections for 2012 as at April ( ) and July [ ] 2012 in parenthesis
Source: IMF World Economic Outlook, October 2012
Second-quarter outcomes for growth have been especially weak, particularly in Europe. The
German economy slowed sharply in the second quarter, while the French economy shrank by
0,1 per cent and that of the UK by 1,5 per cent. Export growth has been soft and unemployment
higher – in France reaching 3 million people. The UK recorded positive growth in the third
quarter boosted by the summer Olympics.
Greece, Spain, Italy, Cyprus and Portugal are all in recession. Greece’s GDP shrank by 6,3 per
cent year on year during the second quarter. Of the peripheral economies, Ireland has achieved
a more consistent recovery (Table 4).

Monetary Policy Review October 2012
Table 4
Real GDP growth in peripheral euro area countries*
Per cent
Share of
global GDP**


Forecasts for 2012 and 2013
** .GDP shares based on the IMF’s purchasing power parity valuation of country’s GDP for 2011
Source: IMF World Economic Outlook, October 2012
Emerging and developing economies will remain the driving force in the global economy as
China continues to expand, but their growth will likely moderate to 5,3 per cent in 2012 before
strengthening somewhat in 2013 to about 5,6 per cent. Developing Asia is still projected to grow
by about 7,0 per cent on average during 2012–13 despite scaled-back expectations.
China’s economy is expected to achieve a soft landing, in part because of a shift to a more
aggressive pro-growth stance early in 2012. India’s economy was hit by a massive electricity
outage at the end of July and exports have been weaker than expected. Forecasts for India
have been lowered, while recently announced economic reform initiatives will take time to bear
fruit. (See Box 2 for a reflection on recent economic reforms in India.)
Growth estimates for advanced and emerging-market economies for 2012 and 2013 have been
lowered by magnitudes of between 0,1 and 0,5 percentage points. Growth in sub-Saharan
Africa remains buoyant, at 5,0 per cent in 2012 compared to 5,1 per cent in 2011.
The growth estimate for the US economy for 2012 was revised slightly upwards in October. The
euro area economy should contract by about 0,4 per cent in 2012 compared to growth of 1,4 per
cent in 2011, and achieve a lethargic 0,2 per cent in 2013. The major shift in the projections concern
Germany, where the growth rate has declined from 3,1 per cent in 2011 to an expected 0,9 per cent
in 2012 and 2013. The UK is expected to contract by 0,4 per cent in 2012, down from a meagre
expansion of 0,8 per cent recorded in 2011, and then to rebound to 1,1 per cent growth in 2013.
Figure 8
Evolution of real GDP forecasts for 2012 for the G-7 and euro area
Annual percentage change

United States

Germany
Source: Consensus Forecasts
Japan
France
United Kingdom
Italy
Euro area
Canada

Jan
Mar
May
Jul
Jul
Sep
Sep
Nov
Nov
Jan
Mar
May
-3
-2
-1

Monetary Policy Review October 2012

Leading indicators still offer little encouragement for better global growth prospects. The
composite leading indicator compiled by the Organisation for Economic Co-operation and
Development (OECD) projects a further contraction in the OECD economies. The JPMorgan
global manufacturing purchasing managers’ index (PMI) declined from 51,4 in April 2012 to
48,9 in September – below the 50 mark that separates expansion from contraction.
The global inflation outlook continues to be relatively benign as the moderation of global
economic activity has been a persistent headwind to upward price movements. Industrial
commodity prices are likely to remain subdued until the recovery regains momentum. These
muted demand pressures contrast, however, with supply factors affecting food and oil prices.
The IMF projects that consumer price inflation in emerging and developing countries will
decelerate marginally from 6,1 per cent in 2012 to 5,8 per cent in 2013.
Box 2: India’s September 2012 announcements on economic reform
India responded to stagflation1 and the current-account and fiscal deficits with the following
reforms to facilitate fiscal consolidation, and to attract capital inflows to encourage privatesector investment:
––
Reduced subsidies with the increase in the retail price of diesel by Indian rupees (INR)
5,00 per litre, or 13,5 per cent, and limiting cooking gas to six cylinders per customer
per year.
––
Introduced foreign direct investment (FDI) into the multi-brand retail sector with a cap of
51 per cent sanctioned by individual states and facilitating direct sales to Indian
consumers.
––
Relaxed conditions on 100 per cent FDI in single-brand retail by making the 30 per cent
of the value of products sold, sourced from local, small-scale manufacturers optional.
––
Liberalised FDI regulations by raising the maximum limit for foreign ownership in the
broadcast sector from 49 per cent to 74 per cent and permitting foreign carriers to buy
up to a 49 per cent stake in domestic airlines.
––
Government equity disinvestments of around 10 per cent in five public corporations with
a fiscal 2012–13 target of INR300 billion.
A second wave of reforms to open up the insurance and pension sectors to higher levels of
foreign investment (from 26 to 49 per cent), the Companies Bill, and amendments to laws
governing competition requires parliamentary approval.
1.
Slow economic growth and stubborn inflationary pressures.
Oil price developments
Crude oil prices remain volatile and threaten already-fragile global economic conditions.
A moderation in prices in the second quarter of 2012 has been followed by increases in
recent months, primarily in response to geopolitical tensions in the Middle East but also to
monetary policy easing in major economies. Global oil supply at 90,8 million barrels per day
in the second quarter of 2012 outstripped demand of 89,0 million barrels per day.
At current levels, oil prices remain high in nominal and real terms (Figure 9). In 2008 the annual
average real oil price almost reached the record level set in the early 1980s before declining due
to sharply lower demand for oil in 2009. However, as the global recovery resumed in 2010, the
annual average real oil price at first rose abruptly to a level close to that recorded in the early
1980s and thereafter ascended further to a new record level. (See Box 3 for the importance of
oil and an analysis of South Africa’s exposure to oil.)

Monetary Policy Review October 2012

-2

Figure 9 World real GDP* and the real price of oil
US dollar per barrel
Per cent

World real GDP growth

Annual average price of Brent crude oil (real US$, 2011 prices) (right-hand scale)
* Estimates for 2012
Sources: IMF World Economic Outlook, October 2012; Bloomberg; own calculations; and US Department of Labor,
Bureau of Labor Statistics
-30

The international oil price gradually trended lower (Figure 10) throughout most of the second
quarter of 2012, declining by almost 30 per cent from a high in March to an 18-month low of
US$88 per barrel towards the end of June. The price of Brent crude oil then rebounded from
an average of US$96 per barrel in June, fluctuating between US$97 and US$118 as it gradually
increased to an average of US$113 in October. Towards the end of October the dollar oil price
was only about 14 per cent below the high in March 2012 but almost 25 per cent below the
peak in 2008 at the onset of the financial crisis.
Figure 10
Price of Brent crude oil

US dollar per barrel

Brent crude spot price

Futures prices (19 July 2012)

Futures prices (20 September 2012)

Futures prices (latest: 25 October 2012)
Source: Bloomberg

Monetary Policy Review October 2012

The rebound and volatility in the crude oil price reflect the net effect of various developments.
The Organization of the Petroleum Exporting Countries (OPEC) forecasts stable oil demand
growth in 2012 while the International Energy Agency (IEA) lowered its demand projections due
to weaker economic growth. Prices have been supported, alternatively, by policy stimulus by
advanced countries and China. Decreases in US crude oil stockpiles, maintenance on North
Sea oil rigs, revived geopolitical tensions and sanctions on Iranian output have supported prices
from the supply side of the market.
Box 3:
Does the oil price still matter? South Africa’s exposure
Oil price trends and volatility affect medium-run growth and inflation outcomes worldwide.
Over the longer term, oil price shocks can generate offsetting economic adjustments
that, in turn, determine economic outcomes from future shocks. In particular, economic
adjustment can result in lower energy intensity1 or a lower oil burden2 in oil-importing
countries, reducing the economic impact of fluctuating oil prices. Insufficient economic
adjustment can occur if oil price shocks are muted by excessive smoothing of prices or
the high cost of technological change, sustaining negative effects from price movements.
South Africa was among the ten countries in 2011 with the highest energy intensity, at
0,299 koe/US$05p. This is slightly worse than China at 0,266 and much worse than
the UK, which ranked second best at 0,093 among the ten lowest-intensity-ranked
countries.3
The oil burden measures the spending of an economy on oil compared to the value of all
economic activity. When the nominal value of oil imports rises faster than nominal GDP, the
economy becomes more vulnerable to oil price shocks. The oil burden for most economies
rose sharply prior to 2008, before falling as the recession and financial crisis set in. As of
February 2012, the oil burden neared its 2008 levels.4 The International Energy Agency (IEA)
estimates the oil burden to reach a record level of 2,3 per cent of GDP in the Organisation
for Economic Co-operation and Development (OECD) countries in 2012, increasing by
0,2 percentage points for each US$10 per barrel increase in the oil price.5
The oil burden of selected advanced, emerging and developing economies and regions
(Figure B3.1) shows an increase from the average for the period 1990–2010 to 2011 and
a further slight increase for most countries in 2012. South Africa’s oil burden (i.e., crude
oil and refined imports net of exports) has increased more than two-fold from 1,4 per
cent in 1998 to 3,4 per cent in 2011 (Figure B3.2). The oil burden has increased by about
0,28 percentage points of GDP for each US$10 per barrel increase in the oil price.
South Africa’s oil burden is slightly higher than that of most of the advanced countries
and significantly lower than that of some of its oil-importing BRICS peers. Compared to
OECD economies, South Africa’s adjustment potential to lower energy intensity appears
to be large, with both adjustment costs and a lower oil burden attainable.
1.
Energy intensity is measured as units of primary energy consumption per unit of GDP at constant US dollar
purchasing power parities.
2.
Oil burden is an oil price vulnerability indicator, calculated as the ratio of nominal oil expenditure (volume
multiplied by average price) to nominal GDP.
3. Enerdata, “Energy Intensity of GDP at Constant Purchasing Power Parities”, Global Energy Statistical
Yearbook 2012 (London: Enerdata, 2011,
region.html). The following, koe/US$05p, is defined as a kilogram of oil equivalent at constant 2005 US$
purchasing power parity prices.
4. J Blas, “Soaring Crude Price Threatens Recovery”, Financial Times (24 February 2012).
5. F Birol, “The Impact of High Oil Prices on the Economy”, World Energy Outlook (Paris: International Energy
Agency, April 2012, O:
accessed 5 June 2012).

Monetary Policy Review October 2012
International monetary policy developments
In 2011 many central banks tightened monetary policy as economic growth resumed and
inflation pressures surfaced. Major world economies eased policy in 2012 in response to the
slowing recovery and moderating inflation. Some economies have been undermined by a
Figure B3.1
The oil burden in selected countries and regions
Percentage of GDP

1990–2010 (average)
Advanced economies: European Union, United States, Japan
BRICS: India, China, South Africa
Emerging-market and developing economies: China, India, South Africa, Turkey
Sources: International Energy Agency (IEA) for European Union and all others World Economic Outlook
database, October 2012

Turkey
South
Africa
India
Japan
China
United
States
European
Union

-2

Figure B3.2
The oil burden and economic growth in South Africa
Ratio in percentage of GDP
Per cent

Real GDP growth

South Africa’s oil burden (Net imports minus exports) (right-hand scale)
Sources: South African Reserve Bank and World Economic Outlook database, April 2012
Downward phases of the business cycle

Monetary Policy Review October 2012

combination of domestic demand weaknesses and external vulnerabilities, such as financial
instability and falling exports. Others have been primarily exposed to external shocks and
negative spillovers, particularly declining demand, lower commodity prices and a retraction
of cross-border lending. Authorities in some of the advanced economies have tended to
pursue more aggressive easing policies and unconventional measures. All central banks have
expressed concern about the threat posed by a further slowdown in global economic growth.
In the US the Federal Open Market Committee (FOMC) of the Federal Reserve (the Fed) kept the
target range for the federal funds rate unchanged at zero to 0,25 per cent but indicated that US
economic conditions would continue to warrant exceptionally low policy rates, at least through
to mid-2015. In June 2012, the Fed extended the maturity extension programme (so-called
Operation Twist) to the end of the year. The FOMC further decided to continue purchases of
additional mortgage-backed securities at a pace of US$40 billion per month. These actions are
intended to put downward pressure on longer-term interest rates, support the mortgage market
and help to make broader financial conditions more accommodative.
Table 5
Selected central bank interest rates
Per cent
Countries
24 May 2012 25 Oct 2012
Real
interest
rate
Latest decision
Cumulative
for 2012
Interest rate change in percentage points
0,00 – 0,25
0,00 – 0,25
-1,75 – -2,0
24 Oct 2012

5 Oct 2012

4 Oct 2012

4 Oct 2012

23 Oct 2012

5 Jul 2012

25 Oct 2012

29 Aug 2012

13 Sep 2012

2 Oct 2012

25 Oct 2012

24 Sep 2012

6 Jul 2012

17 Sep 2012

11 Oct 2012

6 Sep 2012

25 Oct 2012

25 Oct 2012

20 Sep 2012

17 Oct 2012

10 Oct 2012

18 Oct 2012

7 Sep 2012

27 Sep 2012

25 Sep 2012

3 Oct 2012

5 Oct 2012

18 Oct 2012

3 Oct 2012

18 Sep 2012
(0,00)
(0,00)
Sources: National central banks and own calculations

Monetary Policy Review October 2012
Quantitative easing was also continued by other central banks. On 4 October 2012 the MPC of
the Bank of England (BoE) maintained the already-record-low official bank rate at 0,5 per cent
and increased the asset purchases programme by £50 billion to £375 billion on 5 July 2012.
Asset purchases could be increased further subject to the impact of the governments’ creditboosting programme, the £80 billion Funding for Lending Scheme (FLS) and other purchases of
high-quality private-sector securities.
Per cent

Figure 11
Selected policy rates

South Africa
Euro area
Brazil

China
Sources: National central banks
The Governing Council of the European Central Bank (ECB) reduced rates by 25 basis points in
July 2012 and announced in September that it would undertake outright open-market operations
and further non-standard monetary policy measures to repair monetary policy transmission and
to equalise sovereign borrowing costs across the euro area. The outright monetary transactions
(OMTs) bond-buying programme, set up in place of the Securities Market Programme (SMP),
provides for unlimited purchases of euro area countries’ bonds with maturities of one to three years
in the secondary market and for purchases of sovereign debt in the primary market of countries
that have obtained EFSF/ESM support, once they have regained bond market access. The ECB
further widened eligible collateral and lowered rating thresholds to ease collateral standards.
Policy efforts were supported in Europe by the June 2012 Euro Area Summit, which proposed
to establish a single supervisory mechanism for banks in the euro area, backed by the ECB.
In September the German Federal Constitutional Court ruled that Germany could legally
participate in European Union (EU) rescue funds and budget agreements but that the German
Federal Parliament, the Bundestag, must approve liabilities exceeding €190 billion. In the interim,
assistance was provided to Spanish banks from the European Financial Stability Facility (EFSF),
which was replaced with the European Stability Mechanism (ESM) on 8 October 2012.
In September 2012 the Bank of Japan (BOJ) increased its asset purchase programme
and lending facility, currently its key monetary easing tool, by ¥10 trillion (US$127 billion) to
¥80 trillion. The BOJ announced that it would expand the asset-purchase fund to ¥55 trillion
(US$695 billion) from ¥45 trillion but kept its lending facility at ¥25 trillion.
Inflation in China has declined significantly since January 2012 and, despite constraints
imposed by the housing market, has allowed the People’s Bank of China to reduce lending
rates by about 56 basis points. In addition, the use of 7- and 14-day reverse repurchase (repo)
contracts temporarily injected 826 billion yuan (US$130 billion) into the financial system. The
reserve requirement ratio for banks, which was lowered sharply earlier in 2012, has remained at
20 per cent since mid-May.
Monetary Policy Review October 2012

In October 2012 Brazil’s Monetary Policy Committee (COPOM) reduced the Selic rate for a tenth
consecutive time by 0,25 percentage points to a record-low 7,25 per cent, bringing the total
reduction since August 2011 to 475 basis points. Inflation is expected to reach 5,2 per cent in
2012, while growth has slowed to about 1,5 per cent, the largest drop in growth of any major
emerging-market economy.
Russia’s central bank raised all its key interest rates by 25 basis points in September in response
to risks of exceeding its medium-term inflation target.
Domestic economic developments
and growth outlook
Monetary policy decisions are made on the basis of current and expected domestic
developments in the wider economy. This section reviews medium-term developments, and
assesses the near-term outlook in terms of prospects, risks and uncertainties for inflation.
Exchange rate developments
Globally, the downward shift in growth prospects and abrupt changes in risk perceptions in
the financial markets led to volatility in both portfolio flows and currencies. For much of 2012,
South Africa experienced a deterioration in investor sentiment, a wider current-account
deficit and an overall declining trend in commodity prices which have resulted in rand
weakness. This was, however, countered to some extent by strong bond inflows, boosted
by global monetary easing and South Africa’s inclusion in the Citi World Government Bond
Index (WGBI). In September and October, however, rating agencies lowered South Africa’s
credit rating and maintained an investment grade with a negative outlook. The nominal
effective exchange rate (NEER) of the South African rand has, on balance, depreciated since
December 2010 by about 24 per cent.
Index: 2000 = 100 (foreign currency per rand)
Index
Rand per dollar
Rand per euro
Figure 12
Exchange rates of the rand

Rand per US dollar
Rand per euro (right-hand scale)
Nominal effective exchange rate of the rand (NEER)
Reuters/Jefferies CRB Total Return Index (right-hand scale)*
* The CRB Total Return Index tracks international commodity prices
Sources: Bloomberg and South African Reserve Bank

Monetary Policy Review October 2012
The exchange rate of the rand has fluctuated within a wide range against major currencies
in recent years, with differences in its movements against the euro and US dollar reflecting
changes in the euro/dollar exchange rate, which were, in turn, driven by shifting sentiment and
conditions in those major economies. Measured on a bilateral basis, the rand depreciated by
15 per cent against the euro from R9,85 per euro in mid-March 2012 to R11,32 on 25 October.
Similarly, the rand depreciated by 16 per cent against the US dollar from R7,48 per dollar at
the end of February 2012 to R8,70 on 25 October, reaching its lowest level since April 2009
(Figure 12). Against either currency, the rand weakened to levels around those achieved a year
ago in November 2011, when the respective exchange rates were R11,43 and R8,54.
Since the end of December 2010, the NEER of the South African rand has oscillated around
a depreciating trend.1 From November 2011 to mid-March of 2012, the NEER appreciated
by 9 points to an index level of 72, before depreciating again under the weight of deteriorating
global and domestic economic sentiment, with the NEER reaching 61 index points in
October 2012. Since June 2012, widespread industrial action has contributed to sales of
equities by non-resident investors and further depreciation against the US dollar, in contrast
to the appreciations experienced by some of the other emerging-market and commodity
currencies (Figure 13).

Indices: 1 November 2011 = 100
Nov
Dec
Jan
Feb

Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Figure 13
Exchange rate performance against the US dollar

South African rand

Canadian dollar


Sources: Reuters and own calculations

Australian dollar

Mexican peso
From January 2012 to 25 October foreign investors’ cumulative net purchases of bonds
amounted to R83 billion compared to R42 billion in 2011 as a whole (Figure 14). In contrast,
non-residents remained net sellers of shares in the year to October, as in 2011. A cumulative
R11,7 billion has been sold by non-residents in the year to 25 October 2012, compared to
net sales of R17,2 billion in the whole of 2011. The net sales of shares have been prompted
primarily by concerns about industrial unrest and the recovery in domestic economic activity,
given possible spillovers from the euro area crisis and weaker commodity prices.
1. The weighted
average exchange
rate of the rand is
based on trade in,
and consumption of,
manufactured goods
between South Africa
and its most important
trading partners. The
methodology
applied is described
in an article in the
December 2008 South
African Reserve Bank
Quarterly Bulletin.
The weighted average
exchange rate of the
rand is calculated
against 15 currencies.
The weights of the five
major currencies are in
brackets: euro (34,82),
US dollar (14,88),
Chinese yuan (12,49),
British pound (10,71),
and Japanese yen
(10,12). Index:
2000 = 100.
Monetary Policy Review October 2012


Figure 14
Non-resident net purchases of domestic securities and

risk aversion
Index
R billions

Net equity purchases
* Data up to 25 October 2012
Sources: JSE Limited and Bloomberg
Net bond purchases
VIX® (right-hand scale)

Jan
Mar
May
Jul
Jul
Sep
Sep
Nov
Nov
Jan
Mar
May

*
Some part of the currency weakness can be attributed to declining commodity prices, as
suggested by the alignment of the Reuters/Jefferies CRB Total Return Index with movements in
the rand as shown in Figure 12.2 The trend and volatility in the rand/US dollar exchange rate since
November 2011 have generally mirrored that of other emerging-market and commodity currencies
(Figure 13). For instance, all emerging and commodity currencies reversed the appreciations
experienced in the period November 2011 to April 2012 in the following period to June.
Subsequently, the initial appreciation of the South African rand against the US dollar was not as
strong as that of the other countries in the sample before deviating further. South Africa’s real
effective exchange rate (REER), as measured by the Bank for International Settlements (BIS),
followed the same trend (Figure 15), depreciating by about 11 per cent since the middle of 2011.3
(See Box 4 for an estimate of the equilibrium value of the real effective exchange rate of the rand.)
Indices: 2010 = 100

Figure 15
Real effective exchange rates

South Africa

Canada


Source: Bank for International Settlements

Australia

Mexico
2. The Reuters/
Jefferies CRB Total
Return Index reflects
a long-only, broadly
diversified investment
in commodities.
3. The BIS REER
indices include a
total of 61 entities,
including individual
euro area countries
and the euro area
as a separate entity.
The base year for
the indices is 2010
and the REERs are
geometric-weighted
averages of bilateral
exchange rates
adjusted by relative
consumer prices.

Monetary Policy Review October 2012
Box 4
Estimating the equilibrium value of the real effective exchange rate of the rand
The short-term value of a currency changes day to day as importers, exporters, and
other users and investors buy and sell currencies as part of their transactions. A longerterm equilibrium value for an exchange rate can be measured that relates key economic
fundamentals. Since this real equilibrium exchange rate cannot be observed directly, various
methods are used to measure and calculate it.
De Jager estimates the trend of the real equilibrium exchange rate using a vector error
correction model and a series of variables commonly found in the literature – a real interest
rate differential, a productivity measure, commodity prices, the fiscal balance and capital
flows.1 The long-run trend level enables a perspective on shorter-run movements and the
implied gap or extent of the over- or undervaluation.
The actual level of the REER continues to remain volatile, with the degree of misalignment
between the current real value of the currency and its equilibrium level illustrated in
(Figure B4.1). The graph suggests that, generally, in the absence of major exchange rate
shocks, the gap of the actual to its equilibrium value seldom exceeds 10 per cent on either
side of the equilibrium.
Per cent
Figure B4.1
The extent of over-/undervaluation of the real value of


the currency
-30
-20
-10

Undervaluation
Overvaluation

98 2000

The real equilibrium exchange rate was estimated to be nearly 20 per cent undervalued
relative to its fundamentals, towards the end of 2008 at the height of the global financial
crises. However, the exchange rate recovered quite strongly in relation to changes in
fundamentals in the subsequent years and registered an overvaluation of almost 10 per cent
towards the fourth quarter of 2010. The real equilibrium exchange rate then depreciated to
show a more than 3 per cent undervaluation in the last quarter of 2011 and, based on
assumptions for the current period, model estimates suggest the real equilibrium exchange
rate was fairly close to its equilibrium value at an overvaluation of between 2 and 3 per cent
in the second and third quarters of 2012 respectively. The decline in dollar-denominated
commodity prices and the deterioration in the productivity differential from the middle of
2011 were identified as the two key factors contributing to the more depreciated equilibrium
over the last few quarters.
1. “S de Jager, “Modelling South Africa’s Equilibrium Real Effective Exchange Rate: A VECM Approach”, South
African Reserve Bank Working Paper series (WP/12/02) (Pretoria: South African Reserve Bank, April 2012).
The VECM estimation technique basically consists of two components, the long-run relationship in level
terms and the short-run VAR component in first differences.
Monetary Policy Review October 2012

Labour markets
Employment levels increased at a slower pace in 2012 compared to 2011, with job creation
remaining consistent with the moderate pace of recovery in real economic activity. The
moderation in nominal unit labour costs in 2011 preceded a sideways movement in 2012
while average wage settlement rates moderated further. These developments may have
mitigated inflationary pressures but have done little to encourage direct job creation. The
outlook for wage growth in the wake of the events in the mining industry remains uncertain.
From the beginning of 2008 to the middle of 2010, nominal unit labour costs, a key measure of
cost–push pressures, increased rapidly, averaging 10,5 per cent on a quarterly basis. Between
March 2010 and June 2012, growth in nominal unit labour costs moderated significantly,
reaching 6,1 per cent in the second quarter of 2012 (Figure 16). Somewhat higher productivity
growth and moderating wage settlements appear to have contributed to this lower outcome.
Percentage change over four quarters

Figure 16
Remuneration per worker, labour productivity and

unit labour cost in the formal non-agricultural sector

Nominal unit labour cost

Labour productivity


Sources: Statistics South Africa and South African Reserve Bank calculations
-2

Remuneration per worker
Rand per US dollar
Figure B4.2
The actual and equilibrium rand per US dollar exchange rates

Rand per US dollar actual exchange rate
Rand per US dollar equilibrium exchange rate

98 2000

Monetary Policy Review October 2012
The third-quarter Andrew Levy Wage Settlement Survey of 2012 reported that the average
level of wage settlements had moderated from 8,2 per cent in 2010 to 7,7 per cent in 2011
and slightly further to 7,4 per cent in the first nine months of 2012 (Figure 17). Lower measured
and expected inflation and greater economic uncertainty may have contributed to moderation,
while the 7 per cent public-sector wage settlement for the current year and developments in
food, transport and electricity prices lent themselves to higher outcomes. Recent high wage
settlements in the mining sector could set a precedent for wage settlements more generally.
Per cent

2012*
Figure 17
Average annual inflation and wage settlements

CPI

* Data for 2012 are for the first nine months of the year
Sources: Andrew Levy Employment Publications and Statistics South Africa

Average wage settlements
Job creation in the formal sector has remained incremental. Total employment in the formal nonagricultural sector as reported by Statistics South Africa’s Quarterly Employment Statistics (QES)
survey improved somewhat, with consistent quarter-on-quarter increases over nine quarters to the
second quarter of 2012 (Table 6). In the four quarters to the second quarter of 2012, about 125 000
jobs were created. Total employment in the second quarter of 2012 was 339 000 more than the
recent low in the first quarter of 2010, but still lower than the level reached in the fourth quarter of 2008.
Table 6
Employment in formal non-agricultural industries
Thousands
Total employment
Industry

4th qr
1st qr
4th qr
1st qr
2nd qr


Financial intermediation, insurance, real-estate and

Source: Statistics South Africa Quarterly Employment Survey
Monetary Policy Review October 2012

Relatively consistent with the former survey, Statistics South Africa’s Quarterly Labour Force
Survey (QLFS) shows a moderate improvement in total employment and a decline in the
unemployment rate to 24,9 per cent in the second quarter of 2012 – slightly lower than the
25,7 per cent recorded in the second quarter of 2011 (Figure 18).
Per cent
Thousands

Figure 18
Labour market indicators

Total employment

Source: Statistics South Africa Quarterly Labour Force Survey


Unemployment rate (right-hand scale)
Real-estate and equity prices
Reflecting underlying economic conditions, the real-estate market remained subdued, with
a moderately positive rate of increase in nominal house prices and a slight decrease in the
average time that properties remain on the market. Domestic share prices scaled new highs
on the back of low interest rates, international monetary easing and stronger equity markets
in key economies, despite growth concerns and softer international commodity prices.
Underlying domestic economic conditions continue to weigh on the real-estate market. First National
Bank (FNB) house price growth has moderated as from April 2012 and in August Absa‘s House
Price Index recorded its first positive rate of change since December 2011 (Figure 19).
Percentage change over 12 months

-20
-10

Absa

Lightstone
Sources: Absa, First National Bank, Lightstone and own calculations
Figure 19
House prices

First National Bank

Absa: Real

Monetary Policy Review October 2012
Adjusted for inflation, real price changes have become slightly less negative as from May 2012
to a negative 4 per cent in September 2012. The third-quarter 2012 FNB Home Buying Estate
Agent Survey showed a small improvement in the average time that properties remain on the
market from 17 weeks and 4 days in the second quarter of 2012 to 15 weeks and 6 days in the
third quarter – still above the 8-week level deemed as representing a balance between demand
and supply.
The FTSE/JSE All-Share Price Index (Alsi) increased from a low 28 391 index points on 8 August
2011 to a high of 34 482 index points on 2 May 2012 – surpassing the previous record high of
22 May 2008 – and then scaled a number of successive record highs in subsequent months
to an all-time high 37 275 index points on 17 October. Over this period, the Alsi was supported
by the performance of the Industrial and Financial Indices but was held back by the Resources
Index which responded to lower international commodity prices (Figure 20). Compared to the
high point in May 2008, the 12 per cent nominal gain in the Alsi still yields an overall loss in
real terms.
Indices: 2 January 2007 = 100

FTSE/JSE:

All-Share Index

Industrial Index
Sources: JSE Limited, I-Net Bridge and own calculations
Figure 20
Domestic share price indices

All-Share Index: Real
Resources Index
Financial Index
The Alsi also followed the trend in global share prices and especially that of emerging-market
and developing countries (Figure 21), with global sentiment being influenced positively by
renewed monetary policy easing in response to global growth concerns amid the continuing
sovereign debt crisis in the euro area.
Monetary Policy Review October 2012

Indices: 2 January 2007 = 100

FTSE/JSE All-Share Index
Euro area (Dow Jones Euro Stoxx 50)
Brazil (Bovespa)
Australia (ASX All Ordinaries)
Figure 21
International share price indices*

United States (S&P 500)
Turkey (Istanbul)
Mexico (Mexico City IPC)
Canada (Toronto 300 Composite)
* Based on local currency share prices
Sources: JSE Limited and I-Net Bridge
Fiscal policy
Over the course of the global financial and economic crisis, fiscal authorities have implemented
a countercyclical policy that has been supportive of economic growth, and mindful of the need
to avoid unsustainable debt and tax burdens on future generations of South Africans. The fiscal
stance is projected to adjust to a slower growth environment to rebuild fiscal space over the
medium term.
The budget balance is expected to reach -4,8 per cent of GDP in the current fiscal
year 2012/13 before declining to -4,5 per cent in 2013/14 and -3,7 per cent in 2014/15.
Non-interest expenditure over the three years of the Medium Term Expenditure Framework
(MTEF) is expected to remain in line with the projections set out in the February 2012 budget.
Table 7
Public finance data
2011/12
2012/13
2013/14 2014/15 2015/16
Outcome
Budget
MTBPS
estimates
Medium-term estimates
Consolidated government* (R billions)

As a percentage of GDP

Includes national government, provinces, social security funds and selected public entities
**
National government
Source: National Treasury Medium Term Budget Policy Statement (MTBPS), October 2012 and Budget Review 2012

Monetary Policy Review October 2012
With spending on social programmes and infrastructure development maintained, real growth
in public expenditure is expected to amount to about 3,1 per cent a year over the MTEF. The
fiscal stance remains in line with the trajectory of the domestic recovery, providing support to
close the output gap without creating upward pressure on domestic prices.
Monetary conditions
Modest, single-digit growth in money supply and credit extension is consistent with the
recently observed moderate pace of domestic economic activity. In the first nine months
of 2012 money-supply growth increased slightly, while growth in credit extension to the
private sector remained fairly subdued before picking up speed in September. With the
exception of mortgages, the other categories of credit extension, especially general loans
and overdrafts, continued to record strong growth over the period under review, with the
ratio of household debt to disposable income increasing somewhat in the first half of 2012.
Total loans and advances to the private sector firmed to 9,2 per cent in the year to March 2012,
the highest level since early 2009, before moderating to 7,3 per cent in July followed by a slight
acceleration to 8,8 per cent in September 2012 (Figure 22). In real terms, growth in total loans
and advances have turned positive as from December 2011, increasing modestly to 3,2 per cent
in September 2012 – its fastest pace since January 2009.
Other loans and advances (i.e., general loans, credit card advances and overdrafts) accounted
for 70 per cent of the increase in total loans and advances in 2011, and continued to be the main
driver of growth in credit extension. General loans (inclusive of personal loans) have softened
somewhat from 19,2 per cent in March 2012 before recording a strong growth rate of 20,7 per
cent in September, while growth in overdrafts fell back sharply towards its longer-term trend.
Percentage change over 12 months
-20
-10

Figure 22
Banks’ loans and advances to the private sector by type

Total loans and advances

General loans

Credit card advances

Total loans and advances: Real

Instalment sale and leasing

Mortgages

Overdrafts

Growth in instalment sale and leasing finance, benefiting from strong vehicle sales and low
interest rates, continued to accelerate, and from April 2012 has exceeded that of total loans
and advances for the first time since early 2005. Growth in mortgage lending declined from
around the 2 per cent level in the first eight months of 2012 to 1,7 per cent in September, being
constrained on the demand side by continued weakness in the real-estate market and on the
supply side by weak profitability due to tight interest margins and non-performing loans.
Monetary Policy Review October 2012

Demand, output and expected growth
Economic activity in South Africa expanded at a firmer pace in the second quarter of
2012 due to a brisk, but probably temporary, recovery in the primary sector. However, the
rest of the economy lost some momentum as the secondary sector contracted and the
tertiary sector slowed. Spending by general government and capital expenditure remained
healthy, while household consumption moderated somewhat. Domestic economic activity
is expected to moderate from the second to the third quarter of 2012. Growth forecasts
have been revised lower in line with the Bank’s subdued composite leading business
cycle indicator.
Growth in real GDP gained momentum in the second quarter of 2012, accelerating to an
annualised rate of 3,2 per cent from 2,7 per cent in the first quarter (Table 8). This increase
in economic activity was mostly driven by the more volatile primary sector, with a moderate
acceleration in agricultural output and a substantial recovery in mining output. Excluding the
primary sector, however, growth in the rest of the economy slowed from 3,8 per cent in the first
quarter of 2012 to 1,6 per cent in the second quarter. Within the secondary sector, a revival in
the construction sector was more than offset by a contraction in the electricity, gas and water,
and manufacturing sectors. The tertiary sector lost momentum as real growth in the finance and
business services and trade sectors decelerated.
Table 8
Growth in real GDP and expenditure components
Per cent*

1st qr
2nd qr
3rd qr
4th qr
Year
1st qr
2nd qr
Final consumption expenditure

* Quarterly data refer to quarter-on-quarter growth at annual rates of seasonally adjusted data
** Constant 2005 prices
A stronger outcome in government consumption and real gross fixed capital formation by private
businesses and government in the second quarter was only partly offset by a moderation in
household spending, resulting in a rise in real gross domestic expenditure growth from 4,3 per
cent in the first quarter of 2012 to 4,7 per cent in the second quarter.
Despite the depreciation in the exchange value of the rand, real exports of goods and services
contracted by 6,2 per cent in the second quarter of 2012, reflecting slowing global growth.
Import volumes, however, increased in the second quarter of 2012 on the back of buoyant
domestic expenditure, while South Africa’s terms of trade deteriorated somewhat further. (See
Box 5 for a measure of the size of international spillovers to South Africa.)
The intensified global financial crisis and slower global growth have reduced commodity prices
and domestic exports, in turn negatively affecting South Africa’s growth outlook. Since May
2012, quarterly projections of annual average growth in real output have decreased marginally
at each of the consecutive MPC meetings. The September 2012 MPC meeting projected growth
of 2,6 per cent in 2012, 3,4 per cent in 2013 and 3,8 per cent in 2014 (Figure 23).

Monetary Policy Review October 2012
Percentage change at seasonally adjusted annualised rates

Figure 23
Real GDP growth forecast


Short-term indicators show that growth in the third quarter of 2012 is likely to be lower than in
the second quarter and point to a somewhat more pessimistic near-term growth outlook. This
implies that the current sizeable negative output gap will endure over the forecast period.
The main drivers of expenditure growth on the demand side are expected to be gross fixed
capital formation and real household consumption expenditure. On the supply side, the mining
sector is expected to be weaker due to the labour unrest in the third quarter and high base
effects of the second quarter of 2012. In the non-primary sector, manufacturing is expected to
remain weak along with anticipated firm growth in the tertiary sector during the third quarter.
The Bank’s composite coincident business cycle indicator reflected the upward trend in the
economy for the year (Figure 24). Looking forward, the Bank’s composite leading business cycle
indicator declined for four consecutive months through to June 2012 to its lowest level since late
2010. In July and August 2012 the leading indicator edged up slightly, but still recorded a 2,2 per
cent decrease since February – and remained subdued relative to recent highs.
Indices: 2000 = 100
Figure 24
Composite business cycle indicators

Coincident business cycle indicator
Downward phases of the business cycle
Leading business cycle indicator

Monetary Policy Review October 2012

Survey results support the assessment that economic growth (excluding mining) will soften
in the third quarter. The Rand Merchant Bank (RMB)/Bureau for Economic Research (BER)
Business Confidence Index (BCI) again fell below the neutral level of 50 as from the second
quarter of 2012, with sentiment improving somewhat in the third quarter. The increase of 6 index
points to 47 in the third quarter of 2012 only partially neutralised the 11 index point decline in the
second quarter (Table 9).
Table 9
Domestic economic sentiment indicators
Historic range
Most recent
As at MPR:*
Low
High
Low
High
May 2012 Oct 2012


-6

-1
* Improved/Worsened since previous MPR
Sources: Kagiso Securities, Rand Merchant Bank, First National Bank, Ernst & Young and the Bureau for Economic Research,
Stellenbosch University
Although business confidence improved in all five sectors surveyed, the level indicates a slight
majority of respondents being negative about prevailing business conditions. Only the wholesale
sector recorded consistent quarterly improvements in sentiment in 2012. The third-quarter
survey shows an improvement in manufacturing, retail and building contractor confidence but
remains below the neutral level of 50.
According to the third-quarter 2012 BER Manufacturing Survey, manufacturing business
confidence fell sharply in the second quarter by 18 index points and has since recovered
somewhat to 33 index points. Expected business conditions in 12 months’ time deteriorated
markedly, with a net majority of 19 per cent expecting conditions to deteriorate and 7 per cent
an improvement.
Retail business confidence fell by 22 index points to 39 in the second quarter of 2012, before
rising by 7 index points to 46 in the third quarter according to the Ernst & Young/BER Retail
Survey. Confidence was supported by low interest rates and unsecured credit growth, and
weighed down by moderating real income growth and slow employment creation.
Confidence in the building industry remains weak despite a pick-up in construction-sector
activity and rising confidence among architects.
Since the previous MPR, the seasonally adjusted Kagiso/BER PMI has fallen below the neutral
level of 50 to 48,2 in June 2012 and 46,2 index points in September 2012, influenced by business
activity and new sales orders (the components of the PMI with the largest weights). The PMI
indicates weaker manufacturing activity in the third quarter.
Forward-looking PMI indicators have remained subdued since the previous MPR. Expected
business conditions in six months’ time fell from 59 index points in May 2012 to 52,9 index
points in August, before increasing to 55,5 index points in September. The ratio of new sales
orders to inventories remained below 1 for the sixth consecutive month in September, indicating
that inventories exceed demand for manufactured goods.
The FNB/BER Consumer Confidence Index (CCI) declined by 8 index points to -3 index points in
the second quarter of 2012 – its lowest level since the fourth quarter of 2008 as the global financial
crisis intensified – before improving slightly to -1 index points in the third quarter of 2012.

Monetary Policy Review October 2012
Box 5:
International spillovers: Some implications for South Africa
More extensive and intensive trade and financial linkages between economies in recent decades
have been the primary factors driving globalisation. These same connections between economies,
however, also allow negative economic growth shocks to propagate between economies and
across regions. Measuring the size of spillovers and whether they have increased in magnitude
have become important to estimating the impact of contemporaneous and future shocks.
South Africa’s economic cycles are very much in line with developments in advanced countries.
Figure B5.1 shows that South Africa’s economic activity is strongly correlated with that of the
US, euro area, Japan and China. The relationship intensified during the pre-crisis period and
has remained high. There has been a significant decline in the correlation coefficient with China,
as Chinese economic activity remained robust while that of South Africa slowed markedly in the
post-2009 period.
United States
Japan
China (right-hand scale)
Figure B5.1 Trends in industrial production for South Africa, the United States,


the euro area, Japan and China
Percentage change over 12 months*


-0,4
-0,2


84-month rolling correlation coefficient
Log of industrial production

* Three-month moving average
Sources: OECD and F Ruch, “The Impact of International Spillovers on the South African Economy”, South African Reserve Bank
Discussion Paper 12/06 (Pretoria: South African Reserve Bank, 21 August 2012).
Euro area
South Africa
United States and South Africa
Euro area and South Africa
Japan and South Africa
China and South Africa
An estimated business cycle spillover index shows the total share of the variation in domestic
industrial production that is explained by international spillovers.1 Figure B5.2 (left-hand panel)
reflects the total spillover index with the pre- and post-crisis averages for the period 1998m1 to
2012m3. The estimates show a significant rise in the magnitude of international spillovers after
the start of the crisis. Over the pre-crisis period (1998 to 2008) around 36 per cent of variation
in industrial production for the sample as a whole, very close to the estimate for South Africa,
was due to spillover effects – increasing to around 62 per cent after the crisis.
Pre-crisis average
Post-crisis average
Total spillovers index
Pre-crisis average
Post-crisis average
Spillovers to South Africa
Figure B5.2 Business cycle spillover indices
Index

Index

Source: F Ruch, “The Impact of International Spillovers on the South African Economy”, South African Reserve Bank
Discussion Paper 12/06 (Pretoria: South African Reserve Bank, 21 August 2012).
1. The index considers both the contemporaneous correlation of shocks and lagged transmission of shocks
to other countries. A generalised vector autoregressive (VAR) framework in which forecast-error variance
decompositions are invariant to the variable ordering is used for the estimations. (For a detailed description
of the methodology, see F X Diebold and K Yilmaz, “Measuring Financial Asset Return and Volatility
Spillovers, with Applications to Global Equity Markets”, The Economic Journal, 119 (534): 158–171). The
VAR is estimated using a seven-year rolling window (i.e., 84 months) to provide a time-varying analysis of
spillovers.
Monetary Policy Review October 2012

Monetary policy
At the time of the publication of the previous MPR in May 2012, the domestic inflation outlook
had improved (Table 10). Since then, global financial conditions and the outlook for global
growth have deteriorated. Global inflation, however, has been kept in check. Under these
conditions, monetary policy was eased in a range of countries, while others held policy
steady, given already-low interest rates and mostly favourable inflation expectations. The
MPC of the Bank has kept policy rates low since November 2010 and opted to lower the
rate by 50 basis points in July 2012 in response to significantly better inflation projections
and deteriorating growth (Figure 25). The policy stance in coming months will continue to
be shaped by uncertainty derived from global developments, food and oil price shocks,
exchange rate movements, and domestic considerations. Oil prices have ticked up again
recently and food prices are likely to rise in coming months. Industrial unrest may result in
further deterioration in economic growth and adverse wage developments.
By the July 2012 meeting of the MPC, the outlook for the global economy had worsened, with
signs of a widespread slowdown and deteriorating global financial conditions. This negative
growth outlook in an environment of declining commodity prices, subdued global inflation, and
harmful spillover effects between economies and regions contributed to renewed monetary
policy easing in a number of both advanced and emerging-market countries.
Per cent

Prime overdraft rate
Repurchase rate
Three-month negotiable certificates of deposit rate
Figure 25
The repurchase rate and other short-term interest rates

Despite some optimism early in 2012 and a reasonable growth rate of 2,7 per cent in the first
quarter of the year, by mid-year it was clear that the global environment and domestic factors
were weighing on domestic growth. Sectoral outcomes showed diverse trends, with mining and
manufacturing output choppy. Both investment and household spending growth moderated
from the final quarter of 2011 to the first quarter of 2012. Consumer and business confidence
weakened, consistent with a decline in the Bank’s composite leading business cycle indicator.
A range of factors may account for the magnitude of spillovers, including a heightened focus by
economic agents on international economic linkages and global risks, financial interdependence,
the role of global pricing of commodities, and greater openness as shown in the weight of crossborder trade and finance in economic activity. More integrated financial and currency markets are
also likely to play an important role in increasing the size of spillovers.

Monetary Policy Review October 2012
These factors informed the downward revision of the Bank’s growth forecast from 2,9 per cent
to 2,7 per cent for 2012 and to 3,8 per cent in 2013, with the projection for 2014 remaining
unchanged at 4,1 per cent. The possibility of a more widespread global downturn introduced
downside risks through trade links and commodity prices.
Global inflation remained benign, given the environment of weaker global growth prospects
and lower commodity prices. Higher grain prices, however, driven up by the drought in the
US, posed a risk to international food prices. For South Africa, the timing of the pass-through
of global prices into domestic food prices remained uncertain. Domestic inflation continued its
downward trend, with the year-on-year inflation rate as measured by CPI for all urban areas
decelerating to 5,5 per cent in June 2012. Core inflation (excluding food, petrol and electricity
from the headline CPI measure) increased in line with expectations from 4,4 per cent in
May 2012 to 4,6 per cent in June.
These lower-than-expected inflation outcomes contributed to an improved forecast. Headline
CPI was seen peaking at 6,1 per cent in the first quarter of 2012, followed by moderation to a
low of 4,9 per cent in the second quarter of 2013 and to remain fairly stable around the 5 per
cent level to the end of 2014. Inflation was expected to average 5,6 per cent in 2012, and 5,1 per
cent in both 2013 and 2014.
The forecast for core inflation improved, even though the upward trend was expected to persist
in the short term. Core inflation was expected to amount to 5,4 per cent in the final quarter of
2012, before declining to an average of 4,8 per cent in 2014.
Downside risks increased as the negative global growth outlook spread beyond Europe, in
particular to the US, China, India and other emerging-market economies. The likely intensification
of negative spillover effects to South Africa was a source of concern, given the fragility of the
domestic economy. The MPC therefore regarded the balance of risks to the growth forecast to
be skewed to the downside.
Inflation was expected to remain within the target range over the forecast period and the risks to
the inflation forecast were seen to be relatively balanced. Lower global commodity prices would
partially offset upside pressures, while demand pressures were expected to remain muted. Given
these developments and prevailing conditions, the MPC was of the view that further monetary
accommodation was appropriate and would not undermine the inflation outlook. The MPC therefore
decided to reduce the repo rate by 50 basis points to 5,0 per cent from Friday, 20 July 2012.
Table 10
The Bank’s real GDP growth and targeted inflation forecasts during 2012
Per cent
MPC meetings
Real GDP
Targeted inflation

Expected peak
Expected return to target
3,0
6,3
2012 Q2 at
6,5 per cent
2013 Q1
2,9
6,0
2012 Q1 at
6,1 per cent
2012 Q2
Expected low
Expected to stabilise
2,7
5,6
2013 Q2 at
4,9 per cent
at 5 per cent level
to the end of 2014
2,6
5,6
2014 Q3 at
5,0 per cent*
at 5 per cent level
to the end of 2014
*
For the short-term, inflation is expected to peak at 5,3 per cent in the 4th quarter 2012
By the September 2012 meeting, the domestic growth outlook had deteriorated somewhat in
response to both domestic and global developments. Global growth had softened further and
the outlook remained weak, with significant risks still remaining, notwithstanding significant policy
initiatives. Local developments, particularly in the mining sector, suggest lower output in the near term
while high-frequency data pointed to lacklustre third-quarter growth, despite the accommodative
macroeconomic policy environment. The Bank’s forecast for growth in 2012 was revised down to
Monetary Policy Review October 2012

2,6 per cent, compared with 2,7 per cent in the previous forecast, while the forecast for growth in
2013 was revised down from 3,8 per cent to 3,4 per cent with further downside risks.
Global inflation remained relatively benign, with supply shocks being the major risks. Domestically,
inflation surprised on the downside, reaching a short-term low point in July before ticking up by
0,1 percentage point in August. Inflation expectations appeared to remain well contained, albeit
around the upper end of the target range. Inflation was expected to remain contained within the
target range over the forecast period, although the inflation outlook for 2013 was slightly worse than
the previous forecast. The trajectory remained relatively flat over the entire forecast period. The Bank
expected inflation to average 5,3 per cent in the final quarter of 2012, 5,2 per cent in 2013, and 5,0 per
cent in 2014. Core inflation appeared well contained and was projected to peak at 4,9 per cent in the
final quarter of 2012, compared with the previous forecasted peak of 5,4 per cent.
Demand pressures were expected to remain benign, with cost–push pressures from food and
petrol considered to be the main upside risks to the inflation outlook. These price increases
were expected to filter through to domestic consumer prices in coming months. The exchange
Box 6:
The looming “fiscal cliff” in the United States
In the US, the current state of fiscal affairs is a federal budget deficit of 7,3 per cent of GDP at
US$1,1 trillion for fiscal year 2012 (ending 30 September). Federal debt reached 73 per cent of
GDP at the end of fiscal 2012 – its highest level since 1950 and nearly double the level in 2007.
A “fiscal cliff” looms in January 2013 when tax cuts are revoked and spending cuts are
implemented in terms of the Budget Control Act of 2011. Table B6.1 shows the Congressional
Budget Office’s analysis of scenarios where current law is applied as is and where an
alternative is created from the outcome of negotiations between the relevant parties in the US
Congress. Intense political debate is expected before January to attempt to phase in the fiscal
measures and reduce the negative effects on the economy, and the actual outcomes are
contingent on these discussions.
Table B6.1 US Congressional Budget Office projections

Current
Baseline3
Alternative4
Budget projections (US$ billions)

Economic projections (per cent)


Source:. Congress of the United States, Congressional Budget Office (CBO), “An Update to the Budget and Economic
Outlook: Fiscal Years 2012 to 2022”, August 2012,
accessed 1 October 2012.
1. Fourth quarter to fourth quarter percentage change..
2. Fourth quarter level in per cent.
3. Baseline projection of changes contained in current legislation.


4. All expiring tax provisions are extended indefinitely except the payroll tax reduction in effect in calendar years 2011
and 2012; alternative minimum tax (AMT) is indexed for inflation after 2011; Medicare payment rates are held constant;
automatic spending reductions are not implemented but the capped discretionary appropriations remain in place.

Monetary Policy Review October 2012
rate continued to pose a potential risk to the inflation outlook, particularly in the event of an
unsustainable widening of the deficit on the current account of the balance of payments. Against
this backdrop, the MPC assessed the risks to the inflation forecast to be more or less balanced.
Although global and domestic growth conditions remained challenging in a fairly benign
inflation environment, the MPC was of the view that a further reduction in the repo rate was not
appropriate and left the rate unchanged at 5,0 per cent per annum.
Expectations and the Bank’s inflation forecast
Given prospects, risks and uncertainties, the outlook for inflation is presented in this section.
Indicators of inflation expectations
Inflation expectations are an important factor in product price setting and in wage negotiations,
and hence in determining future inflation outcomes. Inflation expectations remain well
anchored even though they continue to straddle the upper limit of the target range.
Measured headline CPI inflation decelerated by 1,2 percentage points from April 2012 to
4,9 per cent in July and then increased by 0,6 percentage points to 5,5 per cent in September.
Expected inflation continues to straddle the upper limit of the target range. The BER survey of
inflation expectations undertaken during the third quarter of 2012 shows combined average
expected inflation for 2012 of 5,8 per cent (Figure 26). This compares favourably with the 6,1 per
cent surveyed in both the first and second quarters. Expected inflation remained unchanged at
6,0 per cent in 2013, followed by a slight increase to 6,2 per cent in 2014 – indicating “sticky”
longer-term inflation expectations.
Annual averages, per cent


Figure 26
BER surveys of headline CPI inflation expectations

Survey conducted during 2012:

1st qr
Source: Bureau for Economic Research, Stellenbosch University

2nd qr

3rd qr
Lower expected inflation in 2012 involved a decline of expectations to within the target by all
subgroups. Trade union officials revised their inflation expectations for 2014 higher to 6,9 per cent.
Inflation expectations, as surveyed by Reuters (Table 11), suggest that the average year-on-year
percentage change in CPI declined to August and levelled out in September 2012. The quarterly
average of the year-on-year percentage change in CPI is expected to remain within the target
through to the second quarter of 2014.
Monetary Policy Review October 2012

Table 11
Reuters survey of CPI inflation forecasts: September 2012*

[6,0]
(5,5)
5,5
[5,5]
(5,3)
5,3
[5,5]
(5,4)
5,4
[6,0]
(5,5)
5,5
[5,6]
(5,4)
5,4
[5,7]
(5,4)
5,4
[6,3]
(6,5)
6,5
[6,6]
(6,2)
6,2
[7,1]
(6,0)
6,0
[5,0]
(5,4)
5,0
[4,7]
(4,5)
4,6
[4,9]
(4,4)
4,8
[19]
(17)

[19]
(17)

[13]
(13)

* April [ ] and August ( ) 2012 survey results in parenthesis
Source: Reuters
Figure 27 shows inflation expectations associated with break-even inflation rates. The breakeven inflation rate proxy for expected inflation is measured as the difference between the
nominal yields on conventional South African government bonds and the real yields on CPI
inflation-linked government bonds of similar maturity. Short-term break-even inflation rates have
declined since the May 2012 MPR, reflecting more favourable near-term inflation expectations.
However, longer-term break-even inflation rates returned to May 2012 levels reflecting, among
other factors, expectations of higher future inflation.
Percentage points

Figure 27
Break-even inflation rates

Spread between R206 and R189 bonds (1-year maturity)

Spread between R186 and R197 bonds (11- to 14-year maturity)
Sources: JSE Limited and own calculations

The South African Reserve Bank inflation forecast
At the time of the May 2012 MPR the Bank’s inflation outlook had improved at both the
March and May meetings of the MPC. The outlook improved even further at the July meeting
in terms of both the projected peak and the time profile for returning back to within the target
band. However, at the September 2012 meeting of the MPC, the Bank’s outlook for targeted
inflation reflected a moderate deterioration over the short to medium term, with a relatively
flat trajectory for the remainder of the forecast period. CPI inflation is expected to have
troughed in the third quarter of 2012 at 5,1 per cent, before rising marginally in the fourth
quarter of this year. Headline CPI is then expected to gradually converge to 5,0 per cent over
the remainder of the forecast period to 2014.

Monetary Policy Review October 2012
The most recent projections of the Bank’s core quarterly forecasting model, presented to the MPC
meeting on 18–20 September 2012, are reproduced in the form of a fan chart in Figure 28. The CPI
inflation forecast of the Bank has been revised marginally upwards since the MPC’s previous meeting
in July 2012, with aggravated upside pressures expected from the significant increase in the petrol
price and the anticipated acceleration in domestic food prices.
Per cent
Figure 28
Targeted inflation* forecast

* CPIX for metropolitan and other urban areas until the end of 2008; CPI for all urban areas thereafter

Conditional on an unchanged repurchase rate, headline CPI inflation is consequently expected
to average 5,6 per cent in 2012, and 5,2 per cent and 5,0 per cent in 2013 and 2014 respectively.
The Bank’s forecast of core inflation (excluding food, petrol and electricity prices) has improved
slightly. While an upward trend is still expected to prevail in the short term, core inflation appears
to be well contained with a peak of 4,9 per cent expected in the final quarter of 2012, compared
to the previous forecast peak of 5,4 per cent. This measure is now expected to average 4,6 per
cent in both 2013 and 2014. (See Box 7 for an updated evaluation of the accuracy of the Bank’s
inflation forecasts.)
Given the central projection for targeted inflation as the most likely outcome, the risks to the
forecast in Figure 28 are viewed as being more or less balanced. A number of supply-side risks
exist from higher petrol prices and an anticipated increase in food prices, but these are offset
by benign demand pressure and excess capacity. Lastly, expectations of a widening currentaccount deficit could contribute to a depreciation of the rand which, in turn, has the potential to
aggravate inflationary pressures over the forecast period to 2014.
Note:
The fan chart uses confidence bands to depict varying degrees of certainty. The darkest
band of the fan chart covers the most likely 10 per cent of probable outcomes foreseen
for inflation, including the central projection. Each successive band, shaded slightly
lighter and added on either side of the central band, adds a further 10 per cent to the
probability, until the whole shaded area depicts a 90 per cent confidence interval (see
Box 4 “Understanding the fan chart” on p. 27 of the March 2001 Monetary Policy Review).
Box 7:
An accuracy analysis of inflation forecasts
Monetary policy decisions require forward projections of key economic variables as one input
to the decision-making process. These forecasts are created by statistically estimating future
values based on past measured values of key variables and put together into economic
models that are imperfect facsimiles of the real world. Forecast outcomes are uncertain
because errors arise from a variety of sources, including incomplete or misspecified
economic relationships, data revisions, unforeseen shocks to the economy, and incorrect or
partial assumptions.
Monetary Policy Review October 2012

This inflation forecast accuracy analysis compares the South African Reserve Bank’s (the
Bank) forecasts of headline consumer price inflation produced by its core model, the
autoregressive integrated moving average (ARIMA) model and the disaggregated inflation
model to the Reuters consensus forecast and both relative to actual measured inflation
outcomes. Since the size of the errors obtained from forecasts (percentage points in Figure
B7.1 of this analysis) is relative to the original (inflation) data, the prediction errors from a
particular model can only be assessed by either comparing them to those of a naïve
forecast or to those of other models or institutions. It is, furthermore, reasonable to expect
that the model-based forecasts of inflation produced by the Bank should, on average, be
better than other forecasts, both naïve and those produced by other institutions.
The core model is a simultaneous-equation macroeconometric model consisting of
27 stochastic equations and several identities. The ARIMA model is based on the
historical properties of the series, providing relative accuracy over the very short term. The
disaggregated inflation model forecasts the main components of the headline consumer
price index (CPI) individually and then aggregates them with the appropriate weights to
calculate the forecast of the headline CPI. The Reuters survey is published monthly and
contains forecasts of several macroeconomic variables over a relatively long time span. The
forecasters consist of economists from major investment banks, corporations, consulting
firms and academic institutions, using different methods and models to produce their
forecasts. On average, the survey contains 22 forecasts each month, and most of the
forecasters have participated in the survey for several years.
A number of descriptive statistics are used in the assessment of the accuracy of the
inflation forecast. The most frequently used error measures are the average forecast error
(measuring projection bias in terms of systematic over- or underestimation) and the root
mean square error (relating errors to the variability of the series).
The average forecast errors for the period May 2003 to August 2012, relative to actual
inflation outcomes, are negative and biased downwards (Figure B7.1).
Percentage points


Quarters ahead

Figure B7.1 Average forecast error

Reuters consensus forecast

ARIMA model
Sources: Reuters and own calculations

Core model

Disaggregated inflation model
This bias indicates that both the Bank and the Reuters participants, on average,
underestimated the actual outcome of headline consumer price inflation over the mediumterm forecast horizon, that is, two to four quarters ahead. These errors were primarily

Monetary Policy Review October 2012
caused by supply-side shocks in 2007 and 2008, including commodity (oil and food)
prices that sharply accelerated quarterly rates of year-on-year headline inflation (exceeding
13 per cent in the third quarter of 2008). The persistence of these shocks resulted in a
series of large consecutive negative forecast errors that dominated and drove up the
average forecast error. Once the supply-side shocks dissipated and more stable inflation
rates were achieved, the forecast errors became smaller and less biased – more evenly
distributed around zero.
A fundamental difference between the forecasts of Reuters and those produced by the
Bank is that the core model employs a constant interest rate assumption, rather than a
“most-likely outcome-based” interest rate forecast.1 The reason for this constant interest
rate assumption is to enable the MPC to assess the impact of all other assumptions
and other changes on the inflation rate between meetings. The constant interest rate
assumption can lead to biases in forecasts in both directions, and should generate a
slightly better performance by the Bank’s forecasts due to information asymmetries.
A second summary statistic used in error analysis is the root mean square error, which
gives a good indication of the magnitude of the error.2 The root mean square error, as
shown in Figure B7.2 indicates that the Bank’s models are generally considerably more
accurate than the Reuters consensus forecast. However, as the forecast horizon extends
and uncertainty increases, the difference in the forecast accuracy narrows. When looking
at the size of the four-quarters-ahead root mean square error, it can therefore be expected
that the forecast of inflation one year ahead, using the core model, will be incorrect by a
margin of slightly more than 1,8 percentage points, while the forecast-error of Reuters3 will
be approximately 2,3 percentage points.
Percentage points


Quarters ahead

Figure B7.2 Root mean square error

Reuters consensus forecast

ARIMA model
Sources: Reuters and own calculations

Core model

Disaggregated inflation model
1.
Implying that the interest rate does not change over the forecast period.
2.
The root mean square error is calculated in three steps. Firstly, the forecast errors are calculated and then
squared. Secondly, the average of these numbers is calculated and, finally, the square root is taken to bring
the answer back to the same unit of measure as the original data.
3. The Bank’s forecast performance is also compared to the 16 individual forecasters or institutions that
regularly participate in the Reuters survey. However, the Reuters consensus forecast is treated in this
instance as a forecasting entity in its own right. It is therefore not the average of the forecast errors of the
selected participants in the Reuters survey.
Monetary Policy Review October 2012

Assessment and conclusion
The global crisis has created major challenges for all countries, and their fiscal and monetary
authorities. One critical challenge – that of global deflation – appears to have been averted by the
combination of fiscal support and monetary accommodation. Yet, faltering and weak economic
growth outcomes in most of the world suggest that some distance needs to be travelled before
economic growth returns to higher sustainable rates. A combination of deleveraging, higher
productivity and job creation, relative price adjustments and reforms supportive of private-sector
growth will be needed to allow fiscal deficits and monetary accommodation to be unwound in
coming years. At a national level, macroeconomic policies should support those outcomes by
creating stability and greater certainty wherever possible. At an international level, co-ordination
of much-needed exchange rate adjustments would help to provide confidence that deficit
economies will be able to grow in future and would increase standards of living globally.
Better economic growth and greater macroeconomic policy co-ordination could set the broad
framework for building confidence as other challenges are addressed. Financial regulations and
the restructuring of financial systems will take time to complete. Re-creating social consensus
in many countries is needed to reconnect governments and citizens, and this too will take time
in a volatile environment. Less amenable to government or central bank action, periodic shocks
to the supply of agricultural products, food and oil will remain a source of turbulence.
It should perhaps also not be too surprising that in an environment of weak growth, social
dislocation and uncertainty that competing visions of how to resolve challenges are asserted.
This has lent, and will continue to lend, itself to policy uncertainty in many places and, in some
instances, generate considerable economic and market volatility.
Over the course of 2012, the global economy has slowed amid negative shocks and spillovers
and heightened concern over policy direction. This has also softened inflationary pressures
generally, despite spikes in food and oil prices, with only a few countries citing concerns about
near-term inflationary pressures.
With that context in mind, monetary policy in South Africa has remained accommodative, but
consistent with keeping inflation under control and inflation expectations well anchored. The
repurchase rate was lowered to 5,5 per cent in November 2010 and then again at the July 2012
The size of this error reflects South Africa’s relatively small and open economy, subject to
regular and substantial external shocks. These shocks are mostly commodity price- and
exchange rate-related, and pose significant challenges to forecasting inflation rates over
most horizons.
The Bank’s forecasting performance is also compared with the 16 individual forecasters
or institutions that participate in the Reuters survey. In Table B7.1 the root mean square
errors of the various forecasts are compared over the one- to four-quarters-ahead
forecast horizons.
Table B7.1 Forecasting error comparison
Root mean square error


Quarters ahead


Average of total Reuters consensus forecasts...

Sources: Reuters and own calculations

Monetary Policy Review October 2012
meeting of the MPC. This stability in rates stands in some contrast to more frequent policy
rate movements in other countries. In 2011, many central banks tightened policy as inflationary
pressures surfaced. Then in 2012, major central banks of advanced countries pursued
aggressive easing and unconventional measures to arrest the deceleration in growth, while
others held rates steady at already low levels or reduced policy rates even further.
The MPC decision of July 2012 was shaped by inflation surprising on the downside to well
within the target range, weakening confidence and high-frequency data pointing to a slowdown
in domestic growth. Since then the Bank’s growth outlook has been revised marginally lower,
while the short- to medium-term inflation outlook deteriorated somewhat – though remaining
within the target range.
Including both domestic and international factors, growth risks remain skewed to the downside
while inflation risks appear fairly evenly balanced. Recent volatility in the mining sector and
a weaker secondary sector suggest lower output growth for the economy as a whole in the
third and likely fourth quarters of 2012. Greater stability in the wage and industrial relations
environment would boost confidence and prove supportive of growth across the economy in
coming months.
Exogenous price pressures coming from higher oil and food prices are expected to continue to
feed through to inflation outcomes in the near future. The exchange rate has responded to the
widening current-account deficit, volatile capital flows and changes to sovereign ratings, and
continues to pose a potential risk to inflation.
Monetary policy decisions over the past year have sought to provide stability through a period
of extraordinary uncertainty, inconsistent inflation pressures and a faltering global economic
recovery. These decisions are made within an inflation-targeting policy framework that
enables the MPC to address negative and positive shocks to the economy flexibly, helps to
smooth the growth of output, and focuses public expectations about the future trajectory of
price inflation.
Monetary Policy Review October 2012

Statement of the Monetary Policy Committee
19 July 2012
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee (MPC) in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), there have been further
indications of a generalised slowdown in the global economy, amid the continuing risks posed
by the banking and sovereign debt crisis in the eurozone. This negative outlook has contributed
to renewed monetary policy easing in a number of countries, including in emerging-market
economies, in an environment of declining commodity prices and subdued global inflation.
Domestic inflation has continued its downward trend, and is expected to remain within the target
range over the forecast period. However, despite some moderate employment creation over the
past year, the economic growth outlook appears to be threatened by global developments and
deteriorating domestic business and consumer confidence.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas was 5,5 per cent in June 2012, down from 5,7 per cent in May. The categories of food,
housing and utilities, and transport together accounted for 3,5 percentage points of the inflation
outcome. Food prices increased by 6,0 per cent, petrol by 14,2 per cent and electricity by
17,1 per cent on a year-on-year basis. Core inflation, as measured by the exclusion of food,
petrol and electricity from CPI, increased in line with expectations from 4,4 per cent in May to
4,6 per cent in June. Administered prices, excluding petrol, increased at a year-on-year rate of
8,7 per cent in both May and June.
Year-on-year producer price inflation moderated further, measuring 6,6 per cent in both April
and May 2012, its lowest rate of increase since April 2011. More than half of this outcome
was accounted for by mining and quarrying and electricity price increases. Food price inflation
continued its downward trend with agricultural prices increasing at a year-on-year rate of 1,7 per
cent in May, while manufactured food prices increased by 8,4 per cent.
The inflation forecast of the Bank has been revised downwards since the previous meeting of
the MPC, apart from the final quarter of 2014 when a slightly higher outcome is forecast. With
inflation expected to have peaked at an average of 6,1 per cent in the first quarter of 2012, it is
now expected to continue to moderate over the next few quarters, reaching a low of 4,9 per
cent in the second quarter of 2013. Inflation is then expected to remain fairly stable around the
5 per cent level to the end of 2014. Inflation is expected to average 5,6 per cent in 2012, and
5,1 per cent in both 2013 and 2014. The improved forecast is mainly due to lower-than-expected
recent inflation outcomes.
The forecast for core inflation is also more favourable, although the upward trend is expected to
continue in the short term. Core inflation is expected to measure 5,4 per cent in the final quarter
of 2012 and the first quarter of 2013, before declining and averaging 4,8 per cent in 2014.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic Research
at Stellenbosch University in the second quarter of 2012 were almost unchanged since the
previous quarter and remain anchored at around the upper end of the target range. On average,
respondents expect inflation to average 6,1 per cent in 2012 and 6,0 per cent and 6,1 per cent
in the next two years respectively. The break-even inflation rates declined across all maturities
since the previous meeting of the MPC to within the target range.
The outlook for the global economy has worsened somewhat since the previous meeting of
the MPC, with mounting evidence of a broad-based global slowdown. Negative indicators
include a fall in the global manufacturing Purchasing Managers Index (PMI) to its lowest level
in three years. The lack of meaningful progress towards a resolution of the eurozone crisis
continues to be a source of global instability and risk, despite initiatives to stabilise the banking
sector. The growth outlook for the region remains negative, as fiscal austerity measures and
bank deleveraging continue to impact adversely on growth and on unemployment rates that

Monetary Policy Review October 2012
have reached new euro-era highs. In the first quarter of 2012, most of the eurozone members
recorded negative or marginally positive growth, particularly those in the periphery. The United
Kingdom (UK) economy is currently also experiencing a recession.
The United States (US) economy slowed in the second quarter and the outlook has deteriorated.
Concerns relating to the so-called fiscal cliff (the possible sharp contraction of fiscal policy in
2013) are beginning to weigh on consumption and investment decisions, and these pressures
are expected to intensify during the second half of this year. Any resolution of this issue seems
unlikely before the end of 2012.
Spill-over effects have also been felt in emerging markets. China recorded a growth rate of
7,6 per cent in the second quarter of 2012, the slowest since early 2009, amid a property-market
downturn and weak exports. It is still unclear if the policy responses of the Chinese authorities
will be sufficient to contain this trend. Materially slower growth has also been recorded in India
and Brazil.
In response to these developments, monetary policy has been eased in a number of both
advanced and emerging-market countries. In the UK, the Bank of England increased the size
of its asset purchase programme, and although the Federal Open Market Committee has not
resumed its programme of quantitative easing, the maturity extension programme has been
extended and monetary policy is expected to remain highly accommodative for a prolonged
period.
Global inflation continues to be benign, given the slowing growth prospects and lower
commodity prices. One area of risk to the inflation outlook emanates from the higher grain
prices in response to the continuing drought in the US.
The increasingly unfavourable and volatile global backdrop continues to impact on the rand
exchange rate, primarily through changing risk perceptions in global financial markets. Since
the previous meeting of the MPC, exchange rate volatility has increased and the rand has
fluctuated in a range of between R8,06 and R8,70 against the US dollar, partly in response to
fluctuations of the euro against the US dollar. The rand has, however, appreciated since the
previous meeting by around 3,4 per cent against the US dollar, by 5,5 per cent against the euro
and by 3,7 per cent on a trade-weighted basis.
During this period the rand was also impacted by strong inflows into the domestic bond market,
following the confirmation that South Africa will be included in the Citibank World Government
Bond Index (WGBI) from late September. Since the beginning of the year, non-residents have
been net purchasers of South African government bonds to the value of R60,1 billion. In June
alone net purchases of bonds by non-residents amounted to R21,7 billion, the second-highest
monthly inflow ever into the bond market. Much of this is estimated to have been real money
inflows, which possibly contributed to the generally appreciating exchange rate trend in that
month and declining yields in the domestic government bond market. These inflows are
expected to persist for some time after the actual inclusion in the index, and will not only help
fund the fiscal deficit but also the widening current-account deficit of the balance of payments.
The rand is expected to remain vulnerable to erratic shifts in global risk perceptions. While
a deterioration of global risk sentiment could cause further rand weakness, this could be
offset to some extent by continued inflows into the bond market or the possible resumption of
quantitative easing in the US.
The domestic economy appears to be slowing further, following the 2,7 per cent annualised
growth rate recorded in the first quarter of 2012. The Bank’s forecast of gross domestic
product (GDP) growth for 2012 has been revised down from 2,9 per cent to 2,7 per cent, and to
3,8 per cent in 2013. The forecast for 2014 remains unchanged at 4,1 per cent. However, given
the possibility of a more widespread global downturn, the risks to this forecast are seen to be
on the downside, with the external impact coming through trade links and commodity prices.
The Bank’s estimate of the output gap is unchanged at around 3,5 per cent. The composite
leading business cycle indicator of the Bank declined for the second consecutive month in April,
indicative of the uncertain and subdued outlook.
Monetary Policy Review October 2012

The mining sector is expected to achieve positive but modest growth in the second quarter of
2012 following the 16,8 per cent annualised contraction in the first quarter. In May the threemonth-to-three-month growth was 1,3 per cent and 0,8 per cent on a year-on-year basis.
Despite this improvement, the mining sector is expected to face a number of challenges,
including declining commodity prices, and further domestic cost pressures which have already
resulted in stresses for some platinum mines.
The manufacturing sector, which grew at an annualised rate of 7,7 per cent in the first quarter
of 2012, is showing some signs of moderation in the second quarter. In May the sector grew
at a year-on-year real rate of 4,2 per cent, but contracted by 0,9 per cent on a three-monthto-three-month basis. The Kagiso/BER Purchasing Managers Index fell to 48,2 index points in
June, its lowest level since August 2011, as the sub-indices for business activity and new sales
orders declined further. This is consistent with the weaker RMB/BER Business Confidence
Index which declined by 11 index points to 41 in the second quarter.
Growth in real gross fixed capital formation lost momentum, having moderated from an
annualised 7,2 per cent rate in the final quarter of 2011 to 5,3 per cent in the first quarter of
2012. Of concern is the substantial decline in the growth of private-sector fixed capital formation
to 1,8 per cent, following successive quarters of steady increases in excess of 5 per cent during
2011. This development, if sustained, will contribute to the fragility of the growth outlook. By
contrast, increases of 13,1 per cent and 9,3 per cent were recorded by public corporations and
general government, reflecting capital spending on infrastructure. This was consistent with the
improvement in the FNB/BER Civil Construction Confidence Index. However, the FNB Building
Confidence Index declined further and remains at low levels, with the real value of building plans
passed declining by 8,7 per cent on a three-month-to-three-month basis in April.
Final consumption expenditure by households, which grew by 5,0 per cent in 2011, also appears
to be slowing somewhat, with growth having moderated to 3,1 per cent in the first quarter of
2012. While real retail sales increased by 6,4 per cent on a year-on-year basis, the momentum
appears weaker, with sales declining by 0,8 per cent on a month-on-month basis in May, while
in the three months to May compared with the previous three months, sales increased by
0,4 per cent. The FNB/BER Consumer Confidence Index deteriorated in the second quarter,
with the index declining from 5 to -3, the lowest level of the index since 2008. According to the
RMB/BER Business Confidence Index, confidence of retailers declined markedly during the
same period to its lowest level in two years. Somewhat anomalously, new vehicle sales have
remained relatively buoyant.
Growth in credit extension to the private sector remains relatively subdued, with twelve-month
growth in total loans and advances to the private sector increasing by 8,0 per cent in May.
Growth in credit extension to the corporate sector moderated during April and May, while credit
extension to households continued to increase, with growth over twelve months of 7,5 per cent
in May. This includes the growth in general loans (including personal loans) which has shown a
softer trend but still at elevated levels of 30,4 per cent. Mortgage advances remained subdued,
reflecting continued weakness in the housing market, while instalment sale credit and leasing
finance increased steadily in line with positive vehicle sales. Despite the increase in personal
loans, household debt to disposable income declined further to 74,7 per cent in the first quarter
of 2012. Personal loans now account for 11,0 per cent of total household debt, but have not led
to excessive consumption expenditure.
Formal-sector employment creation has remained slow. According to the Quarterly Employment
Statistics (QES) of Statistics South Africa, in the four quarters to the first quarter of 2012, just
over 100 000 jobs were created, representing an increase of 1,2 per cent.
The outlook for wage growth is uncertain. Growth in nominal remuneration per worker declined
from 6,8 per cent in the year to the fourth quarter of 2011, to 6,6 per cent in the first quarter of
2012, while unit labour cost increases declined from 5,8 per cent to 5,7 per cent. This trend may
have been reversed recently. According to Andrew Levy Employment publications, the average
wage settlement rates amounted to 7,7 per cent in the first half of 2012. The outcome of the
public-sector wage settlement will be important in this respect.

Monetary Policy Review October 2012
Administered price increases have remained relatively unchanged, but we still await Nersa’s
determination of tariff increases to be granted to Eskom for the coming years. Some of the
other important cost-push factors may have reached a lower turning point recently. Domestic
food price inflation is still expected to moderate further in the short term, but the medium-term
outlook is clouded by the drought-induced increases in maize, wheat and soya bean prices in
the US. This has already impacted on domestic prices of both maize and wheat, and poses
some upside risk to the inflation outlook.
Brent crude oil prices also rebounded from their recent lows of around US$90 per barrel, partly
due to geopolitical factors. Currently oil is trading at around US$105 per barrel, well below the
levels of almost US$130 per barrel that prevailed earlier this year, and prices are expected to
be constrained by weak global demand. The domestic petrol price has declined by a total of
R1,40 per litre in the past two months, although a slight increase may be recorded next month.
The MPC is concerned about the increased downside risks posed to the domestic economy by
global developments. The problems in the eurozone are likely to persist for a protracted period
and since the previous meeting the negative growth outlook has spread beyond Europe, in
particular to the US, China, India and other emerging-market economies. The negative spillover effects to South Africa are likely to intensify. This unfavourable outlook is reinforced further
by the fragile domestic private-sector investment and consumption trends which are confirmed
by declining business and consumer confidence. The MPC therefore sees the risks to the
growth forecast to be on the downside.
The MPC also considered the inflation environment to have improved somewhat, notwithstanding
possible pressures coming from food and energy prices in the medium term. Upside pressure
on inflation could be offset to some extent by lower global commodity prices, while demand
pressures are expected to remain muted. Although the exchange rate is likely to remain
vulnerable to global risk aversion, the rand has shown some resilience in recent weeks. The
MPC expects inflation to remain within the target range over the forecast period and sees the
risks to the inflation forecast to be relatively balanced.
In the light of these developments the MPC views the prevailing conditions to be appropriate for
further monetary accommodation to the economy that will not undermine the inflation outlook.
The MPC has therefore decided to reduce the repurchase rate by 50 basis points to 5,0 per cent
from Friday, 20 July 2012. While it is recognised that such a move on its own will not overcome
the challenges facing the economy, it is felt that it can help alleviate some of the pressures
faced by some sectors. A sustained increase in the potential output of the economy will require
a concerted and co-ordinated effort from both government and the private sector. The MPC will
continue to monitor both domestic and global developments, and will act appropriately in line
with its mandate.
Monetary Policy Review October 2012

Statement of the Monetary Policy Committee
20 September 2012
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee (MPC) in Pretoria
Since the previous meeting of the Monetary Policy Committee, the global growth outlook has
weakened further. However, the near-term risks to global financial markets arising from the
eurozone debt crisis seem to have subsided somewhat following the announcement of the
bond purchase programme by the European Central Bank. While this appears to be a positive
step, significant risks still remain. At the same time, the global environment has been impacted
by further monetary easing in the United States (US) and Japan.
Domestically, inflation continued to surprise on the downside, although it appears that the
short-term low point could have been reached. Despite a number of upside supply-side risks,
inflation is expected to remain contained within the target range over the forecast period. The
growth outlook, however, has deteriorated somewhat in response to both domestic and global
developments.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas was 5,0 per cent in August 2012; up from 4,9 per cent in July. The categories of food,
housing and utilities, and transport together accounted for 3,0 percentage points of the inflation
outcome. Food prices increased by 5,1 per cent, petrol by 9,3 per cent and electricity by
10,0 per cent. Core inflation, as measured by the exclusion of food, petrol and electricity from
CPI, measured 4,6 per cent; up from 4,5 per cent in July. Administered prices excluding petrol
increased at a year-on-year rate of 7,5 per cent.
Year-on-year producer price inflation moderated to 5,4 per cent in July 2012, having measured
6,6 per cent in each of the previous three months. A reversal in the downward trend in food price
inflation was observed, although still at relatively low levels, with agricultural prices increasing
at a year-on-year rate of 3,0 per cent in July, compared with a recent low of 1,7 per cent in May
and 2,2 per cent in June. Manufactured food prices increased by 7,7 per cent and 8,0 per cent
in June and July respectively.
The inflation forecast of the Bank reflects a moderate deterioration for 2013 compared with
the previous forecast, and a relatively flat trajectory over the entire forecast period. Inflation
is now expected to average 5,3 per cent in the final quarter of 2012, 5,2 per cent in 2013 and
5,0 per cent in 2014. The near-term deterioration is mainly due to higher expected petrol and
food inflation. Core inflation appears to be well contained, with a peak of 4,9 per cent expected
in the final quarter of 2012, compared with the previous forecast peak of 5,4 per cent. This
measure is now expected to average 4,6 per cent in both 2013 and 2014.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic Research
(BER) at Stellenbosch University in the third quarter of 2012 were again virtually unchanged,
particularly for 2013 and 2014, and remain anchored at around the upper end of the target
range. Respondents expect inflation to average 5,8 per cent in 2012 and 6,0 per cent in 2012
and 6,2 per cent in 2014 respectively.
There is, however, a divergence of views between the respondents: while all categories of
respondents expect average inflation to be within the target range in 2012, trade union officials
and business executives expect it to exceed the upper end of the target range in both of the
following two years. This is in contrast to financial analysts who expect inflation to average just
over 5 per cent in both of these years.
The survey conducted by Reuters indicates that market analysts expect inflation to average
5,3 per cent in 2013 and 5,4 per cent in 2014. Market expectations as reflected in the breakeven inflation rates initially increased after the previous meeting of the MPC, but have since
declined somewhat. Expectations over the various maturities continue to reflect expectations of
inflation within the target range.

Monetary Policy Review October 2012
The global growth outlook remains weak, notwithstanding significant policy initiatives
announced by the United States Federal Reserve (the Fed), the ECB and Bank of Japan, and
the initial positive reaction from global financial markets. The decision by the Fed to engage
in a further round of quantitative easing was prompted by an assessment that the expected
growth trajectory was not strong enough to generate a sustained improvement in the labour
market. The US economy grew at an annualised rate of 1,7 per cent in the second quarter of
2012, and the outlook is clouded by the risk of a severe fiscal contraction early next year. The
outcome of the US elections in November 2012 will be critical in determining the prospects
for a favourable resolution of this “fiscal cliff”. In the meantime the attendant risks have had an
adverse impact on investment expenditure in the US and various indicators of industrial output
point to a subdued growth outlook.
In the eurozone the immediate risks posed by the continuing debt crisis appear to have abated
somewhat with the announcement by the ECB of its Outright Monetary Transaction (OMT) or
bond purchase programme. In addition, two important event risks were also avoided following
the decision of the Federal Constitutional Court in Germany to uphold the ratification of the
treaty to establish the European Stability Mechanism, although under specific conditions, and
the pro-euro outcome of the Dutch election. The precise workings of the OMT, particularly the
issues relating to conditionality, are still uncertain, but the initiative has bought some time to
implement more permanent solutions. Despite this potential progress, the risk of a Greek exit
from the eurozone remains, and growth prospects in the region have deteriorated following
the overall contraction in the second quarter of this year, continued bank deleveraging and a
further decline in cross-border lending. The UK economy has contracted for three consecutive
quarters, while Japanese economic growth also moderated markedly in the second quarter.
The impact of the US actions on the Japanese yen prompted a surprise increase of ¥10 trillion
by the Bank of Japan in the size of its asset purchase programme. Although the yen depreciated
in response, the impact appears to have been short-lived.
Growth momentum is also somewhat weaker in some of the systemically important emergingmarket economies, particularly in China, Brazil and India, in the face of weakening external
demand. A number of countries have responded by easing monetary policy and, as in the case
of Brazil, by introducing measures to stimulate domestic demand and competitiveness.
Global inflation remains relatively benign, given the weak demand, but supply-side shocks in
the form of higher food prices, due to droughts in the US and some parts of eastern Europe,
and resilient international crude oil prices pose a risk to the outlook. Both of these shocks are
not only a risk to inflation, but could also represent an additional drag on near-term growth; a
combination that poses enormous challenges to monetary policy.
The rand exchange rate has fluctuated generally within a range of R8,10 and R8,50 against the
US dollar since May, and continues to be affected by changing risk perceptions in global financial
markets. More recently, the rand appears to have decoupled from the euro and reacted to
domestic issues, including the wider-than-expected current-account deficit and developments
in parts of the mining sector, following the tragic events at Marikana.
The rand has, however, been underpinned, to some extent, by continued inflows into the
domestic bond markets in the lead-up to South Africa’s inclusion in the Citi World Government
Bond Index (WGBI). Non-resident purchases of South African bonds have amounted to
R12,1 billion since the previous meeting of the MPC, and R74,5 since the beginning of 2012.
These inflows are expected to persist for some time as non-resident portfolios adjust to the
WGBI inclusion. Although the rand, along with most other currencies, initially appreciated against
the dollar following the announcement of further quantitative easing by the Fed, it depreciated
against the euro following the positive response to the announcement of the OMT. Since the
previous meeting of the MPC, the rand has depreciated by about 2,4 per cent against the dollar,
by 7,5 per cent against the euro and by 5,0 per cent on a trade-weighted basis. Over this period
the dollar depreciated by 5,5 per cent against the euro.
The current account of the balance of payments has emerged as a risk to the exchange rate
outlook following the widening of the deficit to 6,4 per cent of GDP in the second quarter. The
Bank’s forecast for the current account in 2012 is for a deficit in the order of 51⁄4 per cent of
Monetary Policy Review October 2012

gross domestic product (GDP). This widening deficit is a consequence of declining commodity
exports, and increased imports and service payments. The current-account deficit has been
financed mainly through portfolio inflows, but could pose a risk to the exchange rate unless it
moderates over the coming months.
The domestic economic growth outlook remains constrained by the weak global outlook
and by recent work stoppages in the mining sector. The economy recorded a growth rate of
3,2 per cent in the second quarter of 2012, but this reflects a distortion arising from the strong
contribution from the mining sector, which recovered from a deep contraction in the first quarter.
Non-mining real output growth measured 1,7 per cent, due in large part to negative growth in
the manufacturing sector.
The Bank’s leading indicator has declined for four consecutive months, and the Bank’s growth
forecasts have been revised down. Real GDP growth is now expected to average 2,6 per
cent in 2012 and 3,4 per cent in 2013, compared with 2,7 per cent and 3,8 per cent in the
previous forecasts. Notwithstanding these downward revisions, the Bank sees further risks to
the downside.
Recent high-frequency data point to a lacklustre growth performance in the third quarter.
Mining output contracted by 1,5 per cent in July compared with June and the impact of the
recent strikes in the mining sector is yet to be reflected in the data. The physical volume of
manufacturing production contracted by 1,1 per cent on a month-on-month basis in July, while
the year-on-year increase of 5,8 per cent was exaggerated by weak base effects. The Kagiso
PMI, which has been moderating consistently since February, declined further in August and
remains marginally above the neutral level of 50.
The First National Bank (FNB)/BER Business Confidence Index improved in the third quarter
following the sharp decline in the second quarter, but remained below the neutral level. The
survey reflected very negative sentiment among manufacturers and building contractors, while
the vehicle trade exhibited high and rising levels of confidence, as reflected in robust vehicle sales.
The real value of building plans passed declined in June and July 2012 after a tentative recovery
in the previous two months. While positive growth was observed in the non-residential sector
up to June, building activity in the residential sector remains subdued, indicative of the weak
housing market. By contrast, confidence in the civil construction index has improved, in line with
increased civil construction activity.
Growth in gross fixed-capital formation increased to 5,7 per cent, contributing 1,2 percentage
points to overall GDP growth. Private-sector investment remains weak, with annualised growth
rates of 1,8 per cent, and 2,4 per cent in the first and second quarters of 2012. By contrast,
fixed-capital formation by public corporations grew at an annualised rate of 9,1 per cent in the
second quarter.
Formal-sector employment growth has remained weak. According to the Quarterly Employment
Statistics (QES) released by Statistics South Africa, employment growth over four quarters to
the second quarter of 2012 measured 1,5 per cent. This represents an increase of 123 300
jobs, one third of which were in the public sector. Although the current level of formal-sector
employment is still about 60 000 less than that attained before the onset of the crisis, the trend
remains positive even if too slow.
Final consumption expenditure by households was again the main contributor to GDP growth,
contributing 1,9 percentage points. Nevertheless, expenditure growth moderated to 2,9 per
cent in the second quarter, mainly due to the contraction in real outlays on services. Expenditure
on goods, particularly durable and semi-durable goods, remained robust. Retail sales also
grew at a more moderate year-on-year rate of 4,2 per cent in July 2012. Despite the decline in
total new vehicle sales in August, the positive momentum in this sector seems to have been
sustained, although exports to Europe are expected to remain under pressure. The FNB/BER
Consumer Confidence Index increased marginally in the third quarter following a large decline
in the second quarter, but remains at a low level. At these levels, consumption expenditure is
not seen to pose a risk to the inflation outlook.

Monetary Policy Review October 2012
Following a recent high in March 2012, growth in credit extension to the private sector has
moderated. Twelve-month growth in banks’ total loans and advances declined from 9,2 per
cent in March, to 8,1 per cent, and 7,3 per cent in June and July respectively. Credit extension
to the household sector increased at a rate of 8,1 per cent in July, while credit extended to the
corporate sector eased somewhat. Mortgage loans remained subdued, while instalment sale
credit and leasing finance reflected the robust vehicle sales.
Growth in general loans to households, which is mainly unsecured lending, accelerated to
32,8 per cent in July, but was still below the peak growth of 39,3 per cent experienced in June
2011. Growth in unsecured lending to companies moderated to 8,3 per cent in July, from a
recent high of 16,1 per cent recorded in March. The continued high rates of unsecured lending
have contributed to rising household debt, with the ratio of household debt to disposable income
increasing from 75,6 per cent to 76,3 per cent between the first and second quarters of 2012.
There is no evidence that unsecured lending has had an adverse impact on the asset quality
of the banking sector, as impaired advances as a percentage of gross loans and advances
measured 4,4 per cent in July compared with 5,5 per cent a year earlier.
The trends in wage growth have been relatively benign from an inflation perspective. Measured
over four quarters, nominal unit labour cost growth was 6,1 per cent in both of the first two
quarters of 2012. According to Andrew Levy Employment publications, the overall wage
settlement rate in collective bargaining agreements amounted to 7,7 per cent in the first half
of 2012, while the public sector settled on an increase of 7,0 per cent. However, there is a risk
that the recent wage settlements in the mining sector could set a precedent for wage demands
more generally.
Food and petrol prices are the main upside risks to the inflation outlook. Following a sharp spike
in July 2012, global grain prices stabilised and then moderated, but remain at elevated levels.
Futures prices indicate an expectation that these prices may have stabilised and may subside
in the medium term. Domestic spot prices of maize and wheat followed global trends, having
increased by about 40 per cent and 20 per cent respectively between the beginning of June
and the end of July. These increases are expected to filter through to domestic consumer prices
in the coming months.
The price of Brent crude oil continued its recent upward trend, reaching around US$117 per
barrel on 14 September, or US$12 per barrel higher than at the time of the previous MPC
meeting. However, the Saudi Arabian government commitment to increasing the supply of oil
has elicited a price response, with oil prices declining to current levels of around US$108 per
barrel. How sustainable this impact will be remains to be seen, given the geo-political factors
prevailing in the Middle East. The domestic price of petrol has increased significantly as a result,
largely offsetting the recent price decreases. Since August, the price of petrol has increased by
a cumulative R1,15 per litre, and a further increase is expected in October.
The MPC remains concerned about the risks posed to the domestic economy from the global
environment. The actions of the ECB appear to have reduced immediate liquidity concerns in
the region and have had a positive impact on sentiment. The continued risk of a possible Greek
exit and its contagion effects are likely to hang over the markets for some time. The fundamental
problems of the eurozone remain, and low or negative growth is likely to persist going forward.
Despite renewed stimulus in the US, growth is expected to remain subdued, at least until the
“fiscal cliff” issue is resolved. This negative global outlook, which is reinforced by a slowdown in
Asia, poses a downside risk to domestic growth prospects, particularly in the form of a weaker
export performance.
The domestic outlook is also likely to be constrained by local developments, particularly in
the mining sector, which have the potential to undermine the already-fragile private-sector
investment sentiment despite the accommodative macroeconomic policy environment. While
the Bank’s forecast for growth has been revised down, the MPC assesses that further risks are
somewhat on the downside.
Monetary Policy Review October 2012

Recent inflation outcomes have been more or less in line with the Bank’s expectations, but some
upside pressure is still expected from food and petrol price increases. Demand pressures are,
however, expected to remain benign. The exchange rate poses a potential risk to the inflation
outlook, particularly in the event of an unsustainable widening of the deficit on the current
account of the balance of payments. To date, the rand has remained relatively resilient. The
committee assesses the risks to the inflation forecast to be more or less balanced.
At its previous meeting the MPC assessed that conditions justified a pre-emptive loosening of the
monetary policy stance. Although global and domestic growth conditions remain challenging,
the MPC is of the view that a further reduction in the repurchase rate is not appropriate at this
stage. The MPC has therefore decided to keep the repurchase rate unchanged at 5,0 per cent
per annum. This accommodative stance is assessed to be consistent with the Bank’s price
stability mandate, and conducive to encouraging growth and domestic investment. Further
actions going forward will be highly dependent on global and domestic developments that may
change the risks to the outlook.

Monetary Policy Review October 2012
Abbreviations
Alsi
All-Share Price Index
API
administered price index
ARIMA
autoregressive integrated moving average
BCI
business confidence index
BER
Bureau for Economic Research [Stellenbosch University]
BIS
Bank for International Settlements
BoE
Bank of England
BOJ
Bank of Japan
BRICS
Brazil, Russia, India, China and South Africa
CCI
consumer confidence index
COPOM
Brazil’s Monetary Policy Committee
CPI
consumer price index
ECB
European Central Bank
EFSF
European Financial Stability Facility
EME
emerging-market economy
ESM
European Stability Mechanism
EU
European Union
FAO
Food and Agricultural Organization
FDI
foreign direct investment
FLS
Funding for Lending Scheme
FNB
First National Bank
FOMC
Federal Open Market Committee
GDP
gross domestic product
IEA
International Energy Agency
IMF
International Monetary Fund
INR
Indian rupee
MPC
Monetary Policy Committee
MPF
Monetary Policy Forum
MPR
Monetary Policy Review
MTBPS
Medium Term Budget Policy Statement
MTEF
Medium Term Expenditure Framework
NEER
nominal effective exchange rate
OECD
Organisation for Economic Co-operation and Development
OMT
outright monetary transaction
OPEC
Organization of the Petroleum Exporting Countries
PMI
Purchasing Managers’ Index
PPI
producer price index
QES
Quarterly Employment Statistics
QLFS
Quarterly Labour Force Survey
REER
real effective exchange rate
RMB
Rand Merchant Bank
SMP
Securities Market Programme
UK
United Kingdom
US
United States
WGBI
World Government Bond Index [Citi]
Glossary
the Bank South African Reserve Bank
the Fed
United States Federal Reserve
repo
repurchase [rate]