Monetary Policy Review
April 2018
South African Reserve Bank
Monetary Policy Review
April 2018
Monetary Policy Review April 2018
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ISSN: 1609-3194
Monetary Policy Review April 2018
Preface
The primary mandate of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. In addition, the SARB has a complementary mandate to oversee and maintain
financial stability.
Price stability helps to protect the purchasing power and living standards of all South Africans. It provides a favourable
environment for investment and job creation, and also helps to maintain and improve international competitiveness. The goal
of price stability is quantified by the setting of an inflation target range after consultation with government. The SARB has full
operational independence. Monetary policy decisions are made by the SARB’s Monetary Policy Committee (MPC), which is
chaired by the Governor and includes the Deputy Governors as well as other senior officials of the SARB.
The MPC conducts monetary policy to keep inflation within a target range of 3–6%. This inflation-targeting framework is
flexible, meaning that inflation may be temporarily outside the target range, under certain circumstances. The MPC takes
into account the time lags between policy adjustments and economic effects. This provides for interest rate smoothing over
the cycle and contributes towards more stable economic growth. The decision of the MPC, together with a comprehensive
statement, is communicated at a media conference at the end of each meeting.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening public understanding of the
objectives and conduct of monetary policy. The MPR covers domestic and international developments that impact on
the monetary policy stance. It is fundamentally a forward-looking document which focuses on the outlook for the South
African economy, in contrast to the Quarterly Bulletin which records and explains recent economic developments.
The MPR is presented by senior officials of the SARB at monetary policy forums in various centres across South Africa in an
effort to develop a better understanding of monetary policy through direct interactions with stakeholders.
Monetary Policy Review April 2018
Contents


Boxes


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

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review April 2018
Foreword
This Monetary Policy Review arrives at a moment economists would call ‘a structural break’ – a point where the behaviour
of the numbers changes. In more everyday terms, we have witnessed the end of one chapter of South Africa’s history and
we are starting a new one. This document represents an attempt to write the economic story of that chapter, or at least the
first pages, in advance. Of course, this is a difficult enterprise, with a reasonable chance of substantial error. But monetary
policy affects the economy with a lag of one to two years, so it must be forward-looking.
The good part of this story is that inflation is settling lower than it has been previously, while growth accelerates. Public debt
stops growing within a few years and starts to decline. Household balance sheets are looking healthier, with debt-to-income
ratios having declined to levels last seen in the mid-2000s. The global economy is as strong as it has been in a decade.
But it is not all good news. Inflation remains within the upper portion of our 3–6% target range, averaging just above 5% over
the forecast period, instead of being firmly anchored at the middle of the target. Growth beat expectations in 2017, but it is
still some distance from longer-run averages – let alone what we need to meaningfully reduce poverty and unemployment.
Government’s much-expanded debt burden weighs on the economy through higher taxes, greater demands on scarce
savings, and higher sovereign risk premiums. In turn, weak growth makes the debt problem more difficult.
What keeps this situation sustainable is that much of the economy’s poor performance is due to other factors, which
are now fading. In particular, business confidence is recovering from some of the lowest survey readings in our modern
history. Exchange rate dynamics are absorbing most of the inflationary pressure from new taxes. There are abundant reform
opportunities. With the right policies, we can grow out of our problems.
This is a good time for South Africans to be ambitious. For the first time in years, I suspect our forecasts lean towards being
too pessimistic rather than too optimistic. A better future is within our reach, if we choose it.
E L (Lesetja) Kganyago
Governor of the South African Reserve Bank
Monetary Policy Review April 2018

Lower inflation and better growth
Introduction
South African growth has improved, while inflation has
declined. The global economy continues to experience a
strong cyclical recovery, with major economies – including
the United States (US), the euro area and Japan – growing
faster than potential. Most commodity exporters, however, are
still lagging. Volatility in world financial markets has picked up
this year, but emerging market assets have coped well. South
African financial markets have performed better still, as policy
uncertainty has dissipated. Over the forecast period, South
African inflation is projected to remain within the target range,
although it rises from just over 4% currently to slightly more
than 5% by 2020. This is nonetheless lower than historical
averages. Growth is expected to accelerate, and could climb
faster given successful implementation of structural reforms.
Between 2013 and early 2016, global developments had
South Africa on the back foot. Capital flows to emerging
markets slowed abruptly following the May 2013 ‘taper
tantrum’. Meanwhile, commodity prices trended lower, with
a sharp decline in mid-2015. Yet global conditions began to
improve at the start of 2016, and the period since has seen
the most sustained, most synchronised growth acceleration
in a decade.
At almost the precise moment that the world economy was
picking up, however, South African conditions took an abrupt
turn for the worse. Starting with the removal of the finance
minister in December 2015, South Africa entered a period of
political uncertainty, the economic aspects of which included
a severe growth slowdown and an investment recession.
(Growth fell to 0.6% in 2016; investment contracted by 4.1%
over the year.) As the global recovery gained pace, South
Africa was conspicuous as the only major economy not in an
expansion phase.1
Over the past year or so, South Africa’s economic performance
has improved. Inflation has returned to within the 3–6% target
range, while growth has accelerated. Through most of 2017,
these gains seemed tentative and impermanent, with the risks
skewed towards worse outcomes. In the new year, however,
this progress has come to look more assured.
The change in South Africa’s fortunes has been most clearly
visible in financial market variables. Long-term government
bond yields have fallen back below longer-run averages, while
credit default swap spreads – a measure of sovereign default
risk – have declined to eight-year lows. The exchange rate has
appreciated strongly, reaching a three-year high against the
US dollar in February 2018, while the real effective exchange
rate (a broader measure which also adjusts for inflation) has
climbed to a six-year high. Survey measures have also shown
signs of recovery, including a rebound in business confidence.

As measured by Purchasing Managers’ Indices.

3–6% Inflation target range
Percentage change on a year earlier (both scales)
Targeted inflation* forecast

* CPI for all urban areas
Sources: Stats SA and SARB
Index (>50 = expansion)
Purchasing Managers’ Indices
Sources: BER, IHS Markit and SARB

South Africa
Global

Monetary Policy Review April 2018
Inflation and growth dynamics
Inflation decelerated quite rapidly over the course of 2017
and early 2018, benefitting from several positive shocks.
In particular, food inflation has collapsed – from 11.8% in
December 2016 to 3.9% in February 2018 – as drought has
finally given way to bumper crops (except in the Western
Cape). Furthermore, sustained exchange rate appreciation
has moderated import prices, largely explaining why core
inflation has fallen below the midpoint of the 3–6% target
range, from a peak of 5.9% in December 2016.
There have also been recent signs of disinflation for services,
mainly in the categories for medical insurance, accommodation
and transport. Services inflation fell to 4.9% in February 2018,
which marks a seven-year low; six months ago it was at 5.8%.
The forecast is pulled down by these outcomes, with services
inflation settling at just over 5% compared with post-crisis
averages of nearly 6%.
Like inflation, output growth has also performed better than
expected. The unanticipated technical recession recorded
for late 2016 and early 2017 raised the possibility that
growth might not pick up from 2016 lows. Yet in subsequent
quarters growth rebounded quite strongly – 2.9% for the
second quarter, 2.3% for the third, and 3.1% for the fourth
– while the technical recession was revised out of the data.
Annual growth ultimately totalled 1.3% for 2017 – versus just
0.6% for 2016.
Growth was better than expected for two main reasons.
First, the primary sector performed very strongly, contributing
0.7 percentage points to 2017 growth – over half of the total –
despite its relatively small share in overall output (around 10%).
As mentioned, the agricultural sector benefitted from much
better rainfall through most of the country. The mining sector
also rebounded, despite heightened investor uncertainty.
This was mainly because the starting point was so bad – a
contraction in 2016. The rebound in commodity prices
also helped.
The second important driver of 2017 growth was stronger
household consumption. Household real incomes benefitted
from declining inflation, and employment held up better than
expected. Household finances have also grown healthier in
recent years. Surveys of consumer confidence remained
negative during this period, but actual consumer behaviour
spoke to better fundamentals.
The fact that growth surpassed expectations, however,
does not mean the economy performed well. Given South
African annual population growth of 1.6%, gross domestic
product (GDP) growth of 1.3% resulted in slightly lower per
capita incomes over the year. Growth barely over 1% is also
unimpressive compared with South Africa’s longer-term
average (3% in the democratic era) or emerging market rates
(4.7% in 2017). Furthermore, as 1.3% growth is in line with the
economy’s potential, the output gap did not shrink or expand.
Rand per foreign currency
The rand against major currencies
Source: Bloomberg
ZAR/US$
ZAR/€

Per cent

Government bond yields
Source: Bloomberg

10-year bond yields

Post-crisis average


* At seasonally adjusted and annualised rates
Sources: Stats SA and SARB
Percentage change* from quarter to quarter (both scales)
Real GDP growth

Monetary Policy Review April 2018

The growth forecasts currently envision some acceleration
over the medium term, but growth only reaches 2% in 2020. It
is possible that growth will exceed these forecasts, however,
and the risks are towards higher growth.
Much like the growth forecast, the outlook for inflation is better
but not yet satisfactory. Although the latest data show headline
inflation below the target midpoint of 4.5%, it is projected to be
higher over the rest of the forecast period, in the upper half of
the 3–6% target range. The shocks that pushed inflation under
4.5% (unusually low electricity and food prices, import price
deflation from a stronger rand) are now fading, and higher
taxes, especially value-added tax (VAT), will raise inflation
again in the near term. Two years ahead, inflation should revert
to the levels identified in surveys of inflation expectations, to a
little over 5%.
Overview of the policy stance
For two of the three Monetary Policy Committee (MPC)
meetings held over the past six months, domestic uncertainties
overshadowed other considerations. The November 2017
meeting followed National Treasury’s Medium Term Budget
Policy Statement (MTBPS), which had set out a path for debt
growth in the absence of any fiscal reforms. This prospect
alarmed markets and analysts, prompting ratings agency
downgrades and rand depreciation (among other adverse
developments). The November MPC meeting also preceded
the elective conference of the African National Congress
(ANC). Given the sheer uncertainty around the outlook, and
the prospect of further ratings downgrades, the MPC chose to
leave the repurchase rate (repo rate) unchanged. That decision
was the unanimous preference of the MPC members.
The January 2018 meeting was likewise shaped by elevated
uncertainty, although in this case it was the upcoming Budget
Speech that took centre stage. Although the rand had
appreciated strongly up to this point, there were risks that a
poorly received Budget would reverse this trend, potentially
costing South Africa its remaining investment-grade credit
rating and thereby provoking a sell-off of South African assets.
The inflation forecast was moderately lower than it had been
in November 2017, but it still inclined upwards towards an end
point of 5.5%. Once again, the proximity of a major unknown
weighed against making any adjustment to the policy rate,
which in this case was the decision preferred by five of the six
MPC members.
The March 2018 MPC meeting took place in a different
context. The major uncertainties of the previous two meetings
had dissipated, and the risks of adverse shocks were much
reduced – a point reinforced by the decision of Moody’s
Investors Service (Moody’s) to keep South Africa’s sovereign
credit rating at investment grade, with the outlook upgraded
to ‘stable’. The inflation forecast improved slightly from where
it had been in January 2018, and the MPC assessed the
risks to this forecast as being balanced. The effects of the
Percentage change over four quarters

Changes to the SARB’s inflation forecast*
Sources: Stats SA and SARB

Sep 2017

Nov 2017

Jan 2018

Mar 2018

Actual
* The dotted lines indicate forecasts.

Per cent
South African repo and prime rates
Source: SARB
Prime rate
Repo rate

Forecast
Per cent
Policy stance
Source: SARB
Real repo rate (Mar MPC)
Neutral real repo rate
-2
-1

Monetary Policy Review April 2018
VAT increase were offset by the more appreciated exchange
rate starting point, and the end point for inflation was lower,
at 5.2% versus 5.5% previously. The growth narrative was
also more positive, based both on better GDP data and on
a recovery in business confidence. In these circumstances,
three MPC members preferred an unchanged stance whereas
four favoured a cut. The ultimate decision was to reduce the
repo rate by a quarter of a percentage point, to 6.5%.
This decision reflected, first, the current lows of inflation as well
as confidence that inflation would be under control throughout
the forecast period. Inflation expectations have moderated to
longer-term lows. Core inflation is projected to be just under
5% in most quarters out to 2020, and the headline forecast is
also generally close to 5%. Food price inflation has stabilised.
The exchange rate outlook is, as usual, uncertain, but global
conditions are presently favourable, and the forecast already
assumes that the rand will weaken from its current levels.
Second, growth is still not strong and the economy appears to
be operating below its potential. Although the growth outlook
is uncertain, and although growth may well pick up faster than
expected, the sense of the MPC was that the output gap will
close more rapidly given somewhat lower rates.
One objection to this view was that there are still inflation risks,
mainly from abroad. The ongoing global recovery makes it
more likely that advanced economy central banks will raise
interest rates at a relatively rapid pace, which could affect
inflation via the exchange rate. A second consideration was
that lower inflation could be used to bring inflation expectations
closer to the target midpoint of 4.5% over a shorter time
frame. However, these factors do not preclude fine-tuning of
the interest rate. The MPC is also not committing to a ratecutting cycle.
Viewed through the lens of the South African Reserve Bank’s
(SARB) Quarterly Projection Model (QPM), the policy stance
will be expansionary over most of the forecast period, helped
by the recent rate cut. The projected rise in near-term inflation,
which lowers the real interest rate, is largely due to the VAT
increase. This will reduce disposable income and is in this
respect actually contractionary. The recent rate cut mitigates
this effect, making policy more clearly accommodative through
the rest of 2018 and 2019.
Nominal interest rates are still projected to rise in 2019 and
2020, but much of this is due to higher neutral rates, not a
forecast tightening of the policy stance. The model theory is
that South Africa can borrow at the world interest rate plus
a country risk premium. Over the next few years, the world
neutral rate is expected to drift higher, prompting interest
rate increases by both the US Federal Reserve (Fed) and the
European Central Bank (ECB), as well as other central banks.
Given these dynamics, the model sees South Africa’s neutral
rate as a little over 0.4 percentage points higher by 2020.
The QPM’s policy rate also reacts to the inflation and output
gaps. Although these gaps partially offset each other during
Per cent
Survey-based inflation expectations*

Two years ahead

Five years ahead

Upper limit of inflation target range

* Total, combining expectations of labour, business and analysts
Source: BER
Forecast
Per cent deviation from equilibrium
Real effective exchange rate gap
Source: SARB


Per cent (both scales)
Repo rate and forecast

90%
60%
30%
Repo rate
The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
Uncertainty bands are always symmetric and do not reflect any
assessment of upside or downside risks.
Source: SARB
Monetary Policy Review April 2018

2018 and 2019, by 2020 the output gap is positive, prompting
an additional hike. Of course, this is not a policy commitment,
just a model-consistent interest rate forecast. It is nonetheless
broadly consistent with market pricing for the path of forward
rates. This path is also not simply an artefact of the QPM’s
4.5% target (see also Box 1).
Conclusion
The most important characteristics of the monetary policy
outlook are that inflation is expected to stay within the target
range across the forecast horizon, while growth accelerates. It
is possible that growth will improve more rapidly than currently
forecast, especially given reforms, and the risks are skewed
towards higher growth. Meanwhile, inflation is projected
below longer-run averages, even at the far end of the forecast
period, with balanced risks. This lower path for inflation reflects
both the moderation visible in current inflation and the SARB’s
new emphasis on keeping inflation more comfortably within
the target range, with inflation expectations closer to 4.5%.
Overall, the forecast promises a benign combination of lower
inflation and higher growth relative to the past few years. This
is a welcome improvement, and may preface further gains.
Box 1 Frequently asked questions about the Quarterly
Projection Model
The Monetary Policy Committee (MPC) switched to using a Quarterly
Projection Model (QPM) for its published forecasts in November 2017.
Although the new model differs in some key respects from the old
Core Model, it appears that analysts, journalists and other users have
mostly interpreted the new forecasts appropriately. There have,
however, been some recurring questions about the QPM, which are
addressed in this box.
Why is the inflation target 4.5% in the model?
The South African Reserve Bank’s (SARB) inflation target is 3–6%.
However, the QPM cannot solve for an entire range; it needs a point
target. The midpoint of the target range is 4.5%. Since shocks to
inflation should, over time, be random and have a symmetric standard
deviation, inflation should settle close to 4.5% in the medium term.
Inflation expectations should also converge around that point.
Having inflation anchored in the middle of the 3–6% range would have
several benefits. One is greater monetary policy flexibility; it would be
easier to look through inflation shocks if underlying inflation were not
already almost outside the target. A second benefit is that permanently
lower inflation would cause interest rates to shift down across the
whole yield curve. The 4.5% QPM target therefore makes sense both
for economic reasons and because it is a natural point interpretation
of a 3–6% range.
Given the model’s 4.5% target, why does inflation not get
there over the forecast?
In gap-based models like the QPM, long-run inflation expectations are
normally fixed at the inflation target. This assumption means inflation

Monetary Policy Review April 2018
has a tendency to revert to target following price shocks. South
African inflation expectations, however, are plainly higher than 4.5%,
and have been for many years. For this reason, the QPM builds in a
degree of inflation persistence to make its inflation forecasts more
accurate. Expectations do moderate over the forecast period, but not
all the way to 4.5%, mainly because inflation is above that point
throughout the forecast period. It would be possible to produce
alternative forecasts with lower inflation expectations, but these
forecasts would probably be unrealistic and therefore misleading.
With a 4.5% target, will the model ever signal rate cuts?
Inflation has slowed, but the QPM’s repurchase rate (repo rate)
trajectory does not show rate cuts. Some commentators believe the
QPM will never show cuts, and is therefore a poor guide to actual
monetary policy decisions. This is not necessarily the case. In fact, the
QPM forecast presented to the MPC at the July 2017 meeting did
indicate lower rates, although the change was forecast roughly one
quarter later than it actually occurred. This cut was based on a wider
estimated output gap at the time, as well as lower inflation.
Importantly, the Taylor rule in the model responds to a range of
variables, including the output gap, so it is possible to get rate cuts
even where inflation is above target.1
So the model did indicate a cut in July 2017. What have
other repo rate forecasts shown?
Although the endogenous repo rate forecast was first published in
November 2017, these projections were also generated for previous
MPC meetings. These have generally shown the nominal rate rising in
the outer years of the forecasts. The January 2017 forecast has been
the chief outlier, with rates rising further in that year. Since then, a
slowdown in inflation (driven mainly by exchange rate appreciation)
has lowered the near-term rate path. It is normal for interest rate
forecasts provided by central banks to change from meeting to
meeting, as new information becomes available. Future repo rate
forecasts will no doubt also fluctuate.
Why does the model consistently indicate higher interest
rates towards the end of the forecast period?
The most recent model path indicates the repo rate rising to about
7.5% by the end of 2020. Although this is partly a response to inflation
persistently above target, most of the repo rate change is due to two
other factors. First, the neutral rate is expected to rise as advanced
economy central banks raise their interest rates towards more normal
levels. Second, because inflation is somewhat higher over the
forecast period, nominal interest rates have to increase simply to
achieve a constant real rate. The gap between the neutral real rate
and the real policy rate is actually quite stable over most of the
forecast period. In fact, the QPM would interpret unchanged rates as
a significant policy adjustment, because that would lower real rates by
about 0.5 percentage points. In this respect, the QPM view of the
world differs from that of most commentators, who tend to focus
exclusively on nominal rates rather than on real ones.

For more information on the QPM Taylor rule, see Box 3 of the
October 2017 MPR.
Per cent
Repo rate forecasts over time
Source: SARB

Jan 2017

Mar 2017

May 2017

Jul 2017

Sep 2017

Nov 2017

Jan 2018

Mar 2018


20Q3
20Q1
19Q3
19Q1
18Q3
18Q1
17Q3
17Q1
16Q3
Percentage points
Per cent
-4
-2

Decomposition of repo rate (end of period)

Neutral repo rate

Output gap

Inflation gap

Repo rate (right-hand scale)

Residual


Source: SARB
Monetary Policy Review April 2018

What happens if the MPC diverges from the model path?
The repo rate forecast is generated endogenously by the model and does
not constitute a policy commitment. The QPM brings structural consistency
to the policymaking process, but the MPC applies judgement to both
model and off-model factors that affect the economic outlook and policy
settings. One area where this judgement often plays a role is in the MPC’s
assessment of the risks to the model forecast. Another is in evaluating the
theoretically crucial but empirically unverifiable estimates at the heart of the
model, such as the potential growth rate or the neutral interest rate. The
MPC statements are the expression of the members’ analysis of the
evidence and reasoning, and they may differ significantly with the
structured outcomes of the QPM.
As a technical matter, the Taylor rule includes a residual term to account for
historical deviations between the modelled and actual rate paths. The rule
also has a substantial backward-looking component, meaning that the
future policy rate is partly determined by the current rate. For this reason,
the forecast path does not automatically reverse any model-inconsistent
decisions at the next available opportunity.

Monetary Policy Review April 2018
The global economy: as good as
it gets?
The global economy continues to perform robustly. World
growth is estimated to have reached 3.7% in 2017, its strongest
rate since 2011. However, without substantial increases in
investment and productivity growth, output gaps will soon
turn positive and growth will likely slow again. Policy settings
in advanced economies are expected to tighten somewhat,
although persistent low inflation could slow this normalisation
process. Commodity-exporting emerging markets have mostly
lagged the global recovery, but they have now mostly improved
their macroeconomic fundamentals enough to restart growth.
A cyclical upswing
The global economy is enjoying its best growth phase since
the rebound from the global financial crisis eight years ago.
Forecasts for global growth continue to be revised higher,
breaking a long trend of downward revisions. The recovery
is also quite widely shared: according to the International
Monetary Fund (IMF), growth has accelerated in 120 countries,
accounting for three-quarters of global output.
Nonetheless, more than half of the improvement in global
growth is due to advanced economies, particularly the euro
area and Japan. Growth remains quite subdued in a number
of emerging markets, with output gaps still negative even as
they are turning positive elsewhere. A second limitation to the
recovery is that it reflects cyclical factors more than structural
gains. Investment and productivity growth rates are still feeble.
Until this changes, growth is likely to decelerate over the
medium term as the recovery runs into supply-side constraints.
Advanced economies
The US economy is in its ninth year of expansion, with
unemployment at long-term lows and growth above its
estimated trend rate. Despite this strong cyclical position,
fiscal policy has now turned very expansionary. New tax
cuts are expected to reduce fiscal revenues by about
US$1.5 trillion over the next decade. Furthermore, the recently
agreed spending plans will add US$300 billion to demand,
mostly over the next two years. Together, these measures
will expand the fiscal deficit to more than US$1 trillion (about
5% of GDP) by around 2019 and will lift national debt to about
100% of GDP, its highest level since the Second World War.
Despite the scale of these measures, their growth and inflation
consequences are expected to be fairly small. Household
incomes will benefit, but as tax cuts disproportionately favour
wealthier households with lower marginal propensities to
consume, spending multipliers should be low. Firms might
decide to invest more, but financial conditions have been so
favourable in recent years that it is unlikely corporates will have
neglected attractive investment opportunities. Accordingly, the
Annual percentage change
Apr 2017
Oct 2017
Current
Global growth revisions
Source: SARB


Percentage of GDP
1940 1950 1960 1970 1980 1990 2000 2010 2020
US government debt
Sources: Congressional Budget Office and Tax Policy Centre
Forecast
Monetary Policy Review April 2018

outlook for the US economy has not changed dramatically,
with consensus forecasts indicating growth will be higher by
around a third of a percentage point in 2018, and inflation up
just a tenth of a percentage point. The fiscal boost is still likely
to hasten the pace of the Fed’s interest rate increases, and it
tilts the risks more clearly towards additional hikes. Rather than
overheating the economy, however, the main danger of these
policies is that they would leave little fiscal space to counter
another recession. Meanwhile, US labour productivity growth
has fallen to its slowest pace since the 19th century.2 This
helps explain how an economy long capable of 3% growth
will still be growing at only about 2.5% in 2018 – despite low
interest rates, fiscal stimulus, and full employment.
In 2017, euro area growth picked up to its fastest pace in a
decade, aided by a very expansionary monetary policy, a
depreciated exchange rate, and more neutral fiscal policy
settings. Growth accelerated in 14 of the 19 euro area
economies between 2016 and 2017, including the three
biggest: Germany, France and Italy.
The political climate also improved following a difficult
2015–2016 period which included referendums on Greece’s
bailout and Britain’s membership of the European Union. The
French presidential election of 2017 yielded defeats for both
the far-left and the far-right candidates, and re-energised
centrists throughout the continent. The German election also
produced a coalition government of the two centrist parties –
albeit only after protracted negotiations. More recently, Italy’s
election has demonstrated substantial popular support for
anti-establishment candidates, suggesting ongoing political
strains in Europe.
In a similar vein, economic conditions are unlikely to remain as
favourable over the medium term, with the euro area growth
forecast expected to moderate from 2.5% in 2017 to 1.9% in
2018. In the longer run, the euro area can probably sustain
growth of about 1.5% versus slightly more than 2% in the US.
Japan has sustained positive growth for eight consecutive
quarters, underpinned by a pickup in external demand and
aggressive policy stimulus. Output expanded by 1.7% in
2017 versus an underlying trend rate of less than 1%, and
unemployment is now down to a quarter-century low of 2.7%.
There are now some signs of a slowdown: GDP expanded by
a disappointing 0.5% in the final quarter of 2017, and recent
activity reports point to future weakness. Yen appreciation
may also have adverse impacts on profits. For these reasons,
growth is expected to average around 1.4% in 2018, with risks
to the downside. Still, it has been almost three decades since
Japan last achieved such a long stretch of unbroken positive
growth rates, and with its population contracting, even 1%
growth implies appreciable per capita income gains.

See Antonin Bergeaud, Gilbert Cette and Rémy Lecat, ‘Long-term
productivity database’, available at

Percentage points
Change in consensus forecasts after
US tax reform announcement
Inflation
GDP growth
Fiscal deficit
(% of GDP)

Source: Bloomberg
Percentage change
Percentage of potential GDP
-6
-4
-2

Euro area output growth

GDP growth

Potential growth

Output gap

(right-hand scale)
Forecast


Source: SARB
Per cent
-2

Changes in G7 GDP per capita since 2009
Sources: IMF and SARB
Italy
France
UK
Canada
US
Japan
Germany

Monetary Policy Review April 2018
Across the advanced economies, unemployment has
declined to levels at or below longer-term averages. Broader
unemployment measures have also declined, while capacity
utilisation rates are now elevated. This reduced slack should be
boosting inflation. However, while real activity has accelerated
more than expected, inflation has increased by less. Against
targets of 2% for 2017, headline inflation averaged 1.7% in the
US, 1.5% in the euro area, and 0.5% in Japan. Core inflation is
also below 2%, as it has been for almost a decade.
Numerous explanations have been offered for the surprising
weakness of inflation, ranging from a breakdown of the
connection between productive capacity and inflation to mere
temporary and idiosyncratic shocks (such as one-off price
declines in data prices3). The outlook remains uncertain, with
each new data point being scrutinised for signs of inflation
momentum. Financial markets have reacted skittishly to fresh
evidence of price pressures.
The stakes are high, not least because low inflation is the only
reason why policy settings are still accommodative given how
much real-economy performance has improved. The US has
already achieved a degree of normalisation, with the benchmark
Fed Funds Rate having been raised six times since December
2015 (bringing it quite close to estimates of its natural rate). In
the euro area, however, the ECB is still in the early stages of
tapering its asset purchase programme, and has yet to raise
its policy rate. Resurgent inflation in these economies is not
the most likely case, but if it were to happen, global financial
conditions could change quickly, perhaps disrupting the calm
that has settled over most emerging markets.4
Emerging markets
While about half of the global growth acceleration last year
came from advanced economies, much of the rest was made
in China. Since 2011, Chinese growth rates have been slowing
consistently, but 2017 interrupted this trend, allaying concerns
that growth would tail off abruptly.
Given China’s much-expanded share in global output, even
a relatively small growth acceleration can have a meaningful
impact on global growth rates. In fact, while Chinese growth
is likely to ease lower over the medium term, from around
6.5% in 2018 to about 6% in 2020, China’s contribution to
world growth will stay fairly constant given the country’s everlarger weights. For this reason, world growth need not slow in
lockstep with China’s.
One risk to this benign scenario is that massive debt growth
over the post-crisis period might start to weigh on new activity,
curtailing growth rates more sharply. Chinese debt has been
funded domestically, and the sovereign balance sheet remains

See Janet Yellen’s press conference of June 2017, available at https://
www.federalreserve.gov/mediacenter/files/FOMCpresconf20170614.pdf.

For a recent discussion of this issue by the new Fed Chairman,
Jerome Powell, see
speechpowell20171012a.htm.

Unemployment rate

(deviation from NAIRU)

Headline inflation

(deviation from target)
Per cent
Japan
Euro area
US

G3 unemployment and inflation dynamics in 2017
Sources: Haver and SARB
Per cent
2001 2003 2005 2007

G3 policy rates
Sources: Bloomberg, IMF and SARB

G3 weighted average

US

Euro area

Japan
-1

Percentage change
Per cent
China’s changing role in the global economy

GDP growth

Contribution to global growth (percentage points)

Output weight (right-hand scale)

Sources: IMF and SARB


Monetary Policy Review April 2018

robust, so the risks of a financial and economic crisis are
probably limited. Nonetheless, large quantities of unproductive
investments and bad debts, if not effectively addressed,
could induce economic stagnation along the lines of Japan’s
experience in the 1990s.
A further concern, in terms of spillovers, is that China’s growth
might become much less commodity-intensive – particularly
for industrial commodities such as coal and iron ore. In this
scenario, China’s headline growth rates could remain quite
healthy, yet the composition of growth could still deliver
negative shocks to China-exposed commodity exporters.
Emerging market growth has not been driven solely by
China; commodity-exporting emerging markets in particular
accelerated in 2017. This growth, however, came from low
bases, including recessions in major players such as Brazil,
Nigeria and Russia. In these economies, commodity price
declines had contributed to serious disequilibria, with widening
current account deficits and rising inflation, which necessitated
economic rebalancing over the 2013–2016 period. In contrast
to some previous episodes, these adjustments were mostly
completed without financial crises or the need for IMF
assistance. Healthier fundamentals should now permit
improved
growth
rates,
allowing
commodity-exporting
emerging markets to finally bring output back to its potential
levels, in line with most other countries. Accordingly, Brazil’s
growth is likely to average around 2.0% over the 2018–2019
period versus -2.2% for 2015–2017. Over the same time
frames, Russian growth is forecast at 1.6% compared with
-0.4% previously.
Elsewhere in the emerging market sphere, the picture is
more mixed. India has recently reclaimed its status as the
world’s fastest-growing major economy, having recovered
from two policy shocks: demonetisation in 2016, then a
complex tax change in 2017. Turkey, by contrast, has recently
accelerated off its own policy shock, a massive quasi-fiscal
stimulus which lifted growth to 5.1% for 2017. Turkey is a rare
instance of an emerging market which has not yet repaired
its macroeconomic fundamentals. Instead, its current account
deficit has persisted at levels of around 5–6% of GDP, while
inflation has accelerated to 13% (versus a target of 5%).
Percentage of GDP

Composition of Chinese growth

Consumption

Investment
Source: Haver

Annual percentage change

2002 2004
2008 2010

GDP growth in selected emerging market
commodity exporters and importers*

Overall emerging markets

Commodity exporters

Commodity importers
* Commodity exporters are a PPP-weighted average of Brazil, Indonesia,
Nigeria, Russia and South Africa. Commodity importers are a PPP-weighted
average of India, Mexico, the Philippines, Poland and Turkey.
Sources: IMF, World Bank and SARB
-2

Percentage change over 12 months

Inflation in emerging economies

Brazil

India

Russia

Turkey
Source: Bloomberg

Monetary Policy Review April 2018
Box 2 The outlook for sub-Saharan Africa
1 World Bank. January 2018. ‘Box 2.6.1: Potential growth in sub-Saharan
Africa’. Global economic prospects: broad-based upturn, but for how long?
Available at
prospects.
Sub-Saharan Africa (SSA) usually plays an incidental role in narratives
of the global recovery. The region accounts for a relatively small
share of global output (less than 3%). Analysis is also complicated by
shortages of reliable, high-frequency data (such as quarterly growth
rates) as well as the sheer diversity of the region’s economies. However,
while institutions with global perspectives can sometimes afford to
overlook SSA, this position is untenable for South Africa. SSA is one
of South Africa’s most important markets. Of South Africa’s 20 biggest
country trading partners, seven are African. Finally, the region – and
the southern African subregion in particular – is undergoing dramatic
changes at present, with large consequences for South Africa. This box
unpacks the local growth outlook, with a special focus on Zimbabwe –
potentially one of South Africa’s highest-ranked trading partners.
Sub-Saharan African growth recovery
SSA is currently making a weak recovery from the crash of 2016, in
which growth hit a 22-year low of just 1.4%. That collapse had the
hallmarks of a traditional emerging market crisis, of the sort that has
become rarer in much of the rest of the emerging market space this
decade. It was precipitated by a sharp decline in commodity prices.
The effects of the shock, however, were amplified by their interactions
with policy settings, including inadequate fiscal buffers and inflexible
exchange rate regimes. The results were, in many cases, large
increases in debt, ineffective attempts to defend currency pegs,
devaluations and bursts of inflation, followed by approaches to the
International Monetary Fund (IMF) for assistance.
In the period since, commodity prices have picked up again.
Macroeconomic frameworks have also undergone some repairs.
Regional growth recovered to 2.7% in 2017 and is projected to
accelerate further over the medium term (to 3.3% in 2018 and 3.5% in
2019, according to IMF data). From a South African perspective, using
trade weights and excluding South Africa’s own contribution, SSA
trade-weighted growth should pick up to 3.5% in 2018 and to 3.8%
in 2019. The regional output gap, however, will likely remain negative
over the medium term, even as output gaps close in most other parts
of the global economy. This is because underlying SSA potential
growth is still probably quite high, around 5% (excluding South Africa).1
South Africa’s foreign output gap is accordingly more negative, by
about 0.2 percentage points, than it would be based on calculations
that exclude SSA.
The Zimbabwe factor
A problem with potential growth analysis, however, is that it tends to
miss structural breaks. Zimbabwe may be going through precisely such
a break now, and if this is true, the foreign growth outlook for South
Africa could be materially different.

Percentage change

SSA: GDP growth and inflation
Inflation
GDP
Forecast

Source: IMF
Per cent

8.2
4.5
2.7

Size of Zimbabwean economy relative
to South Africa
Source: IMF

Percentage of total exports (excluding BLNS*)

3.1
2.7

South African exports to Zimbabwe
* BLNS is Botswana, Lesotho, Namibia and Swaziland.
Source: the dti

Monetary Policy Review April 2018

Over the past two decades, Zimbabwe has experienced one of the
largest economic collapses in modern economic history. Its economy
has recovered somewhat since the end of hyperinflation, but gross
domestic product (GDP) per capita remains below its 2000 level.
Naturally, this disaster has changed Zimbabwe’s economic standing
vis-à-vis South Africa. In 1998, Zimbabwe’s economic output was
around 8% of South Africa’s. This declined to less than 3% in 2008
and is currently around 4.5%. Zimbabwe’s share of South Africa’s
total exports has followed a similar trend. For this reason, Zimbabwe
has gone from being South Africa’s fifth-biggest trading partner to the
twelfth. Given its population size2 and proximity, Zimbabwe’s ranking
should be higher. Were it to regain fifth place, it would move past India
and the United Kingdom on the list of South Africa’s most important
trading partners.
It is still very unclear what growth rates Zimbabwe will be able to
achieve under new leadership, but the finance minister has suggested
6% for 2018 versus the current forecasts of 4.5%. In perspective, this
acceleration would raise South Africa’s trade-weighted world growth
by more than the new fiscal stimulus in the United States, at least in
direct terms. Taking a longer-term perspective, had Zimbabwe simply
matched the per capita growth rate of its neighbours over the past two
decades (2.9% annually), its GDP per person would have been more
than double the current levels. This implies that Zimbabwe’s politically
adjusted potential growth rate could be very high.
Summary
It is difficult to model SSA growth dynamics effectively. Even the
world economy forecasts of the South African Reserve Bank, which
are based on the IMF’s Global Projection Model, omit the region due
to data shortcomings. SSA is nonetheless very important for South
Africa, and it must be included in discussions of South Africa’s global
outlook, even if its effects cannot be neatly quantified. At present, there
is tentative evidence of stronger growth, but the region still lags the
global trend.
2 Zimbabwe’s 2017 population was 16.53 million, according to UN estimates.
The equivalent figure for Botswana is 2.29 million; for Namibia it is
2.53 million. These countries are now ranked 5th and 6th amongst
South Africa’s trading partners respectively, while Zimbabwe is 11th.

Average annual per capita growth in selected
SSA countries, 2000–2017
Zimbabwe
South Africa
Swaziland
Namibia
Botswana
Zambia
Lesotho
Mozambique
Average excl.
Zimbabwe
Sources: IMF and SARB

Percentage change
Percentage of total exports
South Africa’s 20 largest export partners
Source: the dti

China
US
Germany
Japan
Botswana
Namibia
UK
India
Netherlands
Mozambique
Zambia
Zimbabwe
Belgium
Switzerland
Hong Kong
Swaziland
South Korea
Lesotho
Italy
UAE

Monetary Policy Review April 2018
Conclusion
The global economy has at last moved on from the global
financial crisis in the sense that the gap between potential
economic output and actual output now appears to have
closed. Underlying growth rates seem to be lower than they
were in the 2000s, however, and unless productivity gains
and investment rates improve sharply, 2018 growth will set
the high water mark for the world economy for this decade.
Inflation rates in the advanced economies are still generally
below central bank targets. The baseline case is that inflation
will gradually converge on these targets during 2018 and 2019,
but this outcome is not assured.
For emerging markets, it is mainly the commodity exporters
that still have negative output gaps. Provided that commodity
prices remain favourable and global financial conditions do not
tighten abruptly, these countries now have the fundamentals
to improve their growth rates and catch up with the global
recovery.
Monetary Policy Review April 2018

Global financial markets:
volatility, resilience and risks
Volatility has returned to global financial markets after a
period of unusual calm. Emerging market assets have
nonetheless performed relatively well, given their own more
robust fundamentals as well as a weaker dollar, which has
supported commodity prices and capital flows. South African
asset markets have done better still, outpacing their emerging
market peers. It is not clear, however, that global conditions
can remain quite so favourable for emerging markets over the
medium term.
Since the global financial crisis, low inflation and weak growth
have prompted advanced economy central banks to keep
interest rates at historical lows. In turn, these policies have
suppressed financial volatility while boosting asset prices.
Volatility has been subdued because investors have been able
to rely on central banks to offset shocks by keeping rates lower
for even longer. (In technical terms, markets took comfort in a
permanent central bank ‘put’.) Asset prices, meanwhile, have
benefitted from ultra-low rates because these have raised the
present value of future returns.5
Although interest rates have stayed lower, over the past
decade, than almost anyone had previously believed possible,
monetary policy normalisation has never left central banks’
agendas. On occasions when this prospect has loomed
larger, markets have reacted sharply. This was the dynamic
underpinning the ‘taper tantrum’ of 2013. It was repeated, on
a smaller scale, following Mario Draghi’s Sintra speech of 2017.
It has played out again this year, triggered by the most benign
news of all: a positive US jobs report.
The Bureau of Labour Statistics’ Employment Situation
Summary for January 2018 contained one particularly
consequential number: a 2.9% growth rate for average salaries,
the highest figure since the 2009 crisis. Markets read this as
evidence that tight labour markets were finally building up the
kind of wage pressure that would lift inflation and oblige the
Fed to speed up interest rate increases. Within two days of this
report, the Chicago Board Options Exchange Volatility Index
(VIX), a measure of market volatility, had jumped to a three-year
high of 37%.6 US equities experienced a downward correction
of 10% over a period of eight trading days, and other major
equity markets also stumbled. Markets began pricing in three
Fed rate hikes as the most likely scenario for 2018 versus
only two previously, while the likelihood of four rate hikes also
picked up.

In a theoretical world of perennial zero interest rates, asset
prices rise to infinity because any asset that offers a return
has infinite worth. The nearer the real world has come to
this scenario, the higher the asset prices have risen.

The increase in the VIX was much larger than broader market
movements. It appears to have been amplified by new financial
instruments that allow investors to use volatility as an asset class.
For further details, see Vladyslav Sushko and Grant Turner,
2018, ‘The equity market turbulence of 5 February – the
role of exchange traded volatility products’, available at

Per cent

May
Jul
Sep
Nov
Jan
Mar
Probabilities of US interest rate increases in 2018
Source: Bloomberg

Two increases (1.75–2.00)

Three increases (2.00–2.25)

Four increases (2.25–2.50)

Indices (both scales)
Apr

Jun
Aug
Oct
Dec
Feb
Apr
Global equities and volatility
Source: Bloomberg

MSCI World Index

MSCI Emerging Markets Index

CBOE Volatility Index (right-hand scale)

Monetary Policy Review April 2018
The return of volatility, however, has not derailed the recovery.
Nor is it likely to defer additional Fed interest rate increases.
Furthermore, emerging market financial markets, which
have historically suffered during episodes of rising volatility
and higher global bond yields, have proved resilient. The
MSCI Emerging Market Index is still in positive territory for
the year, and has performed better than its World equivalent
(which is dominated by advanced economies). Emerging
market bond spreads have picked up only marginally, and
emerging market currencies have also been slightly stronger.
In part, emerging market assets have held up well because
their valuations seemed comparatively reasonable. By
contrast, investors had come to see advanced economy
assets as expensive. In particular, US equities had stood out
as overvalued, given stretched price-to-earnings ratios and
record-high indices. In this light, the February sell-off looked
like a heathy correction that reduced the risks of a future hard
landing. By contrast, valuations for emerging market assets,
such as real effective exchange rates, have mostly remained
in line with fundamentals. Furthermore, emerging markets
have built up an interest rate buffer in recent years, meaning
that these assets continue to offer attractive yields relative to
advanced economy counterparts.
A second, and complementary, explanation for emerging market
resilience is the weakening US dollar. Although the combination
of a fiscal stimulus and a rising Fed Funds Rate might have
been expected to appreciate the dollar, that currency has in
fact followed a depreciating trend since the beginning of 2017,
reaching a three-year low in mid-February 2018.
There are several reasons why a weaker dollar tends to be
supportive of emerging markets. First, it boosts investment
flows to emerging markets via the carry trade, in which investors
borrow in a low-interest-rate currency (often the dollar) to
invest in higher-yield markets. This trade is always subject to
currency risk, meaning there is the danger that depreciation of
the partner currency will eliminate the gains from interest rate
differentials. A weakening dollar, however, turns this risk into a
source of additional profit.
Second, a weaker dollar supports commodity prices, which
are important to the well-being of many emerging markets.
Because commodities are generally denominated in dollars,
their prices tend to rise when the dollar weakens and fall when
it strengthens.
Third, a depreciating dollar lightens debt burdens for countries
with dollar liabilities – and emerging market debt stocks have
expanded rapidly in recent years, chiefly due to corporate
borrowing.
These three dynamics are not uniformly beneficial for
emerging markets. Commodity importers naturally suffer
when commodity prices rise. Dollar weakness also erodes the
competitiveness of countries with significant export-oriented
manufacturing sectors. On balance, however, a weaker dollar
tends to be supportive of emerging markets, and so it has
proved over the past few quarters.
Per cent
-2
-1

Real ex ante long-term interest rate spreads

Current

Pre-Taper Tantrum (Apr 2013)
Sources: Bloomberg and SARB
Brazil
Mexico
Colombia
Russia
South Africa
India
Turkey
Indonesia
Philippines
Malaysia
Hungary
Index: Jan 1997 = 100
US$/€

Exchange rate of the US dollar
Source: Bloomberg
US dollar broad index
US$/€ (right-hand scale)


Monetary Policy Review April 2018

Domestic assets
South African assets have performed better than emerging
market averages in recent months, although progress has
hardly been smooth. The rand, for instance, reached a
14-month low of R14.47 to the US dollar in November 2017,
partly due to the deteriorating fiscal situation revealed in
the October MTBPS. It reversed course in early December,
however, following the Moody’s decision to review South
Africa’s credit rating rather than downgrading it, as well as the
positive market reaction to the outcome of the ANC’s elective
conference. Rand gains gathered momentum in early 2018,
with the currency reaching a three-year high following the
election of a new state president, a market-friendly Budget
Speech, and a cabinet reshuffle. The appreciation of the rand
so far this year – a gain of 4.3% against the US dollar – has
exceeded the 1.3% rally in the JPMorgan Emerging Markets
Currency Index. The rand has also gained against the euro (up
1.8% in 2018 to date), although it has been stable relative to the
sterling and has depreciated slightly against the yen.
Similarly, the JSE Limited (JSE) All-Share Index (Alsi) has
outperformed its emerging market peers (in US dollar terms)
since the start of 2018, mostly due to the rand’s gains relative
to its emerging market counterparts. Resource stocks have
benefitted from higher commodity prices, and retail shares
have also fared quite well given evidence of a recovery in
domestic retail sales. The Steinhoff scandal briefly weighed on
the Alsi in early December, but its effects on that indicator have
since faded.7
The South African yield curve has shifted lower in response
to reduced political uncertainty, including its corollary of a
strengthening rand and therefore declining inflation. The
five-year credit default swap (CDS) spread on the country’s
sovereign debt has fallen by about 60 basis points since
November last year, indicating reduced credit risk. The yield
curve has also flattened, owing to sharp declines in longerdated yields, reversing the post-MTBPS bond market selloff and pushing yields on 10-year bonds to their lowest level
in three years. At the short end of the market, forward rate
agreements (FRAs) have declined and the FRA curve has
inverted, with market expectations switching from interest rate
hikes to renewed monetary easing. At the height of the selloff (in mid-November 2017), FRAs indicated three 25 basis
points rate hikes. By contrast, the FRA market anticipated the
March rate cut and now assigns a roughly 70% probability to
one further cut by the end of 2018. However, market pricing
indicates that rate increases will resume towards the end
of 2019.

In November 2017, Steinhoff was the 10th-largest company by market
capitalisation on the JSE Top 40 Index, with a weight of 2.72%.
By 23 February 2018, however, Steinhoff was the smallest company by
market capitalisation on the JSE Top 40 Index, with a weight of 0.26%.
Indices: 2 Jan 2017 = 100
Jan

Mar
May
Jul
Sep
Nov
Jan
Mar
Exchange rate of the rand
Sources: Bloomberg and SARB

ZAR/US$

Major FX index

Emerging markets FX index*
(right-hand scale)

* Major FX index is a simple average of
ZAR to €, Yen, GBP.

Per cent
1x4
2x5
3x6
4x7
Forward rate agreements
Source: Bloomberg
Maturities

26 Oct 2017

13 Nov 2017

22 Dec 2017

29 Mar 2018
5x8
6x9
7x10
8x11
9x12
12x15
15x18
18x21
21x24


Monetary Policy Review April 2018
Risks
Despite the sharp sell-off in global financial markets in early
February, global financial conditions remain favourable for
emerging markets. Capital flows have held up well while interest
rates are still unusually low. Volatility is likely to pick up from
the extreme lows of 2016 and 2017 as major central banks
respond to better growth, with the ECB ultimately joining the
Fed in gradually normalising its policy settings and shrinking its
balance sheet. It remains to be seen, however, how far volatility
levels will have to rise before we witness a more significant
impact on emerging market assets.
Meanwhile, further credit rating downgrades of South Africa’s
sovereign ratings appear to have been avoided following
the corrective fiscal measures tabled in the Budget Speech.
Downgrade concerns could nonetheless re-emerge should
fiscal consolidation prove harder than markets currently
anticipate. The rand might also come under pressure if
the current account deficit widens more than expected.
Separately, the rand looks relatively expensive when compared
to its commodity and emerging market peers, which suggests
that the currency has room to depreciate if market sentiment
towards South Africa takes a less optimistic turn. It is clear that
financial conditions are currently favourable for South Africa,
but it is less clear how long this can last.
Monetary Policy Review April 2018

Real economy: turning
of the tide?
South Africa enjoyed a growth recovery in 2017, partly due
to rebounds in the agricultural and mining sectors. For this
recovery to be sustained, broader improvements are needed
elsewhere in the economy. The forecasts indicate somewhat
stronger growth over the 2018–2020 period, underpinned by
a recovery in domestic confidence levels as well as continued
strong growth abroad. Achieving the growth rates envisioned
in the National Development Plan, however, will require
significant reforms.
Understanding the 2017
growth surprise
A year ago, it seemed the economy was falling into recession,
for the first time since 2009. It is now clear that South African
growth actually accelerated in 2017, finishing the year at a rate
of 3.1% (a quarter-to-quarter change at seasonally adjusted
annualised rates). With the benefit of hindsight, the evidence
for stronger growth was there to be seen. In particular, the
SARB’s leading indicator increased strongly in about mid-2016,
signalling an imminent growth improvement. Furthermore,
agricultural and mining data had pointed to a primary sector
recovery – a signal that was visible from the first quarter of
2017 onwards. Finally, as inflation trended lower over the
course of 2017, it was increasingly clear that households would
have more disposable income.
Nonetheless, the SARB’s growth forecasts were too low
throughout the year, reaching a trough of 0.5% in July 2017 and
only recovering to 0.9% for the January 2018 MPC meeting,
compared with the actual outcome of 1.3% (published by
Statistics South Africa (Stats SA) in March). This error was
partly due to subdued survey data (confidence surveys and
Purchasing Managers’ Indices). Most other forecasters were
also surprised by the strength of 2017 growth. Nonetheless,
the economy surpassed expectations in 2017 and may be on
track to repeat this achievement over the next few years.
Growth in South Africa is typically driven by the tertiary sector,
which accounts for about 63% of output. However, in 2017
the primary sector provided more than half of the economy’s
total growth (0.7 percentage points of 1.3%) while the tertiary
sector made its smallest growth contribution (0.5 percentage
points) since the global financial crisis. (The secondary
sector also fared poorly, contracting by 0.1% year on year.)
The primary sector boom was especially pronounced in the
agricultural sector, which expanded by 17.7% over the year.
This was partly a consequence of base effects, with the sector
Percentage change over four quarters (both scales)
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Leading indicator and GDP growth
Sources: Haver, Stats SA and SARB


-4
-2

Leading indicator
(two-quarter lag)
GDP growth (right-hand scale)
Jan Mar

May Jul Sep Nov Jan
Jan
Mar May Jul Sep Nov
Evolution of 2017 real GDP forecast
Sources: Stats SA and SARB
Percentage change

Actual
Forecast
1.3
Millions of tons
Tons per hectare

Grain production and yield
Source: SAGIS

Tons
Tons per hectare (right-hand scale)

Monetary Policy Review April 2018
recovering from one of the worst droughts in South Africa’s
history – agricultural output had contracted by 10.2% in 2016
and by 6.4% the year before that. The 2017 season also saw an
unprecedented harvest, with both grain tonnages and output
per hectare at all-time highs. Even with double-digit growth,
however, the output of the sector as a whole was still below the
levels achieved in 2014, reflecting the costs of past droughts.
Mining output has been acutely volatile in the post-crisis
period, and these fluctuations do not map very well to either
commodity price or exchange rate dynamics. Rather, the
pattern is simply one of output contracting in one year and
rebounding in the next. This cautions against attributing mining
growth in 2017 entirely to commodity prices. The starting point
– a 4.2% contraction in 2016 – had already set the stage for
a mining sector recovery. Nonetheless, the mining sector still
achieved growth of 4.6% in 2017, its strongest rate since the
crisis, which would have been unthinkable had commodity
prices remained in their 2015 trough.
Viewed from the demand side, the recovery was led by
household consumption, which accelerated to 2.2% in 2017
from 0.7% in the previous year. The boost to consumption was
supported by a spike in real wage gains (up 2.2% in 2017),
reflecting ongoing nominal wage increases of 7.6% in the
context of declining inflation. This windfall arrived following
an extended period of deleveraging, which has improved
households’ financial positions. For example, the TransUnion
Consumer Credit Index, a broad measure of consumer
borrowing and repayment behaviour, improved significantly
over the course of 2017, moving from negative territory in
2016 to positive levels. Debt-to-disposable-income ratios also
declined, to levels last seen in the first quarter of 2006. Given
higher disposable incomes, consumption of durable goods
increased at the fastest pace since the global financial crisis,
even as consumers were telling the Bureau for Economic
Research (BER) that it was a bad time to buy durable goods.
Sales of semi-durable goods, such as clothing, also picked
up strongly.
Unemployment has been rising for about two years, and is now
close to post-crisis highs of around 28% – suggesting a worse
position for households. However, this signal is misleading,
because the rise in unemployment has been driven almost
entirely by higher labour force participation, not job losses.
Net employment has performed better, with both the Quarterly
Employment Statistics (QES) survey (for formal jobs) and the
Quarterly Labour Force Survey (QLFS) (for total employment)
indicating higher or stable employment levels in 2017.
A persistent problem with interpreting South Africa’s labour
market trends is that the data are both volatile and sometimes
misleading. For instance, a naïve interpretation of formal sector
employment numbers would hold that more than a million
private sector jobs have been created, on a net basis, since
Percentage change (both scales)
2000 2002 2004 2006 2008 2010
2012 2014 2016
Mining sector production and commodity prices
Sources: Haver, Stats SA and SARB


-40
-20

Mining production
Commodity prices (ZAR)
(right-hand scale)
Percentage change (both scales)

Average earnings and inflation
Sources: Haver, Stats SA and SARB

Nominal average salaries
(right-hand scale)
Inflation
Real average salaries
Index: 50 = break-even
Ratio

Consumer credit health
Sources: Haver, TransUnion and SARB

Household debt to disposable
income (right-hand scale)
Consumer credit
Monetary Policy Review April 2018

2013 – numbers which actually reflect new statistical samples,
not new jobs. But for all the difficulties of assessing these data,
it seems reasonably clear that employment numbers have
held up better than growth, once again providing a degree of
support to households.
South Africa’s growth outlook
The growth recipe for 2018–2020 will not be the same as
that for 2017. In particular, last year’s primary sector boom
was almost certainly a one-off event, and large additional
primary sector contributions are not in the SARB forecasts.
Nonetheless, South Africa’s growth is expected to accelerate
over the forecast period, averaging 1.7% in 2018, 1.5% in 2019,
and 2.0% in 2020.8 Stronger growth makes sense, given that
business confidence is picking up from highly depressed
levels, which should allow investment to recover somewhat.
Global growth levels are also at a cyclical high, with spillovers
to South Africa via stronger exports. Furthermore, households
should be able to sustain consumption at around 2017 rates,
given better financial positions and continued lower inflation
(with exchange rate effects offsetting the VAT increase). The
pickup in growth is not especially strong, however, and growth
remains below long-term averages even at the end of the
forecast period. This is mainly because, at this early stage,
there is little clarity around the reform agenda, and without
specifics it is difficult to quantify growth responses.
Expenditure components of real GDP
Annual percentage change
Actual
SARB forecast


Note: Previous forecasts are in brackets.
Sources: Stats SA and SARB

Growth is fractionally lower in 2019 than in 2018 for purely technical
reasons. The 2018 growth outcome benefits from strong growth
in the fourth quarter of 2017, creating base effects which raise the
annual figure. Subsequently, growth is unable to maintain these higher
growth rates, in part because of VAT effects. This reduces the annual
growth number for 2019 even though growth is accelerating in the
last three quarters of the year, reaching 2% in the final quarter.
Percentage change over four quarters

Household consumption
Sources: Stats SA and SARB


Semi-durable
goods
Total
Durable goods
Per cent

Labour market dynamics
Source: Stats SA

Labour force participation rate
(right-hand scale)
Unemployment rate
Millions

Employment levels
Sources: Stats SA and SARB

Total formal, non-agricultural
employment (QES)
Total employment (QLFS)


Monetary Policy Review April 2018
Reform initiatives are particularly important for the investment
outlook. On current forecasts, this category will stop detracting
from growth, as it did in 2016, but it will not be making large
positive contributions to growth either (adding less than
0.3 percentage points to growth, on average, between
2018 and 2020, compared with a longer-run average of
0.8% between 1994 and 2017). Yet investment is fundamental
to sustaining higher growth rates. At the peak of the boom
in the late 2000s, South African investment levels peaked
fractionally above 23% of GDP. High-growth countries typically
achieve investment rates of at least 25% of GDP, and often
more. The emerging market average is currently over 30% of
GDP, and has been for a decade. South Africa currently invests
less than 20% of GDP.
Real gross fixed capital formation
Annual percentage change
Actual
SARB forecast


Private business enterprises....

Note: Previous forecasts are in brackets.
Sources: Stats SA and SARB
The output gap
In the universe of the QPM, growth is not built out of discrete
components such as investment and exports. Rather, it is a gap
concept: the economy has a trend growth rate to which actual
growth converges over time. The underlying growth trend, as
currently estimated, is very low: 1.3% for 2018 and 2019, and
1.4% for 2020. This is consistent with an economy that has
been starved of investment for some years, that suffers from
acute skills constraints, and that achieves little productivity
growth. However, the economy has not been able to sustain
growth of even 1.3% through 2015 and 2016. Given this legacy,
the output gap is negative, at about -1% of potential GDP.
This negative output gap was largely unchanged despite
better-than-expected growth outcomes in 2017. This is
because last year’s growth gains came, in large part, from
supply-side shocks affecting the primary sector, such as better
rains. Because the output gap is meant to be a measure of the
adequacy of demand, it should not be responding to weak
growth caused by supply constraints or, inversely, to strong
Percentage of GDP
2000 2002 2004 2006 2008 2010
2012 2014

Investment
Sources: IMF and SARB

Emerging markets
Emerging markets
(excluding China)
South Africa
Percentage of potential GDP, t = first <0 output gap
Duration of negative output gaps
Source: SARB
Period
t-8
t+8
t+16
t+24
t+32
t+40
t+48
t

1974–1981

1981–1984

1984–1989

1989–1996

1996–2000

2000–2008

2008–current


Index
Ratio
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Business confidence and private investment
Sources: Haver, RMB/BER and Stats SA

Business confidence
Share of private investment
in total investment
(right-hand scale)
Monetary Policy Review April 2018

growth caused by windfalls. Accordingly, the potential growth
measure in the QPM ‘saw through’ the positive shocks of 2017
(as it did the negative shocks of 2016).
The prevailing negative output gap has been highly persistent.
It has already been negative for 35 quarters since the second
quarter of 2009, and on current forecasts will persist in negative
territory for a further 10 quarters before finally turning positive
in 2020. Such a prolonged period of output below potential
is unprecedented in South Africa’s modern economic history:
negative output gaps have on average lasted for 12 quarters,
and the previous longest-lasting output gap closed after
20 quarters (it was negative between 1989 and 1996).
There are different interpretations of the current gap. One view
is that it testifies to the scale of the growth shocks that have hit
South Africa since 2008, starting with the global financial crisis
but including the European debt crisis of 2011 and 2012, the
commodity price plunge of 2015, and the domestic, politically
induced confidence collapse of 2016 and 2017. Another
interpretation is that potential growth is still being overestimated,
despite repeated revisions, and the gap will look more normal
given new data and better estimation techniques. As ever, the
fact that the output gap is non-observable means it is very
difficult to reach a conclusive verdict.
A further complication is that a long-lived negative output
gap, even if correctly diagnosed, will still pose challenges
for macroeconomic policy. The conventional prescription
for policymakers trying to close such a gap is to provide
countercyclical support to the economy via lower interest
rates and more spending. Yet these policies work by reducing
savings and bringing future consumption into the present. This
is not a sustainable growth recipe for the long term. Indeed, for
South Africa, its unsustainability became clear via a balance of
payments constraint (which started to bite in 2013) as well as a
borrowing constraint (expressed as fast-rising debt payments
and credit ratings downgrades). Policies designed to close an
output gap over a normal business cycle can end up hurting
growth if they are kept up for too long.
South Africa’s twin deficits
South Africa continues to run sizeable twin deficits: on the
current account balance and on the fiscal balance. These
deficits are not necessarily bad, provided they do not become
too large and that they generate sustained growth. But
persistent, large twin deficits are a source of vulnerability,
especially for emerging markets, and South Africa’s remain
quite large even after a period of fiscal consolidation and
current account compression.

Monetary Policy Review April 2018
The current account
South Africa’s current account deficit has narrowed
substantially, averaging -2.5% of GDP in 2017, down from
-2.8% in 2016 and a trough of -5.8% in 2013. Much of this
current account narrowing reflects import compression, with
import values contracting, in real terms, over the past three
years. Commodity price dynamics have also favoured a
narrower deficit, with oil prices climbing more slowly than those
of South Africa’s export commodities – a dynamic that lifted
South Africa’s terms of trade to an all-time high in 2017, above
even the 2011 peak. In these circumstances, it is not surprising
that the deficit has narrowed, and this narrower deficit has
been relatively easy to finance. The problem, however, is that
the deficit has only approached sustainable levels – in terms
of the IMF’s metrics9 – under unusual circumstances and is
therefore likely to deteriorate over the next few years as growth
rates and commodity prices revert to longer-run averages.
One underlying cause of South Africa’s perennial current
account deficit is a large incomes and transfers deficit. This
reflects payments to Southern African Customs Union partners
of around 1% of GDP as well as interest and dividend payments
to foreign investors (a consequence of low domestic savings
rates, another underlying cause of large deficits). Although the
incomes and transfers deficit has been fairly rigid over time,
its subcomponents have adjusted more flexibly. In particular,
dividend payments have moderated in recent years, in line
with lower GDP growth. Yet this effect has been entirely offset
by higher interest payments, reflecting the large proportion
(around 40%) of South African government debt now held by
foreigners. As a result, the income deficit was 3% of GDP in
2017, close to its post-crisis average of 2.6% of GDP.
Over the forecast period, the current account deficit is projected
to deteriorate. (The annual averages are -2.8% of GDP for
2018, -3.5% for 2019, and -3.6% for 2020.) The SARB’s current
account forecasts over the past two years also initially indicated
a widening deficit, which was incorrect. Nonetheless, this
was due to over-optimistic growth projections (implying more
import growth than South Africa actually experienced) as well
as more moderate terms of trade (short of current highs). Given
the current starting point, with better growth and abnormally
elevated terms of trade as well as a stronger exchange rate, the
argument that the current account will widen from here is even
stronger than it was previously.

For details, see IMF, ‘2017 Article IV Consultation’ Annex 1, available at

Index: 2010 = 100
Indices: 2010 Q1 = 100

Commodity prices
Terms of trade
(right-hand scale)
Commodity prices
(US$)
Forecast
Source: SARB

Commodity prices (ZAR)
Percentage of GDP (both scales)

Trade trends
Sources: Haver and Stats SA


Imports

Exports

Net exports (right-hand scale)
Forecast
Percentage of GDP
-9
-6
-3

Current account balance

Income and transfers

Trade balance


Current account balance

Source: SARB
Monetary Policy Review April 2018

Fiscal dynamics
The 2018 Budget Speech introduced substantive new
revenue measures to stabilise sovereign debt. These will lift
real revenues by an expected 4.6% in 2018/19, leading to
an improvement in the fiscal balance from -4.3% of GDP in
2017/18 to -3.6% in 2018/19. Government spending, however,
continues to grow in real terms across the forecast period,
rising faster than actual or potential growth as well as the rate of
population increase. There have been spending cuts affecting
a range of programmes and departments, but these have been
more than offset by higher spending elsewhere: there have
been no net spending cuts relative to prior spending levels.
This is also true of primary spending, which excludes interest
payments. Accordingly, budget deficits remain over 3% for the
foreseeable future.
The existing tax measures will likely prove sufficient to achieve
the projected fiscal consolidation, a judgement corroborated
by Moody’s decision to maintain South Africa’s investmentgrade credit rating. With stronger growth and more efficient
revenue collection, the debt trajectory may even be lower than
currently forecast. Debt sustainability, however, is not the only
criterion of effective fiscal policy, and debt levels closer to or
below 40% of GDP, rather than 50% of GDP, are likely to be
more growth-friendly in the longer term. This would also permit
greater scope for addressing adverse shocks, such as another
global recession.
Conclusion
The South African economy appears to have reached a
turning point. Growth surprised to the upside in 2017, and the
SARB’s forecasts, like those of other organisations, indicate
further growth gains over the medium term. In the absence of
meaningful reforms, however, growth is unlikely to exceed 2%
sustainably. This is still disappointingly low, given that South
Africa already has population growth close to that rate and is
also a long way from the technological frontier (which should
permit rapid catch-up growth). It is plausible that growth will
deliver further upside surprises, and the MPC’s assessments
of the risks to the growth forecast, long to the downside,
have recently skewed the other way. South Africa’s broader
macroeconomic balance, however, remains quite fragile,
as evidenced by persistent twin deficits. This warns against
complacency.
Percentage of GDP
Current account forecast and actual outcomes

Forecast

Outcome
* Forecasted period


Source: SARB
2016*
2017*
Date of MPC meeting
2018*
Jul 2015
Nov 2015
Mar 2016
Sep 2015
Jan 2016
May 2016
Jul 2016
Nov 2016
Mar 2016
Mar 2018
Jul 2016
Nov 2016
Sep 2016
Jan 2017
May 2017
Sep 2017
Jan 2018
Mar 2017
Jul 2017
Nov 2017
Percentage of GDP
Government gross debt outlook
Source: National Treasury

2017 MTBPS

2018 Budget Review

Actual


Percentage change
Percentage of GDP

Consolidated government finances

Real revenue

Real non-interest expenditure

Fiscal balance (right-hand scale)
Source: National Treasury


Monetary Policy Review April 2018
Box 3 Monetary policy and the value-added
tax increase
1 In some of the countries where VAT increases have been large, consumers
have engaged in pre-emptive buying, causing higher growth in the period
preceding the VAT change. Subsequent quarters are then weaker, given
that prices are higher and consumers have already depleted their budgets.
However, the SARB forecasts do not anticipate similar effects, because
the VAT increase is moderate and because there has been a relatively short
period between its announcement and its implementation.

For further details, see Statistics South Africa, Stats SA to ensure
VAT change reflected in CPI, media release, 19 March 2018.
In the February 2018 Budget Speech, the minister of finance raised
the value-added tax (VAT) rate from 14% to 15%, effective 1 April. This
change is expected to raise inflation by 0.6 percentage points for the
12 months following the increase, a period that stretches over the last
nine months of 2018 and the first three months of 2019. The total effect
comprises a 0.5 percentage point direct impact, and a 0.1 percentage
point indirect impact, the latter due to spillovers from the VAT increase
that affect other prices and wages. These (small) indirect effects start
to appear shortly after the VAT increase and then persist through 2019,
adding a bit less than 0.1 percentage points to inflation in that year.
Gross domestic product (GDP) growth is likely to be around
0.2 percentage points weaker between mid-2018 and mid-2019, given
higher prices which subtract from household consumption.1
South Africa’s VAT increase takes place in the context of a much
stronger exchange rate and an improving growth outlook. As a
result, the latest inflation and growth forecasts look similar to the
January 2018 forecasts, which excluded VAT effects.
Inflation forecast with and without VAT
Percentage change
Actual
SARB forecast


Targeted inflation excluding
4.5
5.0
5.2
Sources: Stats SA and SARB
Consumer prices do not rise by the full 1 percentage point increase in
the VAT rate because VAT does not apply to a large portion (43.5%) of
the consumer price index (CPI). Some items, such as basic foodstuffs,
are zero-rated; some, like fuel, are taxed via other measures; and
some are VAT-exempt (notably housing). The inflation contribution of
0.5 percentage points reflects full pass-through to the affected portion
of the CPI basket.
The effects of the VAT change are likely to appear in the CPI rapidly, as
Statistics South Africa has rescheduled some of its surveys to ensure
they capture new prices timeously.2 There are unlikely to be lagged
VAT effects on the CPI from measurement delays.
Although the VAT shock is negative, it is probably still better than the
counterfactual with no VAT increase. The higher VAT rate is one of
National Treasury’s most important measures to stabilise debt growth.
Without higher VAT, or comparable revenue-raising measures, South
Africa’s debt trajectory would remain unsustainable, likely prompting
further credit ratings downgrades. This would have had worse
consequences for both inflation and growth.
Percentage change

Impact of VAT hike on headline inflation
Sources: Stats SA and SARB

Jan forecast

Baseline

Baseline excluding VAT shock

Percentage points

Direct impact and second round effects of the VAT hike

Second-round effects

Direct impact
Source: SARB

Monetary Policy Review April 2018

Price developments:
why inflation has slowed
Positive price shocks have lowered recent inflation outcomes.
In particular, the exchange rate has appreciated strongly,
reducing import price inflation. Headline likely bottomed out
at an estimated 4.1% during the first quarter of 2018 and is
projected to climb above 5% as shocks fade. Nonetheless,
inflation is now forecast to stabilise closer to 5% than 6%
over the medium term, as price and wage setters lower their
inflation expectations in the context of sustained lower inflation.
According to the SARB’s latest projections, inflation will remain
within the target band throughout the forecast period, which
now stretches to 2020. Inflation is projected to average 4.9% in
2018, 5.2% in 2019, and 5.1% in 2020; the quarterly trough is
4.1% in 2018Q1, the peak is 5.5% one year later, and the end
point is 5.2% in 2020Q4.
This inflation profile has three striking characteristics. The first
is that inflation is currently unusually low, in the bottom half of
the target range – something that has occurred only three other
times during the inflation targeting period. The second is that
inflation rises from here, returning to the top half of the range
and staying there across the forecast horizon. The third is that
inflation ultimately settles somewhat lower than its longer-term
average. This chapter deals with each of these points in turn.
Why is inflation currently below 4.5%?
The low starting point for inflation is principally due to the
exchange rate, which has followed an appreciating trend over
the past two years (albeit one punctuated by volatility). In early
2016, the rand was unusually weak. At current valuations, by
contrast, it appears somewhat stronger than its equilibrium
‘fair’ value.
This currency appreciation has had large effects on the prices
of traded goods. Its impact has been especially visible in core
inflation, where the core goods subcomponent – including
items such as vehicles, household appliances and clothing –
has slowed more abruptly than the services subcomponent. In
the first quarter of 2018, for instance, core is estimated to have
averaged 4.2%, which reflects 2.3% for core goods (one-third
of core) and 5.1% for services (two-thirds of core). Import price
inflation was -2.4% (against a post-crisis average of 6.4%).10
Although lower core inflation has more to do with goods than
services, services are also contributing, with inflation in this
category declining to a seven-year low of 4.9% in February.
This slowdown chiefly reflects slower inflation for transport,
accommodation and medical services. These are important
categories, and recent price developments could herald
ongoing lower services inflation. Nonetheless, monthly data
are volatile, and the decline in services is not yet clearly a new
10 As proxied by prices in the US, the euro area and Japan,
adjusted by the exchange rate
Percentage change
South African inflation

Inflation target range

Targeted inflation

Midpoint

Forecast

Sources: Stats SA and SARB
Percentage change over four quarters

Core inflation and its components
Sources: Stats SA and SARB

Forecast

Core goods

Services

Core inflation

3–6% inflation target range

Monetary Policy Review April 2018
trend. Both the lower health and accommodation numbers
have appeared in just one survey to date, while lower transport
has appeared in two surveys (albeit with a slight uptick in
the second survey).11 As discussed below, services inflation
is projected to moderate over the forecast period, but this
claim does not rest solely on the last three months of services
price data.
Current inflation is also benefitting from food and electricity
price movements. As discussed in the real economy chapter,
South African food production grew strongly in 2017, following
two bad years. The price consequences of this rebound, which
have been supplemented by exchange rate effects, have been
much lower food inflation rates: in the first quarter of 2018,
inflation in this category was 4% versus 6.9% in 2017 and 10.5%
in 2016. Similarly, electricity price inflation has also come down
substantially, with the National Energy Regulator of South
Africa (NERSA) granting Eskom only a 2.2% increase for the
12 months starting July 2017.
11 The accommodation numbers have featured in three CPI releases, but as
this component is surveyed quarterly, it is still just one data point.
Box 4 South Africa’s underlying inflation1

The CPI team at Stats SA provided crucial, up-todate micro-price data for the sticky price index. The
authors gratefully acknowledge their assistance.

Some central banks, such as the Bank of Thailand, have
tried targeting core inflation, but have since switched to
targeting headline because it is easier to communicate
and more relevant for price and wage setters.

The Federal Reserve Bank of Atlanta publishes a sticky-price
index for the US, available at
research/inflationproject/stickyprice.aspx. Many central banks
and statistical agencies report trimmed means, including the
Federal Reserve Bank of Dallas (
research/pce) and the Bank of Canada (
gc.ca/imdb-bmdi/document/2301_D63_T9_V1-eng.htm).
Like all other inflation-targeting central banks, the South African
Reserve Bank (SARB) pursues a target for headline consumer price
inflation.2 However, headline numbers are sometimes distorted by
temporary shocks, such as large movements in oil prices. To help
see through these shocks, and focus on underlying inflation trends,
policymakers also consult alternative measures of inflation designed to
exclude volatile items.
The primary indicator used by the SARB for this purpose is a core
inflation index which omits food, non-alcoholic beverages, fuel and
electricity. However, the theoretical rationale for this version of core
is problematic. Although it is meant to exclude volatile items, these
exclusions are not made on the basis of consistent volatility criteria.
As a result, some volatile prices remain in the index, while more stable
prices (such as those for some processed foods) are removed.
Two more rigorous alternatives to core are the so-called ‘sticky prices’
and ‘trimmed means’.3 This box describes both these measures, and
assesses their usefulness as guides to monetary policy.
Percentage change over 12 months

Services inflation and subcomponents*
* Values in brackets are weights in headline CPI.
Source: Stats SA

Services inflation (51.3%)

Owners’ equivalent rent (13.3%)

Transport (3.1%)

Health and medical insurance (8.4%)

Percentage change over 12 months

Sticky-price inflation and SARB’s preferred
measure of core CPI
Sources: Stats SA and SARB

Sticky-price inflation (threshold = 15%)

Core inflation
Monetary Policy Review April 2018

‘Sticky prices’ are the prices in the consumer price index (CPI) which
change least frequently. These slow-moving prices are interesting
because they should contain relatively more forward-looking information:
if prices cannot be adjusted frequently, then mispricing will be more
costly. Price setters for these categories will therefore have stronger
incentives to be thoughtful about the longer-term outlook.4
To ensure that they only capture slow-moving prices, sticky-price
measures tend to be quite narrow. The South African measure discussed
here covers just 16.4% of the CPI basket, with the average price change
occurring every 11 months (the fastest-moving price counted as sticky,
by this rubric, changes once every 6.25 months). By contrast, in the
broader CPI, prices go unchanged for an average of about 3.5 months.5
There are a total of 180 products in this sticky-price measure, the largest
of which – ordered by weight – are university fees, imported beer, lotto
tickets, primary-school fees, secondary-school fees and funeral policies.
‘Trimmed means’ are simpler, showing just the regular headline index
stripped of a fixed portion of outliers. Statistics South Africa’s version
removes the items with the highest 5% and the lowest 5% of inflation
rates, leaving the middle 90% of the basket – making this a much wider
measure than the sticky-price index and also wider than the regular core
measure, which covers 74% of the headline basket.
Both these measures show trends that are surprisingly similar to core
inflation, even though they reflect different methodologies. This suggests
that core inflation is generally capturing more signal than noise, despite
the arbitrariness of its construction – implying it has been a fairly reliable
guide for policymakers. The trimmed-mean measure is generally more
volatile than core, which is probably because price shocks have not
been symmetrical. The sticky-price index has followed core more
closely than the trimmed mean, although recently it has become more
volatile than core, which is mostly due to unusually large changes in
three subcomponents of the index (education, lotto tickets and satellite
television subscriptions).
Over the past year or so, inflation rates for sticky prices, the trimmed
mean and core have all slowed markedly, with all three falling below the
4.5% midpoint of the inflation target range. This decline reverses the long
upward trend in underlying inflation which prevailed between 2011 and
2017. The fact that it is visible across all three measures of underlying
inflation provides further evidence that inflation is now better controlled
than it has been in recent years.
4 For further details, see Ruch, F. 2017. ‘Is our core rotten?’ South African
Reserve Bank Occasional Bulletin of Economic Notes, OBEN 18/01.
5 Because services prices tend to be stickier than goods prices, Stats SA
surveys them less frequently (e.g. only once per quarter or once per year).
The calculations reported here are based on the frequency of price changes
according to Stats SA, although it is possible that some infrequently surveyed
prices may be changing more often.
Percentage change over 12 months

Trimmed-mean inflation and SARB's preferred
measure of core CPI
Sources: Stats SA and SARB

Trimmed-mean inflation

Core inflation

Monetary Policy Review April 2018
Box 5 The changing role of administered prices
in headline inflation
1 For further details, see Fowkes, D, Janse van Rensburg, T and Visser, E.
2017. ‘Onwards and downwards – the changing role of administered prices
in headline inflation; South African Reserve Bank Occasional Bulletin of
Economic Notes, OBEN 18/01.
Administered price inflation is often cited as a source of inflationary
pressure and an obstacle to lowering inflation expectations. However,
administered price inflation has moderated in recent years. In fact,
since mid-2014 it has been, on average, 1.3 percentage points below
headline inflation versus 4.6 percentage points above headline for the
four-and-a-half years before that. This box explores the moderation in
administered price inflation and reflects on policy implications.1
In the period between 2010 and mid-2014, administered prices
underwent a large relative price adjustment, meaning they became
more expensive in real terms. Over this period, the administered price
index rose by 53.5%. The electricity price subcomponent increased by
76.6%. The broader consumer price index (CPI), by contrast, climbed
by 28%. From mid-2014 onwards, however, administered price
increases have actually fallen slightly behind overall consumer prices,
with the index up 12.1% against 16.9% for the CPI.
This shift is not simply due to collapsing world oil prices. Fuel prices
are an important part of the administered price basket, with a weight
of 28.3%, but their prominence in the basket is theoretically dubious.
This is because these prices are heavily influenced by global factors,
which are well beyond the control of local administrators. The relevant
portion of fuel prices, when analysing administered price trends, is
fuel taxes and levies, not the rand price of oil. However, an alternative
administered price measure, which excludes the basic fuel price, shows
a similar trend to the conventional Statistics South Africa administered
price measure – just with less volatility.
Far from being an oil story, the decline in administered price inflation
is actually broad-based, with material contributions from a range
of categories, including electricity prices, fuel margins, water and
university tuition. The disinflation in this category is explained by two
distinct factors. First, unsurprisingly, inflation rates have declined for
a number of items. For instance, electricity price inflation has slowed
from 26.8% in January 2010 to 7.0% in July 2014 and then to 2.1%
in January 2018. Second, more subtly, the weights of the various
administered prices have fallen because consumers have reacted to
large price increases by reducing consumption (by volume). Water, for
instance, has continued to show price increases of around 10% but its
weight in headline CPI has fallen from 1.55% to 1.08% (a 30% decline).
This exercise demonstrates both that administered prices were a
significant source of inflationary pressure in the early post-crisis
years and that this pressure has since eased. Instead of obstructing
disinflation, administered prices have now become a more benign
influence, and sometimes even a benevolent one. The recent ruling
by the National Energy Regulator of South Africa denying Eskom a
double-digit electricity price increase is therefore just one more data
point in a persistently favourable trend.
-5

Percentage change

Headline and administered prices including
and excluding fuel prices
Sources: Stats SA and SARB

Administered prices

Administered prices excl. fuel

Headline inflation
Indices: Jan 2010 = 100 and Aug 2014 = 100

Headline and administered prices
Sources: Stats SA and SARB

Administered prices

Headline inflation
+25.5 above
headline
-4.8 below
headline

Monetary Policy Review April 2018

Contributions to administered price inflation,
excluding the basic fuel price
Percentage points
Averages
Change in
percentage
points
Jan 2010
–Jul 2014
Aug 2014
–Oct 2017
4.7
1.8
-2.9
Fuel margins and taxes (2.54)....

Housing: assessment rates

Motor licences and registration
0.3
-0.2
-0.5
University boarding fees (0.06)...

Notes:
1.
Brackets denote category weights in the CPI.
2.
The formula used for these calculations is consistent with the methodology
used by Stats SA.
3.
Other components include driving licences (0.13), toll fees (0.09), TV licences
(0.09), paraffin (0.04) and public transport (trains) (0.13).
Sources: Stats SA and SARB
The risk, however, is that inflation pressures are now shifting from
administered prices to other costs set by government, including valueadded tax and import tariffs. The lesson from administered prices may
be that where adjustments are necessary, they should be done quickly
so that they do not enter into inflation expectations as a permanent
source of price pressure. Unfortunately, administered price inflation was
high enough for long enough that many informed observers believe it is
still high, even though this is now demonstrably untrue.
Why does inflation rise over
the coming year?
Much as the story of current inflation is one of positive shocks
keeping inflation lower, so the short-term projections are about
these shocks wearing off and new, negative shocks pushing
inflation higher. The most prominent new shock is the higher
VAT rate introduced in the February 2018 Budget, which took
effect from April 2018. Among the fading positive shocks, food
and electricity price dynamics are important. The rand is also
projected to weaken from its current, expensive level.
The exchange rate has been an important source of uncertainty
and forecast errors in the recent past. It is possible the rand
could keep on strengthening from its current levels, perhaps
appreciating to the extent reached in 2006 or 2011 (with real
exchange rate index values of 105.1 and 104.4 respectively
Index

2016 2018
Real effective exchange rate of the rand
Source: SARB

104.2
104.4

Monetary Policy Review April 2018
versus about 94 currently). This is not, however, the view used
for the baseline forecast. Rather, as per the QPM methodology,
the real effective exchange rate is expected to converge on its
equilibrium value over time. This implies nominal depreciation
of nearly 5% over the next four quarters (from mid-2018 to
mid-2019). For this reason, import prices are expected to start
rising again at the start of 2019, concluding a protracted bout
of deflation.
Food, fuel and electricity prices all pick up over the rest of
2018 although the inflation rates for these categories will all be
below longer-term averages. Fundamentals for food and fuel
are generally favourable, if not as favourable as in 2017. The
biggest difference is the new taxes.
For food, crop estimates for 2018 indicate smaller yields
than were achieved in 2017 (12.4 million tons of maize versus
16.8 million last year). These should nonetheless be adequate
for domestic consumption requirements. Wheat production
is being disrupted by drought in the Western Cape, but the
wheat levy was reduced by 60% in mid-2017 (from R947.20
to R379.34 per ton), which should absorb much of this
price effect. Meat prices are normalising following unusual
conditions in 2017 and 2018, mostly herd rebuilding following
the drought and poultry price pressures from avian flu and new
brining regulations. Meat price inflation therefore declines from
nearly 13% in 2017 to just under 10% in 2018. International
Targeted inflation (March 2018 forecasts)
Percentage change over 12 months, September 2017 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–17

2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4

* CPI excluding food, non-alcoholic beverages, fuel and energy
** Combines actual rentals and owners’ equivalent rent
Sources: Stats SA and SARB
Percentage change over 12 months

-60
-40
-20

Grain prices and related inflation

Combined maize and wheat price

Grain starch mill PPI

Bread and cereals CPI (right-hand scale)
Forecast
-15
-10
-5

Sources: SAFEX and Stats SA
Monetary Policy Review April 2018

food prices have picked up slightly in the first quarter of 2018
but are still below early-2017 levels in dollar terms. The forecast
assumption is that these prices will increase by around 3%
annually over 2018–2020, in US dollars – and because the
domestic exchange rate has strengthened, these prices will
be in deflation, in rand terms, throughout 2018. Overall food
price inflation is expected to accelerate from 4% in the first
quarter of the year to 6.5% in the final quarter, chiefly due
to higher taxes. The VAT increase raises food inflation by
0.5 and 0.1 percentage points in 2018 and 2019 respectively.
The sugar tax effects on food and non-alcoholic beverages
are of a similar magnitude. Both these effects fade out early
in 2019.
Similarly, while the world oil price outlook is quite favourable for
2018, domestic fuel prices will rise given higher taxes. World
oil has fallen back from its recent peak of more than US$70 a
barrel reached in January 2018, and the assumptions for the oil
price are US$63, US$62 and US$62 per barrel for 2018, 2019
and 2020 respectively.12 However, the general fuel levy and the
Road Accident Fund levy increased by a combined 52 cents
per litre (10.9%) in April 2018, which is 19 cents per litre above
the previous assumption of 33 cents per litre (6.9%). This effect
is likely to be offset, in part, by the stronger exchange rate.
Accordingly, fuel price inflation is now expected to average
5.6% in 2018 (compared with 6.4% as of the previous Monetary
Policy Review (MPR).
12 A US$70 per barrel assumption was never priced into the forecast.
The January 2018 assumption for 2018 was US$62 per barrel; the
November 2017 assumption for 2018 was US$57 per barrel.
Consumer food price inflation (March 2018 forecasts)
Percentage change over 12 months, September 2017 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–17

2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
Food and non-alcoholic

Bread and cereals....


Sources: Stats SA and SARB

Services

Food and NAB*
Per cent/Percentage points
Contributions to headline inflation
2019Q1
2018Q1

Core goods

Electricity

Fuel

Sources: Stats SA and SARB
* Non-alcoholic beverages

Monetary Policy Review April 2018
NERSA has once again denied Eskom’s application for a
double-digit increase. The approved adjustment for the
2018/19 financial year will therefore be 5.2% compared with
an application for 19.9%. This is still higher than 2017/18’s very
low increase of 2.2%, contributing to an uptick in inflation, but
it is low relative to the post-crisis pattern of sustained increases
above headline inflation levels.
Inflation at the far end of the forecast
For monetary policy purposes, shocks to prices such as those
for oil or food are of limited interest. They matter where they
will be sustained or where they are likely to affect other pricesetting decisions. Otherwise, their inflation consequences will
disappear from the data within a year, before a monetary policy
response can filter through to the economy (a process that
takes around 12–24 months).
The QPM is not an effective tool for modelling specific supplyside shocks, and the near-term forecasts therefore draw on
inputs from other models which utilise fine-grained data.
The QPM’s disregard for consumer price index (CPI) detail,
however, is an advantage as well as a weakness. Price shocks
tend to be unpredictable. Over time, they should be randomly
distributed, meaning they cancel out. The minutiae of the
inflation profile can therefore distract from a rigorous inflation
forecast – the proverbial error of not seeing the forest for
the trees. The QPM provides a different perspective, with all
shocks dissipating over the medium term. What remains are
the core concerns of monetary policy, the inflation target, and
the inflation expectations which determine prices and wages.
For this reason, the question of where inflation finishes the
forecast period is more interesting than where it starts.
The QPM forecast currently ends with inflation at 5.2%. This
is somewhat below longer-run averages and most previous
end-point forecasts. It is also lower than surveyed inflation
expectations or those of other forecasters. (The IMF, to take
one important example, has South African inflation stabilising
at 5.5% over the medium term.) The justification for this more
benign projection is twofold. First, the SARB has made it clear
in recent years that it is not trying to target the upper end of
the 3–6% target band but would prefer inflation to settle closer
to the midpoint of that range. Better target clarity should guide
expectations lower. Second, by the end of 2020, South Africa
will have experienced nearly four years of inflation closer to
5% than 6% (on current forecasts, the average for 2017–2020
will be 5.1%). This will provide reassurance to price and wage
setters that lower inflation is here to stay.
Rand per litre

Fuel price and its components*
* Petrol price prior to January 2017, combined petrol
and diesel price thereafter.
** Movements of the Brent crude oil price (in rand) in January 2018
contributed to the fuel price drop in February.
Sources: Department of Energy and SARB

Fuel
Domestic taxes and margins
Forecast
Brent crude oil (lagged)**
Refinery margin and other costs
Monetary Policy Review April 2018

Box 6 What to expect when you’re expecting
(lower inflation)
South African inflation has been quite muted through most of 2017,
thanks in large part to positive shocks. For monetary policy, a critical
question is how this will affect South Africa’s longer-term inflation trend.
The most important mechanism is likely to be inflation expectations,
with headline inflation falling because of lower goods price inflation,
causing expectations to decline and leading to service price disinflation.
Service prices are, of course, varied, and each category has its own
unique dynamics. Nonetheless, aggregate services inflation tends to
follow two-year-ahead expectations closely: from the beginning of
2008, the correlation is 88%. For this reason, the evolution of inflation
expectations is central to the long-run inflation outlook.
South Africa commenced inflation targeting in 2000, and we have
survey data of inflation expectations starting shortly afterwards. Over
this period, inflation expectations have tended to respond to actual
inflation with a lag. Short-term expectations have moved quite rapidly
while longer-term expectations have adjusted more reluctantly. Based
on the historical elasticities between inflation and inflation expectations,
it is possible to forecast inflation expectations. Given the South African
Reserve Bank’s (SARB) baseline inflation outlook, expectations are
likely to reach 5.1% by 2020 for both the current-year and the twoyear-ahead measures. Services inflation should then settle at this level,
meaningfully below its post-crisis average rate of 5.8%.
In recent years, the SARB has been clear that the 3–6% target range
should not be interpreted as a 6% target and that policymakers would
prefer to have inflation expectations anchored to the 4.5% midpoint of
that range. Anchoring expectations at this level would require a period
of inflation at 4.5%, during which time price and wage setters would
learn what inflation rates to expect in future. Given a scenario where
inflation moves to 4.5% and then stays there indefinitely, currentyear expectations would converge on that point within 7 quarters,
one-year-ahead expectations would get there within 10 quarters, and
two-year-ahead expectations would arrive at target after 11 quarters.
The adjustment is not linear, however, with the final convergence
on 4.5% following an asymptotic trend. One- and two-year-ahead
expectations would be under 5% within three and four quarters
respectively.
Per cent

Services inflation and inflation expectations

Two-year-ahead inflation expectations

Services inflation (year on year)
Sources: BER, Stats SA and SARB

Per cent
Expectation paths with current SARB
inflation forecast
Sources: BER and SARB

Current-year inflation expectations

One-year-ahead inflation expectations

Two-year-ahead inflation expectations

Inflation forecast


Per cent
Expectation paths under a 4.5% inflation scenario
Sources: BER and SARB
t-9
t-7
t-5
t-3
t-1
t+1
t+3
t+5
t+7
t+9
t+11
t+14

Current-year inflation expectations

One-year-ahead inflation expectations

Two-year-ahead inflation expectations

Inflation scenario


Monetary Policy Review April 2018
In thinking about longer-term inflation, two topics are especially
important: wages and salaries, and inflation expectations. The
two are closely related and have large effects on inflation –
especially services inflation, which accounts for around
half of the CPI basket and is vastly more stable than goods
inflation. (By way of illustration: over the post-crisis period,
goods inflation has had a standard deviation of 1.6 percentage
points compared with 0.5 percentage points for services.)
Ultimately, for inflation in South Africa to change its longer-term
behaviours, services price inflation has to fall, which in turn
requires changes to inflation expectations and remuneration
patterns.
Over the past five years or so, longer-term inflation expectations,
as surveyed by the BER, have been highly stable at about 6%.
Current-year expectations have been more volatile, adjusting
for shocks like the oil price collapse of 2015, but the two-
and five-year-ahead expectations have been more or less
unaffected by these events. This behaviour is consistent with
expectations that are well anchored, just at an uncomfortably
high level. More recently, however, there have been some
limited, but encouraging, signs of longer-term expectations
moderating. In particular, expectations for the next five years
have declined to 5.3%, the lowest level they have reached
since this question was added to the survey in 2011. Similarly,
two-year-ahead expectations are down to 5.4%, their lowest
level since mid-2007.
An alternative measure of inflation expectations is breakeven rates, as calculated from the spread between ordinary
government bonds and their inflation-protected equivalents.
Both the 5- and 10-year versions of this measure have trended
lower since early 2016 although they spiked briefly around
the November 2017 medium-term budget.13 They are now
150–200 basis points below their 2016 peaks, which is
consistent with a narrative of moderating expectations.
The outlook for wages and salaries is more complicated. What
matters for inflation is not simply wage settlement rates. Where
a pay increase is accompanied by increased productivity,
it exerts no additional pressure on prices. For this reason,
policymakers pay close attention to the unit labour cost (ULC)
– a measure which incorporates changes in output as well
as in remuneration. Over the course of 2015 and 2016, ULC
forecasts were systematically too low. Yet this was mostly due
to the growth forecasts being too high, which implied better
labour productivity than was actually achieved. Accelerating
growth is now having the opposite effect, moderating ULC
inflation via the output channel.
13 As always, the comparability of this measure with survey
results is compromised by the possibility of markets pricing in
separate inflation risk premiums over and above the most likely
inflation outcomes. The validity of the measure is also affected
by market conditions, especially the liquidity of markets for the
inflation-protected securities which underpin break-evens.
Percentage change over 12 months

Services inflation

Services inflation

Post-crises average
Sources: Stats SA and SARB

Per cent

Inflation expectations*

Two years ahead

Current year
* Total, combining expectations of labour, business and analysts
Source: BER

Per cent
Jul
Oct Jan
Apr Jul
Oct
Jan
Jul
Oct Jan Apr
Apr

Break-even inflation rates

5-year break-even

10-year break-even
Source: Bloomberg

Monetary Policy Review April 2018

Perhaps the most difficult aspect of forecasting ULCs is divining
wage trends. According to the measure used in the SARB
forecasts,14 nominal wage growth slowed from about 8.5% in
early 2016 to about 6.5% in early 2017, suggesting a degree
of wage moderation in difficult economic circumstances.
However, wage growth has since accelerated back towards 8%
as of early 2018. It has also become clearer that employment is
not collapsing; the job growth rate may be disappointingly close
to zero, but the economy is not shedding jobs on a net basis.
These developments suggest that employment and wages are
not doing the hard work of getting ULC inflation down. Instead,
ULC moderation is chiefly due to better economic growth.
Conclusion
Over the forecast period, inflation does not stay at its current
low levels of under 4.5%. Nonetheless, it ultimately stabilises
narrowly over 5%, which is below longer-run averages. Much
of the recent decline in inflation has been due to positive price
shocks, especially to the exchange rate. It remains to be seen
whether long-run inflation forecasts will keep moderating from
here, perhaps ultimately reaching the midpoint of the 3–6%
target range. Nonetheless, recent developments in services
prices and inflation expectations provide some evidence that
positive price shocks, if properly managed, can engender
permanently lower inflation.
14 The forecasts use economy-wide remuneration, which differs in some
respects from the formal sector non-agricultural employment data
published in the SARB’s Quarterly Bulletin. The two series are not
identical but they have had similar trends over the past three years.
Box 7 Understanding the recent inflation forecast errors
1 For instance, the mean absolute errors for the one-year-ahead forecasts
averaged 0.4 percentage points for 2011–2014 versus 0.83 percentage
points for 2015–2017.
Over the past three years, the South African Reserve Bank’s (SARB)
inflation forecasts have been somewhat less accurate than usual.1 This
box briefly describes these errors, then turns to explanations for the
inaccuracies.
The one- and two-year-ahead forecasts for 2015 and 2017 were
too high by an average of 1 percentage point. By contrast, the one-
and two-year-ahead forecasts for 2016 were too low – although
they were off by a smaller margin than the 2015 and 2017 forecasts
(0.5 percentage points). The current-year forecasts were naturally
better, but these are less relevant for monetary policy, which mostly
affects the economy after a year (see the figures).
The 2015 errors are the most easily explained. The forecasts did not
anticipate the collapse in world oil prices which started towards the end
of 2014. As late as September 2014, the oil price assumption for 2015
was US$107 per barrel versus an actual outcome of US$52 per barrel.
Part of the 2016 error is similarly forgivable: one of the worst droughts
in South Africa’s history took hold in late 2015, causing a significant
acceleration in food price inflation.
Percentage change over four quarters

Average wages
Source: SARB
Forecast

Percentage change over four quarters

Unit labour cost
Source: SARB

Forecast
Percentage change
2015 headline CPI forecast

Actual outcome

Evolution of SARB forecast

4.6


Sources: Stats SA and SARB

Monetary Policy Review April 2018
For these reasons, the core inflation forecasts were more accurate, with
a one-year-ahead mean absolute error of 0.2 percentage points, for
these two years, against 0.8 percentage points for headline.
The forecasts also had the exchange rate assumptions for 2016 and
2017 wrong. In the SARB’s Core Model, these assumptions are based
on a simple convention: the rand adjusts from its starting point (generally
an average of the latest quarter) in line with inflation differentials. Because
South Africa’s inflation rates are higher than those of almost all its trading
partners, the local currency is always depreciating in nominal terms in
the forecast. While the exchange rate has, in fact, followed a long-run
depreciating trend, it can behave differently in the short run. This was
the case through most of 2016 and all of 2017, when the rand was
recovering from an overshoot. Far from depreciating to R17.26 to the
dollar by the end of 2017, as envisioned in the January 2016 forecast,
the rand actually ended the year at R13,64 and has appreciated below
R12 to the dollar since.
At each meeting, the Monetary Policy Committee (MPC) announces
a risk assessment around the forecast, specifying either that the risks
are balanced or that they are skewed up or down. This judgement
is also incorporated in the Monetary Policy Review fan charts. Since
2014, these risk assessments have mostly indicated higher-thanforecast inflation: 66% of the assessments were to the upside, 30%
were balanced, and just 4% were to the downside (a single instance,
for the last MPC meeting of 2017). Making the assumption that these
describe the outlook, as proxied by the one-year-ahead inflation
forecasts, the upside risk assessment was incorrect two-thirds of the
time, in the sense that inflation actually came out below the forecasts.2
All the correct assessments were from 2015, where the forecasts for
2016 were indeed too low. But, as with the forecasts, the MPC risk
assessments missed the downside inflation surprises of 2015 (caused
by oil prices) and 2017 (mainly due to exchange rate appreciation).
It may, however, be incorrect to interpret the risk assessments as
guesses on which way the forecasts might be wrong. They may instead
reflect broader risk judgements, incorporating the high-impact but lowprobability events that are very difficult to forecast but very important
when they occur. (By analogy, a driver who gets home safely did
not necessarily make a mistake buying car insurance.) Whatever the
direction of inflation forecast errors in recent years, there were ample
reasons for the MPC to exercise heightened vigilance.
This analysis suggests three conclusions. First, large exogenous shocks
are an occupational hazard, and when they compromise the accuracy
of forecasts, the best response is simply to acknowledge the problem
and remind users that forecasts must be treated with caution. Second,
switching from the Core Model to the Quarterly Projection Model (QPM)
should mitigate errors caused by the exchange rate. This is because the
QPM uses a less naïve and better theoretically grounded method for its
exchange rate assumptions.3 Finally, the risk assessments were mostly
poor predictors of forecast errors, but this is perhaps not the right way
to judge them.
2 It is not possible to assess the one-year-ahead validity of the 2017
assessments because 2018 inflation is still unknown. This section uses the
assessments for the 2014–2016 MPC meetings, matched to the one-yearahead inflation forecasts presented at each meeting.
3 The exchange rate converges on an estimated equilibrium over time and
responds to forecast interest rate differentials instead of just depreciating in
line with inflation differentials.
Percentage change
2016 headline CPI forecast

Actual outcome

Evolution of SARB forecast

6.4


Sources: Stats SA and SARB
Percentage change
2017 headline CPI forecast

Actual outcome

Evolution of SARB forecast

5.3


Sources: Stats SA and SARB
Percentage change
2015*
2016*
May 2013
Nov 2013
May 2014
Nov 2014
May 2015
Nov 0215
May 2014
Nov 2014
May 2015
Nov 2015
May 2016
Nov 2016
May 2015
Nov 2015
May 2016
Nov 2016
May 2017
Nov 2017
2017*
NEER forecasts and outcomes

Evolution of NEER forecast
Actual NEER change
* Forecasted period
9.7
Depreciation
-10.4
-5.5
Source: SARB
Date of MPC meeting


Appreciation
Monetary Policy Review April 2018

Conclusion: monetary policy
under heightened uncertainty
Appeals to uncertainty have become a cliché of central bank
communications. Still, there has been ample justification
for using the word to describe the monetary policy outlook
over the past six months. The period since the last MPR has
included credit downgrades (with Standard & Poor’s cutting
the sovereign’s rating to sub-investment grade) and significant
exchange rate depreciation. It has also featured a dramatic
political transition, a strong decline in sovereign risk measures
and longer-term borrowing costs, and a rally in the rand –
which has appreciated more rapidly than at any point since the
rebound from the global financial crisis.
In these circumstances, monetary policy has taken a cautious
approach. The inflation and growth forecasts have improved
steadily since the November MPC meeting, but they have not
yet reached optimal levels. Projected inflation remains above
the target midpoint across the medium term, although it now
settles closer to 5% than 6%. Growth rates are muted across
the forecast horizon, well below South Africa’s longer-run
3% growth trend. Potential growth is similarly subdued, at
1.3% over both 2018 and 2019, and 1.4% in 2020, reflecting
weak productivity and investment. Some strengthening of
demand means that the output gap keeps narrowing, but it
only closes in 2020.
In sum, although the economy is recovering from the doldrums
of 2016 and 2017, it is still some way from good health.
Monetary policy is contributing to better outcomes in two
ways. The first priority, in line with the SARB’s mandate, is
to ensure that inflation remains well controlled. To this end,
monetary policymakers have taken the strategic decision to
anchor inflation expectations closer to the 4.5% midpoint of
the 3–6% target range, and not to treat the upper bound of
that range as the de facto target. In recent times, policymakers
have assessed growth to have been short of potential, and
have opted to improve welfare by keeping real interest rates
somewhat below longer-run normal levels. The precise repo
rate consistent with these goals shifts with changes in incoming
data and revisions to the forecasts on a meeting-to-meeting
basis. Whatever fine-tuning occurs, however, South Africans
can look forward to both a narrower output gap and inflation
within the target range in the coming years.
Percentage change over 12 months
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Targeted inflation*
* CPIX for metropolitan and other urban areas up to December 2008.
Headline inflation for all urban areas from January 2009 onwards.
Sources: Stats SA and SARB

Inflation target range

Targeted inflation

Target range midpoint

Percentage change over four quarters

Real GDP growth
Sources: Stats SA and SARB

Real GDP growth

Average GDP growth
-4
-2

Monetary Policy Review April 2018
Statement of the Monetary Policy Committee
23 November 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy
Committee (MPC), the upside risks to the inflation outlook
have increased, mainly due to higher international oil prices
and a weaker rand exchange rate. Despite a deterioration in
the forecast, inflation is expected to remain within the target
range for the rest of the forecast period. Domestic event
risks, including rating agency reviews and the economic
policy implications of the African National Congress (ANC)
electoral conference, are likely to dominate rand movements
over the coming weeks.
The domestic growth outlook remains weak, continuing its
deviation from the generally more favourable global pattern.
Stronger world growth has contributed to a further increase
in international oil prices, which could, in turn, provide
a boost to global inflation. This may increase the pace of
monetary policy tightening in the advanced economies, with
possible implications for capital flows to emerging markets.
The year-on-year inflation rate, as measured by the
consumer price index (CPI) for all urban areas, came to
4.8% in October, down from 5.1% previously, marginally
below the short-term forecast of the South African Reserve
Bank (SARB). Food and non-alcoholic beverage inflation
continued to moderate, measuring 5.3% in October, down
from 5.5% in September, but meat price inflation remained
elevated at 15.5%. The SARB’s measure of core inflation –
which excludes food, fuel and electricity – registered 4.5%
in October compared with 4.6% previously.
Year-on-year producer price inflation for final manufactured
goods increased in August and September, to 4.2% and
5.2% respectively, having recorded a low of 3.6% in July.
The higher trend was driven to a large extent by higher
international oil prices and a weaker exchange rate. Food
products price inflation moderated further, to 1.3% in
September, but manufactured meat price inflation remained
elevated at 16.5%. At the agricultural level, prices of live
animals increased by 26.7%, suggesting that it may take
some time for meat price inflation to normalise.
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) shows a deterioration since
September. The average forecast for 2017 is unchanged at
5.3% but has been revised upwards for 2018 and 2019 to
5.2% and 5.5% respectively from 5.1% and 5.4% previously.
The lower turning point, which is expected in the first quarter
of 2018, has increased from 4.5% to 4.7%.
The main upside drivers of these changes are a weaker
exchange rate path (in 2018 in particular), a higher
international oil price, and higher average wage growth.
These pressures are offset to some extent by a more
favourable food price forecast (in 2018 in particular).
Following a number of downside surprises, food price
inflation is now expected to reach a low turning point
of 3.8% in the first quarter of 2018, compared with 4.7%
previously. Average increases of 4.5% and 5.9% are now
expected in 2018 and 2019 respectively, compared with
previous forecasts of 5.3% and 5.9%. Furthermore, the
endogenously determined path of the repurchase (repo)
rate in the QPM also provides an offsetting effect. This path
implies three interest rate increases of 25 basis points each
by the end of 2019, compared with one increase previously.
As we elaborate later, this does not imply an unconditional
commitment to this policy path.
The forecast for core inflation, which is unchanged at 4.8%
for 2017, has been adjusted upwards by 0.2 percentage
points in both 2018 and 2019 to 5.1% and 5.3% respectively.
A low turning point of 4.6% is expected in the final two
quarters of 2017.
The expectations of market analysts, as reflected in the
Reuters Econometer survey, are similar to the SARB’s
forecasts, with a slight deterioration since September. The
survey conducted in November shows median forecasts of
5.2% for 2018 and 5.5% for 2019. The inflation expectations
implicit in the inflation-linked bond yields have increased,
with the five-year break-even inflation rates now close to the
upper end of the target range.
The global growth outlook remains positive despite some
geopolitical risks. Confidence indices in a number of
countries have reached their highest levels since the global
financial crisis. Nevertheless, the expectation is that world
growth will remain below the levels seen before the crisis.
The recovery in the advanced economies appears to be
most sustained in the euro area, the United States (US) and
Japan, but the outlook for the United Kingdom (UK) remains
constrained by the continued uncertainty surrounding the
Brexit process. The extent to which this positive prognosis
for some advanced economies is predicated on continued
monetary accommodation is still unclear.
The outlook for emerging markets remains mixed but
generally favourable, with prospects for oil producers
boosted by higher oil prices. There are, however, some
concerns
about
possible
headwinds
from
slowing
momentum in the Chinese economy.
Inflation pressures are mostly benign in the advanced
economies although there are some incipient near-term
risks from higher international oil prices. Low wage growth is
seen as a brake on core inflation pressures, despite relatively
tight labour market conditions. The US Federal Reserve
Monetary Policy Review April 2018

(Fed) is expected to maintain a gradual pace of monetary
policy tightening, with a further policy rate increase widely
expected in December. The European Central Bank (ECB)
has signalled a reduction in the pace of net asset purchases
from next year but expects interest rates to remain low
for an extended period of time. The Bank of Japan has
also maintained a highly accommodative policy stance.
By contrast, the Bank of England raised its Bank rate in
November in response to inflation pressures driven by the
depreciation of the pound.
The outlook for continued capital flows to the emerging
markets therefore remains relatively favourable despite the
slowdown in bond flows in the past few weeks. However,
the risk of a faster pace of monetary tightening in the US in
particular, in the event of upside inflation or growth surprises,
could reduce capital flows further.
Since the previous meeting of the MPC, the rand has
depreciated by 3.6% against the US dollar, by 3.0% against
the euro, and by 3.3% on a trade-weighted basis. The rand
recorded a weak point of around R14.55 against the US
dollar in mid-November but has recovered somewhat since
then. Factors that impacted on the rand during this period
included the ongoing uncertainty with regard to the outcome
of the ANC electoral conference in December, concerns
about a faster-than-expected pace of monetary tightening in
the US, the negative reaction to the Medium Term Budget
Policy Statement (MTBPS), and speculation regarding the
introduction of free higher education in South Africa.
The last-mentioned two factors have raised the risk of
sovereign ratings downgrades – a risk that has been
hanging over the rand for some time. Downgrades of
domestic-currency debt to sub-investment grade could
lead to South African government bonds falling out of key
indices which require investment grade. Such an event
could trigger significant sales of domestic bonds by nonresidents. Ratings reviews are expected imminently, but
the extent to which any possible downgrades may already
be priced in remains uncertain. The lead-up to the ANC
national elective conference and its uncertain outcome are
also likely to continue weighing on the currency.
Aside from these negative factors, the rand has been
given some support by the continued surpluses on the
trade account of the balance of payments. The SARB’s
forecasts for the current account deficit as a percentage
of gross domestic product (GDP) have been revised down
by about half a percentage point in all three years of the
forecast period: to 2.2% in 2017, 2.9% in 2018, and 3.2% in
2019. Furthermore, the generally positive sentiment towards
emerging markets remains supportive of the rand.
The domestic economic growth outlook remains subdued
but positive. Both consumer and business confidence
remains low and is also likely to be affected by political
developments in December. The forecast for GDP growth
generated by the QPM has been revised up marginally, to
0.7% for 2017, but revised down to 1.2% and 1.5% for 2018
and 2019 respectively from 1.3% and 1.7% previously. The
output gap is expected to remain negative over the forecast
period. The SARB’s composite leading business cycle
indicator increased further in September, consistent with a
mild recovery.
High-frequency data suggest that the main production
sectors have again contributed positively to economic
growth in the third quarter. However, both the mining and
the manufacturing sectors experienced sharp month-onmonth contractions in September. The Absa Purchasing
Managers’ Index (PMI) has increased for three consecutive
months but, at 47.8 index points, remains in contractionary
territory. The construction sector, which recorded negative
growth in the second quarter, remains weak. Of particular
concern is the sharp decline in the First National Bank (FNB)/
Bureau for Economic Research (BER) civil construction
index to 15 index points in the third quarter, its lowest level
since 2000. This is indicative of the poor outlook for
infrastructure expenditure.
Employment prospects remain unfavourable. According
to the Quarterly Labour Force Survey (QLFS) conducted
by Statistics South Africa, year-on-year growth of total
employment measured 2.3% in the third quarter of 2017.
Despite this increase, the official unemployment rate was
unchanged at 27.7% for the third successive quarter. Fiscal
constraints point to further job losses in the public sector.
The outlook for consumption expenditure by households
has improved moderately, following stronger retail trade
sales in the second and third quarters. Retail trade sales
recorded growth of 1.4% in the third quarter despite monthon-month contractions in July and September. New motor
vehicle sales also held up relatively well during the quarter.
By contrast, wholesale trade sales contracted. The ‘Black
Friday’ effect is likely to boost sales in the fourth quarter.
Consumption expenditure is nevertheless expected to
remain relatively subdued over the forecast period.
Favourable drivers of real consumption expenditure include
positive real income and wage growth as well as some
positive wealth effects from higher equity prices. Although
growth in credit extension to households remains negative
in real terms, it has increased in recent months. Constraining
factors include higher tax burdens, low employment growth,
and weak consumer confidence.
Wage growth continues to contribute to the persistence of
inflation at higher levels. Although the year-on-year pace of
increase in nominal remuneration per worker in the formal
non-agricultural sector of the economy declined in the
second quarter of this year, at 6.1% it was still positive in real
terms. Adjusting for labour productivity, growth in nominal
unit labour costs measured 6.0% in the second quarter. Unit
labour cost increases are forecast to remain above the 6.0%
level over the forecast period. According to Andrew Levy
Employment Publications, the average wage settlement rate
in collective bargaining agreements amounted to 7.6% in the
first nine months of 2017.

Monetary Policy Review April 2018
The MTBPS published in October revealed a rapidly
deteriorating fiscal position. Significant revisions were made
to the expected deficits and government debt-to-GDP ratio
over the medium term. This deterioration was mainly the
result of significantly lower tax revenues, although there was
also a provision for a moderate breach of the expenditure
ceiling. The less favourable path of fiscal consolidation
could potentially reduce the scope for further monetary
policy accommodation.
International oil prices have re-emerged as an upside risk
to both domestic and global inflation. Having reached
recent lows of around US$45 per barrel in June, the price
of Brent crude oil has fluctuated in the US$60–65 per barrel
range since late October. This is in response to increased
demand and the reportedly high compliance with the output
restriction agreement brokered by the Organization of the
Petroleum Exporting Countries (OPEC). While we still expect
the flexibility of the shale oil producers in the US to limit
the further upside potential of oil prices, these prices are
expected to remain at elevated levels for some time. The oil
price assumptions in the SARB’s models have accordingly
been increased moderately for both 2018 and 2019. The
combination of a weaker exchange rate and higher product
prices has resulted in a cumulative increase in domestic
petrol prices by R1.00 per litre since September. The current
under-recovery suggests that a further increase in the region
of 70 cents per litre is likely in December.
The latest inflation outcomes show that headline inflation
remains close to the midpoint of the target range while core
inflation has reached its lowest level in five years. However,
the forecasts suggest that both measures are close to their
lower turning points and an upward trajectory is expected
to begin early next year. Although inflation is expected to
remain within the target range over the forecast period,
the risks to the outlook are assessed to be on the upside
at a time when imminent key event risks contribute to an
environment of particularly elevated uncertainty.
These event risks affect monetary policy primarily through
the exchange rate channel. Since the previous meeting
of the MPC, the deterioration in the fiscal stance has
increased the risk of a sovereign ratings downgrade of
domestic-currency bonds to sub-investment grade. As
noted, this could precipitate a significant sell-off of domestic
government bonds by non-residents, with implications for
the exchange rate and long-term bond yields. Should this
occur, there is the possibility of a short-term overreaction
followed by a partial recovery later on. The precise path and
duration is highly uncertain.
International oil prices have become an increasing concern.
While we have adjusted our assumptions in this regard
upwards, a persistence of oil prices at current or higher levels
poses an upside risk to the forecast. As before, a sizeable
electricity tariff increase also remains a risk. We should have
more clarity on Eskom’s tariff increase application by the
time of the next MPC meeting.
There are very few signs of domestic demand pressures, as
reflected in the core inflation outcomes. Although retail sales
have surprised on the upside, household consumption
expenditure is expected to remain relatively subdued. The
economic growth outlook remains constrained as weak
confidence continues to weigh on investment expenditure.
Consumer and business confidence is likely to be sensitive
to the political outcomes in December. The MPC assesses
the risks to the growth outlook to be on the downside.
In light of the high degree of uncertainty prevailing in the
economy and the balance of risks, the MPC has decided
that it would be prudent to maintain the current stance of
monetary policy at this stage. Accordingly, the repo rate
remains unchanged at 6.75% per annum.
The QPM generates an endogenous interest rate path that
implies an increase in the repo rate of 75 basis points by
the end of 2019. We need to stress that this does not mean
an unconditional commitment to change policy rates in line
with this path. The forecasts and the implied path are merely
a broad guide to policy and not necessarily prescriptive.
Depending on economic conditions, the MPC may choose
to diverge from the suggested path and alternative paths
could be generated that are still consistent with achieving
the inflation target range. Collective judgement remains
critical. As always, MPC members need to weigh the risks
to the forecasts and assess the trade-offs. It is also the case
that the implied path can change from meeting to meeting
as the data and risks change.

The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
Uncertainty bands are always symmetric and do not reflect any
assessment of upside or downside risks.
Source: SARB
Per cent
Repo rate and forecast

90%
60%
30%
Repo rate
Monetary Policy Review April 2018

Summary of assumptions: Monetary Policy Committee
meeting on 23 November 2017*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

2. Output gap in South Africa’s major trading-partner countries


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 56 and 57.

Monetary Policy Review April 2018
Selected forecast results (annual)
Actual
Forecast


Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of our three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights, except for the US dollar which is weighted by the sum of US and Chinese trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa
and the trade-weighted CPI of the euro area, the US and Japan).
3.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
4.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
5.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results (quarterly)
Year-on-year percentage change


1. Headline inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4


2. Core inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4

Notes
1.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
2.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Summary of selected forecast results: Monetary Policy Committee meeting
on 23 November 2017
Monetary Policy Review April 2018

Statement of the Monetary Policy Committee
18 January 2018
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
In recent weeks, some of the risks to the inflation outlook
have dissipated somewhat. The rand appreciated following
the African National Congress (ANC) elective conference.
Also, Eskom was granted a lower-than-expected tariff
increase. While S&P Global Ratings downgraded South
Africa’s long-term local-currency sovereign credit rating to
sub-investment grade, Moody’s Investors Service (Moody’s)
placed the country ratings on review for a downgrade.
A further downgrade therefore remains a risk and will depend
on government’s response to the deteriorating fiscal position
and commitment to credible growth-enhancing policies.
Against this more positive backdrop, the inflation forecast
has improved despite continued increases in international
oil prices. Near-term inflation is expected to remain close to
the midpoint of the target range. At the same time, domestic
growth outcomes have surprised on the upside, in large
part due to the recovery in the agricultural sector. While
there have been moderate upward revisions to the growth
forecast, the outlook remains challenging.
The year-on-year inflation rate, as measured by the consumer
price index (CPI) for all urban areas, came to 4.6% in
November, down from 4.8% in the previous month. Lower
food and fuel price inflation contributed to this decline. Goods
price inflation moderated to 3.7% from 4.1% previously, while
services price inflation was unchanged at 5.5%. The South
African Reserve Bank’s (SARB) measure of core inflation –
which excludes food, fuel and electricity – amounted to 4.4%
in November compared with 4.5% previously.
Year-on-year producer price inflation for final manufactured
goods measured 5.1% in November, up from 5.0% in
October. Food products price inflation moderated further
to 0.9% due to strong base effects from lower agricultural
prices. Meat price inflation, however, remains elevated, as
the adverse effects of the recent drought continue to be felt.
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) shows some improvement since
November. The average forecast for 2017 is unchanged at
5.3% but has been revised downwards for 2018 and 2019 to
4.9% and 5.4% respectively from 5.2% and 5.5% previously.
Inflation is expected to average 5.5% in the final quarter of
2019. The lower turning point of the forecast is still expected
in the first quarter of 2018 but has been revised down from
4.7% to 4.4%.
The main drivers of the more favourable forecast were
the stronger exchange rate of the rand and a lower
electricity price assumption following the 5.23% electricity
tariff increase granted to Eskom by the National Energy
Regulator of South Africa (NERSA). This adjustment takes
effect from July, when a 6.0% increase is assumed in the
CPI compared with 8.0% previously. The assumption from
mid-2019 remains unchanged at 8.0%. These effects are
countered to some extent by upward adjustments to the
international oil price assumptions as well as by the impact
of the sugar tax on food prices. This tax is expected to
increase food price inflation and headline inflation by
0.6 and 0.1 percentage points respectively in the year
following its expected implementation in April. Food price
inflation is now expected to average 5.2% and 6.0% in 2018
and 2019 respectively, up from 4.5% and 5.9% previously.
The core inflation forecast remains unchanged at 4.8%
for 2017 but has been adjusted downwards to 4.6% and
5.1% in 2018 and 2019 respectively from 5.1% and 5.3%
previously. Whereas previously a lower turning point of
4.6% was expected in the final two quarters of 2017, a low of
4.4% is now expected in the first quarter of 2018.
The improved forecast for core inflation is driven mainly by
the stronger exchange rate, which is expected to impact
favourably on core goods inflation. Higher wage pressures,
by contrast, are expected to keep core services inflation
more or less unchanged. The closing output gap also
reduces the degree of downside pressure on inflation.
Average inflation expectations for 2018, as reflected in the
survey conducted by the Bureau for Economic Research
(BER) in the fourth quarter of 2017, declined marginally from
5.8% to 5.7% but remain close to the upper end of the target
range. Average expectations for 2019 were unchanged at
5.9%, as were the average five-year inflation expectations
at 5.6%. These moderate moves mask larger adjustments
compared with the third-quarter survey, with business
people revising their expectations higher over the two years,
offsetting the downward adjustment by trade union officials.
The expectations of market analysts, reflected in the Reuters
Econometer survey conducted in January, also show a
slight improvement since November. The median forecasts
for 2018 and 2019 have declined by 0.1 percentage points
to 5.1% and 5.4% respectively while the forecast for 2020
is 5.5%. Inflation expectations implicit in the inflation-linked
bond yields have declined, with the five-year break-even
inflation rates declining to 5.4%.
The global growth outlook remains positive and relatively
synchronised, although uneven across regions. However,
some moderation in growth is generally expected in 2019.
Growth in the United States (US) is expected to be given a
boost by the proposed tax reforms, but the extent of this
is still unclear. The euro area recovery also appears to be
sustained, with a persistent decline in the unemployment

Monetary Policy Review April 2018
rate amid a broad-based firming of fixed capital formation.
The recent positive momentum in Japanese growth is also
expected to continue.
These favourable conditions are expected to have a positive
spillover effect on emerging markets in general, with upward
growth revisions in most regions, although less so for Latin
America and Africa. Commodity exporters are also expected
to benefit from the recovery in commodity prices. Consensus
forecasts suggest that growth in China will be sustained at
current levels despite continued financial stability risks.
By contrast, global inflation trends remain subdued, although
there are indications of emerging upside pressures, driven
in part by higher energy prices. Core inflation pressures
are also becoming evident in the US in particular, and
are expected to intensify gradually should strong growth
and labour market tightness persist. Monetary policies in
the advanced economies, particularly in the US and the
United Kingdom (UK), are expected to maintain a moderate
tightening bias, while the pace of withdrawal of monetary
accommodation in the euro area and Japan is expected
to be slow. These trends should help in sustaining capital
flows to emerging markets.
The rand exchange rate responded strongly to the outcome
of the ANC elective conference, and since then has traded
in a range of between R12.25 and R12.50 against the US
dollar. This is in sharp contrast to the low of R14.47 a month
earlier. Since the previous meeting of the Monetary Policy
Committee (MPC), the rand has appreciated by 13.1%
against the US dollar, by 9.6% against the euro, and by
10.6% on a trade-weighted basis.
In the near term, the rand is expected to remain sensitive
to sentiment generated by political developments. The
favourable outlook for capital flows to emerging markets as
well as the positive trade account balances are expected to
be supportive of the local currency. The latter is a reflection
of the favourable terms of trade and import compression
from lower growth. However, the lingering prospect of
a credit ratings downgrade to sub-investment grade by
Moody’s continues to weigh on the longer-term outlook for
the rand. Such an event would trigger the exclusion of South
African government bonds from the World Government
Bond Index and would likely precipitate significant capital
outflows. The extent of the impact on the exchange rate
remains uncertain.
Domestic growth prospects appear to be showing some
signs of improvement, although off a low base. This follows
encouraging growth rates in the second and third quarters
of this year, driven to a significant degree by the exceptionally
strong recovery in the agricultural sector. The SARB has
consequently revised its forecast for gross domestic
product (GDP) growth up from 0.7% to 0.9% for 2017, while
the forecasts for 2018 and 2019 have been adjusted to 1.4%
and 1.6% respectively, up from 1.2% and 1.5% previously.
This more favourable outlook is consistent with the further
increase in the SARB’s composite leading business cycle
indicator of economic activity in October. The outlook is also
likely to be impacted positively should the recent political
developments lead to a sustained boost in business and
consumer confidence.
High-frequency data suggest that fourth-quarter growth
is likely to be slower than in the previous quarter, but
still positive. On a month-to-month basis, mining output
increased in October but decreased in November, while
manufacturing output increased in both these months.
However, the decline in the Absa Purchasing Managers’
Index (PMI) to 44.9 index points in December is indicative
of the continued challenges faced by the sector. More
positively, the sub-index measuring expected business
conditions in six months’ time improved markedly.
Despite the continued weakness in the Rand Merchant Bank
(RMB) / BER business confidence index, growth in real gross
fixed capital formation improved in the third quarter following
a contraction in the previous quarter. All three sectors
recorded growth rates in excess of 4%. The recovery was
most pronounced in the private sector. The durability of this
improvement will be highly dependent on the extent to which
the recent political developments impact on confidence and
lead to greater policy certainty and credibility. This process
could take some time. At this stage, the forecast is for minimal
growth in gross fixed capital formation this year, followed by a
slight improvement in 2019.
A prolonged recovery in fixed capital formation is needed to
make inroads into the official unemployment rate of 27.7%.
The Quarterly Employment Statistics survey of Statistics
South Africa shows that, during the third quarter of 2017,
formal non-agricultural employment in both the public and
the private sectors declined further. Adjusted for electionrelated employment by the Electoral Commission of South
Africa (IEC), private-sector employment creation more or
less offset public-sector job losses in the four quarters to
the third quarter of 2017.
Growth in real final consumption expenditure by
households decelerated to an annualised rate of 2.6% in
the third quarter but was characterised by a sharp increase
of 19.9% in expenditure on durable goods, mainly motor
vehicles. Some moderation in consumption expenditure
growth is expected in the fourth quarter following weaker
motor vehicle sales. However, the strong ‘Black Friday’
effect evident in the November retail trade sales may
moderate the extent of this slowdown.
Despite being relatively constrained, the outlook for household
consumption expenditure has improved, with annual average
real growth rates of around 1.3% expected over the forecast
period. This category is expected to be the main driver of GDP
growth in the short to medium term. Although consumers
are likely to be adversely affected by possible further tax
increases, expenditure is expected to be underpinned by
lower inflation and positive real wage increases.
Monetary Policy Review April 2018

Growth in banks’ credit extension to households remains
weak but has trended slightly higher in recent months. Much
of this increase reflects growth in instalment sale financing,
consistent with improved motor vehicle sales. Growth in
credit extension to the corporate sector, while more robust,
has been on a downward trend for some time.
Wage pressures are expected to continue contributing to
inflation persistence. Growth over four quarters in nominal
remuneration per worker in the formal non-agricultural
sector increased from 6.3% in the second quarter of 2017
to 6.8% in the third quarter. However, adjusting for labour
productivity, growth in nominal unit labour costs declined
from 6.1% to 5.5%. Average nominal remuneration increases
are expected to remain above 6% over the forecast period.
International oil prices have continued their upward trend to
current levels of around US$70 per barrel for Brent crude oil.
These increases have been caused by supply restrictions
by some producers as well as increased global demand.
At this stage, it is unclear if these prices will settle at these
elevated levels or if the trend will be reversed by increased
US shale output in response to higher prices. The oil price
assumptions in the QPM have been adjusted upwards to
average US$62 per barrel in both 2018 and 2019. Domestic
petrol prices increased by 71 cents per litre in December
but were reduced by 34 cents per litre (for 95 octane) in
January as a result of the stronger exchange rate. The
current over-recovery on the petrol price points to a further
price reduction in February, should current trends persist.
The MPC has taken note of the improved inflation outlook
over the near term in particular. Inflation is expected to reach
a low point below the midpoint of the target range, but is
then expected to resume an upward trajectory and measure
5.5% in the final quarter of next year. This remains above the
midpoint of the target range. The risks to the forecast are
still assessed to be on the upside, although the degree of
the upside risk has subsided.
Two main risks featured prominently in the MPC
discussions. First was the prospect of a sovereign credit
ratings downgrade, which would result in three major
agencies rating South Africa’s local-currency debt as subinvestment grade. The impact on the rand and on longbond yields could be significant, but the extent to which a
universal downgrade is already priced in remains unclear.
Furthermore, the assumption in the forecast for the starting
point of the rand (at R12.90 against the US dollar) is weaker
than current levels.
The response of government to the intensifying fiscal
challenges in the upcoming budget will be key to avoiding
this event risk. In addition, the pressures are now even
more intense, with several state-owned enterprises facing
financial risks. The challenge for government will be to find
ways to finance the deficit in a growth-positive manner
and at the same time to convey a credible commitment to
structural reforms that can raise the potential growth of the
economy. This would also support business and consumer
confidence.
The second risk relates to international oil price
developments. Although the assumptions have been raised
over the forecast period, the MPC still assesses the risks
to be moderately on the upside, and a further upward
adjustment may be required in the future.
Demand pressures are benign, with core inflation pressures
relatively
contained.
While
household
consumption
expenditure is expected to be supported by positive wage
growth, it remains constrained. The economic growth
outlook is also more positive, but fragile. At this stage, the
MPC assesses the risks to the growth forecast to be more
or less balanced.
The endogenous interest rate path generated by the QPM
has changed slightly since the previous MPC meeting.
Whereas three increases of 25 basis points each by the end
of 2019 were indicated previously, the third increase is now
a marginal call. Furthermore, the timing of the first increase
has been pushed out to later in the period. The implied
path remains a broad policy guide and could change in
either direction by the next meeting in response to new
developments and changing risks.
In light of the recent developments and the balance of
risks, the MPC has decided that it would be appropriate to
maintain the current monetary policy stance at this stage.
Accordingly, the repurchase rate remains unchanged at
6.75% per annum. Five members preferred an unchanged
stance, while one member preferred a 25 basis point
reduction.


The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
Uncertainty bands are always symmetric and do not reflect any
assessment of upside or downside risks.
Source: SARB
Per cent
Repo rate and forecast

90%
60%
30%
Repo rate

Monetary Policy Review April 2018
Summary of assumptions: Monetary Policy Committee
meeting on 18 January 2018*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s major

2. Output gap in South Africa’s major trading-partner countries


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 56 and 57.
Monetary Policy Review April 2018

Selected forecast results (annual)
Actual
Forecast


(-2.2%)
(-2.9%)
(-3.2%)
Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of our three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights, except for the US dollar which is weighted by the sum of US and Chinese trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa
and the trade-weighted CPI of the euro area, the US and Japan).
3.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
4.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
5.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Summary of selected forecast results: Monetary Policy Committee meeting
on 18 January 2018
Selected forecast results (quarterly)
Year-on-year percentage change


1. Headline inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4


2. Core inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4

Notes
1. Shaded areas indicate the forecasts of the Monetary Policy Committee.
2. The figures in brackets represent the previous forecasts of the Monetary Policy Committee.

Monetary Policy Review April 2018
Statement of the Monetary Policy Committee
28 March 2018
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 risks to the inflation outlook have
subsided somewhat. Inflation outcomes in recent months
have remained well within the inflation target band, although
this likely represents the low point of the current cycle. While
the increase in the value-added tax (VAT) rate to 15% places
temporary upside pressure on inflation, this is mitigated by
the stronger exchange rate which has contributed to the
changing inflation risk profile. The affirmation of South Africa’s
sovereign rating as ‘investment grade’ and the change of
the outlook from negative to stable by Moody’s Investors
Service has contributed to the recent rand resilience.
The domestic growth outlook is more positive but still
challenging. Growth in the fourth quarter surprised
significantly on the upside, and there are signs of increased
business confidence. This is against a backdrop of
sustained momentum in the global economy which provides
a favourable environment for emerging markets generally.
The year-on-year inflation rate, as measured by the
consumer price index (CPI) for all urban areas, measured
4.4% in January 2018 before declining to 4.0% in February.
Goods price inflation moderated from 3.7% to 3.2% while
services price inflation moderated to a seven-year low of
4.9%. The South African Reserve Bank’s (SARB) measure
of core inflation – which excludes food, fuel and electricity
– remained unchanged at 4.1% in February. Year-on-year
producer price inflation for final manufactured goods
declined marginally to 5.1% in January.
The inflation forecast of the SARB has shown a moderate
improvement despite the adverse impact of the VAT increase
due to be implemented in April. This increase, combined
with base effects and other indirect tax increases, implies
that the low point of the inflation cycle was reached in the
first quarter of 2018, at a forecast average of 4.1%. Headline
inflation is expected to average 4.9% in 2018 (unchanged
from the previous forecast), 5.2% in 2019 (down from 5.4%),
and 5.1% in 2020. A peak of 5.5% is expected by the first
quarter of 2019 before the VAT increase falls out of the data.
The forecast for core inflation is unchanged at 4.6% for 2018
and is 0.2 percentage points lower, at 4.9%, for 2019. It is
expected to remain unchanged at 4.9% in 2020.
The main changes in the forecast related to the VAT increase
and the exchange rate. The VAT increase is expected to
add about 0.6 percentage points to the headline inflation
trajectory for the four quarters from the second quarter of
2018, with marginal second-round effects persisting into
subsequent quarters. The improved exchange rate has
softened the impact of the indirect tax adjustments on the
inflation forecast. The implied starting point for the rand is
R11.97 against the US dollar compared with R12.90 at the
time of the previous MPC meeting.
Inflation expectations, as reflected in the survey conducted
by the Bureau for Economic Research (BER) in the first
quarter of 2018, are at a multi-year low, having declined
across all groups of respondents. Average expectations for
2018 and 2019 have declined to 5.2% and 5.3% respectively
from 5.7% and 5.9% previously, while an average of 5.4%
is expected in 2020. The largest adjustment was seen in
the business category, with downward revisions of around
1 percentage point in both 2018 and 2019. Five-year inflation
expectations declined to 5.3%, their lowest level since they
were first surveyed in 2011. Expectations implicit in the
break-even inflation rates (i.e. the yield differential between
conventional and inflation-linked government bonds)
declined across all maturities. While these developments are
welcome, the MPC would prefer to see inflation expectations
anchored closer to the midpoint of the target band.
The global economic outlook has remained favourable
amid a relatively synchronised upswing in the advanced
economies, although risk and vulnerabilities remain. The
global inflation outlook remains benign but is on a moderate
upward path. However, the recent trade policy actions by
the United States (US) could escalate into a trade war, which
could in turn undermine this positive prognosis for growth
and push inflation higher.
The rand has sustained its recent gains since late last year, and
some of the key risks to the outlook have dissipated. Since the
previous meeting of the MPC, the rand has appreciated by
4.8% against the US dollar, by 3.2% against the euro, and by
3.5% on a trade-weighted basis. At current levels, the SARB’s
model assesses the rand to be somewhat overvalued, and
further strengthening potential is probably limited.
The rand has reacted positively to domestic political
developments in the past months and was given further
support following the recent sovereign credit rating
announcement. The risk of a significant sell-off of South
African government bonds by non-residents has therefore
receded for now. Further support for the rand comes from
recent dollar weakness. Some widening of the current
account deficit is expected over the forecast period as
imports increase in line with higher expected investment
expenditure and the impact of a stronger rand.
Monetary Policy Review April 2018

A key external risk to the rand remains the possibility of a
tighter-than-expected stance of monetary policy in the US
in particular. As anticipated, a moderately faster pace of
tightening was signalled by the US Federal Open Market
Committee, particularly for 2019, and at this stage, further
tightening is expected to remain measured in the absence
of significant inflation or growth surprises. Significantly
higher US fiscal deficits could also elicit a stronger monetary
policy response. The pace of monetary policy normalisation
in some of the other advanced economies continues to be
gradual with a tightening bias.
The domestic economic growth outlook for this year is
more favourable but remains challenging. This follows an
upward revision of historical gross domestic product (GDP)
data and a fourth-quarter outcome of 3.1% which surprised
on the upside. Following an annual growth rate of 1.3% in
2017, the SARB expects a growth rate of 1.7% for 2018
compared with 1.4% previously. The forecast for 2019 is
1.5%, marginally lower than the previous forecast of 1.6%,
while a growth rate of 2.0% is forecast for 2020. At these
growth rates, the negative output gap, which measured
-1.1% in 2017, is expected to close in 2020. The composite
leading business cycle indicator continued its upward trend
in January, consistent with the improved outlook.
The improved growth outlook is driven primarily by an
increase in business and consumer confidence. This is
reflected in the Rand Merchant Bank (RMB) / BER Business
Confidence Index, which increased markedly in the first
quarter of 2018 although it remains below the neutral 50
level. Furthermore, the ‘expected business conditions’
category in the Absa Purchasing Managers’ Index surged
in February to its highest level since 2001. In this context,
growth in gross fixed capital formation is forecast to increase
gradually over the forecast period.
Consumption expenditure by households is also expected
to be positively impacted by the expected increase in
consumer confidence, although this is not yet evident
in the consumer confidence surveys. In the near term,
consumption expenditure is expected to be constrained
by the tax increases, the lack of compensation for fiscal
drag, weak employment growth as well as subdued growth
in credit extension to households. While consumption
expenditure is expected to grow at a slightly slower rate in
2018 compared with last year, the trend over the forecast
period is moderately stronger than previously expected,
reaching 2.1% in 2020. This improvement is also supported
by higher expected wealth growth over the longer term.
Employment trends remain a concern despite an increase
of 102 000 during the past year. The official unemployment
rate was slightly higher when compared to the same quarter
in 2016 while the number of discouraged job seekers
increased markedly.

The national Budget presented in February 2018 proposed
a faster pace of fiscal consolidation than that indicated in
the October Medium Term Budget Policy Statement. This
revised path is expected to result in a stabilisation of the ratio
of government debt to GDP at about 56% over the medium
term. The moderately tighter stance is due to an overall cut
in budgeted expenditure growth as well as an increase in
tax revenues. However, the projected deficits are wider
than those proposed in the February 2017 Budget. The
outcome of the ongoing public sector wage negotiations will
be an important indicator of the sustainability of the fiscal
projections and future wage trends.
Nominal wage growth appears to be moderating slightly,
but the upside pressure on inflation from this source is
expected to persist. Average wage inflation is expected to
decline moderately over the forecast period, from 7.6% in
2017 to 6.8% in 2020, still positive in real terms.
Annual food price inflation is no longer seen as a major
risk to the inflation outlook. While the continued drought in
the Western Cape is likely to adversely affect agricultural
production in the region, the direct impact on food prices is
expected to be fairly limited.
The MPC noted the general improvement in inflation
outcomes and the lower inflation expectations. Although
the bottom of the inflation cycle has likely been reached, the
trajectory of headline inflation is forecast to remain within
the target range, with core inflation expected to remain
below 5% for most of the forecast period. To the extent that
inflation expectations are adaptive, there may be further
downward adjustment in these expectations in the coming
quarters. As mentioned earlier, the MPC would prefer to see
inflation expectations anchored closer to the midpoint of the
target band.
In considering the impact of the VAT increase, the approach
of the MPC is to look through the first-round effects of this
increase and focus on the second-round effects, which
are expected to be relatively small. In any event, the policy
horizon of the MPC extends beyond the period during which
the first-round effects have an impact.
The MPC assesses the risks to the inflation forecast to be
more or less evenly balanced. Some of the key domestic
risks and uncertainties that had overshadowed the outlook in
recent meetings have abated. The government budget was
generally well received, but implementation risks remain.
While the recent sovereign ratings outcome was positive for
the rand, further sustained appreciation of the local currency
is not expected. The exchange rate is currently assessed to
be less of a risk to the inflation outlook. However, the rand
will remain sensitive to a faster pace of normalisation in the
advanced economies, possible heightened global financial
market volatility, as well as domestic developments.

Monetary Policy Review April 2018
Although the growth forecast has improved, the outlook
remains relatively constrained. Despite the higher levels of
consumption expenditure in the latter part of 2017, demand
pressures in the economy are not assessed to pose a
risk to the inflation outlook. The MPC assesses the risks
to the growth forecast to be moderately on the upside.
To make an appreciable impact on employment and
potential output, the current improved levels of confidence
will need to be sustained and translate into higher levels
of investment. This can only be achieved through a firm
commitment to, and implementation of, credible structural
reforms by government.
The MPC was of the view that, in light of the improved
inflation outlook and the moderation in risks to the forecast,
there was some room to provide further accommodation
without undermining the inflation trajectory or the downward
trend in inflation expectations. Accordingly, the MPC has
decided to reduce the repurchase rate by 25 basis points to
6.5% with effect from 29 March 2018. Four members
preferred a reduction while three members preferred an
unchanged stance.
In this uncertain environment, future policy decisions will be
highly data-dependent and sensitive to the assessment of
the balance of risks to the outlook.
The implied path of policy rates generated by the SARB’s
Quarterly Projection Model has changed since the previous
MPC meeting. Whereas previously two to three increases
of 25 basis points each by the end of 2019 were indicated,
one increase of 25 basis points is now implied. Two further
increases are indicated in 2020. As emphasised previously,
the implied path remains a broad policy guide which can
and does change in either direction between meetings
in response to new developments and changing risks.
Therefore, the MPC does not mechanistically respond to
changes in the path.


Per cent (both scales)
Repo rate and forecast

90%
60%
30%
Repo rate
The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
Uncertainty bands are always symmetric and do not reflect any
assessment of upside or downside risks.
Source: SARB
Monetary Policy Review April 2018

Summary of assumptions: Monetary Policy Committee
meeting on 28 March 2018*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

2. Output gap in South Africa’s major trading-partner countries


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 56 and 57.

Monetary Policy Review April 2018
Selected forecast results (annual)
Actual
Forecast


Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of our three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights, except for the US dollar which is weighted by the sum of US and Chinese trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa
and the trade-weighted CPI of the euro area, the US and Japan).
3.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
4.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
5.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Summary of selected forecast results: Monetary Policy Committee meeting
on 28 March 2018
Selected forecast results (quarterly)
Year-on-year percentage change


1. Headline inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4


2. Core inflation
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4

Notes
1. Shaded areas indicate the forecasts of the Monetary Policy Committee.
2. The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2018

Foreign sector assumptions
1. Trading-partner gross domestic product (GDP) growth
is broadly determined using the Global Projection Model
(GPM). The model permits individual country forecasts
for nine major economies, including the euro area, the
United States (US), Japan and China, with the remaining
trading partners incorporated through a ‘Rest of
Countries’ bloc. Average world growth is expressed on
a South African trade-weighted basis.
2. As with GDP growth, the output gap is determined using
the GPM and is adjusted in a similar way. The output gap
is driven by a combination of country-specific domestic
factors, external factors, and financial-real linkages
(beyond interest rate and exchange rate effects).
Domestic factors include expectations of future demand
and medium-term interest rates. External factors include
exchange rate impacts on demand, direct spillovers
through trade with trading-partner countries, and
foreign demand.
3. The commodity price index is a weighted aggregate
price index of the major South African export
commodities.
4. The Brent crude oil price is expressed in US dollars
per barrel. The assumption incorporates supply and
demand dynamics as well as oil inventories (of all grades).
The assumption is also informed by projections from
the US Energy Information Administration (EIA), the
Organization of the Petroleum Exporting Countries
(OPEC) and Reuters.
5. World food prices is the composite food price index
of the United Nations (UN) Food and Agriculture
Organization (FAO) in US dollars. It is weighted using
average export shares and represents the monthly
change in the international prices of a basket of five
food commodity price indices (cereals, vegetable oil,
dairy, meat and sugar). World food price prospects
incorporate selected global institution forecasts for
food prices and imbalances from the anticipated trend
in international food supplies relative to expected food
demand pressures.
6. International consumer prices are also broadly
determined using the GPM. The index is an aggregate
of the consumer price indices of the euro area, the
US and Japan, weighted by their relative trade shares.
Consumer prices are determined for each of these
economies by accounting for inflation expectations,
demand pressures, and pass-through from changes in
the relevant exchange rate. Other institutional forecasts
for international consumer prices are also considered.
7. International policy interest rates are again broadly
determined using the GPM. Interest rates are an
aggregate of the policy rates of the euro area, the US
and Japan. They are individually determined by a ‘Taylortype’ monetary policy rule. The communications of the
relevant central banks and other institutional forecasts
are also considered.

Monetary Policy Review April 2018
Domestic sector assumptions
1. The electricity price is an administered price measured
at the municipal level with a weight of 3.75% in the
headline consumer price index (CPI) basket. Electricity
price adjustments generally take place in the months of
July and August of each year, and the assumed pace of
increase over the forecast period reflects the multi-year
price determination (MYPD) agreement between Eskom
and the National Energy Regulator of South Africa
(NERSA), with a slight adjustment for measurement at
the municipal level.
2. Fuel taxes and levies are the total domestic taxes and
costs included in the price of fuel paid at the pump. They
include the Road Accident Fund (RAF) levy, the fuel levy,
retail and wholesale margins, the slate levy, and other
minor levies. The two major taxes, which are set by the
Minister of Finance in the annual national Budget, are
the RAF levy and the fuel levy. The income generated by
the RAF levy is utilised to compensate third-party victims
of motor vehicle accidents while the fuel levy is used to
provide funding for road infrastructure.
3. Potential growth is derived from the South African
Reserve Bank’s (SARB) semi-structural potential output
model. The measurement accounts for the impact of the
financial cycle on real economic activity and introduces
economic structure via the relationship between potential
output and capacity utilisation in the manufacturing
sector (SARB Working Paper Series, WP/14/08).
4. The inflation target range midpoint is the middle of the
official inflation target range of 3–6%.
5. The neutral real interest rate is the interest rate
consistent with stable inflation and output in line with
the economy’s potential. This variable is the basis for
judging whether a given policy stance is expansionary,
contractionary or neutral.
Monetary Policy Review April 2018

Glossary
Advanced economies: Advanced economies are countries
with high gross domestic product (GDP) per capita,
diversified exports, and close integration into the global
financial system.
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.
Brent crude: Brent crude is a light and sweet blend of oil
from five different fields in the North Sea. The price of Brent
crude is one of the benchmark oil prices in international
markets.
Budget deficit: A budget deficit indicates the extent to which
government expenditure exceeds government revenue.
Business and consumer confidence: These are economic
indicators that measure the level of optimism about the
economy and its prospects among business managers and
consumers.
Commodities: 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 the volatile elements (e.g. food and energy prices).
The South African Reserve Bank’s (SARB) forecasts and
discussions refer to headline CPI excluding food, nonalcoholic beverages, fuel and electricity prices.
Crude oil price: This is the United States (US) dollar price
per barrel of unrefined oil. See also ‘Brent crude’ above.
Current account: The current account of the balance of
payments consists of net exports (exports less imports)
in the trade account as well as the services, income and
current transfer account.
Emerging markets: Emerging markets are countries with
low to middle income per capita. They are advancing rapidly
and are integrating with global (product and capital) markets.
Exchange rate depreciation (appreciation): Exchange rate
depreciation (appreciation) refers to a decrease (increase) in
the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange
rate changes on domestic inflation (i.e. the percentage
change in domestic CPI due to a change in the exchange
rate). Changes in the exchange rate affect import prices,
which in turn affect domestic consumer prices and inflation.
Forecast horizon: This is the future period over which the
SARB generates its forecasts, typically between two and
three years.
Gross domestic product (GDP): GDP is the total market
value of all the goods and services produced in a country.
It includes total consumption expenditure, capital formation,
government consumption expenditure, and the value of
exports less the value of imports.
Gross fixed capital formation (investment): The value of
acquisitions of capital goods (e.g. machinery, equipment
and buildings) by firms, adjusted for disposals, constitutes
gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers to
CPI for all urban areas that is released monthly by Statistics
South Africa (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.
Inflation (growth) outlook: This outlook refers to the evolution
of future inflation (growth) over the forecast horizon.
Inflation targeting: This is a monetary policy framework
used by central banks to steer actual inflation towards an
inflation-target level or range.
Median: This is a statistical term used to describe the
observed number that separates ordered observations in half.
Monetary policy normalisation: This refers to the unwinding
of an unusually accommodative monetary policy. It could
also mean adjusting the economy’s policy rate towards its
real neutral policy rate.
Neutral real interest rate (NRIR): The NRIR is the level at
which the real interest rate will settle once the output gap is
closed and inflation is stable.
Nominal effective exchange rate (NEER): The 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 NEER indicates
a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted
average exchange rate of the rand is calculated against
20 currencies. The weights of the five major currencies are
as follows: the euro (29.26%), the Chinese yuan (20.54%),
the US dollar (13.72%), the Japanese yen (6.03%), and the
British pound (5.82%). Index: 2010 = 100. See also ‘Real
effective exchange rate’ on the next page.
Output gap / potential growth: Potential growth is the
rate of GDP growth that could theoretically be achieved if
all the productive assets in the economy were employed
in a stable inflation environment. The output gap is the
difference between actual growth and potential growth,
which accumulates over time. If this is negative, then the
economy is viewed to be underperforming and demand

Monetary Policy Review April 2018
pressures on inflation are low. If the output gap is positive,
the economy is viewed to be overheating and demand
pressures are inflationary.
Policy rate: A policy rate is the interest rate used by a central
bank to implement monetary policy.
Producer price index (PPI): This index measures changes
in the prices of goods at the factory gate. Stats SA currently
produces five different indices that measure price changes
at different stages of production. Headline PPI is the index
for final manufactured goods. PPI measures indicate
potential pressure on consumer prices.
Productivity: Productivity indicates the amount of goods
and services produced in relation to the resources utilised
in the form of labour and capital.
Purchasing power parity (PPP): PPP is based on the law
of one price, assuming that, in the long run, exchange rates
will adjust so that the purchasing power across countries
is approximately the same. It is often used to make crosscountry comparisons without the distortionary impact of
volatile spot exchange rates.
Real effective exchange rate (REER): The REER is the
NEER adjusted for inflation differentials between South Africa
and its main trading partners. See also ‘Nominal effective
exchange rate’ on the previous page.
Repurchase (repo) rate: This is the policy rate that is set
by the Monetary Policy Committee (MPC). It is the rate that
commercial banks pay to borrow money from the SARB.
Real repo rate: This is the nominal repo rate, as set by the
MPC, adjusted for expected inflation.
Taper tantrum: The term ‘taper tantrum’ is widely used to
describe the strong reaction of global financial markets to
comments made by the US Federal Reserve (Fed) chairman
in May 2013 that the Fed would likely start to reduce (or
‘taper’) the pace of its asset purchases later that year.
Terms of trade: This refers to the ratio of export prices to
import prices.
Unit labour cost (ULC): A ULC is the labour cost to produce
one ‘unit’ of output. This is calculated as the total wages
and salaries in the non-agricultural sector divided by the real
value added at basic prices in the non-agricultural sector of
the economy.
Monetary Policy Review April 2018

Abbreviations
Alsi
All-Share Index
ANC
African National Congress
BER
Bureau for Economic Research
BLNS
Botswana, Lesotho, Namibia and Swaziland
CBOE
Chicago Board Options Exchange
CDS
credit default swap
CPI
consumer price index
CPIX
consumer price index for metropolitan
and other urban areas, excluding the
interest cost on mortgage bonds
ECB
European Central Bank
EIA
Energy Information Administration
EMBI+
JPMorgan Emerging Market Bond Index Plus
FAO
Food and Agriculture Organization
Fed
United States Federal Reserve
FNB
First National Bank
FRA
forward rate agreements
FX
foreign exchange
G3
Group of Three
G7
Group of Seven
GDP
gross domestic product
GPM
Global Projection Model
Haver
Haver Analytics
IEC
Electoral Commission of South Africa
IMF
International Monetary Fund
JSE
JSE Limited
Moody’s
Moody’s Investors Service
MPC
Monetary Policy Committee
MPR
Monetary Policy Review
MTBPS
Medium Term Budget Policy Statement
MYPD
multi-year price determination
NAB
non-alcoholic beverages
NAIRU
non-accelerating inflation rate of unemployment
NEER
nominal effective exchange rate
NERSA
National Energy Regulator of South Africa
NRIR
neutral real interest rate
OECD
Organisation for Economic
Co-operation and Development
OPEC
Organization of the Petroleum
Exporting Countries
PMI
Purchasing Managers’ Index
PPI
producer price index
PPP
purchasing power parity
QES
Quarterly Employment Statistics
QLFS
Quarterly Labour Force Survey
QPM
Quarterly Projection Model
RAF
Road Accident Fund
REER
real effective exchange rate
repo (rate) repurchase (rate)
RMB
Rand Merchant Bank
SAFEX
South African Future Exchange
SAGIS
South African Grain Information Service
SARB
South African Reserve Bank
SSA
Sub-Saharan Africa
Stats SA
Statistics South Africa
the dti
Department of Trade and Industry
UAE
United Arab Emirates
UK
United Kingdom
ULC
unit labour cost
UN
United Nations
US
United States
VAT
value-added tax
VIX
Chicago Board Options
Exchange Volatility Index
ZAR
South African rand