Monetary Policy Review
April 2016
South African Reserve Bank
Monetary Policy Review
April 2016
Monetary Policy Review April 2016
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ISSN: 1609-3194
Monetary Policy Review April 2016
Preface
The primary mandate of the South African Reserve Bank (the Bank) is to achieve and
maintain price stability in the interest of balanced and sustainable economic growth.
Low inflation helps to maintain and improve competitiveness, protects the purchasing
power and living standards of all South Africans, and provides a favourable environment
for balanced growth, investment and employment creation. In addition, the Bank has a
complementary mandate to oversee and maintain financial stability. The Bank’s Monetary
Policy Committee (MPC) is responsible for monetary policy decisions, and comprises the
Governor as Chairperson, the deputy governors and senior officials of the Bank.
Price stability is quantified by the setting of an inflation target range by government after
consultation with the Bank. The Bank has instrument independence, with the commitment
to pursue a continuous target of 3 to 6 per cent for headline consumer price index inflation.
The MPC conducts monetary policy within a flexible inflation-targeting framework that
allows inflation to be temporarily outside the target range under certain circumstances.
The MPC takes into account a viable medium-term time horizon for inflation and considers
the time lags between policy adjustments and economic effects. This provides for interest
rate smoothing over the cycle, and contributes towards more stable economic growth. The
repurchase (repo) rate decision reflects the MPC’s assessment of the appropriate monetary
policy stance.
The decision of the MPC, together with a comprehensive statement, is announced at a media
conference at the end of each meeting. This announcement outlines the MPC’s assessment
of prevailing domestic and global economic conditions, as well as recent outcomes and
forecasts for inflation and real economic activity.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening the
understanding of the objectives and conduct of monetary policy. The MPR covers domestic
and international developments that have affected inflation and that impact on the monetary
policy stance. It also provides an assessment of the factors determining inflation and the
Bank’s forecasts of the future path of inflation and economic growth. The MPR is presented
by the Governor and senior officials of the Bank at monetary policy forums in various
centres across South Africa in an effort to develop a better understanding of monetary policy
through direct interaction with stakeholders.
Monetary Policy Review April 2016
Contents


Boxes


Box 3 Forecast accuracy and the economy’s performance relative to the


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

Statement of the Monetary Policy Committee


Monetary Policy Review April 2016
Executive summary
Monetary policy in South Africa confronts the prospect of a prolonged breach
of the inflation target, even as growth trends lower. The policy rate has been
increased, most recently by a quarter of a percentage point at the March 2016
meeting of the Monetary Policy Committee (MPC). This rate has now been
raised by a total of 2 percentage points since January 2014, when forecasts
for inflation first began showing significant risks of sustained target breaches.
Monetary policy remains in a tightening cycle, although this is subject to data
outcomes.
The period since the publication of the previous Monetary Policy Review
(MPR) in November 2015 has been characterised by volatility and
uncertainty in financial markets alongside generally disappointing real
economy news. Global growth slowed sharply in the final quarter of 2015.
Some of this weakness is expected to be temporary, as the United States (US)
rebounds from an unusually subdued quarter. But other major economies
have underperformed more persistently. The euro area and Japan are barely
expanding, while emerging-market performance continues to deteriorate. In
China’s case this has entailed a shift from rapid to moderate growth. Brazil
and Russia, by contrast, are in protracted recessions. In an environment
of weak demand, commodity prices have fallen and world trade growth
has slumped. Global inflation continues to be unusually low, although
some countries, particularly commodity exporters, have experienced rising
inflation linked to currency depreciation.
Growth in the South African economy has decelerated markedly since 2011.
Output increased by just 1,3 per cent in 2015 and forecasts suggest growth
will be less than 1 per cent this year, the slowest pace of expansion since the
Great Recession, and before that, the emerging-market crisis year of 1998.
In the recent past, disappointing growth outcomes have been traceable to
specific shocks, including strikes, electricity shortages and drought. But the
outlook now indicates more diffuse sources of weakness. Consumer and
business confidence is low in historical perspective. The South African
Reserve Bank’s (the Bank’s) leading indicator of business activity trended
lower throughout 2015 and fell further in early 2016. Over the forecast
period, growth is expected to be low despite a highly competitive exchange
rate, significant public borrowing and a low real policy rate. Net exports
face headwinds from declining commodity prices and slowing world trade
growth. Government is entering a period of intensified fiscal consolidation.
Households remain under pressure, burdened by debt and high levels of
unemployment, among other factors. Businesses continue to see limited
opportunities for expansion.
Despite slowing gross domestic product (GDP) growth, inflation in South
Africa has begun to accelerate again, after a year of relatively moderate price
increases. Inflation in 2015 averaged 4,6 per cent, very close to the midpoint
of the 3–6 per cent target range, mostly due to sharply lower world oil prices.
This positive price shock, however, has had few lasting effects on the longer-
term inflation trajectory. Core inflation dipped only marginally over the
course of the past year and indicators of longer-run inflation expectations
were essentially unmoved. Inflation has since rebounded to 6,2 per cent
in January and 7,0 per cent in February, the highest rate in the post-crisis
period. It is expected to average well over 6 per cent in both 2016 and 2017.


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

Targeted inflation* forecast
Per cent

Inflation target range
* CPIX for metropolitan and other urban areas until the end
of 2008; CPI for all urban areas thereafter
Source: South African Reserve Bank
Monetary Policy Review April 2016

The past few months have also seen considerable market volatility from both
domestic and foreign sources. In December 2015 the rand exchange rate,
equity markets and bond yields all moved abruptly following the removal of
Nhlanhla Nene as finance minister. The losses were partially reversed five
days later, but a portion of the adjustment was more persistent. The rand, for
instance, shifted out of a range between R13 and R14,60 to the US dollar in
which it had moved since August, trading at over R15,50 in late December.
In this fevered environment, the US Federal Reserve’s (the Fed’s) muchdiscussed lift-off – the first rate increase in the US since 2006 – passed
quietly. The timing of the move transfixed markets through large parts of
2015, but clear communications helped to ensure that the final decision was
well anticipated, avoiding further turbulence.
In January, however, there was a further spike in market volatility. The
proximate cause of this disruption appeared to be developments in China
where the Shanghai stock market dropped abruptly and the renminbi was
devalued in a repeat of August’s turmoil. Apparently in response, most
global equity markets traded lower, including in the US, Japan, Europe
and many emerging markets. (The total loss in equity value was about half
that experienced in the depths of the Great Recession.1) Emerging-market
currencies sold off – the MSCI Emerging Markets Currency Index fell
3 per cent over the first 20 days of January before rebounding – and the
rand shifted to well over R16 to the US dollar. Longer-term borrowing
costs also rose in a number of emerging markets, while those for the safest
borrowers declined.
Overview of the policy stance
Financial market volatility is frequently a distraction for policymakers. Its
causes can be obscure and its effects temporary, without much significance
for the real economy. Recent shifts, however, have been sufficiently large and
lasting to materially affect South Africa’s economic trajectory. Of particular
significance for monetary policy, the rand has weakened further. Over the
past five years the currency has depreciated quite steadily, but the change
in 2015 was the largest yet experienced in this period. The currency began
the year at R11,56 to the US dollar and ended at R15,04, a depreciation of
23 per cent. The trade-weighted exchange rate also weakened substantially,
by nearly 20 per cent. In real terms, both the trade-weighted exchange rate
and the bilateral rand/dollar exchange rate are close to record lows.2 This
persistent and substantial rand depreciation is expected to generate higher
inflation over the forecast period.
Pass-through from the exchange rate to inflation has been low in recent
years, relative to past experiences. With substantial depreciation, however,
even low levels of pass-through still generate meaningful amounts of
inflation. South Africa’s import requirements have also risen given the
drought-induced decline in local food production.
These two factors – the exchange rate and food prices – have caused a marked
deterioration in the Bank’s inflation forecast. The January 2016 numbers
showed a sustained departure from the target range lasting throughout 2016

See David Lipton, ‘Policy imperatives for boosting global growth and prosperity’, 2016, available at
org/external/np/speeches/2016/030816.htm.

The measure calculated by the Bank for International Settlements (BIS), based on consumer prices, is at an all-time
low, while other measures are close to but still somewhat above the 2001 trough.
South African government borrowing costs
relative to emerging-market peers*

Sources: JPMorgan and own calculations
* Spread between JPMorgan Goverment
Bond Index for local currency emergingmarket debt and the South African portion
of that index
Basis points

J
M
M
J
S
N
J
M
Indices: December 2001 = 100

Rand real effective exchange rate

South African Reserve Bank

Bank for International Settlements (right-hand scale)
Sources: South African Reserve Bank and Bank for
International Settlements

Monetary Policy Review April 2016
and 2017, with a peak of 7,8 per cent around the end of 2016. The prospect
of an extended breach prompted an upward adjustment of the repurchase
(repo) rate by half a percentage point to 6,75 per cent following the January
meeting of the MPC.
The inflation forecast for the March meeting improved somewhat on more
favourable assumptions for administered prices and the exchange rate as well as
the inclusion of the January repo rate decision. It continued to show inflation
above the upper bound of the target range for most of 2016 and 2017, but the
averages for those years declined to 6,6 per cent and 6,4 per cent respectively
(from 6,8 per cent and 7,0 per cent in January). The forecast was also extended
to 2018, which indicated inflation dipping into the upper reaches of the target
range – although this projection is subject to substantial forecast error.
While the March forecast is lower than January’s, the change probably does
not signal a meaningful improvement in the outlook. The assumptions
underlying the shift are quite tenuous, with both oil prices and the exchange
rate reverting to less favourable levels in the days leading up to the MPC
meeting. Accordingly, the risks to the March forecast were judged to be
towards higher inflation. The forecast also continued to show a protracted
breach of the inflation target, while longer run inflation expectations
remained elevated. In this context, the MPC chose to increase the repo rate
by an additional quarter of a percentage point.
As in many other countries, demand pressures appear to be weak and are
contributing little to inflation. Yet local prices are rising relatively fast because
of currency depreciation as well as shocks such as drought-related food
price spikes and regular large increases in electricity prices. These increases
come on top of wage and salary cost indexation, driven by skills supply
constraints, bargaining arrangements and expected inflation. Monetary
policy can do little about supply shocks but it can affect expectations.
Accordingly, interest rate changes are aimed at preventing temporary price
movements from being incorporated into longer-term expectations and
thereby becoming permanent.
The changes in monetary policy since January 2014 have followed
unfavourable developments in the inflation outlook, but the level of the
policy rate is still geared to a slow-growth economy. Growth has slowed
since the initial phase of the recovery from the global crisis and is likely to
slow further in the near term. Alongside sharp declines in US dollar prices
for most of South Africa’s commodity exports and slower world growth, the
major constraints on domestic growth are structural. The result is declining
potential growth rates. These problems do not respond directly to monetary
policy interventions. Nonetheless, with growth continuing to undershoot
potential, monetary policy is still providing stimulus to help absorb spare
capacity. The policy interest rate remains low from a historical perspective.
In real terms it is still close to zero, and near or below real policy rates in peer
countries. The pace of tightening has also been gradual relative to previous
hiking cycles.
Over the longer run South Africa’s growth interests are best served by
keeping inflation within the target range, not by looking to exploit a
temporary trade-off between growth and inflation. Tolerating additional
inflation in the short run could require larger interest rate adjustments later,
with proportionally greater costs for the economy. Higher inflation would
also have its own economic costs, by damaging competitiveness, eroding
Per cent
Yield curve before and after interest rate
announcements

Wednesday 18 November 2015

Friday 20 November 2015

Wednesday 27 January 2016

Friday 29 January 2016

Wednesday 16 March 2016

Friday 18 March 2016
Sources: Bloomberg and own calculations

Years to maturity
Monetary Policy Review April 2016

living standards and weakening confidence. There also appear to have been
some welcome shorter-run benefits from recent monetary tightening. In
response to all three recent hikes (November 2015 as well as January and
March 2016), borrowing costs as reflected in government debt shifted lower
across most of the yield curve, and the rand also strengthened somewhat.
South African inflation is quite elevated from a world perspective, relative
not only to advanced economies that have been confronting deflationary
risks, but also to emerging markets. Domestic inflation was higher than
the emerging-market median throughout the 2000s and the differential
has risen in recent years. The recent deterioration partly reflects currency
depreciation from adverse trends in commodity prices. Yet South African
inflation is also quite high relative to commodity exporters, including
middle-income economies. This weighs against complacency in assessing
South African inflation levels.
Rand per US dollar
Exchange rate before and after rate increases
Sources: Bloomberg and South African Reserve Bank
Nov
Dec
Jan
Mar

Feb

Box 1
South Africa’s sovereign credit rating and downgrade implications
Sovereign credit ratings are third-party assessments of the ability and willingness of
governments to repay their debts. Ratings agencies use finely calibrated scales to
express risk. Moody’s, for instance, has 27 separate ratings, which are further qualified
by descriptions of the outlook (‘positive’, ‘stable’ or ‘negative’). For all this nuance,
however, one of the most important verdicts is simply binary: is an entity investmentgrade or not? This matters partly because lenders require additional compensation for
funding riskier borrowers, and partly because many large financial institutions such as
pension funds are obliged to hold only investment-grade assets. As such, investmentgrade status is valuable. This box provides some quantification of that value.
South Africa’s foreign currency debt is still rated as investment grade by all three major
rating agencies. Its ratings from two of the three major agencies, Standard & Poor’s
(S&P) and Fitch, are just one level above speculative grade (‘junk’ status). The Moody’s
rating is two levels above speculative grade. Local currency debt ratings are one notch
higher for Fitch and S&P, whereas the Moody’s rating is the same for both local and
foreign-currency debt. Unsurprisingly, the ratings for different kinds of sovereign debt
tend to be closely aligned.
Based on the experiences of a sample of 70 countries for which data are available, it
is possible to estimate some of the consequences of a downgrade below investment
grade. This exercise focuses on the ratings of one agency (Fitch), and considers only
ratings for foreign-currency debt. As would be expected, the evidence confirms that
countries with investment-grade ratings have lower borrowing costs than their
speculative grade peers. As countries move from the investment grade region into the
speculative zone, costs do not rise in a linear trend. Instead, the curve steepens. This
indicates that markets attribute less significance to variations within the investment
grade space than they do beyond it. Based on these observations, a downgrade below
investment grade is likely to increase short-term rates by 80 basis points. Long-term
bond yields would be expected to move more, rising by 104 basis points.
Higher long-term borrowing costs would have a variety of negative effects. Government
would have to allocate more spending towards debt-service costs. Because corporate
borrowing costs are linked to the sovereign rating, the private sector would also be
affected, raising the costs of investment. Furthermore, the rand is likely to depreciate
against major traded currencies should foreign investors offload their sub-investment-
grade holdings. Were this to occur, it would likely exacerbate inflationary pressures in
the economy.
South Africa’s ten-year government
bond yield

Source: Bloomberg
Daily

December 2015 average = 9,4
South Africa’s Standard & Poor’s
sovereign ratings
Source: Bloomberg

BBB+
Investment grade
Speculative grade
BB+
Percentage change
Forecast
Trade-weighted world inflation

Emerging economies

South Africa

Sources: International Monetary Fund, South African Reserve
Bank and own calculations

Advanced economies

Monetary Policy Review April 2016
Overview of the world economy
In the final quarter of 2015, the world economy grew at its slowest rate since
the Great Recession. This performance reflected weakness in the world’s two
largest economies, with the US experiencing an unusually slow quarter and
Chinese growth edging lower. Meanwhile, many middle-income countries
continue to decelerate. Coupled with financial market volatility at the start
of 2016, this has intensified pessimism that the global economy is losing
momentum and is unusually vulnerable to shocks.
For the past few years, the global economic narrative has contrasted recovery
in some advanced economies – principally the US – with stagnation in
Europe and Japan and a slowdown in emerging markets. This has shaped
the outstanding features of the world economy: policy divergence in
advanced economies, dollar strength, commodity price collapses, slowing
world trade and moderating world growth. Since the release of the previous
MPR in November 2015, this account has remained broadly valid. The
Fed delivered on its carefully communicated rate hike, lifting the federal
funds rate away from zero for the first time since the crisis. By contrast, the
Bank of Japan adopted negative interest rates, and the European Central
Bank (ECB) lowered some rates further into negative territory while also
expanding its asset purchase programme. The US dollar continues to be
very strong, having appreciated more in the run-up to this hiking cycle
than in any previous upward cycle in recent history. This strong dollar is
also contributing to lower commodity prices, exacerbating powerful shifts
in commodity market supply and demand dynamics.
On the demand side, weaker world growth is weighing on commodity
prices, especially industrial commodities tied to business cycles and
industrial development. Meanwhile, the supply side is characterised by
significant excess capacity installed during the boom years, which will
persist until enough marginal producers suspend production. In this context,
commodity prices have been depressed, with the Bloomberg Commodity
Index reaching a new low in January 2016 before recovering somewhat
in February and March. Theoretically, falling commodity prices should
redistribute but not reduce world income. Commodity exporters suffer
declining revenues but their loss is an equal gain for importers. However,
the growth response in commodity-importing economies appears to have
been relatively weak, as consumption remains subdued.
Low commodity prices have also put downward pressure on inflation in
most economies, contributing to unusually mild world inflation. The
exceptions to this rule tend to be commodity exporters where currency
depreciation has in some cases generated higher inflation. Much lower
commodity prices have also been an important factor in the slowdown
of world trade, now at levels normally seen in global recessions. Global
growth forecasts continue to show world growth rebounding over the
forecast horizon. Such projections, however, have repeatedly fallen short
over the past five years, and there are significant downside risks to growth,
particularly from emerging markets.
Indices: January 2011 = 100
Commodity prices by category
Source: World Bank

2015 2016

Metals and
minerals
Energy
Precious
metals
Percentage change in real GDP
Forecast
World GDP growth

Emerging markets

Advanced economies
Source: International Monetary Fund

World

-4
-2

Emerging markets

Advanced economies
Source: International Monetary Fund

World

Per cent
World inflation
Forecast
Monetary Policy Review April 2016

Advanced economies
The US economy has enjoyed a relatively substantial recovery. Unemployment
has fallen from 10 per cent of the workforce to less than 5 per cent, with
around 13,5 million net jobs added since 2010. GDP growth has accelerated
over the past three years to 2,4 per cent in 2015 and is forecast to continue
above 2 per cent in 2016 and 2017. Nonetheless, markets are heavily
discounting the Fed’s own guidance on its policy rate, anticipating a lower
level for the federal funds rate over the next three years than suggested by
the most dovish forecast in the Fed’s ‘dot plot’. Financial conditions have
tightened somewhat amid rising corporate spreads and volatility in equity
markets. Low energy prices as well as the strength of the US dollar are
keeping inflation below the Fed’s longer-run 2 per cent goal. US corporate
profit growth has stalled, in particular because the appreciated dollar is
reducing the domestic value of overseas earnings. Productivity growth has
also been weak. The most probable scenario is that the US economy will
continue to expand at over 2 per cent annually and unemployment will fall
somewhat further below 5 per cent. Nonetheless, analysts have raised their
assessments of recession risk.
The euro area appears to have entered a period of expansion following two
recessions in close succession. The Centre for Economic Policy Research,
which has responsibility for dating European business cycles, recently
determined that the euro area had embarked on an upward phase of the
business cycle in the first quarter of 2013. This concludes the recession which
began in the second half of 2011. The expansion has been underpinned
by several factors, including in particular a competitively valued currency
and some loosening of financial conditions as the crisis atmosphere lifts
and monetary stimulus feeds through the region. Growth is still unusually
tepid, however, registering 1,5 per cent in 2015, with European Commission
forecasts anticipating a fractional improvement to 1,6 per cent in 2016.
Unemployment across the euro zone remains at over 10 per cent, albeit with
large country differences (German unemployment is 4,3 per cent; in Spain
it is 20,3 per cent and in Greece, 24,6 per cent). According to the latest data,
the region as a whole has not yet recovered the levels of output attained in
2008, before the Great Recession, although it is likely to surpass that peak
sometime in the first half of this year.
Inflation has been well below the ECB’s inflation target of ‘below, but close
to, 2 per cent’ since 2011. The most recent data provide no evidence of
inflation rebounding, with prices across the region declining by 0,2 per
cent year-on-year in February. The ECB announced a host of additional
easing measures in March, cutting its main policy rate to 0 per cent and
its deposit rate to -0,4 per cent. Asset purchases were also increased, to
€80 billion monthly.
Japan is similar to the euro area in that it is achieving very little growth with
stubbornly low inflation. The economy contracted by 1,4 per cent in the
second quarter of 2015 but avoided a technical recession when data revisions
changed the third-quarter growth rate from -0,8 per cent to 1,4 per cent.
Output declined in the fourth quarter, however, by a worse-than-expected
1,1 per cent, bringing total growth for the year to just 0,5 per cent. Inflation
in January was 0 per cent, with core measures slightly positive but still well
below the 2 per cent inflation target. In this environment, the Bank of Japan
Indices: 1 year before first Fed rate increase = 100
Real effective US dollar during Fed
tightening cycles
Sources: Bank for International Settlements and own calculations


Months before first Fed rate increase

Monetary Policy Review April 2016
adopted a negative interest rate on excess reserves held at the central bank.
Although Japan’s economic performance has been very subdued, this must
be understood in the context of demographic decline. Unemployment is
barely over 3 per cent, a two-decade low, and output per capita continues
to rise, which does not suggest a cyclical downturn. Like the euro area,
however, Japan is contributing essentially nothing to world growth despite
its substantial share in world output (around 4 per cent of the total in
purchasing power parity (PPP) terms; the euro area is close to 12 per cent).
Emerging-market economies
For the past half-decade, Chinese growth has been slowing as that economy
matures into middle-income status. Policymakers have aimed to rebalance
the composition of GDP away from investment and exports and towards
more domestic consumption. They have also pursued liberalisation,
permitting greater scope for market forces in allocative decisions. This
reform process has been through a turbulent phase in recent months. In
particular, exchange rate and equity market developments have affected
financial markets worldwide and fuelled speculation of deeper underlying
weakness in the Chinese economy.
Exchange rate policy has been an especially difficult challenge. The renminbi
has long followed the US dollar, with dollar strength tending to appreciate
the renminbi. Over the past year or so, however, economic conditions in
China have diverged strongly from those in the US. For this reason, the
renminbi exchange rate should not necessarily be moving in the same
direction as the US dollar. Yet sensitivities about renminbi volatility due
to China’s importance in regional and global trade suggest that adopting a
more freely floating currency might be disruptive. Instead, the authorities
have preferred a gradual approach. They recently announced a new
reference basket for the exchange rate, which includes 12 other important
trading-partner currencies such as the yen, euro and rouble alongside the
dollar. (Had the renminbi followed this basket since 2010, it would now
be about 20 per cent cheaper against the dollar.) China has also permitted
two quite small devaluations, of around 2 per cent in August 2015 and
another 1,2 per cent in January 2016. These repeated small adjustments,
however, have fuelled expectations of additional depreciation rather than
fostering stability. This has created perverse incentives for speculators to
short-sell the renminbi and for firms with dollar-denominated debt to
repay it quickly. (The Bank for International Settlements (BIS) estimates
foreign currency-denominated debt in China at about US$1 trillion.)
The result has been substantial capital outflows, requiring offsetting
sales of foreign-exchange reserves to maintain the targeted exchange rate.
Accordingly, China’s reserves have fallen from a peak of over US$4 trillion
in 2014 to around US$3,2 trillion, with reserve sales running at around
US$100 billion in December 2015 and January 2016 before moderating to
about US$29 billion in February.
The Shanghai Stock Exchange Index gained value very rapidly in the first
half of 2015 before reversing course as abruptly in August. In response,
the authorities implemented circuit breakers to cut off trading after sharp
market falls as well as restrictions on the sale of certain stock holdings for a
period of six months. In January 2016 the index fell sharply, apparently on
expectations of mass sales once these restrictions were lifted, and therefore
sure losses. The declines in the index triggered the circuit breakers, so
markets were open only briefly for some days in early January.
Nominal effective exchange rates for
China and major partners

China
South Korea
Source: Bank for International Settlements
Appreciation

Euro area

United Kingdom

Japan

United States
Indices: 2010 = 100

2015 2016
Monetary Policy Review April 2016

In the absence of deeper questions about the health of the Chinese economy,
these events would likely have had limited repercussions. But GDP growth
slowed to just below the 7 per cent growth target in 2015, its lowest rate
since 1990, amid speculation that the data may be overstating the true
growth numbers by several percentage points. China’s recently adopted
five-year plan mandates growth above 6,5 per cent until 2020, a rate which
would double GDP from 2010 levels. Achieving this goal will require more
credit growth. Yet borrowing has already expanded very rapidly since the
crisis, with combined public and private non-financial sector debt expected
to exceed 250 per cent of GDP this year – a level well above the emergingmarket average and close to advanced-economy norms. Debt accumulation
has been concentrated in the corporate sector, with state-owned enterprises
particularly exposed. This leverage has contributed to excess capacity in
major industrial sectors, such as steel manufacturing, where falling prices
will make debt repayment more difficult. It has also funded large investments
in real estate, a sector in which prices have been falling. Government debt
levels remain low and most borrowing has been financed with domestic
savings, suggesting financial stability will be maintained. China could avoid
a crisis, however, and still suffer stagnation, as Japan did after the stock
market bubble burst in the late 1980s. Given that China has been a major
contributor to world growth, both directly through its own rapid expansion
and indirectly as the end-market for many other countries’ exports, this
scenario poses a major risk for the world economy.
Although China’s deceleration is the most important aspect of the emergingmarket slowdown, its growth is still so rapid that the performance of the
emerging-markets category is distinctly worse with China excluded. Two of
China’s major emerging-market peers, Brazil and Russia, are in recessions
which have become deeper and more protracted than previously anticipated.
Russia’s economy declined by nearly 4 per cent in 2015 and is expected
to contract by another 1 per cent this year. Brazilian output shrunk by
3,8 per cent in 2015 and the latest forecasts suggest 2016 will be similar.
The International Monetary Fund (IMF) now expects -3,5 per cent
growth, from a forecast of -1,0 per cent as recently as October 2015, which
would make this Brazil’s deepest recession on record (including the Great
Depression). Both Brazil and Russia face fiscal squeezes as well as high
inflation rates, which have required monetary and fiscal tightening. The
costs of insuring these countries’ debts have risen sharply and sovereign
credit ratings have been downgraded. Moody’s and Standard & Poor’s
(S&P) both cut Russia below investment grade in early 2015, although
Fitch has kept it at the lowest investment-grade level (citing Russia’s low
debt levels and net foreign creditor status). S&P downgraded Brazil to
sub-investment grade in September 2015, followed by Fitch in December
and Moody’s in February 2016.
Developments in Russia, Brazil and China parallel those of their respective
regions, namely emerging Europe, Latin America and emerging Asia.
Economic output in the first two regions contracted in 2015, while
emerging Asia slowed. In Latin America, most economies have been under
pressure from lower commodity prices. Venezuela and Argentina have
experienced severe downturns and opposition parties have won elections
in both countries. According to the IMF, inflation in Argentina is running
at around 30 per cent, whereas Venezuela’s has soared to over 100 per cent
and may reach 720 per cent this year. Growth in Argentina is expected to
Percentage of GDP
Non-financial sector debt as of 2015 Q3

Government

Household

Non-financial corporate sector
Source: Bank for International Settlements

Indonesia
Russia
Turkey
India
South Africa
Brazil
China
Euro area
Japan
United States
Basis points
Emerging-market five-year credit default swaps

January 2014

January 2015

January 2016
Source: Bloomberg

Chile
Thailand
India
Mexico
Indonesia
Turkey
Russia
South Africa
Brazil

Monetary Policy Review April 2016
be narrowly negative in 2016, while Venezuela is in the midst of a deep
downturn, with real output falling about 10 per cent last year and no respite
visible in medium-term forecasts. In the major Latin American economies
with more robust macroeconomic frameworks – Chile, Colombia, Mexico
and Peru – growth has slowed and inflation has accelerated, with central
banks in all four countries tightening policy in defence of their inflation
targets. None of these economies are contracting, however, and inflation
remains in single digits.
In emerging Asia, commodity exporters replicate this familiar story
of currency depreciation and inflation, with Indonesia the major
example. Commodity importers, however, join advanced economies in
having unusually low inflation, which is also being fuelled by industrial
overcapacity. Thailand experienced deflation in 2015, and major peers,
including Malaysia, the Philippines and Vietnam, saw only small price
increases. Although growth in the region has cooled off somewhat in recent
years, reflecting exposure to Chinese demand, it continues to be the most
rapid of any region in the world economy.
Emerging Europe is more complex and diverse. The economies most closely
connected to the euro area, such as Poland and the Baltic states, also reflect
its problems, with very low inflation and tepid growth. Turkey is quite
an unusual case, a commodity importer grappling with elevated inflation
and a large current-account deficit alongside slowing growth. Ukraine is
experiencing a difficult transition period following intense geopolitical
conflict. Growth is expected to turn slightly positive this year following
two years of contraction, while inflation should subside to about 15 per cent
from last year’s spike of close to 50 per cent.
Low-income countries have been a rare bright spot in the world economy.
The emerging-market slowdown has been primarily a middle-income
phenomenon; the majority of low-income countries has been growing above
their longer-run average rates in recent years. India is the most prominent
example. Growth should reach 7,5 per cent in 2016 and 2017, up from
5 per cent in 2012, as the economy benefits from cheap oil and pro-growth
economic reforms, including the adoption of inflation targeting. SubSaharan Africa, a region dominated by low-income countries, is a more
complicated case. The majority of countries in the region is sustaining
relatively high levels of growth. Commodity importers in particular are
achieving high growth rates: Ethiopia, for instance, is expanding at around
10 per cent and Kenyan growth is close to 5,5 per cent. As a result, subSaharan Africa continues to be the fastest-growing region in the world
after emerging Asia. A number of countries are, however, struggling with
adverse commodity price shocks. In some cases these are being compounded
by large fiscal and current-account deficits as well as recently acquired
foreign currency liabilities, which have become much more expensive as
local currencies have depreciated. Even here the risks to growth are to
the downside.
Sources: World Bank and own calculations


Per cent
Share of developing countries with slower
growth in 2015 relative to their 1990–2008
average

Low income
Middle income
Monetary Policy Review April 2016

Conclusion
Eight years on from the crisis, the recovery in global growth continues to
disappoint. The emerging-market growth story has faded. China’s economy
has slowed and commodity exporters have decelerated, with some emerging
markets falling into recession. Among advanced economies, the US has
achieved a relatively robust recovery. By contrast, the euro area and Japan
have stagnated. World inflation is at long-term lows, with only a subset of
emerging markets troubled by excessively high inflation.
South Africa is part of the rising inflation group, reflecting currency
depreciation in the context of price rigidities, among other factors. It has
also joined in the middle-income country slowdown. Weaker world growth
diminishes prospects for South Africa to expand off foreign demand.
Meanwhile, the sense that emerging markets are vulnerable, and that more
middle-income countries are likely to join Brazil and Russia in recession,
makes it more difficult for South Africa to go on being a large net borrower
in world financial markets. The global environment is therefore quite
unfavourable.
Per cent
Share of middle-income countries experiencing
three consecutive years of declining growth

BRICS

Middle-income countries

excluding BRICS
1992 1995

Sources: World Bank and own calculations

Monetary Policy Review April 2016
Overview of the domestic economy
South Africa’s economy is characterised by slowing growth, stubborn inflation
and macroeconomic imbalances. The current-account deficit has averaged
about 5 per cent of GDP over the past four years, and the fiscal deficit has
averaged around 4 per cent over the same period. GDP growth, meanwhile,
has deteriorated from over 3 per cent in 2011 to 1,3 per cent in 2015, with
further deceleration anticipated in 2016. This combination is unsustainable
and inflationary, progressively weakening growth prospects.
South African output growth has been slowing steadily. The most recent
forecast suggests GDP growth of 0,8 per cent for 2016, down from 1,5 per
cent as projected in November 2015 and 2,9 per cent a year before that.
Forecasts for 2017 have also declined, with the latest number indicating
1,4 per cent growth next year and 1,8 per cent in 2018. By way of comparison,
South Africa’s annual growth since 1994 has averaged 3 per cent.
Why has growth weakened, and why are the forecasts still deteriorating?
The slowdown has had a number of causes, some temporary and some
more durable. Households acquired substantial debt burdens in the
pre-crisis period and have since been slowly deleveraging, reducing the
scope for credit-fuelled expansion. Electricity shortages have hampered
production and disincentivised investment. There has been no loadshedding in recent quarters, but this is partly a consequence of feeble
electricity demand in the context of subdued growth. Meanwhile, the
global economic environment has been relatively unfavourable. World
growth weighted by South Africa’s trading partners has slowed from over
5 per cent in 2010 to nearly 3 per cent last year (a similar pattern holds
for PPP-weighted world growth). Traditional trading partners in Europe
have struggled with prolonged recessions. China’s growth moderation and
rebalancing has severely depressed commodity prices. This has limited the
contribution of net exports to growth.
These three relatively persistent problems – household debt, electricity
supplies and the world economic environment – have been exacerbated
by shorter-lived shocks. Strikes have temporarily depressed growth, for
instance in the third quarter of 2013 (in which motor manufacturing
suffered labour disruptions) and in the first half of 2014 (which experienced
the most concentrated effects of the prolonged platinum-sector strike). The
drought conditions in 2015 also sharply reduced output in the agricultural
sector, which contracted 8,4 per cent year-on-year. Such shocks are hard to
forecast. Their effects should also be transitory. However, repeated negative
shocks might have longer-term consequences, for instance by consolidating
a slow-growth narrative for South Africa and thereby damaging confidence.
In this context, judging the economy’s level of unused capacity is a difficult
task. Estimates of potential growth have been lowered yet again, reaching
1,5 per cent for 2016 and 1,6 per cent for 2017. As actual growth is expected
to undershoot these estimates slightly, the output gap deteriorates. Point
estimates of the gap show that it is negative at around 2 per cent of potential
GDP, but the uncertainty around this is substantial. More likely than not, it
is in a range between 0 and -3 per cent of GDP, with a small chance of it being
positive. Given growth under 1 per cent this year, it is very likely moving lower.
Over the longer run, South Africa’s economy should be capable of stronger
Percentage change from quarter to quarter*
South African real GDP growth
* At seasonally adjusted annualised rates
Source: South African Reserve Bank


Percentage change
Forecast
Trade-weighted GDP growth

Trading partners
Sources: International Monetary Fund, South African Reserve
Bank and own calculations

South Africa

Monetary Policy Review April 2016

expansion, and as such the goal of raising potential growth is a priority.
Monetary policy, however, can add relatively little to potential growth except
indirectly via long-term borrowing costs and the real effective exchange rate.
Looking forward, it is difficult to see which sectors could generate
significantly more output in 2016. Household consumption constitutes the
largest proportion of GDP at around 60 per cent, and has also been the main
source of growth in the economy since the crisis. Households, however, are
increasingly constrained. Rising inflation is eroding buying power. Debt
levels remain high and households have actually reduced net savings in
Box 2
Output gap uncertainty
The output gap is an important concept for monetary policy, indicating the degree of
demand pressure in an economy. It is calculated as the accumulated difference between
an economy’s potential growth rate and its actual growth rate. However, potential growth
is difficult to estimate with precision. For this reason, it is important to consider the
uncertainties around output gap estimates. There are three distinct sources of uncertainty,
namely (i) those related to the method used to estimate the gap, (ii) changes when new data
become available, and (iii) occasional revisions of the historical data. This box details the
impact of each of these uncertainties on the Bank’s measure of the output gap.
Estimation uncertainty can be thought of as ‘model uncertainty’. There are different
methods for estimating the output gap which tend to give different answers.1 It is never
possible to deliver a final verdict on the output gap, even with hindsight, because it is
unobservable. (By contrast, it is possible to compare inflation forecasts with actual
numbers from the Statistics South Africa (Stats SA) survey, which measures the tangible
phenomenon of price increases for goods and services in consumer baskets.) Given
these difficulties, the standard error around the point estimate of the output gap is
1,7 percentage points. Approximately a third of that reflects the inadequacy of the
models, and the rest stems from the output gap’s unobservable nature.
Updating uncertainty occurs when a previous quarter’s estimated figure is updated with
recently released data. The additional data provide supplementary information that is then
used to improve the distinction between the cyclical and potential components of gross
domestic product. The result is that the output gap estimate will change as additional
data are released. Based on historical data, updating is likely to cause the current output
gap estimate to change by approximately 0,7 percentage points after two quarters and
by 1 percentage point beyond four quarters of new data.
New data points are of course not the only source of new information. As more
comprehensive data become available, Stats SA occasionally revise their estimates of
GDP, which may cause revision uncertainty. The question here is, ‘To what extent could
the current estimate of the output gap change if the underlying data is revised?’ The
answer, historically, has been that the output gap changes by about 0,1 percentage
points after one quarter and 0,3 percentage points after three years.
Policymakers must make choices in real time, using the best information available. Where
that information is flawed, the imperfections need to be communicated and the material
appropriately discounted. How reliable is the output gap measure in real time? The
Bank’s real-time estimate has the same sign as the final estimate about 90 per cent of
the time, with both revision and uncertainty changes stabilising after three years. Whether
the model is accurate in itself is another problem, but it is an unchanging one: the
uncertainty is the same in real time as it is three years later. Given these limits to the
output gap, it is prudent to view it as one input among many in the policymaking process.

For a review of output gap measures and their varying results, see South African Reserve Bank Working
Paper 16/02 by Johannes Fedderke and Daniel Mengisteab titled ‘Estimating South Africa’s output gap
and potential growth rate’, available at
Attachments/7191/WP1602.pdf.


Output gap uncertainty
Per cent

2012 2013


Output gap
Source: South African Reserve Bank

Index
FNB/BER Consumer Confidence
Source: Bureau for Economic Research


Monetary Policy Review April 2016
recent years. Spending now exceeds incomes by around 2 per cent, from a
position of balance in 2009. Employment growth has slowed since the crisis
and unemployment may increase slightly as government implements a hiring
freeze and the mining sector sheds jobs. In this environment, household
sentiment is pessimistic. The First National Bank/Bureau for Economic
Research (FNB/BER) Consumer Confidence Index fell to a 15-year low in
the middle of 2015, a level last achieved at the end of 2001. (Previous lows
were experienced in 1993 and during the debt standstill of 1985.)
The business sector is also characterised by low levels of confidence. The Rand
Merchant Bank (RMB)/BER Business Confidence Index is at a post-crisis
low, while the South African Chamber of Commerce and Industry (SACCI)
Index has fallen to levels last seen in 1993, suggesting a low likelihood of
expanded corporate investment. Investment by this sector has in fact been
one of the chief disappointments of the post-crisis period (although there have
been notable exceptions, particularly in renewable energy). Private investment,
which accounts for about two-thirds of overall investment, has grown at just
over 2 per cent on average since the recession. This is significantly below precrisis levels (9 per cent between 2000 and 2008) and comes despite favourable
interest rate settings. Investment as a share of GDP has slipped to about 20 per
cent, down from the 2008 peak of 23 per cent and well below the National
Development Plan goal of 30 per cent.
Net exports have made positive contributions to GDP growth in each
of the past three years. The forecast, however, shows net exports will
detract slightly from growth this year and make no contribution in 2017,
before returning to positive territory in 2018. The current-account deficit
expands slightly over the forecast period, approaching 5 per cent of GDP in
the outer year.
The outlook for the current account deficit mainly reflects changes to South
Africa’s terms of trade. These have weakened by about 8 per cent from their
peak in 2011 and are expected to fall further, although the extent of the likely
change is difficult to judge. The January MPC forecast was premised on a
relatively adverse outlook for the terms of trade, taking the current-account
deficit beyond 5 per cent of GDP in 2016 and 2017, from 4,4 per cent in 2015.
The latest forecast uses a slightly more favourable scenario, given cheaper oil
as well as improved prices for export commodities. As a result, the deficit is
now forecast at 4,6 per cent this year, 4,7 per cent in 2017 and 4,9 per cent in
2018. There is a risk of a worse outcome, however, should South Africa’s terms
of trade revert to longer-run historical averages, around 14 per cent below
current levels.
Table 1: Prices of major South African export commodities during previous
episodes of oil prices around US$30 per barrel
US dollar per unit
(averages)
Brent
crude oil
South
African
coal
Iron ore
Gold
Platinum


1 149

Source: World Bank
Percentage points
Contribution of net exports to GDP growth

Imports of goods and services

Exports of goods and services

Net exports
Source: South African Reserve Bank


Forecast
Index: 2010 = 100
Terms of trade*
* Including gold
Source: South African Reserve Bank

2000 2002 2004 2006 2008 2010 2012 2014
Business confidence

SACCI Business Confidence Index

RMB/BER Business Confidence Index

(right-hand scale)
Sources: South African Chamber of Commerce and Industry
and the Bureau for Economic Research
Index
Index

Monetary Policy Review April 2016

International commodity prices have an important effect on South Africa’s
export performance. As these prices have declined from their peak in 2011,
the share of major mining exports in GDP has fallen from over 9,5 per cent
to 7,2 per cent. The full force of the price shock has been cushioned by rand
depreciation, however, which has supported the value of domestic producers’
export earnings relative to their domestic costs. Where world prices have
held up, as in the case of gold, rand prices have been unusually favourable:
in nominal rand terms, the gold price reached an all-time high in early
March. Other major export commodities, including coal and platinum,
have been fairly flat in rand terms. Iron ore, however, has seen such large
price movements that its value has declined even in nominal rands.
Table 2: Exports and imports of major mining commodities
Percentage of GDP
Coal
exports
Gold
exports
Platinum
group
metals
exports
Iron ore
exports
Major
mining
commodity
exports
(total)
Oil
imports

Sources: South African Reserve Bank and IHS Global Insight
On the import side, rand depreciation has partially offset the recent declines
in world oil prices. It has also pushed up the rand costs of other imports,
including food needed to counter drought-induced shortfalls in local
production. This is contributing to some import growth over the forecast
period – adding to what are already elevated import levels. From the trough
of the recession in 2009 goods imports have grown by 48 per cent, versus
GDP growth of just under 15 per cent and export growth of 33 per cent.
This import resilience, despite slowing growth and currency depreciation,
helps to explain why the current-account deficit remains persistently and
substantially negative.
The current-account deficit, however, is not simply a consequence of
South Africa’s overall trade in goods. One important additional factor
is the services account. This has closed quite sharply over the past few
years, from -0,93 per cent of GDP in 2010 to -0,15 per cent in 2015. The
adjustment in this account is partly explained by rising tourism receipts,
which tend to react quite quickly to exchange rate depreciation. The
total number of tourists visiting South Africa declined in 2015, but this
is likely explained by changes in visa regulations. As these measures are
refined, there may be scope for growing tourism further given an even
more attractive exchange rate for most foreigners.
US dollar
US dollar


US dollar prices of South Africa’s main
export commodities
Platinum
Coal (right-hand scale)
Source: World Bank
Gold
Iron ore (right-hand scale)

Rand
Rand


1 200
1 500

Rand prices of South Africa’s main
export commodities
Platinum
Coal (right-hand scale)
Sources: World Bank, South African Reserve Bank and
own calculations
Gold
Iron ore (right-hand scale)

Monetary Policy Review April 2016
The other crucial determinant of the overall current-account balance is
the income and current-transfer account. This has shown a chronic deficit
in the region of 3 per cent of GDP, ensuring that South Africa maintains
a substantial current-account deficit even when the goods and services
accounts are balanced. This large deficit mainly reflects South Africa’s
shortfall of domestic savings and therefore a need to borrow savings from
the rest of the world. The absolute size of this component has increased over
time, in line with the shift to fiscal deficits following the global recession.
Some narrowing in the income and current-transfers account can be
expected, however, as the fiscal deficit contracts.
The fiscal authorities have accelerated the consolidation programme under
increased pressure from rising debt levels and higher interest costs. The
2016 budget sets out a more rapid adjustment trajectory than envisioned in
previous policy announcements, including most recently the 2015 Medium
Term Budget Policy Statement (MTBPS).
Table 3: Comparison of National Treasury forecasts
Percentage of GDP


Source: National Treasury
With slower growth, achieving faster consolidation requires larger spending
cuts and more revenue collection. To this end, there have been a number of
tax adjustments, including to personal income tax and fuel levies. Spending
is reduced, notably on public salaries, with vacant posts being frozen as a
prelude to recalibrating personnel requirements. Government consumption
growth should slow to below GDP growth over the forecast period, averaging
about 1,2 per cent (versus 1,3 per cent on average for growth).
South Africa’s slowing growth is therefore affected by all the main
categories of GDP: constrained household and government consumption,
weak investment and negative net exports. Escaping these forces is not
straightforward. Faster consumption growth is unlikely to be sustainable,
both because of its import intensity and the stresses it would impose on
already-strained household and government balance sheets. But net export
growth is a difficult task when commodities dominate the export basket
and commodity prices are weakening. Greater investment would boost the
economy’s long-run potential, so although it would entail higher capital
goods imports which might exacerbate the current-account deficit, it would
at the same time help to generate the resources to repay those debts. Higher
growth driven by investment would also improve South Africa’s growth
narrative, helping to attract foreign savings. Investment is unlikely to
rebound, however, as long as private-sector confidence is subdued. The most
plausible path towards sustainability is therefore likely to include a stretch
of disappointingly slow growth, during which time domestic savings should
rise and the world environment might become less adverse.
Percentage of GDP
Current-account components
Sources: South African Reserve Bank and own calculations


Trade and services
Income and current transfers
Monetary Policy Review April 2016

The MPC continues to see growth risks to the downside, despite very low
levels of expected growth. In this context, public attention has understandably
focused on whether the economy will fall into recession, usually defined
by the conceptually simple (if theoretically unfounded) rubric of two
consecutive quarters of negative growth. Based on the probabilities in the
fan chart, the likelihood of this occurring never exceeds 9 per cent, meaning
the economy will most likely avoid a recession. With population growth
of around 1,6 per cent, however, living standards will decline at current
growth rates.
Box 3
Forecast accuracy and the economy’s performance relative to the
MPC’s November 2013 forecasts
Monetary policy affects the economy with a lag, with the largest impacts occurring after one
to two years. For this reason, forecasts are a crucial input into the decision-making process.
Indeed, so central are forecasts to inflation targeting that Lars Svensson, a pioneer of the
approach, prefers to call it ‘inflation forecast targeting’.1 Forecasting, however, is an inexact
science. It is therefore important both to test the accuracy of the forecasts against
measured outcomes and to communicate the limits of forecasting. This box examines the
Bank’s growth and inflation forecasts against outcomes and against private forecasts.
Actual data for growth and inflation are now available for both 2014 and 2015. Forecasts
for these years first appeared in the November 2013 MPR. Comparing those forecasts with
the outcomes shows that the inflation forecast performed better than the growth forecast,
with growth coming in well below the Bank’s central projection. The large miss on the
growth forecasts reflects a number of shocks, including electricity shortages, lower
commodity prices, strikes and drought. Inflation also diverged from the central projection of
the forecast for 2015, mainly due to the unexpected collapse in oil prices.
Compared to Reuters’ average forecasts, the Bank’s inflation forecasts again proved more
accurate than the growth forecasts. Two statistical techniques are used for the comparison:
the average forecast error and the root mean square error (RMSE). The average forecast
error measures projection bias in terms of systematic over- or underestimation. The RMSE
reveals the standard deviation or magnitude of the errors. Outcomes for inflation and real
GDP growth are subtracted from their projections and the two error statistics are calculated.
The period under review covers the entire post-crisis period, from the fourth quarter of 2009
until the fourth quarter of 2015.
The results show that the Bank and Reuters’ average errors are slightly positive for most of
the consumer price index (CPI) inflation projections and highly positive for all the GDP
projections. This shows that forecasts were biased upwards, on average, for most of the
post-crisis period for inflation and for all of this period for GDP.
The RMSE shows that the Bank’s CPI inflation forecast has been marginally more accurate
than the Reuters mean for all but one of the seven forecast quarters. By contrast, the
Reuters GDP forecast is more accurate than the Bank’s in every quarter except the first.
Four-quarters-ahead RMSE measures of inflation are substantially lower than the
corresponding measures of GDP. The Bank and Reuters’ four-quarters-ahead CPI RMSEs
measure 0,8 and 1,0 percentage points respectively, while their GDP RMSEs measure
2,1 and 2,0 percentage points respectively. This shows that the growth forecasts have
been generally less accurate than the inflation forecasts. The implication may be that
economists’ models are better-suited to forecasting inflation than growth. Alternatively,
growth may be behaving more abnormally than inflation at present.

See Lars Svensson, ‘Inflation forecast targeting – implementing and monitoring inflation targets’, European
Economic Review 41, 1997, pp 1111–1146.

Target inflation outcomes and projection*
from the November 2013 MPR
Per cent

2012 2013

2014 2015
Inflation target range
* CPI inflation trajectory nine quarters ahead
Source: South African Reserve Bank


Real GDP growth outcomes* and projection**
from the November 2013 MPR
Percentage change
* Real GDP growth outcomes differ from real GDP at the
time the forecasts were made as the data have subsequently
been revised.
** Real GDP growth trajectory ten quarters ahead
Source: South African Reserve Bank

2012 2013

2014 2015

Real GDP at the time of the
November 2013 MPR

Real GDP growth

Monetary Policy Review April 2016
Average forecast error
Percentage points
Quarters ahead
Quarters ahead
Percentage points
CPI
GDP


Root mean square error
Percentage points
Quarters ahead
Quarters ahead
Percentage points
CPI
GDP


South African Reserve Bank

Reuters
Sources: Reuters and own calculations


Monetary Policy Review April 2016

Inflation developments and outlook
Exchange rate and food price shocks have pushed the headline inflation
forecast above 6 per cent for 2016 and most of 2017. The March 2016
forecast for headline inflation has improved somewhat on January’s, given
the rate increase at the start of the year as well as a partial rand recovery and
a more favourable trajectory for administered prices. Nonetheless, the breach
of the target is still expected to last into late 2017, and the inflation risks are
to the upside.
Headline inflation moved above the upper end of the target range in
January 2016, to 6,2 per cent, increasing by a full percentage point relative
to the previous month. In February it accelerated further, to 7,0 per cent, the
highest rate in almost seven years. Inflation is forecast to remain above the
upper end of the target range for 2016 and most of 2017, averaging 6,6 per
cent and 6,4 per cent respectively. The main drivers of this elevated forecast
are the direct and indirect effects of both higher food prices and exchange
rate depreciation.
Between the January and March MPC meetings, the rand regained some
ground in foreign-exchange markets, suggesting some overshooting in
December and January. The oil price assumption was lowered in line with
falling world prices, and the electricity price forecast was also adjusted
downward following the National Energy Regulator’s (NERSA’s) price
ruling on 1 March 2016. These factors produced some moderation of the
inflation forecast relative to January’s outlook, which had indicated inflation
at 6,8 per cent for 2016 and 7 per cent for 2017.
Much of the envisioned respite is uncertain, however, as evidenced by recent
exchange rate volatility and a rebound in world oil prices. Furthermore,
despite the slight improvement to the outlook, inflation is still elevated. Core
inflation, which excludes the more volatile components of the consumer
basket, is forecast at 6,2 per cent for this year and at 5,7 per cent for next
year. Inflation expectations over the longer run are at or above the top end
of the inflation target range. Although the recent acceleration in inflation
is mostly explained by supply shocks, these are exacerbating already high
levels of underlying inflation.
Table 4: Inflation forecasts at 2016 MPC meetings
Per cent
January MPC
meeting
March MPC
meeting
Headline
inflation
Core
inflation
Headline
inflation
Core
inflation

Source: South African Reserve Bank
Percentage change over 12 months
Headline and core inflation

Headline inflation

Core inflation

Inflation target range
Source: Statistics South Africa

2015 2016

-2
-1

Proportion of headline inflation
Percentage points
Contribution of petrol and food prices to
headline inflation*

Food: estimated contribution

Petrol: estimated contribution

Combined contribution (right-hand scale)
* Petrol and food prices have a combined weight of almost
20 per cent in the basket and therefore have a significant
effect on headline inflation.
Sources: Statistics South Africa, Department of Energy
and own calculations

-20
-10

Monetary Policy Review April 2016
Food prices
South Africa is in the midst of its worst drought in over 20 years. For
most of 2015, this drought was expected to raise food prices, but these
higher prices failed to materialise. This was partly because the drought led
farmers to reduce their livestock holdings, which suppressed meat prices.
A contemporaneous decline in oil prices also reduced production costs.
But now food price inflation is accelerating rapidly, proving the original
forecasts not wrong but premature. From a trough of 4,2 per cent in June
2015, food price inflation overtook headline in October and reached 7 per
cent in January 2016. It is expected to average 9,4 per cent for 2016 and
7,8 per cent for 2017, up from 5,1 per cent in 2015.
The largest single contribution to the recent uptick in food price inflation
came from vegetables. These have relatively short growing seasons, so the
drought effects on prices are expected to be quite short-lived. The prospects
for meat and cereals prices, however, are more unfavourable, and price
developments in these categories are expected to shape food prices over the
forecast period. Cereals can only be planted at certain times, and for recent
crops rain arrived too late. For this reason, to use maize as an example, the
2014/15 harvest of 9,9 million tons was 4 million tons lower than the robust
2013/14 harvest. In addition, the drought has led to expectations of an even
lower maize harvest in the current 2015/16 growing season. Cereals imports
are rising to meet demand, and higher prices will boost food price inflation.
Meat prices are likely to follow a similar trend, climbing as farmers rebuild
herds. The upward trend for meat may well outlast that for cereals.
In contrast to domestic prices, international food prices have been shifting
lower. The United Nations Food and Agricultural Organization (FAO)
Food Price Index entered deflation territory in mid-2013, reflecting US
dollar strength as well as good harvests in some countries, among other
factors. In South Africa, cheaper world food prices have been curtailed by
currency depreciation. This has limited the benefits for consumers. For
those domestic producers with goods to sell, however, currency depreciation
has provided some protection from lower world food prices.
Petrol prices
Domestic petrol prices rose by 10 per cent in January compared to prices
one year earlier, concluding a 13 month period of petrol deflation. US
dollar-denominated oil prices have actually fallen further in 2016, relative to
2015 levels. Yet the domestic benefits of this decline have been offset by the
exceptionally weak rand. Between September and late March, Brent crude
oil prices dropped by about US$10 (19 per cent), whereas the domestic
petrol price fell by 7 per cent (R0,83) in total.
The collapse in world oil prices reflects a mix of supply and demand factors,
with supply-side dynamics most important in explaining recent price
movements. During 2015, members of the Organization of the Petroleum
Exporting Countries (OPEC) increased oil supply, hoping to force US shale
producers out of the market. US producers nonetheless managed to cut costs,
maintaining production at lower oil prices than previously thought possible.
This left world markets oversupplied and posed major financial challenges
for both OPEC and US producers. In February, Saudi Arabia and Russia
announced plans to cap OPEC production at January levels – a move that is
Contributions to food inflation

Bread and cereals

Fish

Oils and fats

Vegetables

Other
Sources: Statistics South Africa and own calculations

Meat

Milk, cheese and eggs

Fruit

Sugar, sweets and desserts

Per cent

Rand per ton
Rand per ton

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

White maize SAFEX spot price
Yellow maize SAFEX spot price
Wheat SAFEX spot price
Cents per litre
Cents per litre
-150
-100
-50

South African petrol price and contributions
to changes in the basic fuel price

Movement in international product prices (right-hand scale)

Exchange rate (right-hand scale)

Gauteng price of 95 octane unleaded petrol

Price change (right-hand scale)
Source: Department of Energy

2015 2016


Monetary Policy Review April 2016

expected to stabilise oil prices if it gains the support of other members. But
achieving this consensus could be difficult. OPEC members are reluctant to
reduce production if that means ceding market share to shale oil competitors.
Furthermore, Iran is resuming exports following the lifting of sanctions and
intends to regain market share. An OPEC meeting in April should bring
clarity on the likelihood of a production freeze.
The international oil market has experienced a structural transformation
over the past few years, leading to much uncertainty over the ‘equilibrium’
oil price. What consensus exists points to oil becoming more expensive over
the next few years, but remaining well below the triple-figure prices which
seemed normal as recently as 2014. For instance, the US Energy Information
Administration forecasts a move towards US$50 in the medium term.
Prices are unlikely to stay much lower than this threshold as few countries
can sustainably produce oil for less. Demand is also expected to rebound,
especially from emerging markets. Yet price increases much beyond that
point are likely to be capped by the recent, dramatic expansion in world
supply, particularly from shale energy.
At the March MPC meeting, Brent crude prices were assumed to average
US$37 for 2016 and US$45 for 2017 (below their 2015 average of US$53).
Petrol price inflation is expected at 0 per cent this year, suppressing inflation
in the broader category of administered prices, and 10 per cent in 2017.
Compared to January, the rand’s partial recovery has suppressed petrol price
inflation, which was then expected at 8 per cent for 2016 and 12 per cent
for 2017. Petrol price inflation, alongside food, will thus add to inflationary
pressure in 2017.
Core inflation
Core inflation is expected to average 6,2 per cent in 2016 before declining
somewhat to 5,7 per cent in 2017. This is a significant increase from the
2015 average of 5,5 per cent. The rise in core inflation in the near term
reflects some idiosyncratic and probably temporary shocks alongside more
durable inflationary pressures. The story of core, however, is not simply
about its rise but also about its persistence; it has been above 5 per cent for
the past three years. At such elevated levels, even small shocks can shift this
broad measure of prices beyond 6 per cent, a threat of which the MPC has
been warning for some time.
The recent upward shift in core has several components. One important
factor is rising vehicle price inflation, very likely related to currency
depreciation. This may also explain some of the increase in insurance;
medical aid costs, for instance, have exchange-rate exposure, principally
through equipment and drugs. Alcohol and tobacco is quite a volatile
category which is now making an unexpectedly large contribution to core.
More unexpected still, Lotto tickets increased markedly in January, adding
0,2 per cent to the overall core measure. As some of these adjustments are
likely to be once-off shocks, core should adjust lower on base effects after
a year. For this reason, the core forecast moderates in 2017. Core inflation
is nonetheless a category that normally changes course slowly, suggesting
a risk that it will stay higher for longer.
Rands per litre
Evolution of petrol price forecasts

March 2016

May 2015

May 2014
Source: South African Reserve Bank

January 2016

November 2015
November 2014

Percentage change over 12 months
Core inflation and components

Core inflation

Services inflation

Core goods inflation
Sources: Statistics South Africa and own calculations

2015 2016

Monetary Policy Review April 2016
Inflation expectations
For some time, the MPC has expressed concern over inflation expectations
clustering at around the 6 per cent level. These expectations may become
self-fulfilling prophecies: inflation persists at 6 per cent because wage and
price setters plan on 6 per cent increases simply to maintain real incomes.
With ‘normal’ inflation already at the top end of the target range,
additional shocks also risk sustained departures from the target. Since the
last MPR, expectations have deteriorated, exacerbating this problem.
Inflation in 2015 was close to the midpoint of the target range. Despite
this, inflation expectations as measured by the BER survey barely dipped
below 6 per cent, except for the current year. By the fourth quarter of
the year, overall expectations for one, two and five years had all shifted
above 6 per cent, a finding replicated in the survey published in March
2016. Reuters’ survey of analysts, which closely mirrors the BER’s analysts
subcategory, now also shows inflation expectations for both 2016 and 2017
above 6 per cent, having moved from 6 per cent in January to 6,4 per cent
in February. Expectations for 2017 moved above 6 per cent in January
2016 following the rand’s abrupt depreciation, and increased marginally
to 6,1 per cent in February.
The deterioration in break-even inflation rates was more dramatic. These
are market-based measures of expectations over the longer run, with data
available for five- and ten-year terms. Both spiked close to 8 per cent
in December 2015, but have retraced since mid-January and are now at
around 7 per cent.3 This is significantly above the 2015 averages of 6,2 per
cent and 6,4 per cent for five- and ten-year measures respectively. Breakevens are not precisely comparable to surveys of inflation expectations.
In particular, they reflect not just a market forecast for inflation but also
a premium for the risk of additional inflation. These risks are also of
interest to the monetary policy authorities, especially when the premiums
are substantial and the risks apply to longer time frames over which shocks
should have, on balance, insignificant effects.
Wages and unit labour costs
Supply shocks, such as the exchange rate and food price increases now buffeting
the economy, have consequences for wages and salaries. Fundamentally, South
Africans become poorer when export commodities are worth less abroad
and local food production declines. Incomes should therefore moderate in
real terms. This process might itself subdue inflation as consumers reduce
spending elsewhere. However, if wages and salaries are adjusted upwards to
compensate for these losses, the costs must go elsewhere. One option is that
unemployment will rise. In this case, although average pay rises, fewer people
are employed and total remuneration is unchanged. Another option is that
inflation rises, setting off a series of competitive wage and price increases and
ultimately penalising those without the power to maintain their incomes. One
objective of the inflation-targeting framework is to ensure that supply shocks
do not have such cascading impacts on inflation.

These break-even inflation rates are based on generic Bloomberg series which are calculated as the difference
between maturity-matched sovereign fixed-income and sovereign inflation-linked bonds. In theory, the level of
the rates should reflect inflation expectations as well as the inflation risk premium. Market imperfections make the
interpretation of break-even rates more challenging. Inflation-linked bonds are not traded as intensively as fixedincome instruments. Participants in the two markets also tend to have different characteristics.
Per cent
Survey-based inflation expectations*

Current year

Two years ahead

Inflation target range
Source: Bureau for Economic Research


One year ahead

Five years ahead
* Total, combining expectations of labour,
business and analysts
Break-even inflation rates

Source: Bloomberg

Five year

Ten year
Per cent

Percentage change
Salaries per worker and food inflation
Sources: Statistics South Africa and South African Reserve Bank

Food prices
Salaries per
worker
Per cent
Inflation expectations (2016 Q1 survey)

Current year

Two years ahead
Source: Bureau for Economic Research

Trade Unions
Business
Analysts

One year ahead
Monetary Policy Review April 2016

Over the past three years, unit labour cost (ULC) growth has gradually
moderated from the 2009/10 excesses. These, in turn, were related to the
large food and energy price shocks of 2008/09. The risk is that the current
round of shocks will have similar consequences. Wage and salary agreements
in South Africa tend to be inflation-linked, so higher headline inflation now
may well generate higher ULC growth in a year. In fact, after the extreme
food and petrol price shocks of 2008, salaries per worker accelerated up to
2010. Furthermore, the pressure from ULCs may be more intense as growth
slows, because output will be expanding less rapidly than remuneration.
The exchange rate
Exchange rate depreciation has been persistent over the past five years. Since
January 2011, the rand has depreciated by 50 per cent against the currencies
of trading partners. After adjusting for inflation differentials, the change is
40 per cent. Against the US dollar, in which a disproportionate share of world
trade is invoiced, the adjustment is larger still.
As discussed in the previous MPR, there are two types of medium-run shocks
which have been driving depreciation: a demand shock as the commodity
supercycle ends and a portfolio shock as the Fed begins tightening and capital
returns to the US from riskier investment destinations abroad. In addition, in
December 2015 South Africa experienced a large, idiosyncratic exchange rate
shock. This was exacerbated in the first quarter of 2016 by market volatility
emanating from China as well as ongoing domestic disruptions.
The inflationary impact of these shifts has been limited by lower exchange
rate pass-through to inflation, relative to historical experience. One direct
explanation for this outcome is that weak domestic demand has left firms
reluctant to pass cost increases on to consumers. There is also evidence that
inflation targeting reduces pass-through, possibly by giving wage and price
setters an alternative to the exchange rate as an anchor for their expectations.4
Nonetheless, there is a persistent risk of pass-through reverting to more
historically normal levels, perhaps as the currency passes certain thresholds.
Relatedly, higher pass-through may be triggered if the credibility of the
inflation target appears to weaken. Yet even if these risks are controlled,
exchange rate depreciation still poses an inflation problem. The currency has
weakened significantly – over 20 per cent against the US dollar in 2015 alone
– such that even with low levels of pass-through the total effect on prices is
substantial.
Credit and asset prices
Credit growth has remained relatively weak since the crisis. General lending
to households, fuelled mainly by unsecured loans, grew rapidly up to mid2013 but then decelerated. Growth in total credit to households averaged
around 4 per cent in 2014 and 2015, and has therefore been negative in
real terms. Households are still rebuilding their balance sheets and banks
are adjusting to post-crisis regulatory changes as well as to the decrease in
profitability from a sustained period of low interest rates. Corporate credit
growth strengthened from 2014 to average 14 per cent in 2015. However,
this appears to have been offset by a decline in corporate bond issuance.

See for instance South African Reserve Bank Working Paper 12/08 by Janine Aron, Greg Farrell, John Muellbauer
and Peter Sinclair, ‘Exchange rate pass-through to import prices, and monetary policy in South Africa’, available at

Indices: January 2011 = 100
South African exchange rate measures

REER

NEER

US dollar against the rand
Sources: Bloomberg, Bank for International Settlements and
South African Reserve Bank

2015 2016

Indices: 1 January 2011 = 100
Exchange rate of the rand against
major currencies

US dollar

Japanese yen
Source: Bloomberg

2015 2016

Euro

British pound
Percentage change over 12 months
Imported PPI inflation and NEER changes

Unit value index* for total imports

NEER (inverted)
* Import unit value indices measure inflation in imported commodities
using customs-level data from the South African Revenue Service.
They are not comparable to the discontinued PPI series for imports.
Sources: South African Reserve Bank and Statistics South Africa

2015 2016

-15
-10
-5

Monetary Policy Review April 2016
As with credit, asset prices have not supported stronger household
consumption recently, particularly when adjusted for inflation or currency
depreciation. In real terms, the All-Share Price Index has been flat for the
past two years and is below its pre-crisis peak. House price growth has also
been close to inflation. Given these factors, credit extension and asset prices
are not at present contributing to inflationary pressures in the economy.
Risks to the forecast
Between November 2015 and January 2016 the inflation forecast deteriorated
significantly, from 6 per cent to 6,8 per cent for 2016 and 5,8 per cent to
7 per cent for 2017. This deterioration was not altogether surprising. Some
of the risks had been visible at the time of the November meeting, and the
decision to hike rates by a quarter of a percentage point at that time reflected
the risks as much as the forecast itself.
In January, the visible risks were more closely incorporated into the baseline
forecast. For this reason, for the first time in a year, the risks around the
forecast were deemed to be balanced. Uncertainties remained, but these did
not skew disproportionately to higher or lower inflation.
In March, the forecast for inflation declined marginally, but this
improvement depended heavily on exchange rate and oil price developments.
Before the MPC meeting, both variables had moved in more favourable
directions, but these shifts were reversing even as the MPC met – suggesting
the moderation of the outlook was less signal than noise. Accordingly, the
balance of risks for the March forecast was once again assessed to be towards
higher inflation.
Box 4
The Bank’s CPI inflation forecast revisions for 2016 and 2017
Between the November 2015 and January 2016 Monetary Policy Committee (MPC)
meetings, the Bank revised its 2016 and 2017 inflation forecasts sharply higher. These
adjustments were larger than those made by private-sector forecasters, producing a
sizeable gap between the Bank and private forecasters. Although in general these two sets
of forecasts are well aligned, in truth they serve different purposes. The Bank’s forecasts
estimate inflation outcomes to assess whether policy intervention is necessary. By contrast,
private-sector inflation forecasts estimate inflation outcomes, including their expectations of
policy changes. This is not the only methodological difference between the two types of
forecasts but it is conceptually important. As a result, the two should be expected to
diverge at times. It appears that private-sector forecasts for 2016 were updated after
January, bringing them closer to the Bank’s forecasts. For 2017, much of the discrepancy
remains, likely reflecting methodological differences between the two types of forecasts.
There are two major methodological differences between the Bank’s inflation forecasts and
those of private analysts. First, the Bank’s forecasts use a constant real exchange rate. As
a result, all the depreciation in December and January remains in the forecast, keeping the
rand at real lows across 2016 and 2017. Private forecasters, by contrast, appear to
anticipate some rand recovery. This would particularly affect the petrol price assumption,
which was an important driver of the deterioration between the Bank’s November and
January forecasts. Private forecasters may also be expecting lower oil prices, which
(alongside the improved currency) would result in lower petrol price inflation.
Second, the Bank’s forecasts use a constant nominal interest rate assumption. The
rationale for this is that the forecasts are used to make policy decisions and should not,
therefore, assume or predict what policy decisions will be made. The result, however, is that
while private-sector forecasters include anticipated interest rate adjustments, the Bank’s
Monetary Policy Review April 2016

forecasts do not. This keeps the Bank’s forecasts higher, especially in the outer year of the
forecast period as food and exchange rate shocks generate second-round effects.1
Rate hikes, as at the January and March MPC meetings, are aimed at suppressing these
effects. Wages respond to the experience of higher inflation and so unit labour costs (ULCs)
pick up; for this reason, ULCs were revised upwards by 0,5 percentage points (2016) and
1 percentage point (2017) from the November forecast. The forecast for core inflation rose
by 0,5 percentage points in both years, strongly influenced by ULCs. This change is
probably responsible for much of the divergence between the Bank and Reuters’ median
forecasts for 2017. Of course, if the Bank succeeds in its policy response, these effects will
be more muted and the forecast will be inaccurate. But that forecast is helpful in identifying
the problem that policy needs to address.

Note also that policy decisions by the MPC would be premised particularly on the outer year, as monetary
policy works with a lag of between 18 and 24 months.
Percentage points
Difference between the Bank and Reuters
inflation forecasts

November 2015

February 2016
Sources: South African Reserve Bank and Reuters


January 2016

Monetary Policy Review April 2016
Conclusion
Over the past half-dozen years, hopes for a rebound in world growth have
been disappointed. Instead, global economic growth has decelerated steadily.
Among the major advanced economies, the US has experienced a fairly
robust recovery, but the euro area and Japan have achieved little or no real
growth. The performance of emerging markets has deteriorated, particularly
that of middle-income countries. China has slowed; Brazil and Russia are
in recession. Emerging markets are still contributing the majority of world
growth, but that contribution has fallen steadily every year since 2011.
In an atmosphere of heightened risk aversion, emerging markets have
experienced persistent capital outflows. Markets are highly attentive to
differences in country risk profiles, and specific countries have experienced
sharply higher borrowing costs and currency depreciation as a consequence.
These circumstances make it expensive for South Africa to sustain large currentaccount and fiscal deficits. Compounding these difficulties, the domestic
economy is barely growing, while inflation is outside the target range.
South Africa’s macroeconomic settings provide a robust response to these
challenges. Fiscal policy must navigate higher borrowing costs alongside
diminished revenue prospects. Accordingly, National Treasury has set
out a path of more rapid fiscal consolidation. To make this adjustment as
growth-friendly as possible, public-sector cuts are focused on administrative
spending. To the extent possible, frontline service providers are shielded from
cuts, as is investment. Tax increases have been moderate and progressive.
Monetary policy’s contribution has several dimensions. Interest rates remain
quite low, both in historical terms and compared to peer countries. Much
of South Africa’s growth slowdown is structural but at least some portion is
probably cyclical. Low interest rates help to close the gap between what the
economy is capable of achieving and actual output.
The Bank’s mandate, however, is for maintaining price stability, and so interest
rates have been adjusted to be less stimulatory. Inflation is currently outside
the inflation target range and the latest forecasts suggest it will only return
to target late in 2017. The sources of higher inflation are supply-side shocks,
principally from the exchange rate and food prices. These will naturally make
specific goods and services more expensive. The policy goal is to prevent
these shocks from spreading into prices more generally. Monetary policy
can accommodate temporary shocks that cause target breaches but should
respond if those shocks risk leaving inflation permanently higher, beyond
the target range. To avert this outcome, price and wage setters need to be
confident that the Bank will deliver on its mandate. Both rate increases and
the Bank’s broader communications strategy serve to maintain this credibility.
The exchange rate plays an important role in the macroeconomic framework.
When the economy suffers shocks, for instance to commodity prices, rand
depreciation helps to absorb the impact. A weaker rand improves the local
currency earnings of exporters and raises the competitiveness of importcompeting firms, making it a form of monetary stimulus. If currency
depreciation generates much higher inflation, these advantages will be
eroded. But as long as inflation expectations remain anchored in line with
the monetary policy target, rand depreciation will facilitate rebalancing.
The alternative – to try and fix the exchange rate and thereby subsidise net
imports – is undesirable and also likely to be unsustainable.
These policy responses will help the economy move towards sustainability
and renewed growth. South Africa’s long-run interests are well served by
controlling inflation and other macroeconomic risks now. In the short
term, the fact that South Africa has a consolidated, robust macroeconomic
framework will help to mitigate adjustment costs.
Source: Institute of International Finance
Latin America
Emerging
Asia
Emerging
Europe
Africa and
Middle East
US$ billions
Portfolio flows into emerging-market regions
(Jan 2015–Jan 2016)
-10
-5

US$ billions
Total portfolio flows into emerging markets


Source: Institute of International Finance


Monetary Policy Review April 2016

Statement of the Monetary Policy Committee
28 January 2016
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank, at a meeting of
the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), the inflation outlook
has deteriorated significantly, mainly due to exchange rate and food price developments.
The rand has depreciated considerably in response to domestic and external developments,
while the impact of the worsening drought on food prices is becoming increasingly evident.
The inflation outlook is complicated by the fact that the domestic growth outlook has
weakened further. The global backdrop has also become more challenging, particularly for
emerging markets, and downside risks to the sustainability of the recovery in the advanced
economies have increased.
The year-on-year inflation rate, as measured by the consumer price index (CPI) for all urban
areas, stood at 5,2 per cent in December, up from 4,8 per cent in November. This increase
was broadly in line with both market and the Bank’s expectations, and reflected in part
the delayed response of food price inflation to the impact of the drought on agricultural
prices. Food and non-alcoholic beverages inflation accelerated to 5,9 per cent, up from
4,8 per cent previously, and contributed 0,9 percentage points to the overall CPI outcome.
Goods price inflation increased to 4,6 per cent from 3,8 per cent previously, mainly due to
higher petrol and food prices, while services price inflation remained unchanged at 5,7 per
cent. The Bank’s measure of core inflation – which excludes food, petrol and electricity –
remained relatively stable at 5,2 per cent, up from 5,1 per cent in November.
Producer price index (PPI) inflation for final manufactured goods increased from 4,3 per
cent in November to 4,8 per cent in December. The category of food, beverages and tobacco
products contributed 2,1 percentage points to the December outcome.
The latest inflation forecast of the Bank shows a marked deterioration. Having averaged
4,6 per cent in 2015, inflation is now expected to average 6,8 per cent in 2016 and 7,0 per
cent in 2017. This compares with the previous forecast of 6,0 per cent and 5,8 per cent for
these years. Inflation is still expected to breach the upper end of the target range in the first
quarter of 2016, but is now expected to remain outside the target range for the entire forecast
period. A peak of 7,8 per cent is expected in the fourth quarter of 2016 and in the first
quarter of 2017, followed by a moderation to 6,2 per cent in the final quarter of that year
(5,7 per cent previously). The changes in the forecast are mainly due to a significantly more
depreciated real exchange rate assumption and higher-than-expected food price inflation.
These upward revisions more than offset the impact of the lower international oil price
assumption. The electricity price assumption remains unchanged from the previous meeting.
The forecast for core inflation has also deteriorated, although to a lesser degree than that
for headline inflation. Core inflation is expected to breach the upper end of the target range
for four consecutive quarters from the third quarter of 2016, with a peak of 6,4 per cent
in the final quarter of 2016 and in the first quarter of 2017. This measure is expected to
average 6,0 per cent in 2016 and 5,9 per cent in 2017, moderating to 5,5 per cent by the
final quarter of next year. The deterioration in this forecast is mainly due to the significantly
more depreciated real exchange rate assumption and expected higher unit labour costs.
Inflation expectations, as reflected in the survey conducted by the Bureau for Economic
Research (BER), show a marginal upward movement for 2016 but a more pronounced
deterioration for 2017, with average inflation expectations increasing from 5,9 per cent
to 6,2 per cent, mainly due to changes in the expectations of trade union officials. Fiveyear inflation expectations edged up to 6,1 per cent, also mainly due to changes in the
expectations of trade union officials. This survey was concluded prior to the depreciation of
the rand in December, so the outcome of the next survey will be closely monitored.

Monetary Policy Review April 2016
The impact of the rand exchange rate weakness on market forecasts is evident in the changes to
the Reuters Econometer survey between December and January. Median inflation expectations
were stable in November and December, at 5,9 per cent and 5,8 per cent for 2016 and 2017,
but increased in January to 6,0 per cent and 6,1 per cent. The median forecast for 2018 is
5,7 per cent. Break-even inflation rates also increased significantly across all maturities, with
the five-year maturities rising to current levels of around 7,3 per cent.
The global growth outlook appears to have worsened somewhat in recent weeks, contributing
to a correction in global equity markets. Although most of the downward revisions to global
growth have been due to the deteriorating prognosis for emerging markets, more recently
the risks of a slowdown in the United States (US) have increased, amid declining consumer
expenditure and the impact of low oil prices and a strengthening dollar on business
investment. However, despite the fourth-quarter slowdown, growth of around trend is still
generally expected. While the recovery in the euro area remains modest, the growth forecasts
for the United Kingdom and Japan have generally been revised down.
Emerging market growth prospects, particularly for commodity-producing countries,
remain constrained amid persistent capital outflows. The outlook is heavily influenced by
the slowing Chinese economy, but there are conflicting views as to whether a hard landing
can be expected. There is also uncertainty regarding the efficacy of policy reforms that have
been undertaken. Perceptions of the modifications to the renminbi exchange rate regime as
well as equity market volatility have added to this uncertainty.
Global inflation pressures remain benign, reinforced by a further decline in international oil
prices, but there have been upward revisions in some emerging markets. Monetary policies
in most advanced economies are expected to remain accommodative. The slow pace of
normalisation in the US is expected to continue, but further easing is expected in Japan and
the euro area, while the Bank of England has indicated that monetary policy tightening
is still some way off. Divergent monetary policy paths are also expected in the emerging
markets. Commodity importers with sound macroeconomic fundamentals have scope for
further easing, while some commodity producers, particularly those experiencing exchange
rate-induced inflationary pressures, have been in a tightening mode despite slowing growth.
The exchange rate of the rand has depreciated markedly since the previous meeting of
the MPC, contributing significantly to the deterioration in the inflation forecast. Since
the previous meeting, the rand has depreciated by 13,5 per cent against the US dollar, by
15,2 per cent against the euro, and by 12,9 per cent on a trade-weighted basis. The muted
reaction of the exchange rate to the start of US Fed normalisation suggests that this move was
more or less priced in, but this was overshadowed by the impact of domestic developments
on the exchange rate earlier in the month.
In early January, the rand reacted further to growing concerns about the outlook for the
Chinese economy. While most emerging-market currencies were affected, since the previous
meeting of the MPC, the rand’s depreciation has been in excess of most of its emerging-
market peers. Other indicators, such as widening credit spreads and the sharp increase in
domestic bond yields, point to a higher risk premium attached to South African assets.
Although the rand may appear to be undervalued at current levels, divergences from
equilibrium can persist for some time. Furthermore, the current-account adjustment
remains slow, with the deficit expected to widen further in the face of continued weakness in
commodity prices and higher, drought-induced agricultural imports. The financing of the
deficit will also be more challenging in an environment of persistent capital outflows from
emerging markets. Since the previous MPC meeting, non-residents have been net sellers of
South African bonds and equities.
From a monetary policy perspective, a key risk to the inflation outlook is not only the
possibility of further depreciation, but also the extent to which there is a change in the passthrough dynamics, which have been relatively muted in recent years.
Monetary Policy Review April 2016

The domestic economic growth outlook remains weak, with further downward revisions to
the Bank’s forecast. Growth in 2015 is estimated to have averaged around 1,3 per cent and
is expected to moderate to 0,9 per cent in 2016 before accelerating to 1,6 per cent in 2017.
This compares with the previous forecast of 1,5 per cent and 2,1 per cent for 2016 and 2017.
The Bank’s estimate of potential output growth was revised down from 1,9 per cent to
1,5 per cent for 2016, and from 2,1 per cent to 1,6 per cent for 2017. Although there was
a marginal increase in the Bank’s leading business cycle indicator in November, the trend
remains negative, consistent with the subdued outlook. The RMB/BER business confidence
index declined further in the fourth quarter of 2015, to its lowest level in five years.
High-frequency data indicate that the mining sector remains under pressure in the face of
declining commodity prices and weak demand. Despite a recovery in the third quarter, the
manufacturing sector outlook remains negative. Capacity utilisation has declined further,
and the Barclays Purchasing Managers’ Index (PMI), which has remained well below the
neutral level for some months, is consistent with a contraction in the fourth quarter. The
continuing drought means that near-term respite for the agricultural sector is unlikely.
Underlying this growth outlook is the continued low growth in gross fixed capital formation,
with private sector investment contracting in the third quarter. The prospects for formal‐
sector employment growth therefore remain bleak: the Quarterly Employment Statistics
survey of Statistics South Africa reports static employment levels over the four quarters to
the third quarter of 2015.
Growth in consumption expenditure by households moderated in the third quarter, with
contractions in spending on both durable and non-durable goods. Domestic motor vehicle
sales reflected this weakness, although recent retail sales data, particularly with respect to
semi-durable goods, suggest there may have been a modest improvement in the final quarter
of last year. However, the decline in the FNB/BER consumer confidence index in the fourth
quarter of 2015 to a 14-year low suggests that household consumption expenditure is likely
to remain constrained.
Credit extension to households has increased marginally recently, particularly with respect to
mortgage and general loans. However, these increases remain low and credit growth remains
negative in real terms while instalment sale credit continues to slow. Tighter National Credit
Act Regulations related to affordability assessments became effective from September and
are expected to constrain credit to households further.
While credit extension to corporates remains robust, it is relatively narrow-based and reflects,
in part, increased demand for mortgage loans by property funds.
Wage and salary trends continue to contribute to the persistence of inflation at higher levels.
Year-on-year growth in nominal salaries and wages, while lower in the third quarter of
last year, was still above the upper end of the inflation target range. After adjusting for
labour productivity increases, growth in total unit labour costs slowed marginally to 5,0 per
cent in the third quarter. Andrew Levy Employment Publications reported an average wage
settlement rate in collective bargaining agreements of 7,7 per cent in 2015.
Food prices remain a significant risk to the inflation outlook. The surge in agricultural
commodity prices since early 2015 is beginning to impact on consumer food price inflation,
and these pressures are likely to increase in light of the persistent drought and the weaker
exchange rate – despite continued moderation in global food prices. Although previous
forecasts had incorporated an expectation of higher food price inflation, recent adverse
developments have resulted in a further deterioration of the Bank’s food price forecast,
which is now expected to peak at around 11 per cent in the fourth quarter of this year.
International oil prices have declined to multi-year lows since the previous MPC meeting.
The global oversupply and consequent low prices are expected to persist in the short term,
particularly following the lifting of sanctions against Iran. But with marginal producers

Monetary Policy Review April 2016
expected to reduce production or even shut down, prices are expected to follow a moderate
upward trend over the forecast period. The impact of this upward trend on domestic petrol
prices has contributed to the higher inflation forecast for 2017 in particular. The potentially
favourable impact of the international oil price decline on domestic petrol prices has been
more or less offset by the depreciation of the rand. Petrol prices have declined only marginally
since November, and the current under-recovery suggests a possible increase of around
7 cents per litre in February.
Previously, the Committee expressed concerns about the growing risks to the inflation
outlook, mainly due to exchange rate and food price risks. These risks appear to be
materialising and have contributed to the significant deterioration of the inflation forecast.
The intensity of the drought has brought about a sizeable revision to the Bank’s food price
outlook, while the exchange rate has depreciated significantly more than expected. While
oil prices have a moderating impact on the inflation outlook in the near term, base effects
and the assumed upward trajectory contribute to the adverse inflation outlook for 2017. The
forecast also incorporates changes in administered prices, in particular for water, while an
upside risk remains regarding electricity tariff increases.
The MPC assesses the risks to the inflation outlook to be relatively balanced. While there
may be potential for further rand weakness in the short term given the negative outlook
for emerging markets in general as well as domestic factors, the lower observed exchange
rate pass-through remains a mitigating factor. However, there is still uncertainty as to the
sustainability of this low pass-through, particularly in the face of large nominal exchange
rate movements as recently experienced. The upside risk from the exchange rate is more or
less offset by the downside risks from the international oil price assumptions and projected
food price inflation.
Demand pressures remain constrained, and the focus of the MPC will therefore be on the
evolution of inflation expectations and indications of second-round effects of the exogenous
shocks to the inflation outlook. There are some indications that inflation expectations may
have deteriorated, but the extent of this will become more evident in the coming surveys.
The trend in core inflation provides some indication of the possible emergence of secondround effects. Although core inflation has remained relatively contained in recent months,
it is expected to accelerate and to exceed the upper end of the inflation target range for some
time in response to exchange rate and wage pressures.
The Committee faced the continuing dilemma of a deteriorating inflation environment
and a worsening growth outlook. The risks to the growth outlook are assessed to be on the
downside, despite the downward revision to the forecast.
Given the deterioration in the inflation outlook, the MPC has decided to increase the
repurchase rate by 50 basis points to 6,75 per cent per annum, effective from 29 January
2016. Three MPC members supported a 50 basis point increase, two members preferred a
25 basis point increase; while one member preferred no change.
The MPC still views the stance of monetary policy to be accommodative. Despite the rate
increase, the real repurchase rate remains low given the higher-than-expected inflation over
the period.
The MPC will remain focused on its core mandate of containing inflation within a flexible
inflation-targeting framework. As noted on a number of occasions in the past, the MPC is of
the view that the growth constraints facing the economy are primarily of a structural nature
and cannot be solved solely by monetary policy. Nevertheless, the MPC remains sensitive,
to the extent possible, to the possible negative impact of monetary policy actions on cyclical
growth. As before, future moves will be highly data-dependent.
Monetary Policy Review April 2016

Summary of assumptions: Monetary Policy Commitee
meeting on 28 January 2016*
1. Foreign-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


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


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign-sector assumptions and domestic-sector assumptions, see pages 38 and 39.

Monetary Policy Review April 2016
Selected forecast results: Monetary Policy Committee meeting on 28 January 2016
Selected forecast results (annual)
Per cent
Actual
Forecast


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


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2016

Statement of the Monetary Policy Committee
17 March 2016
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), headline inflation
has exceeded the upper end of the target range as pressures from higher food prices in
particular have intensified. Although the longer-term inflation outlook has improved
somewhat, inflation is still expected to remain outside the target range for an extended
period, and upside risks remain. The domestic economic growth prospects remain fragile
following a fairly broad-based weakening in the final quarter of last year, while global
economic prospects remain uncertain.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas increased markedly in January to 6,2 per cent, up from 5,2 per cent in December. Food
price pressures intensified, with food and non-alcoholic beverages inflation accelerating to
6,9 per cent, up from 5,9 per cent previously. Goods price inflation increased from 4,6 per
cent to 6,5 per cent, mainly due to higher food prices and base effects of petrol prices, while
services price inflation increased from 5,7 per cent to 6,0 per cent. The Bank’s measure of
core inflation, which excludes food, fuel and electricity, which had been relatively stable for
some time, increased from 5,2 per cent in December to 5,6 per cent in January. Part of this
may reflect some evidence of higher exchange rate pass-through.
Producer price inflation for final manufactured goods was also indicative of increased cost
pressures, having increased from 4,8 per cent in December 2015 to 7,6 per cent in January.
The main contributor to this acceleration was the category of food, beverages and tobacco
products which contributed 2,8 percentage points to the January outcome.
The latest inflation forecast of the Bank has improved somewhat but, nevertheless, the
protracted, albeit lower, breach remains a serious concern. Inflation is now expected
to average 6,6 per cent and 6,4 per cent in 2016 and 2017 respectively, compared with
6,8 per cent and 7,0 per cent previously. The forecast period has been extended to the end of
2018, and the forecast average for that year is 5,5 per cent. Inflation is expected to peak at
7,3 per cent in the fourth quarter of 2016, down from 7,8 per cent previously, and to return
to within the target range, to 5,5 per cent, during the fourth quarter of 2017. Inflation is
then expected to remain within the target range for the rest of the forecast period. These
changes are due in part to the higher interest rate assumption following the increase in
the repurchase (repo) rate at the previous meeting, a slightly less depreciated exchange rate
assumption, and downward revisions to the international oil price and electricity tariff
assumptions. The latter follows the National Energy Regulator of South Africa’s (NERSA)
decision to grant a lower-than-expected tariff adjustment of 9,4 per cent to Eskom. These
pressures are counteracted to some extent by a higher food price forecast.
The forecast for core inflation reflects a marginal near-term deterioration, reflecting expected
exchange rate and wage cost pressures, but is slightly improved for 2017. Core inflation is
expected to breach the upper end of the target range in the second quarter of 2016 for four
consecutive quarters, with a peak at 6,5 per cent in the third and fourth quarters of 2016.
This measure is expected to average 6,2 per cent in 2016, and 5,7 per cent and 5,2 per cent
in the subsequent two years.
The survey of inflation expectations conducted by the Bureau for Economic Research in
the first quarter of 2016 presents a mixed picture. Although average expectations remain
unchanged at 6,2 per cent for 2016 and 2017, those of analysts increased significantly, while
expectations of business people and trade unions moderated for both years. Inflation is
expected to average 6,0 per cent in 2018, with both analysts and trade unionists expecting
inflation to be within the target range. The five-year average inflation expectations remained
unchanged at 6,1 per cent and have been stable within a range of between 5,8 per cent and
6,2 per cent since the first quarter of 2012.

Monetary Policy Review April 2016
The near-term expectations of economic analysts as reflected in the Reuters Econometer
survey also increased following the depreciation of the rand in December. In the survey
conducted in March, the median expectation for 2016 and 2017 was 6,4 per cent and 6,3 per
cent respectively, but inflation is expected to return to within the target range in 2018 at a
5,6 per cent average. Bond market expectations implicit in the break-even inflation rates are
more or less unchanged since the previous meeting and remain at fairly elevated levels.
The international economic outlook remains challenging following a marked decline in
global growth in the fourth quarter of 2015 as well as a continued moderation in industrial
production in the advanced economies. This included a slowdown in the United States (US)
amid contractions in business fixed investment and exports, and a weakening in consumer
spending. Some improvement is expected in the first quarter, although growth is expected to
remain below potential in the coming months. Subdued growth is expected in the Japanese
economy following a contraction in the fourth quarter, with only a slightly more favourable
outlook for the euro area and the United Kingdom.
The outlook for many emerging-market economies remains weak, with continuing recessions
in Brazil and Russia. The slowdown in China appears to be broad-based, with a declining
Purchasing Managers’ Index (PMI), moderating consumer demand, and lower imports
and exports. The uncertain prospects for China remain a source of intense speculation and
uncertainty for the rest of the global economy.
There are few signs of global inflation pressures, with inflation below target in most advanced
economies, particularly in Japan and the euro area. These trends, combined with slowing
growth, have prompted looser monetary policies in a number of advanced economies, and
accommodative policies are likely to persist. Contrary to this trend, the US Federal Reserve is
expected to continue on its normalisation path, but at a gradual pace. By contrast, exchangerate-induced inflationary pressures persist in a number of emerging economies, particularly
in Latin America, where more sustained tightening can be expected.
The rand exchange rate has recovered somewhat from the lows experienced in December and
January, but nevertheless remains highly volatile and vulnerable to domestic and external
developments. Since the previous meeting of the MPC, the rand traded in a wide range of
between around R16,40 and R15,07 against the US dollar, and has appreciated by 4,5 per
cent against the US dollar, by 0,9 per cent against the euro, and by 2,0 per cent on a tradeweighted basis.
A number of factors contributed to the appreciation of the rand during this period. These
included the reaction to further monetary policy easing in the advanced economies, and
the moderation of the US normalisation path; policy stimulus measures in China which
overshadowed disappointing Chinese economic data; and the reaction to domestic
monetary tightening. Offsetting factors included the weak domestic growth outcome and
higher inflation outlook; the increased risk of a sovereign ratings downgrade; and domestic
political developments which have had a significant impact on the rand in the past few days
in particular.
The exchange rate was also negatively impacted by the wider-than-expected current-account
deficit and its slow pace of adjustment to a depreciated exchange rate. The adjustment is
expected to remain slow, particularly in the context of declining global trade. While the
current account was adequately financed in the fourth quarter of 2015, the lack of portfolio
capital flows remains a concern, despite expectations of some improvement of flows to
emerging markets in 2016. According to JSE Limited (JSE) data, since the beginning of the
year, non-residents have been net purchasers of bonds to the value of around R6 billion, but
net sellers of South African equities to the value of around R20 billion.
The domestic economic growth outlook has deteriorated further. Annual economic growth
of 1,3 per cent in 2015 was in line with the Bank’s expectations, but the forecasts for 2016
and 2017 have been revised down from 0,9 per cent and 1,6 per cent to 0,8 per cent and
1,4 per cent respectively. Growth of 1,8 per cent is forecast for 2018. The potential output
Monetary Policy Review April 2016

growth estimate remains unchanged at 1,5 per cent, rising to 1,8 per cent by 2018. The weak
growth trend remains consistent with the Bank’s leading business cycle indicator which
declined further in December. Although the Rand Merchant Bank/Bureau for Economic
Research (RMB/BER) business confidence index was unchanged in the first quarter, it
remained at its five-year low and masked a collapse in the manufacturing confidence index.
The gross domestic product (GDP) slowdown was fairly broad-based, with contractions in
the agriculture, manufacturing, and transport and communications sectors. The outlook for
the first quarter for mining and manufacturing is constrained, following sharply negative
growth rates in both sectors in January, particularly in mining. Although the Barclays
PMI increased marginally in February, it remained below the neutral 50-point level for the
seventh consecutive month, and capacity utilisation in the sector also remains relatively low.
The continuing drought also points to an unfavourable outlook for the agricultural sector.
While growth in expenditure on gross fixed capital formation improved in the final
quarter of 2015, it remains low at an annual growth rate of 1,4 per cent. Although capital
expenditure by the private sector turned positive in the fourth quarter, it was concentrated in
the renewable energy sector, while in most other sectors real capital investment contracted.
These growth and investment trends create an unfavourable climate for making inroads into
the unemployment rate which increased marginally to 24,5 per cent in the fourth quarter of
2015 from 24,3 per cent a year earlier.
Growth in consumption expenditure by households increased in the final quarter of 2015,
but at 1,6 per cent was still at relatively low levels. While retail sales growth on a year-onyear basis was fairly resilient, the consecutive month-to-month contractions in real retail
trade sales growth in December and January could signal further pressures on consumption
expenditure, consistent with the low levels of consumer confidence. Total new vehicle sales
continue to decline although, more positively, there was strong vehicle export growth in
February.
A number of factors are expected to constrain consumption expenditure despite the
persistence of wage and salary increases in excess of inflation. These factors include rising
inflation and higher interest rates, high levels of household debt, and negative wealth effects
from low or negative asset price growth. Furthermore, credit extension to households by the
banking sector remains subdued, in contrast to the more vibrant growth in credit extension
to the corporate sector, particularly with respect to mortgage advances on commercial
properties and renewable energy investments.
The recent budget tabled in parliament provides for a fiscal consolidation path which sees
the consolidated government budget deficit declining from an estimated 3,2 per cent of
GDP in 2016/17 to 2,4 per cent in 2018/19. This is expected to be achieved through a
combination of a lower expenditure ceiling and increased tax revenues. This path, if realised,
can be expected to moderate inflation somewhat while improving South Africa’s credit
metrics and confidence in general.
Food price pressures, driven by the drought and the depreciated exchange rate, have
intensified by more than previously forecast and remain a significant upside risk to inflation.
Manufactured food price inflation measured 7,8 per cent in the producer price index (PPI),
while agricultural prices increased by 25,9 per cent, with cereals and other crops increasing
by 79,2 per cent. These increases are expected to impact with a lag on consumer prices.
Annual CPI food price inflation is now expected to peak at 11,6 per cent in the final quarter
of 2016, compared with 11,3 per cent previously.
International oil prices have recovered somewhat from their lows of below US$30 per barrel
seen in January as the global oversupply appears to have subsided in the wake of production
cutbacks in a number of countries. Although the Bank has reduced its oil price assumption
for the forecast period, it still assumes an upward trajectory as in the previous forecast.
However, there is some upside risk to this forecast, should some agreement on an output
freeze be reached by some of the larger producers. The domestic petrol price was reduced by

Monetary Policy Review April 2016
about 69 cents per litre earlier this month, to its lowest level since March 2015. However, the
current under-recovery, driven mainly by higher international product prices, suggests that
this decline could be substantially reversed in April. This increase will be in addition to the
30 cent per litre increase in the fuel levy announced in the budget.
Although the inflation forecast has improved moderately since the previous meeting of the
MPC, the Committee remains concerned about the protracted nature of the breach of the
target. Furthermore, the Committee assesses the risks to the forecast to be on the upside.
The main risk factors relate to the exchange rate and food prices. The exchange rate of the
rand continues to be highly volatile and vulnerable to changes in both domestic and external
developments. While the pass-through from the exchange rate to inflation is still relatively
low, there are signs that this may be increasing.
Food prices have been accelerating faster than previously expected due to the weaker exchange
rate and the intensification of the drought, resulting in an upward revision to the food price
forecast. The Committee views the risks to this forecast to be on the upside, particularly for
2017 when fairly strong favourable base effects are expected. A more protracted drought,
combined with a weaker exchange rate and restocking of herds, may keep food price inflation
elevated for a longer period than currently forecast. The Committee also assesses the risks to
the international oil price assumption to be on the upside.
The MPC is cognisant of the fact that demand pressures on inflation remain subdued, and
indications are that household consumption expenditure is likely to remain constrained.
Nevertheless, the recent increase in core inflation and its expected upward trend is indicative
of broader inflationary pressures and possible second-round effects from supply-side shocks.
While the evolution of inflation expectations is critical in this regard, at this stage there is
no clear evidence of a deterioration in longer-term inflation expectations, but they remain
at an elevated level.
The Committee remains concerned about the weak growth outlook amid negative business
and consumer confidence. The growth challenges facing the economy are compounded by
the deteriorating outlook for global growth. The Committee assesses the risk to the growth
outlook to be on the downside.
Given the upside risks to the inflation forecast and the protracted period of the expected
breach, the MPC decided that further tightening was required to complement the previous
moves. Accordingly, the MPC decided to increase the repurchase rate by 25 basis points
to 7,00 per cent per annum, effective from 18 March 2016. Three members favoured a
25 basis point increase while three members preferred no change. Ultimately, the Committee
decided on an increase.
The Committee faced the continuing dilemma of a deteriorating inflation environment and
a worsening growth outlook. The MPC remains sensitive to the possible negative effects of
policy tightening on cyclical growth, but will remain focused on its mandate of maintaining
price stability.
Monetary Policy Review April 2016

Summary of assumptions: Monetary Policy Commitee
meeting on 17 March 2016*
1. Foreign-sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

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

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


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign-sector assumptions and domestic-sector assumptions, see pages 38 and 39.

Monetary Policy Review April 2016
Selected forecast results: Monetary Policy Committee meeting on 17 March 2016
Selected forecast results (annual)
Per cent
Actual
Forecast


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


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2016

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

Monetary Policy Review April 2016
Domestic-sector assumptions
1. Government consumption expenditure (real) is broadly based on the most recent
National Treasury budget projections. However, since these projections take place
twice a year, the most recent actual data points also play a significant role in the
assumptions process.
2. Administered prices represent the total of regulated and non-regulated administered
prices as reflected by Statistics South Africa (Stats SA). Their weight in the consumer
price index basket is 18,48 per cent and the assumed trend over the forecast period is
largely determined by the expected pace of growth in petrol prices, electricity tariffs,
school fees as well as water and other municipal assessment rates.

The petrol price is an administered price and comprises 5,68 per cent of the overall
basket. The basic fuel price (which currently accounts for roughly half of the petrol price)
is determined by the exchange rate and the price of petrol quoted in US dollars at refined
petroleum centres in the Mediterranean, the Arab Gulf and Singapore. The remainder
of the petrol price is made up of wholesale and retail margins as well as the fuel levy and
contributions to the Road Accident Fund (RAF). Since most taxes and retail margins
are changed once a year, the assumed trajectory of the petrol price largely reflects the
anticipated trend in oil prices and the exchange rate.

The electricity price is an administered price measured at the municipal level with a weight
of 4,13 per cent in the CPI basket. Electricity price adjustments generally take place in July
and August of each year, and the assumed pace of increase over the forecast period reflects
the multi-year price determination (MYPD) by the National Energy Regulator in respect
of Eskom, with a slight adjustment for measurement at municipal level.
3. The pace of potential growth is derived from the Bank’s semi-structural potential
output model. The measurement accounts for the impact of the financial cycle on
real economic activity and introduces economic structure via the relationship between
potential output and capacity utilisation in the manufacturing sector (see South African
Reserve Bank Working Paper Series WP/14/08).
4. The repurchase rate (commonly called the ‘repo rate’) is the official monetary policy
instrument and represents the interest rate at which banks borrow money from the Bank.
Although the rate is held constant over the forecast period, this assumption is relaxed in
alternative scenarios where, for instance, the policy rate responds to deviations of output
from its potential and the gap between future inflation and the inflation target, in other
words, via a stylised ‘Taylor rule’, one that is based on market expectations of the future
path of the policy rate, and other paths (as requested).
Monetary Policy Review April 2016

Glossary
Administered prices: These prices are set according to government’s policy rather than
determined by market supply and demand forces.
Advanced economies: Advanced economies are countries with high levels of gross domestic
product per capita. These countries are sometimes described as industrialised. With further
growth, however, they have tended to diversify, with particular emphasis on services sectors.
Balance of payments: This is a record of transactions between the home country and the
rest of the world over a specific period of time. It includes the current and financial accounts.
See also ‘current account’ below.
Baseline (forecast): The baseline forecast is the one that is considered most likely. Alternative
scenarios use different assumptions.
Budget deficit: A budget deficit indicates the extent to which government expenditure
exceeds government revenue (a budget surplus occurs when revenue exceeds expenditure).
Business and consumer confidence: These are economic indicators that measure the state
of optimism about the economy and its prospects among business managers and consumers.
Central projection: This is the most likely outcome for the variable of interest over the
period, according to the forecast of the South African Reserve Bank (the Bank).
Commodity prices: Commodities can refer to energy, agriculture, metals and minerals.
Major South African-produced commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication of aggregate price changes
in the domestic economy. The index is calculated using a number of categories forming a
representative set of goods and services bought by consumers.
Core inflation: Core generally refers to underlying inflation, excluding volatile elements
(e.g. food and energy prices). The Bank’s forecasts and discussions refer to headline CPI
excluding food, non-alcoholic beverages, petrol and electricity prices.
Crude oil price: This is the price, in US dollars, per barrel of unrefined oil (Brent crude
refers to unrefined North Sea oil).
Current account: The current account of the balance of payments consists of net exports
(exports less imports) in the trade account, as well as the services, income and current transfer
account.
Demand pressures: Demand pressures refer to price pressures from increased consumption
in the domestic or foreign economy.
Emerging-market economies: Emerging-market economies are those with low to middle
income per capita. They are advancing rapidly and are integrating with global (product and
capital) markets.
Exchange rate depreciation (appreciation): Exchange rate depreciation (appreciation)
refers to a decrease (increase) in the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange rate changes on domestic inflation
(i.e. the percentage change in domestic CPI due to a 1 per cent change in the exchange rate).
Changes in the exchange rate affect import prices, which in turn affect domestic consumer
prices and inflation.

Monetary Policy Review April 2016
First-round effects: Price shocks entail direct and indirect first-round effects. For example,
should the petrol price rise sharply, this directly affects the cost of transport for the consumer.
It also impacts on producers who will then increase the price of their goods to cover the
transport, thus indirectly affecting consumer prices.
Flexible inflation targeting: This refers to inflation-targeting regimes that consider changes
in inflation and other variables affecting the real economy in the short term. Under strict
inflation targeting only inflation matters, but flexible inflation-targeting takes into account
other variables, such as output.
Forecast horizon: This is the future period over which the Bank generates its forecasts,
typically between two and three years.
Gross domestic product (GDP): GDP is the total market value of all goods and services
produced in a country. It includes total consumption expenditure, capital formation,
government consumption expenditure and the value of exports less the value of imports.
Gross fixed capital formation (investment): The value of acquisitions of capital goods
(e.g. machinery, equipment and buildings) by firms, adjusted for disposals, constitutes gross
fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers to CPI for all urban areas that
is released monthly by Statistics South Africa. Headline CPI is a measure of price levels in all
urban areas. The 12-month percentage change in headline CPI is referred to as ‘headline CPI
inflation’ and reflects changes in the cost of living. This is the official inflation measure for
South Africa.
Household consumption: This is the amount of money spent by households on consumer
goods and services.
Inflation (growth) outlook: This outlook refers to the evolution of future inflation (growth)
over the forecast horizon.
Inflation targeting: This is a monetary policy framework used by central banks to steer
actual inflation towards an inflation target level or range.
Leverage: This refers to the process of borrowing money to buy assets or fund consumption;
highly leveraged entities are those with a large amount of outstanding debt.
Load-shedding: Eskom has adopted a policy of load-shedding to manage insufficient
electricity supply. This entails pre-planned, rotating interruptions to electricity supply to
alleviate pressure on the national grid, thus avoiding a national blackout.
Median: This is a statistical term used to describe the observed number that separates ordered
observations in half.
Monetary policy normalisation: This refers to the unwinding of unusually accommodative
monetary policies. It could also mean adjusting the economy’s policy rate towards its real
neutral policy rate.
Nominal effective exchange rate (NEER): A NEER is an index that expresses the value of
a country’s currency relative to a basket of other (trading-partner) currencies. An increase
(decrease) in the effective exchange rate indicates a strengthening (weakening) of the
domestic currency with respect to the selected basket of currencies. The weighted average
exchange rate of the rand is calculated against 15 currencies. The weights of the five major
currencies are as follows: euro (34,82), US dollar (14,88), Chinese yuan (12,49), British
pound (10,71) and Japanese yen (10,12). Index: 2000 = 100. The real effective exchange rate,
by contrast, is the NEER adjusted by relative consumer prices in South Africa and its main
trading partners.
Monetary Policy Review April 2016

Output gap/potential growth: Potential growth is the rate of GDP growth that could
theoretically be achieved if all productive assets in the economy were employed in a stable
inflation environment. The output gap is the difference between actual growth and potential
growth, which accumulates over time. If this is negative, then the economy is viewed to be
underperforming and demand pressures on inflation are low. If the output gap is positive, the
economy is viewed to be overheating and demand pressures are inflationary.
Producer price index (PPI): This index measures changes in the prices of goods at the
factory gate. Stats SA currently produces five different indices that measure price changes at
different stages of production. Headline PPI is the index for final manufactured goods. PPI
measures indicate potential pressure on consumer prices.
Productivity: Productivity indicates the amount of goods and services produced in relation
to the resources utilised in the form of labour and capital.
Purchasing power parity (PPP): PPP is based on the law of one price, assuming that
in the long run, exchange rates will adjust so that purchasing power across countries is
approximately the same. It is often used to make cross-country comparisons without the
distortionary impact of volatile spot exchange rates.
Real effective exchange rate (REER): See ‘Nominal effective exchange rate’.
Repurchase rate (repo rate): This is the policy rate that is set by the Monetary Policy
Committee (MPC). It is the rate that commercial banks pay to borrow money from the Bank.
Real repo rate: This is the nominal repurchase rate, as set by the MPC, adjusted for expected
inflation.
Second-round effects: If a price shock goes beyond first-round effects by shifting inflation
expectations (and hence wage demands), then it is seen to have second-round effects. These
are the effects that the MPC would seek to counter in the event of a price shock.
Terms of trade: This refers to the ratio of export prices to import prices.
Unit labour costs: A unit labour cost is the labour cost to produce one ‘unit’ of output. This
is calculated as the total wages and salaries in the non-agricultural sector divided by the real
value added at basic prices in the non-agricultural sector of the economy.
Unsecured loans: These are loans extended without any collateral (guarantees or underlying
assets) as security to protect the value of the loan.

Monetary Policy Review April 2016
Abbreviations
BER
Bureau for Economic Research
BIS
Bank for International Settlements
BRICS
Brazil, Russia, India, China and South Africa
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
US Energy Information Administration
FAO
United Nations Food and Agriculture Organization
FNB
First National Bank
GDP
gross domestic product
GPM
Global Projection Model
IMF
International Monetary Fund
JSE
JSE Limited
MPC
Monetary Policy Committee
MPR
Monetary Policy Review
MTBPS
Medium Term Budget Policy Statement
MYPD
multi-year price determination
NEER
nominal effective exchange rate
NERSA
National Energy Regulator
OPEC
Organization of the Petroleum Exporting Countries
PMI
Barclays Purchasing Managers’ Index
PPI
Producer price inflation
PPP
purchasing power parity
RAF
Road Accident Fund
REER
real effective exchange rate
repo (rate)
repurchase (rate)
RMB
Rand Merchant Bank
RMSE
root mean square error
SACCI
South African Chamber of Commerce and Industry
S&P
Standard & Poor’s
SAFEX
South African Futures Exchange
Stats SA
Statistics South Africa
the Bank
South African Reserve Bank
the Fed
United States Federal Reserve
ULC
unit labour cost
US
United States