South African Reserve Bank
Monetary Policy Review
June 2015
Monetary Policy Review
June 2015
Monetary Policy Review June 2015
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ISSN: 1609-3194
Monetary Policy Review June 2015
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 maintain and improve competitiveness, protects the purchasing
power and living standards of all South Africans, and provides a favourable environment
for balanced growth, investment and employment creation. In addition, the Bank has a
complementary mandate to oversee and maintain financial stability. The Bank’s Monetary
Policy Committee (MPC) is responsible for monetary policy decisions, and comprises the
Governor as Chairperson, the deputy governors and senior officials of the Bank.
Price stability is quantified by the setting of an inflation target range by government after
consultation with the Bank. The Bank has instrument independence, with the commitment
to pursue a continuous target of 3 to 6 per cent for headline consumer price index inflation.
The MPC conducts monetary policy within a flexible inflation-targeting framework that
allows inflation to be temporarily outside the target range under certain circumstances.
The MPC takes into account a viable medium-term time horizon for inflation and considers
the time lags between policy adjustments and economic effects. This provides for interestrate smoothing over the cycle, and contributes towards more stable economic growth. The
repurchase (repo) rate decision reflects the MPC’s assessment of the appropriate monetary
policy stance.
The decision of the MPC, together with a comprehensive statement, is announced at a
media conference at the end of each bimonthly meeting. This announcement outlines the
MPC’s assessment of prevailing domestic and global economic conditions, as well as recent
outcomes and forecasts for inflation and real economic activity.
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 affected inflation and that impact on the
monetary policy stance. It also provides an assessment of the factors determining inflation
and the Bank’s forecasts of the future path of inflation and economic growth. The MPR
is presented by the Governor and senior officials of the Bank at Monetary Policy Forums
in various centres across South Africa in an effort to develop a better understanding of
monetary policy through direct interaction with stakeholders.
Contents


Boxes


Appendix

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

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review June 2015

Monetary Policy Review June 2015
Overview of the macroeconomic environment
and policy stance
South African consumer price inflation has been near 6 per cent, at the
top end of the target range, for the past three years. In recent months, this
pattern has been interrupted by the sharp fall in oil prices, which slowed
inflation to a low of 3,9 per cent in February 2015. However, prices are now
accelerating again, and are expected to breach the target temporarily during
the first half of 2016. Average inflation is forecast at 6,1 per cent for 2016,
easing slightly to 5,7 per cent in 2017.
Petrol price inflation is forecast to spike early in 2016, reflecting the annual
comparison with the low prices from the start of 2015. Food prices are also
picking up in response to drought conditions in the maize triangle in South
Africa. Meanwhile, underlying inflationary pressures are proving persistent,
and risks to the forecast have increased. This raises the odds of a sustained
breach of the inflation target and narrows the scope to look through price
shocks, even if demand pressures in the economy remain weak. For these
reasons, monetary policy in South Africa remains in a tightening cycle.
The evolution of the inflation outlook
From the vantage point of mid-2014, the plunge in oil prices has delivered
sizeable inflation benefits. At that time, headline inflation was expected to
average 5,9 per cent in 2015, barely within the target range. The forecast
has since improved to 4,9 per cent, close to the target’s midpoint. However,
relative to the outlook from the start of the year, the windfall has been more
disappointing. In January, the inflation forecast for 2015 averaged 3,8 per
cent. It now appears that inflation will not be that low in even one month
during 2015.
The oil benefit has been attenuated by several factors. Oil prices have
recovered from under US$50 per barrel, averaging around US$65 in May,
although they remain well below the levels seen in the middle of last year.
Continued rand depreciation against the United States (US) dollar has
pushed up domestic fuel costs, adding about 40 cents to pump prices since
January. Higher fuel levies have also softened oil’s disinflationary impact.
Cheaper oil is having only limited effects on the prices of other goods and
services. Core inflation, which excludes food and energy prices, is projected
to average 5,6 per cent in 2015, significantly above headline inflation.
Inflation expectations as surveyed by the Bureau for Economic Research
(BER) have shifted lower for 2015, but remain around the top of the target
range for the next two years. Expectations have also converged in recent
years, suggesting a greater degree of consensus that inflation will be close
to 6 per cent. This is reflected in wage expectations and settlements, which
have been slow to fall in line with lower headline inflation.
The risks to the inflation forecast have once again shifted to the upside,
following a brief period of balanced risks. The rand remains vulnerable, in
particular because the US Federal Reserve (the Fed) is expected to commence
policy tightening some time this year. Higher rates in the US should
attract capital away from emerging markets, especially those which have
been absorbing large quantities of capital and are running correspondingly
large current-account deficits. The Fed has taken pains to communicate
Monetary Policy Review June 2015

the probability of rate hikes this year, as well as the likely gradual pace of
tightening. This implies some of the exchange rate adjustment to higher US
rates may be priced in. Additional policy easing by the European Central Bank
(ECB) and the Bank of Japan may support capital flows to emerging markets,
further moderating the risk of an abrupt decline in emerging-market (EM)
currency prices. Nonetheless, recent history warns against relying on smooth
market adjustments. Instead, currency markets have been characterised by
intermittent, sharp sell-offs between periods of uneasy calm. So far this year,
countries such as Brazil and Turkey have experienced large depreciations,
with the Brazilian real falling by 13,2 per cent and the Turkish lira down
13 per cent against the US dollar. (By way of comparison, the South African
rand has weakened by 3,7 per cent; in 2014 it depreciated 11 per cent. The real
fell by 8,3 per cent and the lira by 12,9 per cent in 2014.)
A second important risk comes from electricity prices. These are currently
scheduled to rise by more than headline inflation, directly adding
approximately half a percentage point to the inflation forecast over each
of the next three years. However, tariffs could be raised even further, and
Eskom has approached the national regulator to re-open the multi-year
tariff agreement. Higher electricity prices will promote more efficient usage
of scarce electricity and ensure the sustainability of supply. Nonetheless,
large additional increases are expected to place greater pressure on secondround inflation effects.
A further, familiar concern is real labour remuneration outpacing productivity
gains. This sustains inflation at relatively high levels because wage settlements
start at cost-of-living increases, which are often based on previous years’
experiences. Furthermore, excessive wage deals also threaten to accelerate
inflation as firms respond to growing costs by raising their prices. Some of
this pressure is alleviated through reduced employment as firms substitute
capital in place of labour. This tends to moderate wage-price spirals, but is an
unwelcome shift in a high unemployment economy. Lower labour demand
may also lag higher wages, and is therefore not necessarily inflation-neutral.
Growth prospects
The relatively unfavourable outlook for inflation is matched by mediocre
growth prospects. For several years, growth has been forecast above 3 per
cent, but it has repeatedly fallen below this level. A prominent cause of
this underperformance has been strikes in the mining and manufacturing
sectors. But low growth in South Africa is also the consequence of three
broader, longer-term factors.
First, foreign demand is weak. Commodity prices have been sinking since
2011, weighing down South Africa’s terms of trade. Cheaper oil has provided
some stability recently, but this offers only partial and late compensation for
comparably large declines in coal and iron ore prices. (Gold and platinum
prices have also declined, but by smaller magnitudes.) Economic growth in
trading-partner economies has been modest. In particular, the euro area has
still to regain its pre-crisis levels of output. Growth in world trade has slowed
markedly from pre-crisis averages. In this environment, and with sustained,
robust growth in imports to South Africa, net exports have subtracted from
gross domestic product (GDP) growth. It has also been more difficult to
remedy the current-account deficit through higher exports, despite sustained
currency depreciation.


Figure 1 Real GDP growth forecast
Percentage change*
* At seasonally adjusted annualised rates
Source: South African Reserve Bank

Monetary Policy Review June 2015
Second, the financial cycle is not in a growth-accelerating phase: credit
expansion has been low in real terms despite accommodative monetary policy
settings. One aspect of this is that households have been paying off large debt
burdens incurred during the pre-crisis boom. Another aspect is that businesses
are reluctant to invest, given weak demand and other constraints reflected
in low levels of business confidence. On top of these private-sector trends,
the state’s borrowing behaviour is changing. Since 2009, National Treasury
has exploited the fiscal space won before the crisis to stimulate the economy
with large budget deficits. This capacity is now largely exhausted. Persistent
structural deficits have doubled the public debt level (as a share of GDP) and
endanger the sustainability of non-interest spending. In response, government
has correctly embarked on a programme of fiscal consolidation. The economywide appetite for greater leverage is currently quite limited, with both the
public and private sectors expanding borrowing at a subdued pace.
Third, electricity shortages have returned as a major constraint on growth.
Although South Africa’s electricity supply problems have been widely known
since 2008, they re-emerged with the resumption of load shedding towards
the end of 2014, and it is now clear they will persist over the medium
term. The electricity constraint will hamper growth both by interrupting
production and by deterring future investment. The forecast shows growth
picking up towards 3 per cent in 2017, but this will require a mix of efficiency
gains and improved electricity supply.
The policy stance
The macroeconomic policy response to the global financial crisis has been
counter-cyclical. Large fiscal deficits and much lower interest rates provided
significant support to growth. Growth rebounded in 2010, beating forecasts,
and was slightly stronger in 2011. Inflation fell from pre-crisis levels well above
6 per cent to the bottom end of the target range, bottoming out at
3,2 per cent in September 2010. At this juncture, South Africa’s economic
recovery appeared broadly on track, with growth expected near 4 per cent in
2012 and inflation forecast to remain within the target range.
Economic conditions thereafter became more challenging. Growth in 2012 was
closer to 2 per cent than 4 per cent, and disappointed again in both 2013 and
2014. With potential growth estimated at around 3 per cent, this meant the
negative output gap kept widening. Weak demand implied minimal pressures
on inflation. Nonetheless, adverse supply pressures yielded a series of inflation
target breaches. Headline rose above 6 per cent for two months in 2011, three
months in 2012, and two months in 2013. Given supportive factors, including
relatively muted second-round effects and low pass-through from exchange rate
depreciation, rates were not raised in response. Indeed, the repo rate was even cut
one more time in July 2012, as growth slowed. Yet the combination of inflation
settling in around the top of the target, and consistently underwhelming
growth, presaged difficult choices for monetary policy.
By the start of 2014, the inflation forecast indicated a sustained breach of the
inflation target, due chiefly to exchange rate factors. Monetary policy entered
a tightening cycle, with a repo rate hike of half a percentage point in January,
followed by another quarter of a percentage point in July. Inflation breached the
target in March and peaked at 6,6 per cent in May and June. It then declined
sooner than expected, returning to target in September as oil prices began
falling. By the first quarter of 2015, average inflation was below the midpoint
of the target range. In this environment, the rate hiking cycle was paused.
Per cent
Figure 2
Real GDP growth and forecasts
diverged after 2011
Actual growth
Current-year forecast
One year in advance
Source: International Monetary Fund


Monetary Policy Review June 2015

However, the overall impact of cheaper oil has proven limited, with muted
second-round effects. The inflation forecast deteriorated from the January
2015 to the March 2015 MPC meetings, as the outlook for domestic food
prices worsened with drought in the maize triangle. The risks to the forecast
also shifted. In January they were assessed to be more or less balanced, whereas
in March the prospect of higher electricity prices tipped the balance towards
higher inflation. The forecast for the May 2015 meeting showed inflation
slightly higher than in March, with an average of 6,1 per cent projected
for 2016, followed by 5,7 per cent in 2017. The risks remained skewed to
the upside, with a strong chance of a sustained breach of the target. In this
environment the case for rate cuts evaporated. Instead, the main question for
monetary policy became how long to keep rates on hold.
Both electricity prices and the exchange rate could quickly shift forecasted
inflation above the upper bound of the target. With underlying inflation and
inflation expectations close to the top of the target range, continued flexibility
in the face of supply shocks is likely to generate second-round effects
inconsistent with the inflation target.
Demand pressures on inflation remain weak in the context of low growth.
Part of the puzzle of consistently weak growth and missed forecasts has
been resolved by evidence that potential growth has fallen. The output
gap is accordingly smaller than indicated by earlier estimates. With actual
growth in line with potential growth, the output gap remains largely static
despite mediocre economic performance. Accordingly, most of the burden
for achieving higher growth rates rests on structural reforms. The persistence
of some slack in the economy, however, leaves space to maintain a relatively
accommodative monetary policy stance.
Interest rates remain low in historical perspective, with the repo rate still
negative in real, ex ante terms. Should the risks to the forecast materialise,
with potentially significant second-round effects, interest rate normalisation
will resume. Private-sector forecasts and market indicators are reflecting a
more gradual pace of tightening than in previous hiking cycles. Moderate
rate hikes are likely to achieve price stability, the Bank’s primary mandate,
without unduly sacrificing growth.
Figure 3 Targeted inflation* forecast
Per cent
3-6 per cent inflation target range
*
CPIX for metropolitan and other urban areas until the end
of 2008; CPI for all urban areas thereafter
Source: South African Reserve Bank

Figure 4 Current and previous monetary
policy tightening cycles

September 1994
May 1998
January 2002
June 2006
January 2014
Reuters survey (May 2015)
Sources: South African Reserve Bank and Reuters
Months since first repurchase rate increase
Cumulative change (Percentage points)

Monetary Policy Review June 2015
Box 1
Enhancing monetary policy transparency in South Africa
South Africa’s flexible inflation-targeting framework allows policymakers discretion on
how they make their decisions, for example, in distinguishing between first- and
second-round effects from external shocks. But this discretion, coupled with the
South African Reserve Bank’s institutional independence, makes transparency an
important operational principle to ensure public accountability.1 In addition,
transparency is central to the clear communication and explanation of monetary
policy decisions.
The South African Reserve Bank (the Bank) has become progressively more
transparent over the past two decades. In rankings of central bank transparency, it is
above the global average, alongside peer emerging-market countries such as Brazil
and Chile.2 There are several options for advancing monetary policy transparency in
South Africa. The Bank could release more information about the monetary policy
decision making process or it could provide additional information on the inputs to
policymaking.
Table 1.1
Evolution of transparency in the South African Reserve Bank
First MPC meeting, accompanied by published statements
with interest rate decision
Adoption of inflation-targeting framework (2002 as first target year)
First MPR, including inflation fan chart
Core model published, WP/07/02
Real GDP growth fan chart first published in MPR
Core inflation forecast first published in MPR
Interest rate decision preferences disclosed in the statement
Potential growth model published, WP/14/08
Forecast assumptions published with the MPC statement
Source: South African Reserve Bank
A risk arising from increased transparency is that the public may over interpret the
data. Assumptions and forecasts inform policymakers’ decisions but do not determine
them: judgement plays a crucial role in navigating policy through the enormous
complexity of the macroeconomy. Specific forecasts depend on many different
assumptions – for instance, even a relatively simple forecast input such as the petrol
price is affected by world oil prices, the exchange rate and fuel levies. Change one
assumption and many others must also shift. There is also a risk of increasing financial
market volatility. For instance, the Bank does not have a superior method of
forecasting the exchange rate, and does not target it. Nonetheless, as the monetary
authority, its exchange rate assumptions could move markets.
In light of these advantages and risks, the Bank will improve transparency about its
forecasts and assumptions in a targeted way. From July 2015, the assumptions
underlying the forecast will be published with the MPC statement. This MPR details
the inflation and growth forecasts, and presents an alternative inflation scenario given
additional hikes to electricity tariffs (Box 4). The central design principle is not just to
give as many numbers as possible, but to provide useful information and to
contextualise it.

J C Williams, ‘Monetary policy and the independence dilemma’, Federal Reserve Bank of San
Francisco Economic Letter 2015-15. See
economic-letter/2015/may/fed-independence-goal-mandate-accountability-transparency/?utm_
source=mailchimp&utm_medium=email&utm_campaign=economic-letter-2015-05-11.

N N Dincer and B Eichengreen, ‘Central bank transparency and independence: updates and new
measures’, International Journal of Central Banking 10(1), 2014. The authors rank 120 central banks from
1998 to 2010; South Africa’s score moved from 5 to 8,5 over the period, while the average score moved
from 3,2 to 5,5. Sweden had the highest score of 14,5 (although this is below the potential maximum of 15).
Monetary Policy Review June 2015

Global economic assessment
Growth in the world economy slipped below 3,5 per cent in 2012 and has
remained at these rates since, betraying hopes of a prompt and robust recovery
from the crisis. The composition of world growth shifted unexpectedly
as emerging markets slowed, disturbing a pattern of rapid EM growth
relative to advanced economies. The latter group, however, has improved its
performance over the past two years, owing chiefly to a sustained recovery
in the United States.
Over the next few years, these trends are likely to reverse. The United States
should return to growth rates closer to 2 per cent, which are appropriate for a
mature economy at the technological frontier. Many other wealthy countries
will lag the US, given constraints including ageing populations and more
restrictive labour and product market institutions. The euro area is expected
to grow at about 1,5 per cent over the medium term; Japan’s economy will
likely expand by just 0,5 per cent annually. The advanced economy category
will therefore slow.
Global growth should nonetheless accelerate. Emerging markets are expected
to pick up from a trough this year. Furthermore, these economies will
continue expanding their share of world production. Whereas in the 1980s
rich countries accounted for 79 per cent of world output, at market exchange
rates, by 2010 this was down to 66 per cent. By 2020 this proportion should
fall to 57 per cent, or 39 per cent at purchasing power parity. As emergingmarket productivity growth outpaces that of advanced economies, their
larger share translates into faster overall expansion. Consequently, world
growth should revert to approximately 4 per cent annually – a high rate in
historical perspective.
Trends in advanced-economy growth
The December 2014 MPR noted a divergence amongst advanced economies.
The US and United Kingdom (UK) were recovering strongly, inclining
monetary policymakers to contemplate normalisation. In the euro area and
Japan, by contrast, growth was stagnant. Accordingly, monetary policies
were premised on increasingly aggressive easing strategies.
These trends have persisted, although the collapse in oil prices has suppressed
inflation everywhere, extending the lifespan of super-loose monetary policies.
In the UK in particular, rate increases – once mooted for late 2014 – have
been deferred in the face of inflation at 50-year lows. In the US, inflation
is also very low, with consumer prices in deflationary territory during early
2015. First-quarter performance was also muted. Nonetheless, the economic
recoveries in these countries remain healthy.
The US recovery and monetary policy normalisation
In 2014 the US economy added over 3 million jobs, on a net basis – its
strongest employment gains since 1999. In keeping with these developments,
unemployment fell quite steadily, reaching 5,6 per cent at the end of the
year. (By April 2015, unemployment was down to 5,4 per cent.) The
Congressional Budget Office estimates the natural rate of unemployment
to be between 5,5 and 5,7 per cent, and although these estimates are
subject to some uncertainty, the US labour market is certainly close to full
employment. The puzzle for US policymakers has, therefore, been the failure
of low unemployment to spark inflation, both in wages and more broadly.
Per cent
Figure 5
World growth and components
Emerging markets

World
Advanced economies

Source: International Monetary Fund
Figure 6
US unemployment and NAIRU*

1994 1997 2000 2003 2006 2009 2012

Actual rate of unemployment
Natural rate of unemployment (short term)
Natural rate of unemployment (long term)
Per cent
*
NAIRU: non-accelerating inflation rate of unemployment
Sources: Congressional Budget Office and US Bureau of
Labor Statistics

Monetary Policy Review June 2015
Prices should rise as tighter labour markets intensify competition between
firms for workers, producing higher wages and also higher costs for firms. But
wages have shown persistently small real gains. There are several possible
explanations for this phenomenon. Perhaps the best is that the number of
people working part time, despite preferring full-time work, remains elevated.
This suggests that firms already have the employees they want. As the economy
improves, they will increase hours rather than wages. A related explanation is
that the labour force participation rate remains unusually low. Although this
partly reflects demographic trends, as baby boomers retire, it also demonstrates
the presence of discouraged people who might return to labour markets as
conditions improve.1 As such, the unemployment rate understates the true
labour supply. A further explanation is that wages failed to fall sufficiently
during the crisis, owing to their downward nominal rigidity – essentially,
employers were very reluctant to cut wages, although this was warranted by
economic conditions.2 If this is true, wages are unlikely to grow until the excess
accumulated during the crisis is exhausted. Finally, it remains possible that the
disconnection between unemployment and inflation will be temporary, and
the puzzle will evaporate over the coming months.
The overwhelming majority of Federal Open Market Committee members
have taken the view that the economic recovery justifies raising interest rates
this year. Unfortunately, much analysis of this consensus has focused on the
exact timing of ‘lift off’ – the first adjustment of the federal funds rate above the
zero lower bound. This question is less important than the pace of tightening.
The Fed’s economic projections indicate that over the longer run the policy
rate should be about 3,5 per cent. Markets expect a much lower rate, in the
range of 1,7 per cent. The gap has mostly to do with differing evaluations of
the natural real rate, instead of expectations for unemployment or inflation.
This divergence creates scope for another ‘taper tantrum’ event, as in May
2013, should markets suddenly shift towards the Fed’s expressed views.
However, the arrival of the longer run is probably not imminent. The
inflation outlook remains benign, supported by both low energy prices and
the stronger dollar. Headline personal consumption expenditure (PCE)
inflation has fallen sharply to 0,3 per cent, whilst core PCE inflation has
remained stable at around 1,3 per cent. (The Fed has a 2 per cent goal for
PCE inflation.) When monetary tightening in the US occurs, it is therefore
likely to take the form of a gradual hiking cycle.
Improving conditions in the euro area
In the euro area, there are some tentative signs of recovery after a sustained
period of stagnation. Output contracted in 2013, by half a per cent, but
recovered this ground in 2014. The European Commission forecasts growth
of around 1,5 per cent in 2015, roughly half the rates expected for the US
or UK. Germany is expected to continue growing by slightly more than
the eurozone average. It also enjoys the lowest unemployment rates in the
currency bloc, below 5 per cent. By contrast, France and Italy – the next two
largest economies in the euro area – are likely to lag, with persistent doubledigit unemployment.

J Yellen, ‘Labor market dynamics and monetary policy’, 22 August 2014. See
newsevents/speech/yellen20140822a.htm.

J C Williams, ‘The view from here: the economic outlook and its implications for monetary policy’, 23 March 2015.
See
federal-funds-rate-normalization-sf/.
Figure 7
US labour force
participation rate

Per cent
Source: US Bureau of Labor Statistics
Figure 8
US average hourly earnings:
all private sector

2011 2012

Percentage change over 12 months

Source: US Bureau of Labor Statistics
Figure 9
US personal consumption
expenditure inflation

Percentage change over 12 months

Headline PCE inflation
Core PCE inflation
Source: Federal Reserve Economic Data (St Louis Fed)
Monetary Policy Review June 2015

The European Central Bank has started quantitative easing, purchasing assets
worth around €60 billion per month. It will continue this programme until
September 2016, swelling its balance sheet by about €1 trillion. Bank lending
surveys suggest that financial conditions are improving. Interest rates on new
loans have fallen and lending standards have loosened. Inflation remains very
low, with deflation recorded throughout the first quarter of 2015. However,
retail sales data suggest consumers have not started deferring purchases in
anticipation of lower prices. Demand is also likely to benefit from consumer
confidence, which reached a seven-year high in March 2015.
The longer-run economic health of the euro area remains at risk from
high debt burdens and uncompetitive price levels in some peripheral
economies. Government debt levels in the euro area are over 90 per cent
of GDP, more than one and a half times the permitted maximum under
the Maastricht Treaty. However, with interest rates at historical lows,
interest payments are claiming around 2,5 per cent of GDP, which is a
manageable level. (By contrast, in South Africa interest payments are over
3 per cent of GDP, despite debt levels close to half the euro area average.)
The euro has depreciated significantly, losing 18,1 per cent against the US
dollar since January 2014. This has helped sustain a substantial currentaccount surplus for the euro area as a whole. Peripheral countries remain
largely uncompetitive, however, with their balance of payments improvements
stemming more from import contractions than stronger exports. Their price
disadvantages stem from years of relatively high internal inflation during
the euro’s first decade, which has been only partially reversed. This lack
of competitiveness remains a fundamental constraint on these countries’
growth prospects.
China’s rebalancing
The Chinese economy continues to slow. This is more or less in line with the
process of rebalancing towards domestic consumption, and away from export-
and investment-led development. However, the extent of the slowdown is
somewhat unsettling. Growth in 2014, at 7,4 per cent, was close to target but
lower than in previous years. The first quarter of 2015 registered less rapid
growth still, at 7,0 per cent year on year – the lowest quarterly number since
the global financial crisis. Meanwhile, inflation has fallen markedly. Producer
prices have been in deflationary territory for over three years, with falling
commodity prices suppressing costs at factory gates. Excess capacity is also
exerting strong disinflationary pressure. Consumer prices rose just 2 per cent
in 2014, versus a target of 3,5 per cent. Inflation is likely to remain below
target in 2015, despite the target being lowered to 3 per cent.
Chinese monetary policy is undergoing a paradigm shift as the exchange rate
becomes less of a policy priority. The Chinese renminbi, which is connected
to the US dollar by a crawling peg, has appreciated strongly against other
major currencies. Foreign-exchange reserve accumulation has stopped,
with China’s holdings apparently peaking at almost US$4 trillion. This has
liberated policymakers from the obligation to sterilise the renminbi created
for reserve purchases. Accordingly, the authorities have been able to ease
policy in response to weak growth and below-target inflation. Policy rates
have been lowered three times in six months after two and a half years of
stability. Required reserve ratios, previously the main sterilisation tool,
have also been reduced. Both these policy settings nonetheless remain tight
by world standards; the ex ante real policy rate, for instance, is one of the
highest amongst major economies.
Per cent
Figure 11 Interest rates on new business
Up to 1 year
Over 5 years
Source: European Central Bank

Up to 5 years

Per cent
Figure 10 Interest rates on new loans for
house purchase
Up to 1 year
Over 5 years
Source: European Central Bank


Up to 5 years
Figure 12 Euro area deflators*

2000 2002 2004 2006 2008 2010 2012 2014
France
Greece
Italy
Spain
Germany
Ireland
Portugal
Indices: 2000 = 100
* Higher index values for the GDP deflators imply lower
competitiveness within the common currency area
Source: World Bank

Monetary Policy Review June 2015
The dilemma for policymakers is that China has already experienced extremely
rapid credit growth since the crisis, whilst output growth has slowed. Total
debt now exceeds 200 per cent of GDP for the public and private sectors
combined, an unusually high level amongst emerging markets. Additional
policy easing risks even more debt accumulation. Yet below-target inflation
and slowing growth makes debt servicing more difficult. Further easing
measures are therefore to be expected, and will likely be targeted in an effort
to limit credit growth in the most leveraged sectors.
Commodity prices and their consequences
China’s slowdown is being felt across the world economy, particularly in
commodity-exporting countries. Metals prices have been falling since 2011,
the year China’s growth peaked with the help of a massive stimulus package.
Energy prices remained elevated until the second half of 2014, but then
collapsed, catching up with metals. (Food inflation has behaved differently,
with prices trending down gently over the past few years, although they
remain elevated in historical perspective.)
The immediate causes of falling energy and metals prices differ. The oil price
collapse is usually traced to large increases in North American production,
which also weakened the Organization of the Petroleum Exporting Countries’
monopoly power. Of course, this adjustment does not equally apply to copper,
coal or iron ore prices. Nonetheless, energy and metals prices performed similar
downward level shifts between 2011 and 2014. The common factor is a legacy
of strong demand and high prices, starting in the mid-2000s, which elicited a
vigorous supply response. This capacity is now serving to keep prices relatively
low in a world of weaker global demand growth.
This environment poses acute challenges for commodity-exporting countries.
In particular, it has been difficult to improve export performances. Brazil’s
current-account deficit has deteriorated to nearly 4 per cent of GDP, from
2 per cent in 2011. Over the same time frame, Colombia’s has moved from
3 per cent to 5 per cent of GDP, Peru’s from nearly 2 per cent to 4 per cent,
and Indonesia’s from a slight surplus to a deficit of 3 per cent of GDP. South
Africa is similarly placed, with a current-account deficit of 5,4 per cent of
GDP in 2014, from 2,2 per cent in 2011. These widening deficits have
occurred despite significant currency depreciation in all these countries. The
resulting predicament – unbalanced economies with limited export demand
– is an important aspect of the worldwide emerging-market slowdown.
Faster growing emerging markets
Sub-Saharan Africa shares in this difficulty, to some extent. Energy producers
have been hit by collapsing prices: the International Monetary Fund (IMF)
estimates growth will be about 2,5 percentage points lower across oil
exporters for 2015, relative to earlier forecasts. Other economies with large
commodity sectors, such as Zambia, have also slowed. But all these economies
are growing off low bases, and the returns from better policy frameworks and
new technologies will in most cases permit growth to be sustained at quite
rapid levels, despite sinking commodity prices and tighter world financing
conditions. As a result, the region can look forward to output expanding by
about 5 per cent a year over the medium term.
India is even better placed. It is the second largest of the BRICS (Brazil,
Russia, India, China and South Africa) countries, but also the poorest in per
Figure 13 Growth in Chinese foreign reserves


Percentage change
over 12 months
US dollar trillions
Reserves (right-hand scale)
Growth of reserves
Sources: People’s Bank of China and own calculations
Figure 14 Chinese policy rates

2000 2002 2004 2006 2008 2010 2012

1 Year Benchmark Lending Rate

1 Year Benchmark Deposit Rate
Source: People’s Bank of China
Per cent
Indices: 2010 = 100
Figure 15 Real commodity prices

Coal, crude oil and natural gas

Base metals

Precious metals
Source: World Bank

Monetary Policy Review June 2015

capita terms. Its growth is expected to overtake China’s this year: the IMF
forecasts 6,8 per cent growth in China versus 7,5 per cent in India. India has
benefited from declines in both energy and metals prices – unlike many other
emerging markets for which at least one of these categories is an important
export industry. Its current-account deficit, a source of vulnerability during
the 2013 ‘taper tantrum’, has narrowed markedly, from about 4,8 per cent of
GDP in 2012 to 1,4 per cent in 2014 (aided by restrictions on gold imports.)
Reflecting these improvements, the rupee has been roughly constant against
the US dollar this year, despite that currency’s general strength. In addition,
India has made progress on fundamental economic reforms. For instance, in
the monetary sphere, this has included the adoption of an inflation target of
4 per cent, plus or minus 2 per cent, to be achieved from 2016/17.

Monetary Policy Review June 2015
Inflation developments and outlook
South Africa’s inflation dynamics contrast starkly with prevailing global
conditions. Many advanced economies, and even some emerging markets,
are grappling with ultra-low inflation and sometimes deflation. South
African inflation, however, has not fallen below the target range. Similarly, a
number of central banks have reached the zero lower bound with their policy
rates, forcing them to adopt unconventional measures, including negative
rates and quantitative easing. By contrast, the repurchase rate in South Africa
remains 575 basis points above zero. Furthermore, whilst central banks facing
undesirably low inflation have welcomed currency depreciation as a stimulus
to prices, in South Africa it is a primary threat to the inflation outlook.
The common factor explaining low world inflation has been weak demand
pressures. Yet South African inflation has been close to the top of the target
range despite subdued demand. The origins of this divergence lie in a series
of cost shocks affecting food and administered prices (including petrol) that
produced repeated target breaches. With headline inflation close to 6 per
cent over several years, inflation expectations converged at the top end of
the target range.
This pattern contrasts with the dispersion of expectations which occurred
between 2007 and 2010. In these years, inflation moved in a wide range from
3 to 13 per cent, driven by turbulent commodity prices in the context of a
global boom and bust. As inflation volatility receded in 2011, expectations
began to converge. Since the start of that year, realised headline inflation
has been locked in a range between 3 and 7 per cent; for 41 months out
of 50 it has been between 5 and 7 per cent. By 2014, expectations were as
concentrated as they have been at any stage since the introduction of the
BER survey.
In keeping with these patterns, core inflation has shifted steadily upwards,
towards the top of the target. Services inflation, a major component of core
that tends to adjust quite slowly, has also settled close to 6 per cent. Breakeven inflation rates, as measured by the yield differentials between ordinary
and inflation linked bonds, are back above 6 per cent for all maturities,
reversing a fall to within the target range in the second half of 2014. The
result of these shifts is reduced monetary policy flexibility. With underlying
inflation and expectations already at the high end of the target, additional
shocks are more likely to produce sustained breaches of the target and detach
expectations from the target range.
Figure 16 Inflation in South Africa and in
trading-partner economies

South Africa

Advanced economies*
* Trade-weighted averages
Sources: International Monetary Fund, South African Revenue
Service and South African Reserve Bank

Emerging economies*
Annual average, per cent
Figure 17 Shocks to headline inflation

Headline inflation

3–6 per cent inflation target range
Source: Statistics South Africa
Food and
administered
prices
Petrol prices

Core inflation
Percentage change over 12 months

Food and petrol
prices

0,0
0,5
1,0
Per cent
Figure 18 Inflation expectations in 3D*
* This graph illustrates the distribution of inflation expectations
over time. ‘Higher’ peaks (i.e. red colouring) imply that
expectations are converging
Sources: Bureau for Economic Research, Stellenbosch University;
and South African Reserve Bank
Monetary Policy Review June 2015

Box 2
Accuracy of the inflation fan charts
The MPR displays inflation forecasts using fan charts. These help convey the
essentially probabilistic nature of forecasting, as well as the uncertainty involved in the
process. By skewing the fans, it is also possible to show asymmetric risks to the
forecasts.
Figure 2.1 shows an illustrative fan chart, from 2010, together with its observed
inflation outcome. Over the past decade, more than 20 such charts have been
published in the Bank’s MPR. This box discusses the accuracy of those fans. Three
aspects are explored: the confidence intervals, the shape and width of the fans, and
the possibility of bias.
The Bank’s fans have been divided into 10 per cent confidence intervals. This
establishes a prediction: inflation should be within the 20 per cent confidence band
20 per cent of the time, within the 50 per cent interval half the time, and so forth. In
fact, not all the bands have been reliable guides. In the near term, the forecasts are
generally better than the confidence bands imply. Over the medium term, which is
more relevant for monetary policy, a number of the bands have been less accurate.
(See Figure 2.2) This shows that 10 per cent intervals pretend to a greater level of
forecast precision than has proved achievable. Accordingly, the inflation fan charts will
henceforth use fewer bands. The middle 10 per cent band, which has been reliable,
will be surrounded by 20 per cent intervals out to 90 per cent. This is the same design
used by the Central Bank of Chile. The majority of inflation-targeting central banks
utilise even fewer bands, although a few use more (see Table 2.1).
Table 2.1 Fan charts of established inflation-targeting central banks
Countries
Confidence bands

None
* Central bank also publishes mode of fan chart
Sources: Policy documents of central banks
The width of the fans is broadly determined by the standard deviation of past forecast
errors. At times, larger shocks have been discounted so as to avoid very wide fans.
The distribution is assumed to be normal. However, when the risks to the forecast are
skewed, a two-piece normal distribution is used instead.1 The fans are drawn to cover
90 per cent of cases, with the remaining 10 per cent excluded in recognition of the
uncertainty inherent in forecasting.
This analysis finds that the fans have actually missed 18 per cent of outcomes,
showing the ‘tail risks’ to the forecasts have been larger than expected. However,
statistical tests do not prove that observed inflation has followed a different distribution
to that used for the fan charts. The misses mostly stem from 2007 and 2008, when
inflation exceeded forecasts thanks to skyrocketing food and fuel prices and
accelerating domestic demand pressures.
The final aspect is bias. Of the 154 inflation forecasts studied, 75 of the outcomes
were below the midpoint of the fan and 79 above – an insignificant difference.
Comparing different time horizons, it appears the forecasts have somewhat
exaggerated inflation in the near term, meaning outcomes were lower than expected.
By contrast, over the medium term, inflation has tended to come in above the central
projection. However, this pattern is partially explained by the large inflation surprises
of 2007 and 2008, and the sample size is too small to claim that the bias
is meaningful.

A two-piece normal distribution is made up of the halves of two normal distributions with a shared mode.

Figure 2.3 Normal distribution* and
targeted inflation
-4
-2

Normal distribution

Targeted inflation

(2004Q1−2014Q3)


* Normal distribution is a randomly generated normal
distribution of 10 000 draws with mean and standard
deviation of targeted inflation
Source: South African Reserve Bank


Percentage of observations per band
Figure 2.2 Outcomes per band over time

Source: South African Reserve Bank

t+8
t+4
t+1
Per cent
Figure 2.1 Targeted inflation outcomes and

projection* from the

May 2010 MPR
2005 2006 2007 2008 2009 2010 2011 2012 0

Targeted inflation outcome

3–6 per cent inflation target range
* CPI inflation trajectory 11 quarters ahead
Sources: Statistics South Africa and
South African Reserve Bank

Monetary Policy Review June 2015
The Bank’s inflation forecasts
Inflation is presently expected to average 4,9 per cent for 2015. This is a
major improvement on last year’s forecasts, which showed inflation much
closer to the top of the target range than the midpoint. The latest forecasts,
however, indicate that the disinflationary impact of petrol prices was not as
great as projected in January, when it appeared headline inflation would be
3,8 per cent in 2015, below the midpoint of the target.
By the start of next year, base effects from petrol prices will cause headline
inflation to spike, with the year-on-year figures high relative to the very low
petrol price numbers experienced at the beginning of 2015. The result will
be a temporary breach of the upper bound of the target range, with headline
averaging 6,8 per cent in the first quarter of 2016. As the oil effect recedes,
it will be replaced by food and electricity prices as the key determinants of
price movements. These will keep headline inflation around the upper end of
the target range. Average inflation for 2016 is forecast at 6,1 per cent, falling
to 5,7 per cent in 2017.
Domestic food price inflation is forecast to average 5,2 per cent in 2015,
down from a four-year high of 7,6 per cent in 2014. The decline in food
prices will not be as large as previously thought as domestic drought
conditions and exchange rate depreciation push a wedge between domestic
and international prices. Drought conditions in the maize triangle are
expected to accelerate domestic food prices in the second half of the year.
Box 3
How will higher fuel levies affect inflation?
The collapse of oil prices created an opportunity for government to raise additional
revenue. This is needed as part of South Africa’s fiscal consolidation and to finance
the Road Accident Fund (RAF). South Africa’s fuel levies are comparatively low by
international standards.1 As a consequence, government announced an 80,5 cents
per litre increase in fuel levies comprising a 30,5 cents per litre increase in the general
fuel levy and a 50 cents per litre increase in the RAF contribution.
These increases are significant by historical standards. The RAF contribution
increased by only 8 cents per litre each year over the past five years, while the general
fuel levy increased by an average 14 cents per litre over the past eight years.
There are two channels through which increasing fuel levies will impact overall
consumer price inflation. First, these levies will directly increase consumer inflation by
the weight of petrol in the consumer price index (CPI) basket (5,68 per cent). Second,
the petrol price increase should feed through to firms’ production costs, raising the
cost of other goods and services, as well as to inflation expectations, possibly
increasing nominal wages. These effects are in comparison to price levels as they
would have been without the higher levies – actual fuel prices will still be substantially
lower than they were before world prices plunged.
Figure 3.1 highlights the likely impact of increased fuel levies, which are included in the
baseline projection. Overall these levies add 0,3 percentage points to consumer price
inflation, bringing it to 4,9 per cent in 2015. Most of that increment reflects the direct
impact of petrol in the CPI basket. The petrol price is expected to decline by 8,4 per
cent in 2015, compared to what would have been a 12,7 per cent drop without the
higher levies. Over time the indirect impacts appear, pushing up the prices of other
goods and services and raising inflation expectations. Targeted inflation in 2016 is
expected to be 0,2 percentage points higher, mainly as a result of these indirect
effects. One important contributing factor is food prices, which are expected to rise
by 0,5 percentage points in 2016 to 5,9 per cent due to the importance of fuel in the
food supply chain.

National Treasury, Budget Review 2015, 25 February 2015, p 4.
Cents per litre
-150
-100
-50

Figure 20 South African petrol price and

contributions to changes in the

basic fuel price

Movement in international product prices

Exchange rate

Gauteng price of 95 octane unleaded petrol (right-hand scale)

Price change
Source: Department of Energy

2014 2015


Percentage change over 12 months
Figure 3.1 Impact of fuel levy and RAF

contribution on headline CPI

Headline CPI (without fuel levies)

Headline CPI (baseline)

Indirect impact (right-hand scale)

Direct impact (right-hand scale)


Source: South African Reserve Bank
1,0
Percentage point contribution
Figure 19 Decomposition of targeted inflation

Food

Petrol

Targeted inflation

Electricity

Core inflation

-2

Sources: Statistics South Africa and South African Reserve Bank
Monetary Policy Review June 2015

Meanwhile, international food prices have been favourable, with the Food
and Agriculture Organization’s Food Price Index presently at a four-year
low. These prices are expected to contract by 11 per cent in 2015 before
rebounding in 2016. As a result, domestic food prices should rise 5,9 per
cent in 2016 and 5,5 per cent in 2017.
Electricity prices are assumed to increase by about 10 per cent in 2015 and
by about 13 per cent annually in the next two years. Although electricity
prices make up only 4,13 per cent of the inflation basket, these increases will
add as much as 0,5 percentage points to targeted inflation in 2016 and 2017,
before second-round effects. (The contribution is somewhat smaller in 2015
as the increase arrives late in the year.) It is possible that electricity prices will
add even more to inflation if the scheduled tariff increases are revised. This
scenario is explored in Box 4.
Core inflation should remain at the upper end of the target. Core most
likely reached its peak in February 2015, at 5,8 per cent, and is expected to
average 5,6 per cent in 2015. The decline in targeted inflation should lower
inflation expectations in 2015 and feed into unit labour costs (ULCs). After
an extended period above 6 per cent, ULCs are expected to moderate to
5,5 per cent in 2015 and 5,4 per cent in 2017. This development is premised
on output picking up over the forecast horizon, as well as some moderation
of wage and salary increases.
Risks to the forecast
This forecast faces a number of risks, all of which are skewed towards
higher inflation than currently expected. Three are particularly prominent:
electricity prices, wage settlements and the exchange rate.
Electricity prices
Electricity prices are already slated to rise faster than headline inflation.
Nonetheless, Eskom has requested a 25,3 per cent tariff increase in 2015/16,
considerably more than the confirmed 12,7 per cent increase. A large
additional increase would have significant consequences for inflation. The
inflation effects of a 25 per cent hike scenario are detailed in Box 4.
Box 4
Scenario on electricity tariffs
Eskom has recently applied to the National Energy Regulator of South Africa (NERSA)
for higher electricity prices. The application proposes an increase of 25,3 per cent for
2015/16. This roughly doubles the 12,69 per cent increase already approved. It
includes an additional 10,1 percentage points to cover higher generation costs,
mainly from diesel powered open cycle gas turbines (OCGTs). It also covers a
2,51 per cent environmental levy, as announced in the Budget Review 2015.
If Eskom’s application is successful, it is unlikely that the additional 10,1 per cent
increase would be implemented in July, as has happened historically. Municipalities
have already prepared budgets. They would also require their own approval from
NERSA to amend the electricity prices they charge to their clients. Therefore, the
scenario shown here assumes that prices will increase in September 2015, not July.
Electricity price hikes are assumed to return to 13,1 per cent for 2016/17 and
2017/18.
In this scenario, headline inflation is 0,1 and 0,4 percentage points higher at 5,0 and
6,5 per cent in 2015 and 2016 respectively. Inflation breaches the target ceiling for four
quarters, peaking at 7,4 per cent in the first quarter of 2016 compared to 6,8 per cent
in the baseline. Most of the impact on targeted inflation is through the direct effects of
Per cent
Figure 21 Evolution of the power

subcomponent

May 2015 MPC

May 2014 MPC

November 2014 MPC

November 2013 MPC

Source: South African Reserve Bank
Percentage change over 12 months
Figure 4.1 Impact of proposed electricity

tariffs

Electricity price inflation (baseline)

Electricity price inflation (alternative)
Source: South African Reserve Bank

Monetary Policy Review June 2015
Wage settlements and inflation
In several major economies, including the United States and Japan, wage data
are studied for the slightest indications of higher pay. These would suggest
accommodative monetary policies are working to improve living standards
and return inflation to targets. In South Africa, there is abundant evidence
of real pay increases. But these increases are much less welcome, posing risks
to both employment and inflation.
Excessive wage settlements affect inflation in two ways. The obvious problem
is that inflation accelerates. The more subtle consequence is that inflation
does not fall but is sticky at relatively high levels, pointing to wage indexation.
It is possible that even high wage settlements could be consistent with low
inflation, if firms respond to higher labour costs by reducing their demand
for workers. But not all inflationary pressure is likely to be relieved in this
way. In some instances, it may not be possible to substitute capital for labour.
The connection between remuneration and job losses is also likely to operate
with a lag, as firms start reducing labour demand only after conceding high
wage settlements.
Wage settlements as measured by the Andrew Levy survey3 have remained
high and sticky, averaging 7,9 per cent from 2010 to 2014. (The average
level for the first quarter of 2015 was also 7,9 per cent.) Wage and salary
expectations are also above inflation, according to the BER’s survey. In the
first quarter of 2015, respondents reported 6,8 per cent for this year and
7,0 per cent for 2016 (although these figures are noticeably lower than
expectations of 7,8 per cent captured in the previous quarter).4
Growth in average formal (non-agricultural) salaries and wages has averaged
8,4 per cent over the past five years. Labour productivity in the formal, nonagricultural sector has risen 1,7 per cent annually.5 The gap between these
numbers is reflected in higher unit labour costs (ULCs), which grew on
average by just under 7 per cent over the same period (well above inflation,
which averaged 5,4 per cent). ULCs spiked in 2008 and have since subsided
slowly. In the years 2008 to 2012, ULCs grew by less than 6 per cent for
only four quarters out of 20. More recently, growth in ULCs has been more
moderate, at around 5 per cent, although it was back over 6 per cent towards
the end of 2014.
This decline in ULCs suggests productivity gains and job shedding have
together reduced the inflationary consequences of rising labour costs.
However, the fact that ULCs continue to grow by close to 6 per cent shows
these pressures continue to feed inflation.

This survey, however, covers a very small proportion of the labour force.

This question is also asked in the BER’s inflation expectations survey.

These numbers must be interpreted with caution because of various measurement problems with labour data.
However, the key point is the trend of total wage growth above growth in labour productivity or in general prices.
electricity prices, which have a weight of 4,13 per cent in the CPI basket. The forecast
also reflects some indirect effects, which are adding about 0,1 percentage points in
2016. Inflation remains unchanged in 2017 at 5,7 per cent.
The aim of Eskom’s application is to frontload revenue collection. Given base effects
from higher electricity tariffs in 2015/16, increases in 2016/17 and 2017/18 may be
lower than those currently scheduled in the third Multi Year Price Determination
(MYPD3). This could provide some inflation relief in 2017.
Per cent
Figure 22 Unit labour cost and productivity

Labour productivity

Nominal unit labour cost
Source: South African Reserve Bank

Percentage change over 12 months

Targeted inflation (baseline)

Targeted inflation (alternative)

3–6 per cent inflation target range
Source: South African Reserve Bank

Figure 4.2 Impact of proposed electricity

tariffs
Monetary Policy Review June 2015

Unemployment in South Africa has been fairly constant at around 25 per
cent since 2010, and net job creation has been positive over that period,
demonstrating that the economy as a whole has not been shedding jobs.
However, there is some sectoral evidence of high wages driving job losses.
The pattern is clearest in the manufacturing sector, which has seen a
structural shift away from labour since about 2006. There is also evidence
of job shedding in the mining sector, with the Chamber of Mines reporting
about 35 000 job losses since 2012, close to 7 per cent of total mining
employment.
The main engine of job creation since the crisis has been the public sector.
By contrast, private-sector employment is still below pre-crisis levels. Over
the past seven years, the public-sector workforce has expanded by over
400 000 people, on a net basis, and now accounts for almost 25 per cent of
overall employment. (The private sector has shed close to 300 000 jobs, net,
over the same time frame.) The state’s wage bill has climbed from around
13 per cent of GDP during the 2000s, to 15 per cent of GDP, with individual
wages rising 15 per cent between 2007 and 2015 in real terms. This wage
growth is not easily evaluated because of the difficulty in measuring publicsector labour productivity. It is clearer, however, that although real publicsector wage costs will keep rising over the next three years, public-sector
employment is likely to stop growing as the state implements a personnel
head count freeze. Without the state driving employment gains, we may
now begin to see net job losses not just in specific sectors but also across the
economy as a whole. The alternative would be wage and salary moderation
alongside rising productivity. This would provide a more sustainable basis for
continued employment gains, and should over time stimulate private-sector
employment.
Currency depreciation
The rand has been depreciating against the US dollar for over four years –
the longest such trend since 1994. However, the rand’s recent performance
against other currencies has varied. In particular, although the domestic
currency is presently close to a 13-year low against the US dollar, it has
gained against the euro. In keeping with this divergence, the trade-weighted
exchange rate has been little changed since early 2014.
What scope exists for additional currency depreciation? South Africa remains
vulnerable to further rand weakness given a relatively large and persistent
current-account deficit. This is likely to become more difficult to finance
as the Fed normalises monetary policy, because higher interest rates in the
United States should redirect capital away from emerging markets, including
South Africa. The consequences of US normalisation could, however, be
mitigated by several factors.
Long US rates will not necessarily move in tandem with short rates, a pattern
last seen in the mid-2000s, when it was termed the ‘Greenspan conundrum’.
A comparable ‘Yellen conundrum’ would mean longer-term investors would
not suddenly find more lucrative opportunities in the US relative to emerging
markets, so capital flows would not reverse sharply.
Second, the policies of major central banks are diverging, with the ECB
and the Bank of Japan still easing policy. This is keeping world monetary
conditions loose and making investors’ search for yield correspondingly
difficult. (Indeed, this is a likely cause of the mooted ‘Yellen conundrum’).
Index: 2000 = 100
Percentage change
over four quarters

Figure 23 Employment and average wage

growth in manufacturing

Growth in average salaries and wages*

Employment (right-hand scale)
* Four-quarter moving average
Sources: Statistics South Africa and South African
Reserve Bank

2009 2011 2013 2015
2005 2007

Percentage of GDP
Figure 24 Public-sector wages
2006 2008 2010 2012 2014

Sources: Statistics South Africa and South African Reserve Bank
Indices: January 2011 = 100
Figure 25 Various exchange rate measures

NEER

Euro against the rand
Sources: Bloomberg and South African Reserve Bank

201550

US dollar against the rand
Japanese yen against the rand

Monetary Policy Review June 2015
Third, it is uncertain to what extent Fed normalisation has already been priced
in to markets, including exchange rate markets. The process of normalisation
has been extensively communicated. US policymakers are endeavouring to
avoid repeating the ‘taper tantrum’ of May 2013, when market actors abruptly
revised their views of the Fed’s normalisation timetable following comments
by the incumbent chairman, Ben Bernanke. But there is still scope for
surprises over the exact pace and timing of Fed normalisation. For instance,
market expectations of the federal funds rate remain well below the median
expectations of policymakers, as expressed in the Fed’s ‘dot plots’. Domestic
factors will also interact with US developments and may prompt sharp selloffs, like those recently witnessed in several other emerging markets.
Compounding the difficulty of forecasting exchange rate developments is
the problem of pass-through, an abiding concern for monetary policy in
South Africa. The amount of depreciation that feeds through into consumer
price inflation appears to have fallen during the current depreciating
trend, relative to previous periods of rand weakening. Estimates vary, but
pass-through may be closer to half its average longer-run level of around
20 per cent. This phenomenon is likely related to weak domestic demand,
which makes it more difficult for importers to pass higher costs on to their
customers. Other possibilities are that importers have been able to absorb
higher costs through hedging strategies, or have deferred price hikes on the
expectation that the currency will rebound. Should pass-through revert to
its longer-run average, this would release pent-up inflationary pressure into
the economy.
Per cent
Figure 26
US Federal Reserve ‘dot plot’

and federal funds futures

Federal funds futures 21 May 2015

FOMC participants (end of year)

Median (March 2015 FOMC)
Sources: US Federal Reserve and Bloomberg

Monetary Policy Review June 2015

Domestic growth outcomes
South Africa recorded meagre growth in 2014. Output expanded just 1,5 per
cent, even lower than the mediocre 2,2 per cent achieved in the preceding
two years, and the lowest growth rate since the crisis. This under performance
appears to have re-opened the output gap, which had been approaching
zero at the end of 2013. The main driver of this was strikes, particularly the
record-length platinum-sector strike in 2014. As these disputes were resolved
in the second half of the year, growth rebounded, reaching an annualised rate
of 4,1 per cent in the fourth quarter.
Yet that high number does not signal an upward shift in South Africa’s
growth trajectory. Instead, growth is likely to remain slightly over 2 per cent.
This is similar to the average of the past three years, and significantly below
pre-crisis levels. It is also close to estimates of the economy’s potential growth
rate. A major reason for this downward shift is electricity shortages. In
addition, the credit cycle is not yet in a leveraging, growth-supporting phase.
Furthermore, the external sector remains relatively unfavourable, with weak
world trade growth and lower commodity prices.
Electricity
In November 2014, an accident at the Majuba power station prompted the
return of load shedding in South Africa. Although originally considered a
temporary disturbance, load shedding has continued through the first half
of 2015. Shortages of electricity are now expected to persist over the medium
term – a crucial constraint on growth. The problem has several dimensions.
Eskom has seen underinvestment in generating capacity over the past
20 years. New investments have been hampered by prolonged and repeated
construction delays. South Africa’s usage of electricity is also comparatively
inefficient.
Following supply shortages during the 1970s, Eskom invested heavily in
new generating capacity. Weak growth in the 1980s led to excess supply, a
situation which persisted through the 1990s. Thereafter, a resurgent economy
began reducing the slack, but new capacity was not approved until 2004.
This delay stretched supply and created a maintenance backlog. Over the past
five years, Eskom’s energy availability factor – the proportion of theoretical
capacity actually available to generate power – has declined to around 75 per
cent, compared to a target of 80 per cent. More than half of the recent load
shedding has been caused by breakdowns or emergency maintenance. The
electricity problem is unlikely to be alleviated by the completion of the main
new power stations, Medupi and Kusile, which have anyway experienced
repeated delays and will be years overdue. The maintenance backlog means
these plants will merely substitute for others which will need to be taken
off line for repairs. Furthermore, parts of Eskom’s fleet are old and due for
decommissioning.
Compounding the problem, South Africa’s economy is relatively energyintensive. Historically low electricity prices have encouraged inefficient use
of electricity by firms and households. The World Economic Forum’s Energy
Architecture Performance Index shows that South Africa produces less output
per unit of energy than commodity-producing peers such as Australia, Brazil
and Canada. The Organisation for Economic Co-operation and Development
(OECD) has also demonstrated that South African electricity is relatively
Percentage of potential GDP
Figure 27
South Africa’s estimated

output gap
Source: South African Reserve Bank
-3
-2
-1

2006 2008

2012 2014

Per cent
Figure 28
South Africa’s estimated and

forecast potential output growth

2000–2017

Potential growth

Real GDP growth
Source: South African Reserve Bank

2004 2006 2008 2010 2012 2014 2016

-3
-2
-1

Mexico
Turkey
Chile
UK
Germany
US
Canada
South
Africa
US dollars per MWh
Figure 29
2013 electricity prices in global

comparison

Industry
Sources: International Energy Agency, Eskom, i-Net and
own calculations

Households

Monetary Policy Review June 2015
cheap, despite recent price increases.6 In other countries, higher prices have
induced users to moderate their electricity requirements. Pushing electricity
costs closer to world norms should serve the same purpose here, although it
will stoke inflation. Price increases are also likely to achieve a more efficient
allocation of scarce electricity by reducing demand at the margins, instead of
rationing electricity more indiscriminately through load shedding.
Electricity supply constraints affect economic growth by interrupting
production in the short term, and deterring investment, which is a longer-term
problem. Production suffers immediately because firms cannot quickly ensure
alternative energy sources for production. Over the longer run, uncertainty
over the availability and pricing of electricity may cause firms to postpone
expansion plans, despite extremely favourable financing conditions. They
are also likely to divert some investment expenditure to mitigate electricity
shortages. For example, they may purchase generators or make alternative
energy supply arrangements with independent power producers.
Table 1 South Africa’s international ranking for electricity provision and quality
WB: Ease of
Doing Business
WEF: Global
Competitiveness Index
WEF: Energy
Architecture
Provision Index
Getting electricity
Quality of electricity supply
Overall
Latest ranking
158/189 (2015)
99/144 (2014/15)
66/125 (2015)
Previous ranking
156/189 (2014)
94/144 (2012/13)
59/105 (2013)
Sources: World Bank (WB) and World Economic Forum (WEF)
The credit cycle
During the boom of the mid-2000s, the South African private sector leveraged
up fast – an important ingredient in South Africa’s growth surge. The public
sector, meanwhile, acted in a counter-cyclical manner, with the state reducing
its (gross) debt burden to around 26 per cent of GDP by 2008. When the crash
came, this left significant fiscal space for expansionary policy. Meanwhile, an
overextended private sector lost its appetite for additional debt, despite very low
interest rates. This combination of public leveraging and private deleveraging
has prevailed since the crisis. As a result, sustained fiscal deficits have pushed
the state’s debt burden to relatively high levels. National government net debt
is expected to reach 40,8 per cent of GDP in 2014/15. Total public sector debt,
including local government and public enterprises, is closer to 60 per cent of
GDP. Slowing potential growth has raised the structural component of the
deficit, meaning debt will not automatically stabilise over the cycle. National
Treasury has therefore begun a fiscal consolidation process to gradually reduce
the speed of debt accumulation.
South Africa’s debt dynamics contrast with the patterns seen in other major
emerging markets, where private-sector borrowing typically ramped up
only after the crisis and public-sector debt growth has been more modest.
Nonetheless, South Africa’s overall debt levels are close to the emergingmarket average. South Africa is also following what appears to be a widespread
turn in EM credit cycles, away from debt accumulation and towards net
deleveraging – an important contributing factor to the generalised emergingmarket growth slowdown.

Organisation for Economic Co-operation and Development, OECD Economic Surveys: South Africa 2013, OECD
Publishing, 2013. See
Indices: 2010 = 100
Figure 30 Electricity production and

consumption

Electricity production

Electricity consumption
Source: Statistics South Africa

Per cent of total electricity produced
Figure 31 Planned and unplanned

electricity outage factor
Source: Eskom

2015 YTD

2015 (weeks)
Percentage of GDP
Figure 32 Public and private debt-to-

GDP ratios

Household debt

National government gross debt

Corporate debt* (right-hand scale)
* Includes loans and bonds
Sources: National Treasury and South African Reserve Bank

2008 2010 2012 2014
2004 2006

Monetary Policy Review June 2015

Private-sector credit growth has been slow despite extremely accommodative
monetary policy settings. The reasons for this lie in a mix of supply and
demand factors. Credit demand is weak owing to high debt levels in
households and firms’ low confidence. Meanwhile, it appears that credit
supply has been at least partly affected by continuous large-scale changes in
financial regulation in reaction to the global financial crisis.
The average household debt to disposable income ratio is now 77,6 per cent,
compared to a 2008 peak of 88,8 per cent. This indicates that households
have made gradual progress in improving their balance sheets since the
crisis. The main driver of the change has been meagre growth in mortgage
lending, a category that dominates household debt stocks, such that even
large increases in categories such as unsecured lending do not change
the overall deleveraging trend. (Mortgage lending accounts for nearly
60 per cent of household credit extension, down from 70 per cent in 2010.
General loans, a category which includes unsecured lending, is about
15 per cent of the total.) For corporates, pressure to deleverage has been low
in an environment of plentiful, cheap funding via low-yield bond markets or
high-priced equities. Lending to corporates has seen some growth over the
past year, to fund working capital requirements, renewable energy projects
and expansion abroad (especially on the African continent), amongst other
activities. This has offset household deleveraging and maintained credit growth
to the private sector, in real terms, at around 2,3 per cent in 2014, in line with
the two preceding years.
On the supply side, financial institutions in South Africa – as in highly
developed financial markets internationally – are in the midst of transformative
regulatory changes. These include the implementation of the stepwise
Basel III requirements as well as domestic measures such as the Regulations
for Affordability Assessment as part of revisions to the National Credit
Regulations. The process of reform entails some uncertainty, which in itself
may be hampering lending. These changes may also raise risk premiums on
new credit for financial institutions, reducing the willingness to make loans.
An unfavourable external environment
The third contributing factor in South Africa’s growth slowdown is a relatively
unfavourable external environment. World trade has slowed markedly since
the crisis, and commodity prices have declined. In this environment, the
current-account deficit has been large and persistent. The domestic economy
has continued shifting resources from the tradeable to the non-tradeable
sector – a pattern which pre-dates the crisis. This helps explain the economy’s
relatively soft response to substantial rand depreciation.
Prices for South Africa’s commodity exports peaked in 2011. They remain
elevated in historical perspective, and the collapse in oil prices has improved
South Africa’s terms of trade. Nonetheless, these are still 8 per cent down on
2011 levels, with more favourable oil prices only now compensating for the
comparable collapses seen in some of our main export commodities. Coal,
which accounts for 6 per cent of exports, has seen its price fall by 37,8 per
cent from 2011 to 2014. For iron ore, which provides close to 7 per cent of
exports, prices have moved even more dramatically, falling 65 per cent from
2011 to the first quarter of 2015 (before staging a partial recovery more
recently). Precious metals prices, especially for gold and platinum, have
moved less sharply, falling 19 per cent each.
Per cent
Percentage change
over 12 months
Figure 33 Credit growth and accommodative

monetary policy

Total loans and advances

Real repurchase rate* (right-hand scale)

Shaded area: negative real repurchase rate
* Real repurchase rate is calculated as repurchase rate
less one-year-ahead inflation up to 2002, and less
Reuters consensus forecast for one-year-ahead
inflation after 2002.
Sources: Statistics South Africa, Reuters and
South African Reserve Bank

-20
-10

-20
-10


Percentage of GDP
Figure 34
The current-account deficit
Source: South African Reserve Bank

Monetary Policy Review June 2015
Growth in world trade has shifted to a new, lower level in the wake of the
crisis. This pattern holds for the world as well as advanced and emerging
economies separately. World growth in imports, for instance, which averaged
6,8 per cent annually from 2000 to 2007, has fallen to just 3,6 per cent for
the period 2011 to 2014. This has narrowed one of the more successful
routes used by emerging markets to move up development rankings. It has
also made it more difficult for countries with undesirably large external
imbalances to remedy them through higher exports.
South Africa’s current-account deficit has averaged 5,4 per cent of GDP
since 2012 – an uncomfortably high number, particularly in the context of
diminished domestic growth. Part of this stems from net income payments
and transfers, categories that are permanently in deficit (by about 3,5 per
cent of GDP on average for the past three years). More important for
understanding the change in the current account has been South Africa’s
trade performance, both in goods and services. Services exports have grown
steadily, with particular help from travel receipts – net services exports
achieved a surplus in the fourth quarter of 2014 for the first time since the
end of 2004. However, the share of services exports in total real exports is
quite small, at 16,5 per cent in 2014 (up from 11 per cent in 2000). Goods
exports, meanwhile, remain below their 2008 peak. And the proportion
of exports in GDP, which fluctuated between 31 per cent and 33 per
cent of GDP before the crisis, has since fallen to around 29 per cent. This
weak growth in total exports, coupled with rising import penetration, is
reflected in a negative contribution of net exports to GDP growth, averaging
-0,1 percentage points over the past three years.
One aspect of this weak trade performance is that the part of the economy
producing tradeables has declined relative to the non-tradeable sector. The
tradeables sector covers businesses that compete with foreign producers,
either in the domestic market or abroad. Since about 2000, this sector –
which contains mining, manufacturing and agriculture – has grown more
slowly than the non-tradeables sector, which comprises everything else in
the economy, including the public sector. More precisely, the non-tradeable
sector has expanded faster than the tradeable sector in 41 of the last
58 quarters. As a result of this growth divergence, the ratio of the nontradeable sector to the tradeable sector has risen from 2:1 in the mid-1990s
to 3:1 currently. This shift helps explain the persistence of a large currentaccount deficit despite sustained currency depreciation: the share of the
economy that benefits from a weaker real exchange rate has shrunk.
Domestic growth outlook
In line with the forces discussed above, the domestic growth outlook has
deteriorated. Forecasts of growth over 3 per cent in 2015 and 2016, which
were maintained until the middle of 2014, have now given way to growth
expectations of just over 2 per cent. In particular, the outlook has been
changed by the electricity constraint. Reflecting this, the Bank’s GDP growth
forecast was revised down significantly at the January 2015 MPC meeting,
by 0,3 and 0,5 percentage points for 2015 and 2016 respectively. The
forecast also reflects goverment’s shift to fiscal consolidation. The February
2015 Budget Review announced higher personal income taxes and spending
reductions of R25 billion, as well as significant increases in the general
fuel levy and contributions to the Road Accident Fund. These measures
will moderate the short-term growth boost from government leveraging.
Percentage of GDP
Figure 35
Net exports of goods and

services

Trade balance

Services balance
Source: South African Reserve Bank


Percentage of GDP
Figure 36
Income and current transfer

components of the SIT* account

Income balance

Current transfer balance
* SIT: services, income and current transfer account
Source: South African Reserve Bank


Figure 37 Evolution of the real GDP

growth forecast

Mar
Jan
Nov

May Jul
Sep Nov Jan Mar May
Annual per cent change


2015 real GDP

2017 real GDP
Source: South African Reserve Bank
2016 real GDP

Monetary Policy Review June 2015

They will also reduce the growth benefit from cheaper oil, although this is
still providing support to economic activity through stronger world growth
as well as higher household incomes.
The growth forecast improves in 2017, with a rebound to 2,7 per cent. This
assumes that electricity shortages will be relieved by new production coming
online, as well as reduced demand from rising electricity prices.
Annual growth in real consumption expenditure by households is forecast
to remain below 2 per cent over 2015 and 2016, despite the gains from
lower international crude oil prices. Additional fuel taxes by government will
redirect some of this windfall away from households. Household incomes
will also be affected by the announced increase in the marginal personal
income tax rate. Employment growth is likely to be weak, in the context of
lower economic growth and the public-sector personnel head count freeze.
Total fixed investment has been revised down in line with lower growth, weak
demand and fragile business confidence. Private-sector fixed investment
growth fell to a five-year low in 2014, with six sectors contracting during the
year, including manufacturing and finance. Furthermore, a spike in green
energy investment in 2013 went unrepeated in 2014, pulling down the yearon-year comparison. Private investment should improve somewhat over the
forecast period, reaching 4,7 per cent in 2017. This follows from a mild
recovery in business confidence, opportunities for further independent power
producers, and the need to maintain and upgrade existing equipment. In the
public sector, investment by general government is forecast to slow in 2015
from double-digit growth rates over the past couple of years. Investment by
public corporations will be lower than previously expected due to revised
investment plans by Eskom and Transnet.
Net exports are expected to remain a drag on growth over the forecast
period, although their impact is likely to be smaller than in previous years.
Export volumes are forecast to rebound in 2015 as mining exports normalise
from 2014’s multi-month platinum-sector strike. These will be more than
offset, however, by the simultaneous rebound in import volumes, with a
projected increase in import penetration. Demand for intermediate goods is
expected to remain robust as firms substitute away from domestic suppliers,
particularly those affected by rising costs and unreliable electricity. Diesel
import volumes are likely to be elevated, with Eskom relying heavily on
OCGT power stations to meet electricity demand.
Risks to the forecast
Risks to growth remain mainly on the downside. The electricity constraint
is a primary concern. The baseline forecast suggests it will relax over the
medium term, owing to more efficient electricity usage and improved supply.
However, these expectations may be misplaced. In particular, additional
delays to new capacity or further breakdowns in existing infrastructure could
lower growth across the forecast horizon.
Annual percentage
change
Percentage point
contribution
-10
-5

Figure 38 Select components of growth

Net exports

Gross fixed capital formation

Government consumption expenditure

Household consumption expenditure

Real gross domestic product (right-hand scale)
Source: South African Reserve Bank

-10
-5

Monetary Policy Review June 2015
Protracted labour disruptions represent an ongoing risk to growth. In 2014,
close to 12 million workdays were lost to strikes, mainly in the mining and
metal or manufacturing sectors. (By comparison, 3,5 million days were lost
in 2012 and 5,2 million in 2013.) This year, new wage deals are due in the
coal and gold sectors. In 2016, wage agreements need to be reached in the
automobile production, fuel, and retail motor industries. Encouragingly, the
new public-sector pay deal was achieved without work stoppages. But there
is a risk this could be the exception and not the rule.
The world economy poses significant additional risks. China is expected
to slow gradually and the euro area to accelerate slightly. In both cases,
however, there is a non-trivial risk of significantly worse outcomes. China
has so far managed to avoid a hard landing, but still faces the challenge of
bringing debt to sustainable levels whilst maintaining adequate growth. An
abrupt slowdown in China could affect South Africa directly through lower
commodity prices and indirectly through weaker world growth. In the euro
area, the main risk to South Africa is a spillover from the Greek crisis to
the rest of the euro area. By itself, the Greek economy is a relatively small
fraction of the eurozone’s. There are presently few signs of spillovers to other
euro area economies, including Italy and Spain, the third and fourth biggest
economies on the continent. But the outlook is subject to considerable
uncertainty.
A final, important risk to growth comes from the adjustment to monetary
normalisation in the United States. As this process unwinds, emerging
markets, including South Africa, should see interest rates rise across the yield
curve to maintain inflows, with exchange rates acting as shock absorbers to
ease the transition. The baseline expectation is that policy changes in the
US will be gradual and clearly communicated, helping markets to adjust
smoothly. If markets abruptly revise their expectations of US policy, however,
these adjustments could be sharp, which would raise borrowing costs
and might damage confidence. That said, the macroeconomic framework
is designed to insulate the real economy from such shocks, in particular
through low levels of foreign-currency debt and a floating exchange rate.
There are many historical examples of emerging markets suffering crises
when US monetary policy tightened, but these countries tended to have
more brittle policy frameworks.


Per cent
Figure 40
Evolution of 2015 and 2016

growth forecasts for the

euro area

August 2014

May 2015
Source: Consensus Economics

January 2015


Per cent
Figure 39
Evolution of 2015 and 2016

growth forecasts for China

August 2014

May 2015
Source: Consensus Economics

January 2015
Monetary Policy Review June 2015

Conclusion
The main storylines of this MPR are as follows.
Collapsing oil prices have lowered inflation in 2015, keeping it close to the
midpoint of the target range. The respite is proving to be quite brief. A temporary
breach of the target is expected early next year as petrol prices rebound. Food
prices and electricity costs are also exerting pressure. Average headline inflation
in 2016 should be 6,1 per cent, falling to 5,7 per cent in 2017.
Underlying inflationary pressures are resilient and expectations have
converged at the top of the target range. This makes a sustained breach of
the inflation target more likely. Furthermore, risks to the forecast are skewed
towards higher inflation. Three stand out. The exchange rate may depreciate
further, with US monetary policy expected to enter a rate hiking cycle this
year. Electricity prices could rise even faster than currently scheduled, should
NERSA amend the existing tariff increase in line with Eskom’s request.
Remuneration of employees may rise by more than productivity, in real
terms, and put pressure on prices. Given all these factors, monetary policy
remains in a tightening cycle.
South Africa’s economic growth rates are converging with estimated potential
growth. Unfortunately, this process has entailed falling potential rather than
rising growth. The output gap nonetheless remains negative. This tends to
alleviate demand-side inflation pressures in the economy. As a result, the rate
hiking cycle is expected to be gradual.
Potential growth appears to be around 2 to 2,5 per cent. Actual growth
could come in even lower, as in 2014, if shocks such as protracted strikes
intervene. But there are deeper reasons that explain why even normal growth
is quite low. The external environment is fairly unfavourable. In particular,
commodity prices have declined. Furthermore, the euro area – a major
trading partner – has still not recovered its pre-crisis level of output. The
financial cycle is not accelerating growth. Private-sector credit extension has
been subdued since the crisis; more recently, the public sector has begun
a process of consolidation to guarantee debt sustainability. Finally, the
electricity supply has emerged as a major constraint on growth. It is expected
to relax only slowly, with help from improved supply and more efficient
demand. By the end of the forecast period, growth may therefore approach
3 per cent.

Monetary Policy Review June 2015
Appendix 1 The Bank’s fan charts
This appendix is intended to assist in interpreting the growth and inflation
fan charts. The MPC uses fan charts to focus the discussion of risks lying
ahead and their impact on the inflation and growth forecasts. These fan
charts assume that the repurchase rate will remain fixed at its pre-meeting
rate throughout the forecast horizon.
Fan chart projections are based on assumptions and are subject to uncertainty.
These graphical representations reflect the MPC’s collective judgement (a
single view of the probability) of the most likely path of inflation and growth
outcomes in the future. However, there is no mechanical link between either
the central projection or the distribution at the forecast horizon and the
setting of monetary policy.
Fan charts reflect the MPC’s view of uncertainty associated with the
projections at different horizons through a range of confidence intervals.
The mode – the darkest band at the centre of the fan chart – represents
the most likely 10 per cent of the probable outcomes, including the central
projection. Moving away from the central projection, the area covered by
each successive band, shaded slightly lighter and added on either side of the
central band, adds a further 20 per cent to the probability, until the whole
shaded area depicts a 90 per cent confidence interval.7 The width of the
coloured confidence bands is an indication of the estimated uncertainty.
The fan becomes progressively wider and flatter as the projection extends
into the future, reflecting increased uncertainty. The MPC also takes a view
on the balance of risks. The probability distribution will be symmetrical if
risks are viewed as evenly spread. If risks are viewed as not evenly spread
then the probability distribution will be asymmetrical and skewed. A skewed
probability distribution reflects a higher likelihood of outcomes in one
direction (above or below the central projection). An upward bias is reflected
by a slightly larger shaded area covered by the upper bands and a downward
bias by a slightly larger shaded area covered by the lower bands.

Actual inflation and growth outcomes are therefore expected to be somewhere within the fan on 90 out of 100
occasions. For the remaining 10 out of 100 occasions inflation and growth can be anywhere in the area outside the
shaded range.
Monetary Policy Review June 2015

Statement of the Monetary Policy Committee
29 January 2015
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank, at a meeting of
the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), the inflation
outlook has been dominated by the further decline in international oil prices, from around
US$75 per barrel in late November to current levels of around US$46 per barrel. Domestic
petrol prices declined by almost R2 per litre over the period (and over R3 per litre since
August), and a further sizeable decrease is expected in February. This decline in domestic
prices occurred despite some offsetting effects from a further depreciation of the rand against
the US dollar.
The near-term inflation outlook has therefore changed significantly, but the favourable
impact of these developments on both inflation and growth in the longer term will depend
on the persistence of the oil price decline. Even a moderate increase in oil prices going forward
will reverse the favourable inflation trajectory, and the inflation and growth benefits, while
welcome, are expected to be temporary. At the same time, the impact of load shedding and
a deterioration of the global growth outlook are likely to offset some of the positive impacts
of the lower petrol price on domestic growth.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas maintained its recent downward trend and measured 5,8 per cent and 5,3 per cent in
November and December respectively, down from its recent peak of 6,6 per cent in May
and June 2014. This trend reflected continued moderation in food and petrol prices. Food
price inflation measured 7,4 per cent in December, down from 7,7 per cent in November,
while petrol prices declined by 5,5 per cent. By contrast, core inflation, which excludes
food, petrol and electricity, remained near the upper end of the inflation target range, but
moderated to 5,7 per cent in December from 5,8 per cent previously.
Headline producer price inflation for final manufactured goods was also favourably impacted
by declining oil and agricultural crop prices, and measured 6,5 per cent and 5,8 per cent in
November and December respectively compared with 6,9 per cent and 6,7 per cent in the
preceding two months.
The decline in international oil prices has prompted a downward revision of the oil price
assumption in the Bank’s forecasting model, with a significant impact on the near-term
inflation forecast. The longer term impact will be dependent on the persistence of these
lower prices, which have been a reaction to global supply and demand factors as well as a
change in the behavior of key oil producers. With supply still plentiful and global growth
prospects remaining relatively subdued, lower oil prices are expected to persist for some
time. However, our forecast makes provision for a moderate increase over the next two years.
Having averaged 6,1 per cent in 2014, inflation is now expected to average 3,8 per cent
in 2015, compared with the previous forecast of 5,3 per cent, and to reach a low of
3,5 per cent in the second quarter of this year compared with 5,1 per cent previously.
The steep decline in 2015, however, produces a strong base effect in 2016, and, when
combined with a slightly higher oil price assumption and a depreciated nominal effective
exchange rate of the rand, results in an average inflation forecast of 5,4 per cent for the year
(5,5 per cent previously), and 5,3 per cent in the final quarter.
The impact on core inflation is far less pronounced. Core inflation is expected to average
5,5 per cent and 5,1 per cent in 2015 and 2016 respectively, from 5,7 per cent and 5,3 per
cent previously. The peak is expected at 5,8 per cent in the first quarter of 2015.

Monetary Policy Review June 2015
Inflation expectations as reflected in the survey conducted by the Bureau for Economic
Research at Stellenbosch University moderated from 6,1 per cent in the third quarter of 2014
to 5,8 per cent in the final quarter. Analysts and trade unionists revised their forecasts for
2015 downwards by 0,3 percentage points to 5,4 per cent and 5,9 per cent respectively, while
the forecasts of business people were 0,2 percentage points lower at 6,2 per cent. Forecasts
for 2016 are unchanged for the latter category, but both analysts and trade unionists expect
a 0,1 percentage point increase in 2016 relative to 2015. While this downward revision is a
welcome development, it is too early to assess whether or not this represents the start of a
sustained downward trend. At these levels, expectations still remain uncomfortably close to
the upper end of the target range.
According to the Reuters poll of economic analysts conducted in January 2015, the median
inflation expectation is 5,0 per cent in 2015, rising to 5,5 per cent in 2016. The low point of
the inflation trend is expected in the second quarter, with the median at 4,6 per cent, but with
expectations ranging from 3,4 per cent to 5,9 per cent. Inflation expectations as reflected in
inflation-linked bonds have been volatile, having increased in response to the weaker exchange
rate in November 2014, but since mid-December have exhibited a steep decline. Both the
5-year and 10-year break-even rates have declined to levels below 5,5 per cent.
The global economic growth outlook remains mixed, despite a strong performance by
the United States (US) economy, lower international oil prices and the quantitative easing
announced by the European Central Bank (ECB). The US economy grew at an annualised
rate of 5,0 per cent in the third quarter of 2014, the fastest quarterly growth since 2003. The
unemployment rate continued to decline as job creation accelerated, and lower oil prices
have provided a boost to consumption expenditure. Growth in the United Kingdom (UK)
also remains robust, despite slower fourth-quarter growth. By contrast, growth prospects in
a number of other advanced economies have deteriorated, with Japan in a technical recession
and the eurozone remaining weak amid fears of deflation.
Lower oil and other commodity prices have had divergent implications for growth forecasts
of different emerging-market economies. Deteriorating prospects in some emerging markets
contributed to the lowering of the International Monetary Fund’s (IMF) 2015 global growth
forecast by 0,3 percentage points to 3,5 per cent, with notable downward revisions to Brazil,
China, Mexico, Nigeria and Russia. Growth in China is now expected to moderate to
6,8 per cent from 7,4 per cent in 2014 as the economy continues to rebalance towards
domestic consumption and reduce vulnerabilities in its banking system. Although Africa
remains one of the high-growth regions, weaker commodity prices pose a risk to the outlook.
The impact of lower oil prices on global inflation is expected to influence monetary policy
responses. Although the US Federal Reserve (the Fed) has indicated that policy rates are still
likely to rise from around the middle of the year, recent market expectations are pricing in a
later start, as inflation remains low. Furthermore, Fed guidance suggests that normalisation,
when it does begin, is likely to be at a gradual pace. Whereas the UK had been expected to
be the first of the advanced economies to begin raising policy rates in the first half of this
year, the lower expected inflation trajectory has changed expectations to later in 2015 or
early 2016.
While the UK and US contemplate monetary tightening, the ECB has embarked on openended quantitative easing, amid risks of deflation, and the slowdown in Japan is also expected
to result in a resumption of asset purchases. Since the previous meeting of the MPC, monetary
policy rates have been lowered in Canada, China, Denmark, Egypt, India, Norway, Switzerland
and Turkey, while policy has been tightened in Brazil, Nigeria and Russia.
Global foreign-exchange market volatility increased in recent weeks in anticipation of
quantitative easing by the ECB; possible risks to the euro from the Greek elections; the
ending of the Swiss franc floor against the euro; and changing expectations regarding the
Monetary Policy Review June 2015

timing and pace of US policy normalisation. Since the previous MPC meeting, the euro
has depreciated by about 10 per cent against the US dollar. Over the same period, the
rand depreciated by 5 per cent against the US dollar and by 1,5 per cent against the pound
sterling, but appreciated by about 6 per cent against the euro. Given the relatively high
weight of the euro in the trade-weighted index, the nominal effective exchange rate of the
rand depreciated by 0,6 per cent.
Market perceptions of a possible delay in US normalisation, coupled with the ECB action,
has changed global market risk sentiment and improved the near-term prospects for capital
flows to emerging markets. This follows a generalised sell-off in December. These flows are
likely to be highly volatile and expected to be more discriminating than in the past. The
spill-over effects of the ECB quantitative easing on the rand are therefore not expected to be
as pronounced as was the case with the US quantitative easing.
Capital flows to South Africa have been in line with these global developments. During
December 2014, non-resident net sales of bonds and equities amounted to R17,9 billion
and R8,2 billion respectively. This trend reversed in late December, as portfolio flows to
emerging markets resumed, and in the first three weeks of January 2015, non-residents were
net purchasers of bonds to the value of R5,8 billion, while net equity sales amounted to
R1,5 billion.
The rand has also been affected by domestic factors, including the disappointing domestic
growth and current-account deficit outcomes, as well as a resumption of load shedding by
Eskom. The rand is expected to remain sensitive to developments on the current account of
the balance of payments, which measured 6,0 per cent of gross domestic product (GDP) in
the third quarter of 2014. Non-oil commodity prices have been on a declining trend since
around 2011, so the recent decline in the oil price represents a positive terms of trade shock
that could have a favourable impact on the current account. However, this effect is expected
to be limited, in part due to the possible constraining effects of load shedding on exports.
The domestic economic growth outlook remains subdued. Despite an expected growth
acceleration in the fourth quarter of 2014 following an annualised growth rate of 1,4 per
cent in the previous quarter, growth for 2014 is expected to average 1,4 per cent, with at
least 1 percentage point lost to work stoppages. The Bank’s forecast for growth in 2015 has
been revised down from 2,5 per cent to 2,2 per cent, and that for 2016 from 2,9 per cent to
2,4 per cent. This forecast attempts to take account of electricity-supply disruptions which
more than offset the positive growth impact of lower oil prices. The Bank’s composite
business cycle indicator has followed a moderate downward trend in the past months,
confirming the subdued outlook. More positively, the Rand Merchant Bank/Bureau for
Economic Research (RMB/BER) Business Confidence Index returned to net positive levels
for the first time since the first quarter of 2013, when it increased by 5 points to 51 index
points in the fourth quarter of 2014.
The mining sector, which expanded output by 6,2 per cent on a three-month-to-three-month
basis in November, is expected to contribute positively to fourth-quarter growth, despite the
1,2 per cent month-to-month contraction in that month. Nevertheless, platinum output still
remains below pre-strike levels, and the sector is likely to face headwinds in 2015 from lower
commodity prices and electricity-supply uncertainty. The outlook for the manufacturing
sector, which contracted for three consecutive quarters, is looking more positive following
the resolution of the strikes in the sector, with a three-month-to-three-month increase in
November of 4,1 per cent. However, output declined by 2,1 per cent on a month-to-month
basis due to electricity-supply disruptions. The Kagiso Purchasing Managers’ Index (PMI)
declined to 50,2 index points in December from 53,3 points in November, indicating an
expectation of positive but subdued growth in the sector.
Although gross fixed capital formation was the largest contributor to GDP growth in the

Monetary Policy Review June 2015
third quarter of 2014, the trend remains weak. Growth in gross fixed capital formation
measured 2,1 per cent in the third quarter of 2014 following two consecutive quarters of
contraction. While the private sector investment reversed its negative trend in the previous
two quarters, at 0,7 per cent it remains extremely low.
The weak growth and investment trends are reflected in the slow rate of formal sector
employment creation. According to the Quarterly Employment Survey of Statistics South
Africa, employment levels decreased by 5,9 per cent on a seasonally adjusted basis in the
third quarter of 2014, mainly due to the termination of temporary employment contracts
related to the general elections in the second quarter. This contributed to the annualised
20,8 per cent decline in public-sector employment, while private-sector employment over
the quarter increased by 0,1 per cent or 2 000 jobs. Compared with a year ago, employment
increased by 1,0 per cent, predominantly in the public sector.
Growth in real final consumption expenditure by households remains weak, despite a
slight acceleration in the third quarter of 2014 to 1,3 per cent from 1,1 per cent in the
previous quarter. However, expenditure on durable goods increased at an annualised rate
of 6,2 per cent, and reflected in stronger new vehicle sales. Retail trade sales improved in
November with a month-to-month increase of 1,5 per cent, and year-on-year by 2,6 per cent.
Consumption expenditure is expected to get some boost from lower petrol prices. Consumer
confidence, while still relatively low, also showed a slight improvement in the fourth quarter
of 2014, having increased to a level of zero from the previous level of -1.
Trends in bank credit extension to the private sector continue to reflect tight conditions
for households while credit to the corporate sector remains buoyant. Growth over twelve
months in total loans and advances to the private sector measured 8,7 per cent in November.
However, growth in loans to households, which has been steadily declining over the year,
reached a low of 3,6 per cent in November 2014, while that to the corporate sector recorded
15,2 per cent. Growth in general loans to the private sector, mainly unsecured lending,
remains weak, despite an increase to 2,9 per cent in November, growth in instalment sale
credit and leasing finance moderated further to 6,1 per cent, while mortgage advances
continued to grow below 3 per cent in line with the subdued housing market. These trends
are assessed to be a reflection of both continued tight credit conditions and weak demand,
as household indebtedness remains high.
Wage settlements indicate a continuation of above-inflation wage and salary increases.
According to Statistics South Africa data, nominal remuneration per worker in the formal
non-agricultural sector increased at a year-on-year rate of 6,9 per cent in the third quarter
of 2014. With labour productivity growth of 0,3 per cent, growth in nominal unit labour
costs amounted to 6,7 per cent in the quarter. According to Andrew Levy Employment
Publications, the average settlement rate in collective bargaining agreements amounted to
8,1 per cent in 2014, compared with 7,9 per cent in 2013. The outcome of the public-sector
wage settlement, due to be implemented in April, is expected to have an important bearing
on the general trend of wage settlements in the economy in 2015.
Food prices remain a major source of inflation pressure with increases still in excess of the
headline inflation rates. However, the moderation observed in recent months is expected
to continue, despite the reversal of the downward trend in manufactured food prices at
the producer level since October. Agricultural food price inflation remains low, having
measured 1,4 per cent in December, with a bumper maize crop expected this year. Global
food prices have continued to decline, with the Food and Agriculture Organization’s Food
Price Index declining by 3,7 per cent in 2014.
The inflation landscape has changed significantly in recent weeks, but the outlook for
international oil prices is highly uncertain. Unless a persistent oil price decline is assumed,
the impact on the inflation trajectory will dissipate over time. The key issue for the MPC
Monetary Policy Review June 2015

is the extent to which second round effects become evident and lead to a more generalised
inflation moderation over the forecast period, and to a further and sustained decline in
inflation expectations. The forecast of core inflation at this stage indicates a relatively muted
decline in underlying inflation.
The rand exchange rate against the US dollar remains an upside risk to the inflation outlook
and is vulnerable to the timing and pace of US policy normalisation, despite the partial
offset from a weaker euro. Further depreciation of the rand against the US dollar could also
erode the positive benefits of lower oil prices on inflation. The slow pace of contraction of
the current account will continue to keep the rand sensitive to both domestic and external
factors.
Along with the exchange rate, wage and salary increases in excess of inflation and
productivity growth remain an upside risk to the inflation outlook. Unless nominal
wage increases moderate in the lower inflation environment, the beneficial effects of the
depreciated currency on competitiveness will be eroded. The MPC views the overall risks
to the inflation outlook to be more or less balanced, with no evidence of excess demand
pressures on inflation.
Notwithstanding a downward revision to the growth forecast, the risks are assessed to be
moderately on the downside. This is due to the likely protracted nature of the electricity
supply constraints, and their consequences for domestic output, as well as for business
and consumer confidence. However, given the supply-side nature of this constraint, the
impact of further monetary policy accommodation on growth is likely to be limited, in the
absence of progress being made in the alleviation of electricity constraints. In addition, the
implementation of structural reforms is necessary to raise potential growth.
For some time we have emphasised that we are in a process of interest rate normalisation.
The lower inflation path gives us some room to pause in this process, particularly against
the backdrop of continued weakness in the economy. The MPC has therefore unanimously
decided to keep the repurchase rate unchanged at 5,75 per cent per annum.
The MPC is aware that the moderation in inflation could raise expectations of lower interest
rates. The MPC is of the view that the bar for further accommodation remains high and
would require a sustained decline in the inflation rate and inflation expectations.

Monetary Policy Review June 2015
Statement of the Monetary Policy Committee
26 March 2015
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank, at a meeting of
the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), the near-term
inflation outlook has deteriorated with the partial reversal of the recent petrol price declines,
emerging upside pressures on food, and possible further electricity tariff increases. The rand
exchange rate has depreciated further, adding to upside inflation risks, against the backdrop
of the expected, but uncertain, tightening of United States (US) monetary policy. The
domestic economy, however, remains weak amid electricity supply constraints and relatively
subdued domestic demand.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas measured 4,4 per cent and 3,9 per cent in January and February respectively. The
lower trend in inflation was mainly due to lower petrol prices, but recent oil price and
exchange rate developments suggest that this is likely to be the low point for the mediumterm inflation trajectory. The February outcome was marginally above market consensus
and the Bank’s forecast of 3,8 per cent, partly as a result of higher-than-expected health
insurance price inflation of 9,6 per cent.
Petrol prices declined by 26,6 per cent in February, while food price inflation measured
6,5 per cent in February, down from 6,6 per cent in January. By contrast, core inflation,
which excludes food, petrol and electricity, remained near the upper end of the inflation
target range, having measured 5,8 per cent in both January and February.
The favourable impact of the lower oil price was also evident in the headline producer price
inflation for final manufactured goods, which measured 3,5 per cent and 2,6 per cent in
January and February respectively, compared with 6,5 per cent and 5,8 per cent in the
preceding two months. The downward trend is also expected to reverse in the face of adverse
fuel and food price developments.
According to the Bank’s latest forecasts, inflation is now expected to average 4,8 per cent in
2015, compared with the previous forecast of 3,8 per cent. A first-quarter average of 4,2 per
cent is now projected as the low point, compared with 3,5 per cent previously. The strong
base effects in the first quarter of 2016 are expected to result in a temporary one-quarter
breach of the inflation target during that quarter at 6,7 per cent, with the average for the
year expected to measure 5,9 per cent, compared with 5,4 per cent previously. Inflation is
expected to average 5,5 per cent in the final quarter of the year, compared with the previous
forecast of 5,3 per cent.
The forecast for core inflation is more or less unchanged at 5,5 per cent and 5,2 per cent
in 2015 and 2016 respectively, the latter up marginally from 5,1 per cent. The peak is still
expected at 5,8 per cent in the first quarter of 2015. The deterioration in the headline forecast
is due to an expected acceleration in food price inflation and the impact of the higher fuel
and Road Accident Fund (RAF) levies on the petrol price, due to be implemented in April.
This is in addition to the current under-recovery on the petrol price. The international oil
price assumption remains unchanged from the previous meeting, with a moderate increase
over the next two years. The electricity price assumption is also unchanged, with increases
of 11,6 per cent assumed from July 2015 and July 2016. However, there is a high possibility
of significant further electricity tariff increases.
Inflation expectations, as reflected in the Bureau for Economic Research (BER) survey
conducted in the first quarter of 2015, improved for all respondents for 2015, but returned
to levels around the upper end of the target range in the next two years. On average,
Monetary Policy Review June 2015

expectations for 2015 declined from 5,8 per cent to 5,4 per cent, with a 1 percentage point
decline in the expectations of analysts to 4,4 per cent, and a 0,2 percentage point decline
in expectations of business people and trade union officials to 6,0 per cent and 5,7 per
cent respectively. However, expectations for 2016 and 2017 are higher, with expectations of
the categories of respondents ranging between 5,6 per cent and 6,2 per cent in 2016, and
between 5,3 per cent and 6,3 per cent in 2017.
The global economic outlook remains uncertain, with a moderate slowdown in the US and
China, and an improvement in the outlook and performance of the euro area and Japan.
The US grew at a rate of 2,2 per cent in the fourth quarter of 2014, down from 5,0 per cent
in the previous quarter, as the stronger dollar impacted negatively on export growth and
investment. Nevertheless, the longer-term growth outlook remains positive. By contrast,
the weaker euro and accommodative European Central Bank (ECB) monetary policy have
contributed to improved growth prospects in the region, particularly in the core countries.
In the fourth quarter of 2014, euro area growth surprised on the upside at 1,3 per cent and
ECB forecasts for 2015 have been revised upwards by 0,5 percentage points to 1,5 per cent.
The Japanese economy emerged from two quarters of negative growth, recording a growth
rate of 1,5 per cent in the fourth quarter.
The larger emerging markets continued to be a drag on global growth. China’s economic
prospects remain relatively subdued with most domestic demand indicators weakening since
the beginning of the year. Consensus forecasts are for both Russia and Brazil to record
negative growth rates in 2015. The outlook for the Indian economy, by contrast, is more
positive.
Global financial markets continue to be dominated by changing expectations of the timing
and speed of the normalisation of US monetary policy. Favourable labour market data in
the past weeks in the US resulted in a strong appreciation of the US dollar against most
currencies, as expectations of the start of policy tightening were brought forward. However,
these expectations were tempered following the March Federal Open Market Committee
(FOMC) meeting where the growth and inflation forecasts were downgraded. Uncertainty
persists regarding the timing of the first interest rate increase. The FOMC has not only
re-emphasised the gradual nature of the expected path of interest rates, but the members’
individual expectations of the interest rate path were also revised down significantly. In
response to this guidance, the dollar weakened somewhat against most currencies.
While the US prepares to tighten monetary policy, the global trend has generally been
towards policy easing or maintaining an accommodative bias. Both Japan and the euro
area have continued with their quantitative easing, while a number of countries have eased
their policy further, amid benign inflation pressures and concerns about deflation in some
countries.
The volatile global trends were reflected in the high degree of volatility in the rand/
US dollar exchange rate. Since the previous MPC meeting, the rand has depreciated by
about 2 per cent against the US dollar, but traded in a wide band of around R11,27 and
R12,52 against the US dollar, with a marked recovery after the recent FOMC meeting. Over
the same period, the rand was more or less unchanged against the euro. On a trade-weighted
basis, the rand depreciated by 0,7 per cent. Although the rand movement reflected US dollar
strength to a large degree, the rand was also negatively impacted by domestic factors, including
the weak January trade data and issues relating to Eskom and the domestic growth outlook.
The rand is expected to remain volatile while uncertainty regarding the outlook for US
monetary policy persists. The commencement of US interest rate increases, when it happens,
is expected to put the currency under pressure. The rand is also expected to remain sensitive
to developments on the current account of the balance of payments. The marked narrowing
of the trade account in the fourth quarter, reflective of higher export volumes and lower

Monetary Policy Review June 2015
import volumes, contributed to the narrowing of the deficit to 5,1 per cent of gross domestic
product (GDP) in that quarter, and to 5,4 per cent for the year. At this stage it is unclear
whether or not this represents the beginning of a sustained compression of the current
account after a long period of real exchange rate depreciation. While lower international
oil prices are expected to continue to impact favourably on the import bill, as oil imports
account for just under 20 per cent of merchandise imports, the wide trade deficit in January,
should it persist, suggests that the adjustment may remain slow.
Although the current-account deficit to date has been relatively comfortably financed,
the global capital flow environment is increasingly challenging, particularly against the
backdrop of expected increases in US interest rates. During the fourth quarter of 2014, the
deficit was financed primarily through flows into the banking sector. In the year to date, the
net sales of bonds and equities by non-residents as reported by the exchanges suggest that net
portfolio flows on the financial account of the balance of payments in the first quarter may
be negative for the second consecutive quarter.
The outlook for the domestic economy remains overshadowed by the electricity supply
constraint, which appears to have had an adverse effect on recent economic activity. This
constraint is likely to persist for some time, and has resulted in a downward revision of shortterm potential output to between 2,0 and 2,5 per cent. Nevertheless, some improvement on
the 2014 growth rate of 1,5 per cent is expected in 2015, in the absence of protracted work
stoppages. The Bank’s growth forecast for 2015 is unchanged at 2,2 per cent, and marginally
lower at 2,3 per cent for 2016. The Bank’s leading indicator of economic activity, which had
followed a moderately declining trend in 2014, also suggests a continuation of the sluggish
growth outlook.
Underlying this outlook is the continued weakness in growth of gross fixed capital formation,
which contracted by 0,4 per cent during 2014, with private-sector fixed investment contracting
by 3,4 per cent, despite some recovery in the final quarter of the year. The main contribution
to fixed capital formation came from general government, which accounts for a relatively
small proportion of the total. With business confidence subdued, and amid binding electricity
supply constraints, the prospects for a meaningful acceleration remain weak.
Initial high frequency data for 2015 are also a cause for concern, should the trends persist.
Both real mining and manufacturing output contracted on a month-on-month basis in
January; the Kagiso Purchasing Managers’ Index (PMI) declined sharply to below the
neutral 50 level in February; the Rand Merchant Bank/Bureau for Economic Research
(RMB/BER) Business Confidence Index declined to below the neutral 50 level in the first
quarter of 2015 to 49 points, with the decline most marked in the manufacturing sector;
and the building sector also shows signs of slowing, with both buildings completed and new
plans passed declining, along with lower confidence in the sector, particularly with respect
to residential construction.
Against this backdrop, employment growth has stagnated and is likely to remain low:
according to the Quarterly Employment Statistics of Statistics South Africa, formal-sector
non-agricultural employment contracted by 0,2 per cent over four quarters in the final
quarter of 2014, with growth in public-sector employment more than offset by job shedding
in the private sector.
Growth in final consumption expenditure by households increased marginally to an
annualised quarterly rate of 1,6 per cent in the fourth quarter of 2014, and measured 1,4 per
cent over the year. Both retail trade and wholesale trade sales declined on a month-to-month
basis in January, and the outlook remains uncertain, as the potential boost to consumption
from lower petrol prices has been partially reversed. However, confidence of retailers,
particularly of durable goods, remains relatively high. High debt levels, low employment
growth and continued tight credit conditions are likely to constrain consumption expenditure
Monetary Policy Review June 2015

growth in the absence of strong increases in real disposable incomes or strong positive wealth
effects.
Fiscal policy is set to continue on its consolidation path. As outlined in the recent Budget
Review, the projected deficit for both 2014/15 and 2015/16 is estimated at 3,9 per cent of
GDP, despite lower GDP growth forecasts, and is expected to narrow to 2,5 per cent of GDP
by 2017/18. This is envisaged to be achieved through a combination of lower expenditure
compared with the 2014 budget estimate and higher tax revenues. This is expected to exert
a moderate constraining effect on household consumption expenditure growth.
Trends in bank credit extension to the private sector have remained relatively unchanged,
with highly divergent patterns in loans granted to the corporate and household sectors.
While growth over twelve months in total loans and advances to the private sector measured
8,3 per cent in January, credit extended to corporates increased by 14,3 per cent, while that
to households increased by 3,5 per cent. Growth across all the main categories of credit
extension to households has remained subdued in recent months, despite a slight increase
in unsecured lending off a low base. Both mortgage credit extension and instalment credit
and leasing finance reflected slow growth in housing and motor vehicle sales. Commercial
mortgages, by contrast, experienced buoyant growth.
The recent higher trend in wage settlements has the potential to put further upside pressure
on inflation. Nominal remuneration per worker over four quarters increased by 7,7 per
cent in the fourth quarter of 2014 and, after accounting for changes in labour productivity,
resulted in a unit labour cost increase of 6,2 per cent, up from 5,7 per cent in the previous
quarter. The Andrew Levy Employment Publications survey shows that during 2014, the
average wage settlement rate in collective bargaining agreements amounted to 8,1 per cent,
compared with 7,9 per cent in 2013. The public-sector wage settlement is still not agreed,
and the outcome is expected to have an important bearing on the general trend of wage
settlements in the economy in 2015.
The recent downward trend in consumer food price inflation is forecast to be reversed in the
coming months, following the severe drought in some of the maize producing areas of the
country. With drastically reduced maize crop estimates, South Africa is expected to become
a net importer of maize during the year, and spot prices have moved closer to import parity.
The spot price of white maize, for example, has increased by around 30 per cent since the
beginning of the year, reinforced by a depreciating currency and despite moderating global
prices. Meat prices have also remained elevated.
International oil prices have been relatively volatile but at vastly lower levels than those
that prevailed for much of 2014. Having reached a low of around US$45 per barrel in
January, Brent crude oil prices increased to around US$62 per barrel at the end of February,
before declining to current levels of around US$57 per barrel. The partial recovery in the
international oil price, in conjunction with the recent depreciation of the rand against the
US dollar, and the impending fuel and RAF levies, will have reversed a large part of the
favourable impact on domestic petrol prices, which had declined by about R4 per litre
between August 2014 and February 2015.
The respite to the headline inflation outlook from lower international oil prices appears to
have been short-lived. However, the expected breach of the target range in 2016 is likely to be
temporary, and the main drivers of the deterioration of the inflation forecast are exogenous.
While the MPC will look through these developments, the Committee remains concerned
about the possible impact on inflation expectations, which remain at the upper end of the
target range over the longer term.

Monetary Policy Review June 2015
The rand exchange rate continues to be the main upside risk to the inflation outlook, and
remains highly vulnerable to the timing and pace of US monetary policy normalisation. The
extent to which US rate increases are priced into the exchange rate remains uncertain. While
the weaker euro has provided some offset, and therefore a more moderate depreciation of the
trade-weighted exchange rate, this effect is partial. Furthermore, the rand will also remain
sensitive to domestic developments, including the slow pace of contraction in the deficit on the
current account of the balance of payments.
Wage and salary increases in excess of inflation and productivity growth also pose an upside
risk to inflation. The MPC assesses the risk to the inflation outlook to be on the upside,
with the possibility of further electricity tariff increases accentuating this risk.
At the same time, the growth outlook remains constrained by electricity supply concerns and
low business confidence, and the risks to the growth forecast are assessed to be moderately
on the downside. Demand pressures on inflation remain muted, reinforced by a moderately
tighter fiscal policy stance.
In its previous statement the MPC noted that the more favourable inflation path allowed
for some room to pause in the process of domestic monetary policy normalisation. The
deterioration in the outlook suggests that this scope has narrowed. However, given the
uncertainties related to US policy normalisation and the weak state of the domestic economy,
the MPC has unanimously decided to keep the repurchase rate unchanged for now.
The timing of future interest rate increases will be dependent, as before, on a range of
domestic and external factors. The MPC will remain vigilant and will not hesitate to act in
order to maintain the integrity of the inflation-targeting framework.
Monetary Policy Review June 2015

Statement of the Monetary Policy Committee
21 May 2015
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank, at a meeting of
the Monetary Policy Committee in Pretoria
The challenges facing monetary policy have persisted and, as expected, the downward trend
in inflation, which was mainly attributable to the impact of lower oil prices, has reversed.
Headline inflation is expected to temporarily breach the upper end of the target range early
next year, and thereafter to remain uncomfortably close to the upper end of the target band
for most of the forecast period. The upside risks have increased, mainly due to further
possible electricity price increases. The exchange rate also continues to impart an upside
risk to inflation as uncertainty regarding impending United States (US) monetary policy
continues. Domestic demand, however, remains subdued, while electricity constraints
continue to weigh on output growth and general consumer and business confidence.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas measured 4,0 per cent and 4,5 per cent in March and April respectively. The petrol
price increase of R1,56 per litre in April resulted in a decline in the rate of disinflation from
the transport category, from -5,0 per cent in March to -1,1 per cent in April, while food price
inflation moderated further. The main contributions to the April headline rate came from
the categories of food and non-alcoholic beverages, housing and utilities, and miscellaneous
goods and services, which together accounted for 3,2 percentage points of the outcome.
Core inflation, which excludes food, petrol and electricity, moderated from 5,7 per cent in
March to 5,6 per cent in April.
Producer price inflation for final manufactured goods appears to have reached a low point
in February at 2,6 per cent, following the 3,1 per cent outcome in March, which was higher
than market consensus. While food price inflation moderated, the main upside contribution
came from coal and petroleum products where disinflation slowed. The recent increase in
international oil prices and higher agricultural crop prices, along with further electricity
price increases from mid-year are likely to sustain the upward momentum.
The inflation forecast of the Bank has changed since the previous meeting of the MPC.
Inflation is now expected to average 4,9 per cent in 2015, with a first quarter low of
4,1 per cent. A temporary breach of the upper end of the inflation target band is still expected
during the first quarter of 2016, to peak at 6,8 per cent, and to decline to 6,0 per cent by the
second quarter of that year. An average inflation rate of 6,1 per cent is forecast for the year.
The forecast period has now been extended to the end of 2017, with an average inflation rate
of 5,7 per cent expected for the year, and 5,6 per cent in the final quarter.
The forecast for core inflation has also increased marginally, to 5,6 per cent in 2015, and to
5,4 per cent in 2016. Core inflation is expected to average 5,2 per cent in 2017, with a final
quarter average of 5,1 per cent. Much of the persistence of core inflation at these levels is
attributed to high levels of wage growth, currency depreciation and inflation expectations
entrenched at the upper end of the target range.
The headline inflation forecast assumes electricity price increases of 13,0 per cent from
July 2015 and July 2016 in line with the original multi-year price determination process
of the National Energy Regulator of South Africa (NERSA). However, the application by
Eskom for a further 12,6 per cent increase from 1 July 2015 will be decided at the end of
June. Given the uncertainty regarding this decision, both in terms of quantum and timing
of implementation, it has not been incorporated into the forecast, but poses a significant
upside risk. Should NERSA fully accede to the Eskom request, a higher peak of headline
inflation as well as a more extended breach of the target can be expected. The direct and

Monetary Policy Review June 2015
indirect effects of such an increase could increase average inflation by around 0,5 percentage
points over a year.
The Bureau for Economic Research (BER) inflation expectations survey for the second
quarter of 2015 will only be released in June 2015. Median inflation expectations as
reflected in the Reuters Econometer poll, at 4,9 per cent and 5,9 per cent for 2015 and 2016
respectively, are similar to the Bank’s forecast, although there is a fairly wide dispersion
between respondents. The break-even inflation rates, as reflected in the yield differential
between conventional bonds and inflation-linked bonds, have been more volatile and are
above the upper end of the target range over all maturities, having reversed their earlier
declines this year.
The outlook for the global economy is broadly unchanged since the previous meeting of
the Monetary Policy Committee (MPC). The US growth forecast for 2015 has been revised
down by about half a percentage point following the broad-based first quarter estimate
of 0,2 per cent, although this deterioration is generally believed to be temporary. Growth
of around 3,0 per cent is now expected in 2015, still above estimated potential. Eurozone
growth has surprised on the upside, and while still relatively subdued at an expected 1,5 per
cent for 2015, there are indications that the region is responding to the European Central
Bank (ECB) monetary stimulus. Any possible fall-out from the debt crisis in Greece remains
uncertain. Japan is expected to growth by just below 1 per cent this year.
Growth in some of the larger emerging markets remains weak. Negative growth is being
experienced in Brazil and Russia, and although the Chinese economy is still slowing, with
first quarter growth of around 5,3 per cent, a hard landing is not expected amid further
monetary policy easing. By contrast, the Indian economy has been performing strongly,
partly in response to policy reforms. While growth in Africa has remained relatively robust,
downside risks have emerged in some of the oil and commodity-producing countries.
Global inflation remains benign, but the partial recovery in the international oil price has
ameliorated the deflationary risks in some of the advanced economies in particular. Higher,
but still low, inflation expectations contributed to a sharp rise in bond yields in some of the
advanced economies, with spillovers to other bond markets. However, most central banks
remain in loosening mode, with further reductions in policy interest rates in a number of
countries since the previous meeting of the MPC. A notable exception has been Brazil,
where monetary policy was tightened for the third time this year.
Global financial markets remain focused on the timing of US monetary policy tightening.
Low inflation and the weaker first quarter growth outcome have pushed out expectations
regarding the starting date, but financial markets generally expect the first move to be
during 2015, most likely in September, followed by a gradual data-dependent tightening
cycle. Continued financial market volatility is likely to ensue with each relevant data release.
The uncertainty regarding US growth prospects contributed to a weakening of the US dollar
against most currencies in recent weeks. Since the previous meeting of the MPC, the rand
has traded in a relatively narrow band of between R11,80 and R12,20 against the US dollar,
and is currently almost unchanged since then. However, in line with US dollar weakening,
the rand has depreciated by 0,6 per cent against the euro and by 4,0 per cent against the
pound sterling. On a trade-weighted basis, the rand has depreciated by 0,3 per cent.
The rand continues to be vulnerable to the ebbs and flows of global risk perceptions and
associated capital flows, particularly in response to anticipated changes to US monetary
policy. At the same time, there is a great deal of uncertainty regarding the extent to which
US monetary policy normalisation has been priced into the rand. However, past patterns
suggest that some further pressure is likely on the exchange rate and long bond yields as the
start of the US tightening cycle becomes more certain. Reflecting this uncertainty, nonresident bond and equity flows have been quite volatile. According to JSE Limited data,
Monetary Policy Review June 2015

non-residents have been net buyers of bonds and equities to the value of around R15 billion
since the beginning of this year.
The rand therefore remains an upside risk to the inflation outlook, although the degree of
upside risk is tempered somewhat by the continued relatively low level of pass-through to
consumer price inflation. The Bank estimates that the actual pass-through could be about
half of what is currently implied in the forecast model, but it is still uncertain as to whether
this reflects a permanent change or a temporary phenomenon which can reverse rapidly.
The domestic growth outlook remains weak, amid continued electricity supply constraints
and low and declining levels of business and consumer confidence. The Bank’s forecast
for gross domestic product (GDP) growth is marginally down from the previous forecast:
growth is expected to average 2,1 per cent and 2,2 per cent in 2015 and 2016 respectively,
and to increase to 2,7 per cent in 2017. Growth for the next two years therefore is expected
to be more or less in line with the Bank’s estimate of short-term potential output growth
of between 2,0 and 2,5 per cent. It also suggests that the negative output gap, currently
estimated at around 1,5 per cent, is likely to persist. This forecast makes an assumption
regarding the persistence of electricity shortages, which are expected to be relieved somewhat
only in 2017. However, the risks to growth are assessed to be on the downside. The moderate
decline in the Bank’s composite leading business cycle indicator also suggests a continuation
of the sluggish growth outlook.
Despite a strong performance by the mining sector in March, first-quarter growth is expected
to be subdued and much lower than the 4,1 per cent measured in the fourth quarter of 2014.
According to Statistics South Africa, the physical volume of mining output increased at a
quarter-to-quarter rate of 1,9 per cent in the first quarter. Platinum group metals output
was particularly strong in March with a month- on-month increase of 26,6 per cent. By
contrast, manufacturing output appears to have contracted by about 0,6 per cent in the
quarter, consistent with the continued decline in the Kagiso Purchasing Managers’ Index
(PMI), down to 45,4 index points in April, and the slight decline in capacity utilisation
in the manufacturing sector. The real value of building plans passed declined for a fourth
successive month in February, in line with a weaker First National Bank/Bureau for
Economic Research (FNB/BER) Building Confidence Index in the first quarter of the year.
Consumption expenditure by households is expected to remain relatively subdued, as higher
personal tax rates take effect and the benefits of lower petrol prices dissipate. There are
mixed signals from the retail trade sales, which rebounded strongly in February but then
contracted in March on a month-on-month basis. A quarterly growth rate of 0,9 per cent was
recorded in the first quarter of 2015. Growth in expenditure on durable goods in particular
is expected to decline, as reflected in the sluggish new vehicle sales, which decreased further
in April. The FNB/BER Consumer Confidence Index declined sharply in the first quarter
of 2015, signalling modest growth in consumption expenditure going forward.
Subdued levels of household consumption expenditure are reflected in credit extension by
banks to households, where the divergence between households and corporates continues.
Growth in credit extension to the corporate sector was 13,9 per cent in March 2015,
compared with 3,6 per cent to households. The latter is reflective of continued weak growth
across all the main categories of credit, influenced by both supply and demand factors.
These trends are likely to be reinforced further by the implementation of affordability
assessment regulations as part of revisions to the National Credit Regulations in March.
The impending changes in the Basel III regulatory requirements are also contributing to
relatively tight credit conditions. At the same time, weak employment growth, high debt
levels and continued household deleveraging, as well as expectations of higher interest rates
may have impacted on the demand for credit.

Monetary Policy Review June 2015
Trends in remuneration growth remain a concern to the MPC. Average wage and salary
growth has been in excess of inflation for some time, imparting some degree of automatic
indexation to wage settlements, and therefore maintaining higher levels of inflation. In the
fourth quarter of 2014, year-on-year growth in nominal remuneration per worker in the nonagricultural formal sector increased by 7,7 per cent. After accounting for labour productivity
growth of 1,3 per cent, unit labour costs showed an increase of 6,3 per cent, from 5,7 per
cent in the previous quarter. According to Andrew Levy Employment Publications, the
average wage settlement rate in collective bargaining agreements measured 7,9 per cent in
the first quarter of 2015. The public-sector wage settlement appears to have been settled
at an increase of 7 per cent, but the full impact on the total government wage bill is still
unclear. Upside risks to inflation from wage pressures are still expected, with the unresolved
settlements in the coal and gold-mining sectors of particular concern.
While high wage settlements could underpin household consumption expenditure, this
could be offset in part by inevitable reductions in employment.
Food price inflation is expected to contribute to upside inflation pressures. This is despite
the continued moderation of global food prices and a recent declining trend of food price
inflation at the CPI level and lower meat price inflation at the producer price level. Food price
inflation measured 5,0 per cent in April following eight successive months of moderation.
Similarly, final manufactured food producer price inflation moderated to 5,8 per cent in
March. However, domestic drought conditions have resulted in a need to import yellow
maize, contributing to maize prices rising close to import parity levels. These pressures,
along with the weaker exchange rate, are expected to reverse the favourable trend in food
price inflation by the second half of this year.
The international oil price appears to have stabilised in the US$60–US$70 per barrel range,
as capital expenditure plans have been scaled back following the collapse of prices in the
later part of last year. Since the previous meeting of the MPC, Brent crude oil prices have
increased by about US$10 per barrel. Domestic petrol prices remained unchanged in May,
but a further increase of around 50 cents per litre, should current trends persist, is likely in
June, attributable mainly to higher international product prices.
Although the upward revision of the inflation forecast was relatively small, the persistence
of medium-term inflation at elevated levels and the deteriorating risks to the outlook are an
increasing concern to the MPC. While currently the breach is expected to be temporary, the
longer-term trajectory is close to the upper end of the target range, and the upside risks make
this trajectory vulnerable to any significant changes in inflation pressures.
The main risks to the outlook remain electricity tariff increases, the exchange rate and wage
settlements. Significant additional electricity tariff increases are likely to cause inflation to
diverge significantly from the target range for a more extended period than our baseline
forecast suggests. The rand remains vulnerable to global market reaction to US policy
normalisation, particularly in the context of South Africa’s twin deficits. Any significant
weakening of the exchange rate in reaction to US monetary policy tightening could cause
inflation to diverge even further from target, and set in motion an exchange rate-inflation
spiral. Furthermore, the possibility of a wage-price spiral, should settlements well in excess
of inflation become an economy-wide norm, also poses a risk to the outlook.
The MPC recognises that domestic inflation is not driven by demand factors that are more
easily dealt with through monetary policy responses. Household consumption expenditure
remains relatively subdued. While monetary policy should generally look through supply
side shocks, such as large electricity tariff increases and oil price changes, the MPC has to
be mindful of the second-round effects of such shocks. In particular, we need to monitor
closely the possible impact on inflation expectations which remain uncomfortably close to
the upper end of the target range over the longer term.
Monetary Policy Review June 2015

Growth remains fragile, constrained by electricity shortages and low business confidence,
and the risk to the outlook remain on the downside. But this cannot be solved by monetary
policy alone. Monetary policy action will need to achieve a fine balance between achieving
the Bank’s primary mandate of price stability and not undermining growth unduly.
The MPC has decided to keep the repurchase rate unchanged at this meeting. Four
members of the committee favoured an unchanged stance while two favoured a 25 basis
point increase. The deteriorating inflation outlook suggests that this unchanged stance
cannot be maintained indefinitely. The MPC will continue to closely monitor the evolution
of inflation expectations and other factors that could undermine the longer-term inflation
outlook and stands ready to act when appropriate.
From the next meeting in July, the Bank will take further steps to increase transparency by
publishing the assumptions underlying the Bank’s forecast with the MPC statement.

Monetary Policy Review June 2015
Abbreviations
BER

Bureau for Economic Research
BRICS
Brazil, Russia, India, China and South Africa
CPI

consumer price index
ECB

European Central Bank
EM

emerging market
FOMC
Federal Open Market Committee
GDP

gross domestic product
IMF

International Monetary Fund
MPC

Monetary Policy Committee
MPR

Monetary Policy Review
MYPD
Multi Year Price Determination
NAIRU
non-accelerating inflation rate of unemployment
NEER
nominal effective exchange rate
NERSA
National Energy Regulator of South Africa
OCGT
open cycle gas turbine
OECD
Organisation for Economic Co-operation and Development
OPEC
Organization of the Petroleum Exporting Countries
PCE

personal consumption expenditure
Repo [rate]
Repurchase [rate]
RAF

Road Accident Fund
SIT

services, income and current transfer [account]
the Bank
South African Reserve Bank
the Fed
United States Federal Reserve
UK

United Kingdom
ULC

unit labour cost
US

United States
WB

World Bank
WEF

World Economic Forum
Monetary Policy Review June 2015

Glossary
Administered prices: These prices are set according to government’s policy rather than
determined by market supply and demand forces.
Advanced economies: Advanced economies are countries with high levels of GDP per capita.
These countries are sometimes described as industrialised. With further growth, however,
they have tended to diversify, with particular emphasis on services sectors.
Balance of payments: This is a record of transactions between the home country and the rest
of the world over a specific period of time. It includes the current and financial accounts. See
also ‘current account’ below.
Basel III: This refers to a set of global banking reforms in both the micro- and macroprudential
spheres. It is aimed at improving banking regulation, supervision and risk management.
Implementation began in early 2013 and is ongoing.
Baseline (forecast): The baseline forecast is the one that is considered most likely. Alternative
scenarios use different assumptions.
Budget deficit: A budget deficit indicates the extent to which government expenditure
exceeds government revenue (a budget surplus occurs when revenue exceeds expenditure).
Business and consumer confidence: These are economic indicators that measure the state
of optimism about the economy and its prospects among business managers and consumers.
Central projection: This is the most likely outcome for the variable of interest over the
period, according to South African Reserve Bank forecasts.
Commodity prices: Commodities can refer to energy, agriculture, metals and minerals.
Major South African-produced commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication of aggregate price changes
in the domestic economy. The index is calculated using a number of categories forming a
representative set of goods and services bought by consumers.
Core inflation: Core generally refers to underlying inflation, excluding volatile elements, e.g.
food and energy prices. The Bank’s forecasts and discussions refer to headline CPI excluding
food, non-alcoholic beverages, petrol and electricity prices.
Crawling peg: An exchange rate regime that lies between the fixed and floating regimes. A
crawling peg adjusts slowly based on the changes to an ‘anchor’ exchange rate against which
it is linked.
Crude oil price: This is the price, in US dollars, per barrel of unrefined oil (Brent crude refers
to unrefined North Sea oil).
Current account: The current account of the balance of payments consists of net exports
(exports less imports) in the trade account, as well as the services, income and current transfer
account.
Demand pressures: Demand pressures refer to price pressures from increased consumption
in the domestic or foreign economy.
Emerging-market economies: Emerging-market economies are those with low to middle
income per capita. They are advancing rapidly and are integrating with global (product and
capital) markets.
Ex ante: This refers to an object’s value before an event.

Monetary Policy Review June 2015
Exchange rate depreciation (appreciation): Exchange rate depreciation (appreciation)
refers to a decrease (increase) in the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange rate changes on domestic inflation
(i.e., the percentage change in domestic CPI due to a 1 per cent change in the exchange rate).
Changes in the exchange rate affect import prices, which in turn affect domestic consumer
prices and inflation.
First-round effects: Price shocks entail direct and indirect first round effects. For example,
should the petrol price rise sharply, this directly affects the cost of transport for the consumer.
It also impacts on producers who will then increase the price of their goods to cover the
transport, thus indirectly affecting consumer prices.
Fiscal consolidation: A process whereby the government reduces its budget deficits and the
pace of its debt accumulation, in order to ensure a sustainable financial position.
Flexible inflation-targeting: This refers to inflation-targeting regimes that consider changes
in inflation and other variables affecting the real economy in the short term. Under strict
inflation-targeting only inflation matters, but flexible inflation-targeting takes into account
other variables, such as output.
Forecast horizon: This is the future period over which the Bank generates its forecasts,
typically between two and three years.
Gross domestic expenditure: This refers to the total value of expenditure on goods and
services within the country plus expenditure on imports less exports.
Gross domestic product (GDP): GDP is the total market value of all goods and services
produced in a country. It includes total consumption expenditure, capital formation,
government consumption expenditure and the value of exports less the value of imports.
Gross fixed capital formation (investment): Value of acquisitions of capital goods (e.g.,
machinery, equipment and buildings) by firms, adjusted for disposals, constitutes gross fixed
capital formation.
Headline consumer price index (CPI): Headline CPI refers to CPI for all urban areas that is
released monthly by Stats SA. Headline CPI is a measure of price levels in all urban areas. The
12-month percentage change in headline CPI is referred to as ‘headline CPI inflation’ and
reflects changes in the cost of living. This is the official inflation measure for South Africa.
Household consumption: This is the amount of money spent by households on consumer
goods and services.
Household disposable income: Household disposable income is defined as primary income,
net current transfers and social benefits, less taxes on income and wealth.
Import penetration: This ratio shows the degree to which domestic demand is satisfied by
imports. It is calculated as imports divided by domestic demand (where domestic demand is
gross domestic product minus exports plus imports).
Inflation (growth) outlook: This outlook refers to the evolution of future inflation (growth)
over the forecast horizon.
Inflation-targeting: This is a monetary policy framework used by central banks to steer
actual inflation towards an inflation target level or range.
Leverage: This refers to a process of borrowing money to buy assets or fund consumption;
highly leveraged entities are those with a large amount of outstanding debt.
Monetary Policy Review June 2015

Load shedding: Eskom has adopted a policy of load shedding to manage
insufficient electricity supply. This entails pre-planned, rotating interruptions
to electricity supply to alleviate pressure on the national grid, thus avoiding
a national blackout.
Maastricht Treaty: The signing of this treaty brought the European Union
(EU) into existence in 1992. It includes a number of rules governing limits
to government debt and budget deficits. EU countries must abide by these
rules in order to use the common currency (the euro).
Median: This is a statistical term used to describe the observed number that
separates ordered observations in half.
Monetary policy normalisation: Refers to the unwinding of unusually
accommodative monetary policies. It could also mean adjusting the
economy’s policy rate towards its real neutral policy rate.
Mortgage: A mortgage is a form of secured loan extended for the purchase
of real estate.
Nominal effective exchange rate (NEER): A NEER is an index that
expresses the value of a country’s currency relative to a basket of other
(trading partner) currencies. An increase (decrease) in the effective exchange
rate indicates a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted average exchange
rate of the rand is calculated against 15 currencies. The weights of the five
major currencies are as follows: euro (34,82), US dollar (14,88), Chinese
yuan (12,49), British pound (10,71) and Japanese yen (10,12). Index: 2000
= 100. The real effective exchange rate, by contrast, is the NEER adjusted
by relative consumer prices in South Africa and its main trading partners.
Non-tradeables: Goods and services produced and consumed domestically
that are not close substitutes for goods and services that are imported or
exported.
Output gap/potential growth (GDP): Potential growth is the rate of
GDP growth that could theoretically be achieved if all productive assets in
the economy are employed in a stable inflation environment. The output
gap is the difference between actual growth and potential growth, which
accumulates over time. If this is negative, then the economy is viewed to be
underperforming and demand pressures on inflation low. If the output gap
is positive, the economy is viewed to be overheating and demand pressures
are inflationary.
Producer price index (PPI): This index measures changes in the prices of
goods at the factory gate. Stats SA currently produces five different indices
that measure price changes at different stages of production. Headline PPI
is the index for final manufactured goods. PPI measures indicate potential
pressure on consumer prices.
Productivity: Productivity indicates the amount of goods and services
produced in relation to the resources utilised in the form of labour and
capital.
Purchasing power parity: PPP is based on the law of one price, assuming
that in the long run, exchange rates will adjust so that purchasing power
across countries is approximately the same. It is often used to make cross-

Monetary Policy Review June 2015
country comparisons without the distortionary impact of volatile spot
exchange rates.
Quantitative easing (QE): QE involves the central bank purchasing assets
on the open market so as to inject liquidity into the economy.
Real effective exchange rate (REER): See ‘Nominal effective exchange rate’.
Repurchase rate (repo rate): This is the policy rate that is set by the
Monetary Policy Committee (MPC). It is the rate that commercial banks
pay to borrow money from the South African Reserve Bank.
Real repo rate: This is the nominal repurchase (repo) rate, as set by the
MPC, adjusted for expected inflation.
Second-round effects: If a price shock goes beyond first-round effects by
shifting inflation expectations (and hence wage demands), then it is seen to
have second-round effects. These are the effects that the MPC would seek to
counter in the event of a price shock.
Sterilisation: In monetary policy terms, this refers to actions taken to offset
undesired increases in the overall money supply, which are triggered by the
purchase of foreign exchange.
Structural reforms: The reforms necessary to increase a country’s potential
growth rate, which differ from country to country. In South Africa, the
National Development Plan is considered the most comprehensive guide to
necessary structural reforms for the economy.
Terms of trade: This refers to the ratio of export prices to import prices.
Tradeables: Goods or services that are imported or exported.
Unit labour costs: A unit labour cost is the labour cost to produce one
‘unit’ of output. This is calculated as the total wages and salaries in the nonagricultural sector divided by the real value added at basic prices in the nonagricultural sector of the economy.
Unsecured loans: Loans extended without any collateral (guarantees or
underlying assets) as security to protect the value of the loan.