South African Reserve Bank
Monetary Policy Review
June 2014
Monetary Policy Review
June 2014
Monetary Policy Review June 2014
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ISSN: 1609-3194
Monetary Policy Review June 2014
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 bimonthly meeting. This announcement outlines the
MPC’s assessment of prevailing domestic and global economic conditions, as well as recent
outcomes and forecasts for inflation and real economic activity.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening
the understanding of the objectives and conduct of monetary policy. The MPR reviews
domestic and international developments that have affected inflation and that impact on the
monetary policy stance. It also provides an assessment of the factors determining inflation
and the Bank’s forecast of the future path of inflation and economic growth. The MPR
is presented by the Governor and senior officials of the Bank at Monetary Policy Forums
in various centres across South Africa in an effort to develop a better understanding of
monetary policy through direct interaction with stakeholders.
Contents


Boxes
Box 1
How the economy performed relative to the MPC’s

Box 2
Exchange rate volatility under inflation targeting: Is the rand

Box 3

Appendix

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

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review June 2014
Monetary Policy Review June 2014
Figures
Figure 1
Figure 2
Figure 3
Figure 4
Figure B1.1 Targeted inflation outcomes and projection from the November 2011 MPR.... 6
Figure B1.2 Real GDP growth outcomes and projection from the November 2011 MPR.... 6
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure B2.1 Exchange rate volatility against the US dollar before and after adoption


Figure 13
Figure 14
Figure 15
Figure 16
Figure 17
Figure 18
Figure 19
Figure 20
Figure 21
Remuneration per worker and unit labour cost in the formal
Figure 22
Figure 23
Figure 24
Figure 25
Figure 26
Figure 27
Figure 28
Figure 29
Figure 30
Figure 31
Growth in electricity supply and real GDP in the upward phase


Figure 32
Tables
Table 1
Table 2
Table 3
Table 4
Table 5
Table 6
Table 7
Table 8
Table 9
Table 10
Table 11

Monetary Policy Review June 2014
Executive summary
Higher interest rates and persistent uncertainty
Global growth is improving, but progress is incremental and the outlook is suffused with
uncertainty. Monetary policy normalisation in advanced economies, which presages a
return to economic health after what has been an unusually protracted recovery, is both
an unavoidable and essentially positive development. Nonetheless, this process will exert
considerable pressure on emerging economy currencies and policy settings. It will also create
volatility; over the past year, sentiment has moved sharply against emerging markets before
reversing, as markets were persuaded that subdued inflation and modest growth in advanced
economies meant interest rates would be lower for longer.
In this context, South Africa’s macroeconomic settings remain generally expansionary.
Interest rates are very low, with the real repurchase rate slightly negative. Fiscal deficits are
substantial, although they are programmed to decline over the medium term. South Africa
is absorbing considerable quantities of foreign savings to supplement its own meagre savings
rate, and the corresponding current-account deficit has been large and persistent at more
than 5 per cent of gross domestic product.
In January, the Bank’s policy rate was raised from 5 per cent to 5,5 per cent, the first upward
adjustment in over half a decade, marking the beginning of an interest rate tightening cycle.
The policy change was predicated on a deteriorated inflation forecast, which showed an
extended breach of the target starting sometime in the second quarter of 2014. In line with
this projection, inflation breached the target in April, reaching 6,1 per cent. It is expected to
remain outside the target range until the second quarter of 2015.
The primary cause of the deteriorating outlook has been rand depreciation, a trend dating
back to 2011, and which accelerated in late 2013 and early 2014. Over much of this period,
the pass-through from exchange rate weakness to consumer prices seems to have been
low, aided by falling international food and stable crude oil prices. Petrol prices, which are
administered, respond promptly to changes in the exchange rate, but there is now also a more
generalised rise in prices, as evidenced by a gradual increase in core inflation. Furthermore,
inflation expectations are clustered around the top end of the target, reducing policymakers’
leeway to accommodate shocks.
In recent months, a relatively stronger rand has provided some moderation in depreciationdriven inflation, but this has stemmed mainly from increased global risk appetite instead
of a specific re-assessment of South Africa’s fundamentals. As a result, the rand remains
sensitive to both global and domestic factors.
The short-term difficulty for monetary policy is that South Africa’s exposure to international
developments, and uncomfortable levels of inflation, are matched by a deteriorating domestic
growth outlook. The economy has been buffeted by repeated negative supply shocks, the
latest of which have produced the first quarter of negative growth (-0,6 per cent) since 2009.
Domestic demand has been feeble, as seen in anaemic credit indicators and weak retail sales.
In addition, South Africa’s export income is moderating as the terms of trade edge lower, and
government spending growth has slowed in line with tighter budget consolidation targets.
These developments have partially mitigated cost–push pressures on inflation.
In the coming years, a more robust global economy should provide much-needed buoyancy
to the South African economy. A depreciating currency should help narrow the current-
account deficit by discouraging imports and boosting exports, and there is some tentative
evidence for this in the trade data (although it is too soon to identify a new trend).
Monetary Policy Review June 2014

However, the deficit would certainly not benefit from a weaker currency if consumer price
inflation were allowed to cancel out any competitiveness gains. Furthermore, the ability of
firms and households to take advantage of improved foreign demand will depend greatly on
how much of the current income they can spend on investment.
Overall, inflation in South Africa is projected to be above target for an extended period of
time, with risks tilted towards higher inflation. Over the longer term, this necessitates higher
interest rates, and therefore a tightening cycle. However, with domestic economic growth
weak, and world inflation and interest rates remaining low, monetary policy tightening is
likely to be moderate. This will provide continued support to the economic recovery. It is
important not to mistake the direction of policy changes for the sum of the policy position:
the change is towards higher rates, but actual rates are still not high. In the long run, rates
will inevitably be higher, and also influenced by the pace of normalisation in the United
States. But the road back to normality is unmapped and unlikely to be direct, with each leg
of the journey depending on data and signals from a range of indicators.
The Monetary Policy Review
This Monetary Policy Review includes a technical appendix to aid the interpretation of the
Bank’s forecasts, as well as a comprehensive glossary. In addition, some topical issues are
discussed in boxes. These include economic performance relative to forecasts (Box 1), rand
volatility (Box 2) and inflation expectations (Box 3).

Monetary Policy Review June 2014
Monetary policy stance
The policy stance has been adjusted to counter rising inflation, which
is projected to breach the target for four quarters, starting in the second
quarter of 2014. While fuel and food prices have been the main contributors
to rising inflation, overall inflationary pressure is much broader-based, as
evidenced by rising core inflation. Domestic demand pressures, however,
remain modest and have softened in recent months. With economic
performance disappointing this creates difficult policy choices.
Overview of South Africa’s policy settings and the
global environment
Since the depths of the crisis in 2008 and 2009, South Africa’s macroeconomic policy settings have been set to support economic recovery. Fiscal
policy has emphasised ongoing infrastructure development and sustained
government spending, while monetary policy with negative real interest rates
has been encouraging demand for credit and investment. The repurchase
(repo) rate was lowered from 12,0 per cent at the time of the crisis to 5,5 per
cent in late 2010, and then shifted further to 5,0 per cent in mid-2012 where
it remained for 18 months.
Over the past six months, developments at home and abroad have
prompted adjustments to both these settings. Global interest rates, proxied
by the United States (US) five-year government bond yield, doubled
between January 2013 and January 2014, rising from 0,79 per cent to
1,64 per cent. For South Africa, a greater sensitivity by the market to
changing yield differentials has made it harder to sustain borrowing from
the rest of the world. Foreign borrowing is represented by the currentaccount deficit, which has become a significant macroeconomic risk. The
rand, which has depreciated steadily since 2011, weakened abruptly after
May 2013 and again in January 2014, before recovering some of its value.
The inflation outlook has deteriorated, with inflation now forecast to
be outside the target for an extended period of time, owing to persistent
cost–push pressures and the depreciating currency.
The fiscal response has been stronger budget consolidation, which
complements the monetary policy decision to enter a tightening cycle. Both
these policy changes are designed to minimise inflationary pressures, reduce
demands on capital markets, and lower external payments risks as the global
environment normalises. The policy adjustments should be incremental,
however, as the world normalisation process is likely to be protracted and
the domestic economy is vulnerable to a number of threats. Growth has
been low and volatile, with the economy suffering from repeated supply
shocks and tepid demand. Monetary policy remains accommodative, with
the real repo rate (the current repo rate adjusted for expected inflation), still
marginally negative.
Per cent
-2

Figure 1
Monetary policy and the prime

lending rate

Prime lending rate

Repurchase rate

Real repurchase rate (nominal rate adjusted by

Reuters one-year-ahead CPI forecast)
Sources: Reuters and South African Reserve Bank

Monetary Policy Review June 2014

The view in January
At the time of the previous Monetary Policy Review (MPR) published in
November 2013, inflation was projected to remain within the target band
throughout 2014 and 2015 – but successive Monetary Policy Committee
(MPC) statements emphasised the risks to this outlook. The period from
November 2013 to January 2014 witnessed a shift in projected headline
inflation as favourable food prices gave way to a sharp depreciation in
the currency, exchange rate induced petrol price hikes, and an expected
deterioration in food price inflation. As a result, the forecast for the January
2014 meeting showed a material and extended breach of the target.
Inflation expectations had been relatively well-anchored for some time,
albeit at the upper end of the target range, where they risked becoming deanchored by a more sustained depreciation. Other key drivers of domestic
inflation such as unit labour costs remained elevated, although growth in
these costs had decelerated to under 6 per cent in the fourth quarter of
2013 as the economy’s output rebounded from the lows of the third quarter.
The outlook for growth in the economy had also improved somewhat, as
it became clearer that the economy had rebounded in the fourth quarter of
2013 from the poor results of the third quarter.
Together, the deteriorated inflation forecast, somewhat better growth
outlook, risk of further currency weakness from policy normalisation, and
the threat to inflation expectations from the new projections prompted an
increase in the policy rate in January 2014 for the first time since 2008.
After January: A lull and a storm
Since January, the rand has strengthened but domestic economic
performance has fallen well short of expectations as the economy suffered
two severe shocks. In the platinum sector, the strike which began in
January has persisted far longer than anticipated – a record 19 weeks thus
far. Furthermore, electricity load shedding has impeded economic activity
generally. In this context, credit growth to the household sector decelerated
from 5,6 per cent in January to 4,6 per cent in April. General loans which
are mainly made up of unsecured lending plummeted from 34,3 per cent in
November 2012 to 3,5 per cent in March 2014, underscoring very modest
household consumption growth and poor retail sales figures.
Meanwhile, the exchange rate’s long depreciating trend was interrupted
by renewed global appetite for risk. The rand joined the currencies of
many other emerging markets in regaining some of the ground lost over
previous months, and although it recovered by relatively less than many of
its peers, it still appreciated by 7,5 per cent (against the US dollar). Domestic
factors may explain some of this strengthening, with market sentiment
bolstered by the responsiveness of monetary policy to the deteriorating
outlook and some evidence of current-account narrowing. However, these
are unsatisfying explanations for the exchange rate’s improvement, both
because it was replicated by several other countries and because domestic
economic performance has been highly disappointing. Rather, the rand’s
appreciation stemmed from market assumptions that monetary policy in
the US, euro area and the United Kingdom (UK) will not tighten as early
as previously anticipated, given growth below expectations, economic slack
and low inflation.
Percentage change in the indices
since December 2010
Figure 2
Inflation and the exchange rate

Headline CPI

Nominal effective exchange rate of the rand

(inverted scale)
Sources: Statistics South Africa and South African
Reserve Bank

Monetary Policy Review June 2014
At the March and May meetings, inflation projections were relatively
unchanged when compared to the January forecast, although they still
showed an extended breach of the inflation target. The Bank’s gross domestic
product (GDP) forecasts for 2014, however, fell to 2,6 per cent in March and
2,1 per cent in May, well below January’s 2,8 per cent, with downside risks
still prevalent. These developments supported the decisions of the MPC to
leave the monetary policy stance unchanged at both these meetings, while
indicating that the overall policy setting remains in a tightening cycle.
Evolution of the inflation outlook
Over the course of 2013, the Bank’s inflation outlook was shaped by
exchange rate concerns, low pass-through and declining commodity prices,
with risks tilted to the upside. Between November 2013 and January 2014,
the forecast for headline inflation deteriorated significantly, mainly as a
result of changes to the exchange rate and expected upward pressure from
lagged exchange rate pass-through. Increases in food and petrol prices were
anticipated and priced-in to the forecast. Consequently, the January 2014
inflation projections for both 2014 and 2015 were higher by 0,6 percentage
points, at 6,3 per cent and 6,0 per cent respectively.
The Bank’s most recent central projection is similar to the March projection,
although food prices are higher and unit labour costs slightly elevated.
Inflation breached the upper bound of the target range in the second quarter
of 2014 and is expected to peak at 6,5 per cent in the final quarter of 2014,
before returning to within the target range by the second quarter of 2015. It
is then expected to remain close to the upper level of the target range.
The central projection, found within the darkest band of the fan chart,
is the best estimate of future inflation outcomes. Towards the end of the
forecast horizon, uncertainty increases and so the bands become wider. In
Figure 3 the larger shaded area above the central projection shows risks to
the upside, indicating a higher probability of inflation outcomes above the
central projection than below it.1
Table 1 Evolution of the Bank’s targeted inflation forecasts
Per cent
MPC meetings


Source: South African Reserve Bank
The outlook for core inflation shows similar risks. The forecast moderated
after the January increase in the repo rate, but underlying inflation is
nonetheless expected to rise until 2015.

See Appendix 1 on how the MPC uses the fan chart to assess the risks inherent in the forecast and communicates
the uncertainties that lie ahead.
Per cent
Figure 4
Targeted and core inflation

forecasts

Targeted inflation

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

Core inflation
Figure 3 Targeted inflation* forecast
Per cent
3–6 per cent inflation target range
* CPIX for metropolitan and other urban areas until the end
of 2008; CPI for all urban areas thereafter
Source: South African Reserve Bank

Monetary Policy Review June 2014

Table 2 Evolution of the Bank’s core inflation forecasts
Per cent
MPC meetings


Source: South African Reserve Bank
Evolution of the growth outlook
The South African economy is forecast to grow slightly faster in 2014
than in 2013, but the Bank’s growth forecasts have been revised down
markedly since the November 2013 MPR. The pace of anticipated growth
is disappointing. There are also risks of growth falling short of even these
lowered expectations, with protracted labour disruptions, commodity
prices, and electricity shortages all clear dangers. However, the outlook
gets some support from improving growth in advanced economies, as well
as a depreciated real exchange rate, which could boost net exports. A one
percentage point rise in GDP growth in South Africa’s main trading partners
typically increases domestic GDP with a lag and by slightly less than 1 per
cent, as estimated over the past 14 years.
Figure 5
Real GDP growth forecast
Percentage change*


* At seasonally adjusted annualised rates
Source: South African Reserve Bank

Box 1
How the economy performed relative to the MPC’s
November 2011 forecasts
The MPC uses forecasts1 of targeted inflation and real GDP growth when setting
monetary policy. The first published forecasts for the entirety of 2012 and 2013
appeared in the November 2011 MPR, two and a half years ago. We now have actual
data for this period, which allows us to contrast our forecasts with the outcomes. The
comparison shows that inflation has behaved much as expected but growth has
come in well below our central projection.
There were only two CPI surprises – in late 2012 and late 2013. Inflation was less than
anticipated in the third quarter of 2012 owing to food and electricity prices, which
grew but not as dramatically as had been forecast. The unexpected breach of the
upper level of the inflation target in 2013 was primarily the result of higher petrol
prices, which rose by a cumulative 111 cents (for 95-octane petrol) over the third
quarter of 2013.
Domestic real GDP growth was correctly anticipated to remain weak during the
second half of 2011 as South African exporters grappled with anaemic global demand
and an appreciated currency. Growth was then expected to recover fairly quickly,
reaching an above-trend average of around 4 per cent at an annualised rate towards
the end of 2013. This failed to materialise, mostly because the euro area crisis proved
more severe than expected and also because of unforeseen domestic developments,
including protracted labour unrest and electricity-supply constraints.

The use of fan charts in the above analysis outlines how uncertain the outcomes may be when reacting
to foreign and domestic shocks.
Figure B1.1 Targeted inflation outcomes

and projection* from the

November 2011 MPR
Per cent
Targeted inflation
* CPI inflation trajectory nine quarters ahead
Sources: Statistics South Africa and South African
Reserve Bank

2011 2012 2013

Figure B1.2 Real GDP growth outcomes*

and projection** from the

November 2011 MPR
Percentage change
Real GDP growth
Real GDP at the time of the November 2011 MPR
* 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
Sources: Statistics South Africa and South African
Reserve Bank


Monetary Policy Review June 2014
Domestic growth
South Africa’s economy expanded just 1,9 per cent in 2013, its worst
performance since the 2009 contraction. Growth was also particularly
uneven, with the first and third quarters very weak and the second and
fourth much stronger, owing to strike episodes. This pattern has persisted
into 2014, with first-quarter growth dragged down by both the mining and
manufacturing sectors. By contrast, the tertiary sector – which is the largest
component of GDP – has seen muted but consistent growth.
Table 3
Real domestic sectoral growth rates
Per cent*
Sector

Year
1st qr
2nd qr
3rd qr
4th qr
Year
1st qr

Gross value added at basic prices

Wholesale and retail trade, catering

* Quarterly data refer to quarter-on-quarter growth at seasonally adjusted annualised rates
Sources: Statistics South Africa and own calculations
The Bank’s most recent central projection for GDP growth incorporates the
effect of the January 2014 rate hike and otherwise assumes an unchanged
repo rate.2 Economic growth for 2014 has been revised down by a cumulative
0,9 percentage points since November 2013, owing mainly to domestic
factors, including lower government and household consumption
expenditure. Global growth has made relatively small contributions to
the changes in the forecasts. The positive outlook for advanced economies
is counteracted by weakness in emerging markets and softening world
commodity prices. The downward growth revision for 2014 suggests weaker
demand for limited resources, alleviating some inflationary pressure. Despite
the revision, growth is still expected to improve over the forecast horizon.
Table 4 Evolution of the Bank’s real GDP growth forecasts
Per cent
MPC meetings


Source: South African Reserve Bank
Short-term economic indicators, which aim to assess economic performance
in the near future, corroborate the Bank’s subdued growth outlook for 2014.
Business confidence is generally tepid although it varies from sector to sector,
improving among builders but declining in the motor, civil construction and

This fan chart represents the information available to the MPC at the time of the May 2014 meeting.
Figure 6
Composite leading business

cycle indicator

Index: 2010 = 100

Downward phase of the business cycle
Note: The direction of movements of this indicator show the
expected movements in aggregate economic activity over
the next 6 to 12 months
Source: South African Reserve Bank
Monetary Policy Review June 2014

wholesale trades. The pace of recovery in manufacturing capacity utilisation
has been slow and there is still spare capacity, particularly with respect to
durable goods production.
Table 5 Domestic economic sentiment indicators
Historic range
Most recent
As at MPR*
Low
High
Low
High
Nov

Jun


-8

-7
-6
* Improved/worsened since previous MPR
Sources: Rand Merchant Bank; Bureau for Economic Research, Stellenbosch University; Kagiso Securities; and
First National Bank
Household consumption and wealth effects
Household expenditure slowed by almost one percentage point in 2013
and there are limited prospects for improvement in 2014, owing to rising
inflation, weak employment growth and muted wealth effects. Household
expenditure will also be constrained by continued moderate credit growth,
knock-on effects from the mining strike and rate hikes, which raise debt
service costs and disincentivise further borrowing. The household sector
has, however, made progress in improving its balance sheet, with the debtto-disposable income ratio declining from a record high of 83,0 per cent
in the first quarter of 2009 to 74,3 per cent in the fourth quarter of 2013.3
However, even this reduced level of debt remains relatively high and will
likely constrain credit demand for some time. Although nominal equity and
property prices continue to increase, the real gains from such investment
have been quite modest since the onset of the financial crisis, limiting wealth
effects and consumption demand.
Table 6 Growth in expenditure on GDP

Per cent*

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

* Quarterly data refer to quarter-on-quarter growth at seasonally adjusted annualised rates
Note: Data for 2012 and 2013 as published in the March 2014 Quarterly Bulletin
Source: South African Reserve Bank

The long-term average (1999–2013) for household debt-to-disposable income is 67,9 per cent.
Figure 7
Equity-market performance in

US dollar terms

Indices: January 2007 = 100

QE1
QE2
QE3
“Taper
talk”
Tapering

2014*

Emerging-market equity price index

FTSE/JSE All-Share Price Index

S&P 500 price index
Note: Black vertical lines represent the US Federal Reserve's
implementation of its quantitative easing programme (QE1)
and subsequent renewals of the programme (QE2 and QE3)
followed by the first announcement of the possibility of tapering
and the month in which tapering was announced
* Data to 29 May 2014
Sources: Bloomberg and Reuters

Monetary Policy Review June 2014
Credit conditions
On aggregate, credit growth over the past six months remained nearly flat,
averaging 7,7 per cent in nominal terms, but this conceals variation between
different categories of credit. Mortgages, the largest component of credit, have
grown at a rate of below 3 per cent since late 2011. Instalment sales and ‘other’
credit4 continue to grow strongly. Since mid-2012 these categories have grown
at slightly more than 10 per cent, with general loans to businesses (for the recent
phase of renewable energy contracts) driving the ‘other’ category in recent
months. However, unsecured lending to households, which also fits into the
‘other’ category, has slowed markedly since November 2012 after a period of
exceptionally rapid growth. Looking forward, a recovery in mortgage lending
would be helpful in bolstering demand. Credit categories such as instalments
have contributed to financing consumer durables which tend to be imported,
such as cars, so reduced lending may well be the necessary concomitant of
current-account rebalancing.
Government expenditure
The 2014 Budget Review reiterated government’s theme of gradual fiscal
consolidation to ensure sustainable debt levels without jeopardising
economic recovery. The budget deficit is expected to narrow to 4,0 per cent
in 2013/14, down from 4,3 per cent in the 2012/13 budget, a level of deficit
spending that remains expansionary.
Table 7
Public finance medium-term estimates
Percentage of GDP
Consolidated
government*

MTBPS
Budget
MTBPS Budget
MTBPS Budget
MTBPS
Budget

Public-sector borrowing

* Includes national government, provinces, social security funds and selected public entities
** National government
Note: Owing to a change in presentation of budget statistics, the budget balance now includes extraordinary receipts
and payments
Sources: National Treasury, Medium Term Budget Policy Statement (MTBPS), October 2013 and Budget Review 2014
As the economy begins to grow more rapidly, the budget deficit is projected
to narrow over the medium term expenditure framework to 2,8 per cent by
2016/17, at which time projected net debt is expected to stabilise at around
R2 trillion or 44,3 per cent of expected GDP. Crucial to achieving these
outcomes is the non-interest spending ceiling, which limits real expenditure
growth to 1,9 per cent per annum.5

‘Other’ credit consists of general loans, overdrafts and credit card advances.

Non-interest spending refers to expenditure by government on policy-related items such as wages and
infrastructure. Interest spending is related to the amount of debt that government has outstanding, as well as
prevailing interest rates.
Figure 8
Banks’ loans and advances to the

private sector
-10
-5

Percentage change over 12 months

Total loans and advances
Real total loans and advances
Mortgages
Instalment sale and leasing
Credit extended to households
General loans
Other loans and advances

Source: South African Reserve Bank
R billions
R billions


Figure 9 Fiscal stance

MTBPS 2013

Budget Review 2014
Sources: National Treasury, Medium Term Budget Policy
Statement (MTBPS), October 2013 and Budget Review 2014

Consolidated
government
budget balance
Total national
government
net loan debt
Monetary Policy Review June 2014

Inflation outcomes
Consumer price inflation
Headline consumer price index (CPI) inflation6 – the measure targeted
by the Bank – has been on a moderate upward trend since mid-2012.
Inflation temporarily breached the target in July 2013, reaching 6,4 per
cent in August, followed by an equally brief dip to 5,3 per cent in November
caused by short-lived reductions in food and petrol prices. CPI inflation
then breached the upper bound of the target range in April 2014, in line
with the Bank’s forecasts, reaching 6,1 per cent.
Table 8 shows contributions to targeted inflation. Services inflation remains
high and sticky, with health insurance, water supply and education inflation
far in excess of 6 per cent. Goods inflation has increased strongly in 2014,
with significant contributions from food and petrol prices driving the changes
in headline inflation. Inflation in administered prices, which includes petrol
prices, remains above the target, but has moderated in recent months.
Table 8 Contributions to targeted inflation
Percentage change over 12 months* and percentage points

Weights
Oct
Nov
Dec
Jan
Feb
Mar
Apr

Targeted inflation*........................... 100,00

Food and non-alcoholic beverages

Of which:

Sources: Statistics South Africa and own calculations
The exchange rate
One of the most important causes of rising inflation has been pass-through
of rand depreciation. The currency has been on a steady downward trajectory
since 2011, which accelerated in 2013 and early 2014. Against the US dollar,
the rand depreciated by 19 per cent in 2013 and slipped a further 6 per cent
from the beginning of 2014 to the January meeting. The nominal effective
exchange rate (NEER), a broader trade-weighted measure, followed a similar
trend. The January repo rate increase was followed by a steady appreciation
of the currency back to end 2013 levels, in line with the experience of other
emerging markets that suffered large depreciations and raised policy rates.
However, the causes of rand depreciation, especially softening commodity
prices and a large current-account deficit, are unlikely to abate, and the

This refers to the 12-month percentage change in the headline CPI.
Figure 10 Consumer price inflation:

Targeted inflation*
* CPI for all urban areas
Source: Statistics South Africa

Percentage change over 12 months
Figure 11 Exchange rates of the rand


Index: 2000 = 100
Foreign currency
unit per rand
Note: A depreciation is represented by a downward
movement in the above graph
Sources: Bloomberg and South African Reserve Bank

Euro
US dollar
Nominal effective exchange rate
(right-hand scale)

Monetary Policy Review June 2014
currency is expected to remain vulnerable to changing global expectations
for US monetary policy and appetite for risk.
The rate of pass-through varies depending on economic conditions but
also the kind of price. For certain administered prices, such as petrol, passthrough is fast and complete. In other categories, pass-through has been
low over much of the recent depreciation period, in part because firms have
delayed price increases in the face of subdued demand conditions. The rise
in inflation in 2014, however, suggests that firms are pricing-in a larger
share of rand depreciation, passing it on to consumers and producing a
broad-based rise in inflation.
Input costs
Producer price indices (PPIs) suggest strong ongoing cost pressure on firms
from currency depreciation and other sources. Headline PPI inflation, the
PPI for final manufactured goods, spiked twice in the past 12 months, after
May 2013 and January 2014, both periods of marked currency depreciation.
It also displayed an upward trend over this period, driven by almost all the
subcategories of the index, including vehicles and machinery, which tend to
Figure 12 Exchange rate performance

against the US dollar

Indices: 31 December 2012 = 100

South African rand

Australian dollar

Indonesian rupiah

Chilean peso
Sources: Reuters and own calculations

Brazilian real

Turkish lira

Indian rupee

“Taper talk”
Tapering
January MPC
Box 2
Exchange rate volatility under inflation targeting: Is the rand
excessively volatile?
The adoption of inflation targeting in South Africa occurred in parallel with (and largely
required) less central bank activity in the foreign exchange market. The scale of capital
movements and shifts in direction that accompanied the long period of international
financial contagion in the late 1990s and into the 2000s made currency intervention as a
policy tool ineffective and unsustainable. In this new environment, it might be expected
that the shift to a floating exchange rate policy regime would result in a major increase in
exchange rate volatility. However, international evidence on whether flexible inflation
targeting per se leads to this increase is mixed. Figure B2.1 compares long-term currency
volatility before and after the adoption of inflation targeting for six significantly traded
emerging-market currencies. It shows, on average, an overall decline in long-term1
volatility after the adoption of inflation targeting for all but two countries.2
Despite this decline, volatility could still prove excessive. Amod and Hassan establish a
benchmark for ‘normal’ volatility calculated using a standard monetary model, comparing
exchange rate volatility against that justified by volatility in the macroeconomic
fundamentals of monetary conditions, real output, and price levels. If a currency’s volatility
exceeds scaled3 changes in these fundamentals, then it is considered excessively
volatile. By this measure the rand is not excessively volatile, although volatility relative to
macroeconomic fundamentals has increased in the inflation targeting period.
How should we interpret this result? Evidence on the effects of volatility on growth is
mixed. Moderate volatility may in fact be beneficial, if it means that the currency is
reacting nimbly to economic news and thereby avoiding large exchange rate misalignments
in real terms. In South Africa, real misalignment has decreased by about 10 per cent in
the inflation targeting period. This outcome is positive given the clear evidence that
substantial, persistent real exchange rate misalignment is damaging to growth.

Long-term volatility is measured using quarterly data. Because countries adopted inflation targeting at
different times, the pre- and post-inflation targeting periods vary, but the shortest period for any country
in our sample is 15 quarters. This analysis is not applicable to short-term currency volatility.

Shaista Amod and Shakill Hassan, “Are Emerging Market Currencies Excessively Volatile Under Inflation
Targeting?”, South African Reserve Bank Working Paper Series (forthcoming).

The monetary model relates discounted (expected future) macroeconomic fundamentals to the exchange rate.
The scaling term is based on the discount factor.
Standard deviation
Pre-inflation targeting
Post-inflation targeting

Turkey
South
Korea
South
Africa
Mexico
Chile
Brazil
Figure B2.1 Exchange rate volatility against

the US dollar before and after

adoption of inflation targeting


Source: Amod and Hassan
Monetary Policy Review June 2014

be imported, as well as food. Another measure of input costs, the PPI for
intermediate manufactured goods, shows a rapid rate of growth, especially
since the start of 2013. Importantly, both headline PPI and intermediate
goods PPI have generally remained above headline CPI, indicating that
some producers and retailers have been absorbing rising production and
import costs.
Table 9 Measures of producer price inflation
Percentage change over 12 months

Oct
Nov
Dec
Jan
Feb
Mar
Apr

Excluding:

Intermediate manufactured goods....

* Unit value indices use customs-level data to measure inflation in imported and exported commodities.
They are not comparable to the old PPI series for imported commodities.
Source: Statistics South Africa
Petrol and food prices
International crude oil prices have been high but fairly stable in recent
years, with a moderate downward trend since April 2011. Brent crude oil
has traded between US$100 and US$120 per barrel for most of the past
three years, and its price has been in the bottom half of that range in 2014,
at around US$108 per barrel. Although geopolitical instability in a number
of major producing regions has hampered production, this effect has been
offset by strong US shale oil growth, so international markets have been
relatively well supplied. But domestic prices have been volatile and rising,
owing to currency movements which pass through to the basic fuel price7
quickly and completely. The basic fuel price has increased by a cumulative
71 cents in 2014, and by June 2014 unleaded petrol in Gauteng cost R14,02
per litre, up from R13,02 in November 2013. In recent months, currency
appreciation has provided some relief, with the price of 95-octane petrol
declining by 37 cents per litre over May and June.
Food prices are more complex than the petrol price, comprising many
different items and having a large domestic supply component, which buffers
the exchange rate impact. Since the previous MPR, food prices moved
sharply down and then sharply up again. The trough came in December
2013, with food inflation of just 3,5 per cent, the lowest rate since February
2011, following the drought-related culling of herds which increased
the meat supply and reduced demand for animal feed. In 2014 prices
reversed, with vegetable and meat prices in particular rebounding strongly.

This reflects the price of refined oil, excluding levies and surcharges imposed by government.
Percentage change over 12 months

Figure 13 Price pressures

Intermediate manufactured goods

Final manufactured goods

Import unit value index* (right-hand scale)
* Import unit value indices measure inflation in imported
commodities using customs-level data from the
South African Revenue Service


Source: Statistics South Africa

Figure 14 Spot and futures prices of

Brent crude oil, and the

petrol price
-60
-40
-20

Percentage change over 12 months

Petrol price (one-month lag)

Brent crude (rand)

Brent crude (US dollar)

Futures (30 May 2014, rand)

Futures (30 May 2014, US dollar)
Sources: Department of Energy, Bloomberg, JSE Limited
and own calculations
Proportion of
headline inflation
Percentage points

Figure 15 Contribution of petrol and food

prices to headline inflation*

Petrol: Estimated contribution

Food: 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

Monetary Policy Review June 2014
International food prices have maintained a declining trend over the past
three years although they have ticked up in recent months. In particular,
cereals prices responded to weather uncertainty in the US and geopolitical
tensions in Ukraine (an important supplier of wheat to South Africa).
Food prices remain a risk to the inflation outlook, although the short-term
risks have moderated somewhat after the recent sharp reversal in domestic
maize prices, which followed an upward revision of the domestic maize crop
forecast. If sustained, this development could help mitigate the pressures
evident in the PPI since the beginning of the year.
Core inflation
Food and petrol prices are volatile, causing at times significant but not
necessarily persistent movements in headline inflation. To gauge underlying
inflationary pressures, which move less but also have more momentum, the
Bank considers several measures of core inflation. The broadest measure
– which excludes food, non-alcoholic beverages (NAB), petrol and energy
prices – started increasing again after a period of stability, reaching 5,5 per
cent in March and April 2014. The core measure including energy, but
excluding food and NAB, shows a stronger uptick in recent months, as
does the core measure excluding administered prices. These pressures are
assessed to be a reflection of exchange rate pass-through, rather than strong
underlying demand pressures.
Inflation expectations
Inflation expectations shape prices and wage demands and therefore
inflation outcomes. When expectations are well-anchored, they remain
stable well within the inflation target. This is a significant policy advantage
because it frees policymakers to ‘look through’ temporary departures from
the inflation target, chiefly those generated by supply shocks. However,
inflation expectations have become a steadily greater concern as they have
clustered around the top end of the target.
The Bureau for Economic Research (BER) surveys three groups – financial
analysts, firms and trade unions – to establish their expectations for
inflation. The average of these opinions indicates above-target inflation in
both 2014 and 2015, an outlook held since the second quarter of 2013. More
problematically, firms and unions, which have greater influence on actual
price outcomes, have systematically higher expectations than financial
analysts, rendering the average expectation somewhat misleading. The
latest survey, conducted after the January 2014 repo rate increase, suggests a
healthy impact from the policy adjustment on expectations for 2016, which
return to within the target range – although the expectations of businesses
and unions remain above the target.
A similar pattern emerges from Reuters surveys of private-sector economists,
aimed at establishing their inflation expectations over a three-year horizon.
Index: 2002–2004 = 100
Rand per ton


Figure 16 Maize and cereals prices

White maize SAFEX spot price

FAO cereal price index (right-hand scale)
Note: The top grey line is the import parity price and the
bottom grey line is the export parity price. These prices
are the theoretical upper and lower bound prices
for commodities.
Sources: Grain South Africa and the Food and
Agriculture Organization (FAO)

Figure 17 Targeted inflation* and

food inflation

All food items

Meat

Targeted inflation measure
* CPI for all urban areas
Source: Statistics South Africa
-5

Percentage change over 12 months

Bread and cereals

Milk, cheese and eggs

Vegetables

Figure 18 Core measures of inflation

Percentage change over 12 months

Headline CPI

CPI excluding food and NAB* prices

CPI excluding food, NAB*, petrol and energy prices

CPI excluding administered prices
* NAB: Non-alcoholic beverages
Source: Statistics South Africa
Monetary Policy Review June 2014

The median forecasts, between December 2013 and January 2014, revealed
deteriorating inflation expectations for both 2014 and 2015. However, more
recent surveys indicate declining inflation over the period to 2016.
Table 10 Reuters survey of CPI forecasts: May 2014*
Per cent


(19)

(14)

* January 2014 forecasts in parenthesis
Source: Reuters
Labour costs
The past ten years provide ample evidence that feedback effects from
inflation outcomes to and from wage and price determination are strong
and operate in both directions. Rising wages, when they are not matched by
productivity gains, push up firms’ costs and may cause them to raise their
prices, lifting inflation. In turn, spikes in the CPI are likely to provoke high
wage demands for several years, as seen after the 2002 and 2008 highs.
Growth in nominal remuneration per worker, a broad measure encompassing
non-agricultural employees in the economy, declined from 16,8 per cent
in the first quarter of 2010 to less than half of that over the succeeding
three years as the impact of the 2008 CPI acceleration gradually dissipated.
Similarly, growth in unit labour costs declined from 11,2 per cent in the first
quarter of 2010 to an average of 6,0 per cent in 2013. This reflected lower
nominal wage growth relative to CPI but also the economic recovery, which
pushed up productivity per worker and thereby moderated growth in unit
labour costs.
Figure 19 BER surveys of headline CPI

inflation expectations


Annual average, per cent
Surveys conducted during:

3rd qr 2012
4th qr 2012


3rd qr 2013
4th qr 2013

1st qr 2014


Source: Bureau for Economic Research, Stellenbosch University

Box 3
Are inflation expectations in South Africa homogeneous?1
Inflation outcomes are partially determined by the public’s expectations about future
inflation. In South Africa, the Bureau for Economic Research (BER) surveys inflation
expectations of analysts, businesses and trade unions, and provides an average for these
three groups. This average underpins most discussion on the subject. In a recent paper,
however, Kabundi, Schaling and Some show that the three groups have systematically
different expectations. The authors demonstrate this with implicit inflation targets,
meaning the long-run average inflation expectation for each group. Analysts have an
implicit inflation target of 5,4 per cent, which contrasts sharply with businesses (6,8 per
cent) and trade unions (6,6 per cent).
While analysts’ expectations are generally well-anchored within the Bank’s 3 to 6 per cent
target range, the expectations of businesses and trade unions seem to track realised
inflation with a significant lag. Businesses and trade unions reacted with prolonged spikes
in expectations following the negative supply shocks of 2002 and 2008 (which drove
inflation above the target band), whereas the reactions of analysts were transient and
restrained.

This work is based on a recent paper by Alain Kabundi, Eric Schaling and Modeste Some (2014) published
as South African Reserve Bank Working Paper 1401.

Percentage change over 12 months
2000 2002

2012 2014

Analysts

Trade unions

3–6 per cent inflation target range

Sources: Bureau for Economic Research, Stellenbosch University;
and Statistics South Africa

Businesses

Realised targeted inflation
Figure B3.1 One-year-ahead inflation

expectations and realised inflation
Figure 20 Average annual inflation and

wage settlements
-2

2014*

Per cent

Average wage settlements

Average real wage settlements

CPI inflation
* Data for 2014 are for the first three months of the year
Sources: Andrew Levy Employment Publications,
Statistics South Africa and own calculations

Monetary Policy Review June 2014
However, labour-market outcomes are unlikely to contribute to lower
inflation in the medium term. Wage settlements increased by an average
of 7,9 per cent in 2013 and have maintained that growth rate in the first
quarter of 2014. Furthermore, moderate growth rates in unit labour costs
may not be sustained without stronger economic activity.
Global growth and policy developments
Since 2009, the global economy has twice started to recover but then
stumbled, first in 2011 and then again in 2013, when world growth hit a
four-year low. The end of 2013 brought some improvement, but it is too
soon to tell if this is the beginning of the oft-predicted sustained recovery or
merely another false start. In contrast to the pattern of the past four years,
prospects for stronger growth now depend on advanced economies, which
are starting to accelerate even while emerging markets slow down. The US
and the UK in particular are expected to perform strongly, while the euro
area is no longer contracting. Meanwhile, the biggest emerging markets
have exhausted their old growth strategies.
Table 11 Global growth rates
Per cent
Long-run
average*
Outcomes
Estimates


Emerging-market and

* Long-run average: Average growth rates from 1980 until 2006
Source: International Monetary Fund, World Economic Outlook, April 2014
Advanced economies: Sunnier with a chance of storms
Viewed purely from the growth numbers, the US recovery is not so obviously
impressive: the second half of 2013 was certainly better than the first, but the
economy contracted in the first quarter of 2014. Much of this disappointment
seems attributable to bad weather, but lingering weakness in the housing
market, and disappointing retail sales in April, suggest additional obstacles
to a robust recovery. The labour market is more encouraging, however, with
the unemployment rate falling to a low of 6,3 per cent in April 2014. This
is still some way from the 5,5 per cent natural rate of unemployment (as
estimated by the Congressional Budget Office), but much better than the
10,0 per cent level reached in October 2009. Furthermore, other measures
of labour market health now tend to corroborate the good news from this
indicator, with the participation rate bottoming out, more people leaving
their jobs voluntarily, long term unemployment declining and wage growth
rising. Inflation, which has long been below the US Federal Reserve’s (the
Fed) 2 per cent goal, has also edged higher. Consumer prices rose 2 per cent
in April and private consumption expenditure inflation, the Fed’s preferred
measure, is forecast to rise to similar levels in the second quarter of 2014.
In this context, the members of the Federal Open Market Committee have
been willing to continue tapering their programme of monetary stimulus
through asset purchases, in regular decrements of US$10 billion per
meeting, and foresee raising the policy rate from the zero lower bound
Figure 21 Remuneration per worker and

unit labour cost in the formal

non-agricultural sector


-2

Percentage change over four quarters

Nominal unit labour cost

Nominal remuneration per worker

Real unit labour cost
Sources: Statistics South Africa and own calculations
Figure 22 Purchasing Managers' Indices

Index points

G3*

South Arica
* G3: Purchasing power parity (PPP)-weighted index of PMIs
of the United States, Japan and the euro area
** BRI: PPP-weighted index of PMIs of Brazil, Russia and India
Sources: JPMorgan; International Monetary Fund, World Economic
Outlook, April 2014; and own calculations

BRI**

China

Monetary Policy Review June 2014

sometime in 2015. Meanwhile, fiscal policy has become more supportive of
growth, with the approval of a budget in January 2014 and the suspension
of the debt ceiling for a year.
The recovery in the UK has been strong at 3,2 per cent in the first quarter
of 2014, with growth of 2,9 per cent expected for 2014, and stronger growth
now overdue. Unemployment has fallen much more quickly than anticipated.
The Bank of England has kept policy rates and asset holdings unchanged,
and has emphasised that it is waiting for significant improvement in a broad
range of economic indicators before it starts normalising policy rates –
although the threat to financial stability from buoyant house prices may
force its hand.
In Japan, authorities face a difficult choice between reviving what has long
been a moribund economy and managing the fiscal challenge of the world’s
highest debt level. Abenomics has so far had some success in boosting asset
prices and bolstering growth, which reached 1,5 per cent in 2013. It also
appears to have ended deflation, with prices rising by 3,4 per cent in April
2014. However, the value-added tax increase of 1 April 2014, implemented
to ensure fiscal sustainability, may arrest the economy’s momentum.
The euro area returned to positive growth from the second quarter of 2013,
although growth for the whole year remained negative at -0,4 per cent. The
forecast for 2014 indicates a 1,2 per cent expansion, with Germany expected
to grow somewhat faster, at 1,7 per cent. The peripheral economies at the
heart of the crisis have all experienced huge and painful adjustments, with
current accounts shifting from large deficits to small surpluses, growth
finally returning and ratings agencies now awarding more upgrades than
downgrades to both sovereigns and companies. Bond yields for the peripheral
countries have come down sharply, in most cases reaching pre-crisis lows,
signaling confidence in these economies.
The biggest threat to the euro area recovery has become low and falling
rates of inflation. By April 2014, Greece, Cyprus, Portugal and Slovakia had
experienced at least three consecutive months of deflation. Furthermore, all
but three euro area countries had inflation at less than 1 per cent, significantly
below the European Central Bank’s 2 per cent guideline. Deflation is a
significant risk to euro area growth as it could cause consumers to defer
purchases and raises the real cost of debt. Indeed, the decline in sovereign
yields for peripheral countries is less marked if one calculates real yields
using current inflation rates, and by this measure these yields are quite
distant from pre-crisis norms.
Emerging-market imbalances
The emerging-market slowdown has a variety of drivers, the greatest of
which is China, which grew at 7,7 per cent in 2013 and is expected to slow
down to between 7,0 and 7,5 per cent in 2014, its slowest pace of expansion
since 1990. Some of China’s deceleration is the natural consequence of
rebalancing towards more sustainable sources of growth, with consumption
displacing exports and investment.
The most important vulnerability in China, and the most plausible trigger
for a growth collapse, is its financial system. Credit expansion has been
extremely strong since the crisis, with credit to the non-bank private sector
Figure 23 Growth rates in advanced

economies

World

United States

Euro area
Source: International Monetary Fund, World Economic
Outlook, April 2014

Advanced economies

Japan

United Kingdom
-6
-4
-2

Per cent

Figure 24 Ten-year real bond yields in the

euro area periphery
-2

-5

Per cent

2013 2014

Portugal

Greece (right-hand scale)
Sources: Bloomberg and own calculations

Italy

Spain

Monetary Policy Review June 2014
now at about 180 per cent of GDP. Money supply growth has finally
begun to slow, returning to levels last seen more than a decade ago, and the
authorities have also begun introducing greater market discipline into credit
allocation, eliminating tacit debt guarantees and planning for liberalised
interest rates. Significantly lower growth will likely prompt small stimulus
packages from time to time.
Several other major emerging markets join China in experiencing growth
challenges and debt vulnerability, but these cases differ in that they have
lower savings rates and therefore borrow abroad. This borrowing gives rise
to large current-account deficits and thereby greater exposure to global
risk sentiment, which in 2013 and 2014 has intermittently moved against
emerging markets. Consequently, these countries have suffered currency
depreciation and rising inflation, requiring tighter monetary policy, for
example in Brazil, India, Indonesia and Turkey. The exception is Chile,
which has eased monetary policy in the face of slower growth and declining
terms of trade – a response made possible by low inflation and anchored
inflation expectations.
Although the most adverse symptoms of the Fed’s tapering have appeared in
emerging markets with high current-account deficits and not in emerging
markets generally, it is misleading to characterise these imbalances as a
purely domestic problem. Emerging-market deficit countries have aided the
world’s recovery by generating demand which has otherwise been scarce
in a world of excess savings and ultra-low interest rates. The eight largest
emerging-market current-account deficits totalled around US$277 billion
in 2013, almost three-quarters of the US figure. The implication is that
pressure to narrow deficits will cause already anaemic global demand to
decline. The best case would be for surplus countries to generate more
demand and for deficit countries to find safer ways to fund their deficits.
Global inflation and commodity prices
In line with weak world demand, global inflationary pressures remain
subdued. The International Monetary Fund projects consumer price
inflation in advanced economies to increase by 0,1 percentage points to
1,5 per cent in 2014, and to fall by 0,3 percentage points to 5,5 per cent
over the same period for emerging-market and developing economies. In
addition to subdued demand, these inflation outcomes are influenced by
relatively stable food and energy price trends.
Viewed over the longer term, metal commodity prices remain elevated,
but they have trended downwards over the past two to three years, owing
mainly to weaker growth in resource-intensive countries such as China.
The outlook for commodities is varied, with base and precious metals
likely to do worse as China rebalances, but food prices much less affected.
Although moderating commodity prices are generally helpful for inflation,
falling metals prices are a concern for producer countries such as Australia,
Chile, South Africa and Zambia. The danger is especially acute where trade
performance is already inadequate, as falling commodity prices would
damage export performance and push up trade deficits.
Figure 25 Growth rates in emerging-market

and developing economies

World

China

Sub-Saharan Africa

Nigeria
Source: International Monetary Fund, World Economic
Outlook, April 2014

Emerging-market and

developing economies

Brazil

-2

Per cent

Figure 26 Monetary policy interest rates

of selected countries
J
M
J
M
M
M
J

S
N
Per cent

Chile

Indonesia

Turkey
Sources: National central banks

India

Brazil
Indices: 2010 = 100
Figure 27 Real commodity prices

Coal, crude oil and natural gas

Base metals

Precious metals
Source: World Bank

Monetary Policy Review June 2014

Risks to the outlook
The Bank bases its projections on a set of assumptions about the future
behaviour of key economic variables. These assumptions inform the baseline
scenario. However, due to risks associated with these assumptions, the MPC
also considers alternative scenarios.
The main international risks to the Bank’s forecast are unforeseen changes to
the pace of monetary policy normalisation by advanced economies and the
economic slowdown in China (described earlier in this MPR). Domestically,
the economy remains vulnerable to supply shocks, notably labour disruptions
and electricity shortages, and the possibility of credit rating downgrades.
These risks, together with high structural unemployment, amplify South
Africa’s vulnerability to global risks.
Global risks
Monetary policy normalisation
Advanced-economy central banks responded to the global financial crisis
with extraordinary stimulus, including zero interest rates, large-scale asset
purchases and unprecedented policy co-ordination. Monetary policy
normalisation entails unwinding stimulus policies, with central banks
raising interest rates, tapering asset purchases and consolidating balance
sheets. For emerging markets, the basic policy implications of this process
are reasonably clear: policy rates will ultimately rise and fiscal policy should
adjust in the direction of reduced debt. Nonetheless, there is considerable
scope for surprises around the implementation of exit strategies, as evidenced
by the shock waves unleashed by Fed tapering. Financial markets seem to
have priced in continued steady quantitative easing tapering in the US,
reducing volatility and uncertainty.
South Africa’s capital flows and borrowing
Since October 2013, South Africa has continued to record a net inflow
of foreign capital in the balance of payments despite fairly consistent net
sales by non-residents of both domestic government bonds and shares.
Non-resident net inflows declined from R85,2 billion in 2012 to only
R1,3 billion in 2013. Strong net outflows of R71,0 billion were recorded
from November 2013 to January 2014. Non-resident net transactions then
reverted to inflows of R33,9 billion from February to May 2014, following
the January rate hike, thereby providing support to the currency. South
Africa’s current-account deficit is not funded exclusively by non-resident
inflows. In fact, more than half of the 2013 deficit was paid for by the
category of ‘unrecorded transactions’, which also covered the majority of the
deficit in the crisis year of 2008. The Bank continues to devote resources
to providing a more adequate accounting of these transactions, and further
details will be forthcoming in future Quarterly Bulletin publications.

-150
-100
-50

R billions

Total change in the financial account

Net portfolio investment
Source: South African Reserve Bank
Figure 28 Flow of capital to and

from South Africa


R billions
R billions
-30
-20
-10

Figure 29 Monthly non-resident net

purchases of domestic securities

Bonds

Total (right-hand scale)


* Data to 29 May 2014
Source: JSE Limited

*

Shares

Monetary Policy Review June 2014
Trade flows and the current account
As global capital flows have grown scarcer and more erratic, South
Africa’s large current-account deficit has become a serious macroeconomic
vulnerability. The expansion of the deficit over the past half-decade stems
from disappointing export performance, linked to falling terms of trade
and production disruptions, and rising imports. Of the latter, three main
categories of imports stand out: capital goods for investment, durable
consumption goods (such as motor vehicles) and intermediate goods (fuel).
Policy changes will help to moderate demand for some of these items, while
the depreciating currency should make South African goods more attractive
to foreign buyers and discourage imports.
By January 2014, the real effective exchange rate had reached a six-year
low, and trade surpluses were recorded during some months in late 2013
and early 2014. However, it is too early to say whether these mark a new
trend, especially because these surpluses have been mixed with very large
deficits. South Africa will still need to attract significant capital inflows. An
important risk here is that declining terms of trade, likely linked to China’s
slowdown, could place further pressure on the current-account deficit.
There is also a danger that elevated inflation outcomes will cancel out the
effects of the exchange rate depreciation, depriving South Africa of sorely
needed competitiveness.
Domestic risks
Electricity
As in the previous upward phase of the business cycle, output growth
is significantly outpacing electricity-supply growth, necessitating load
shedding in early 2014. An unreliable electricity supply is especially
detrimental for the embattled mining and manufacturing sectors, which are
large contributors to growth and employment. Chronic electricity shortages
hinder private fixed capital formation and economic growth. Although new
electricity-generating capacity is now scheduled to come on line during
2014, construction of the requisite power stations has faced repeated delays.
Employment and labour relations
Employment creation remains the most significant challenge to long-term
economic stability and growth. In the first quarter of 2014, unemployment
increased to a high 25,2 per cent in a declining growth environment.
Figure 32 shows that since the onset of the global financial crisis, employment
growth in South Africa has been concentrated in the public sector. The
slow recovery in private-sector employment is a concern, particularly in the
context of fiscal consolidation.
The other great concern in the labour market is antagonistic labour
relations and persistent strikes. In particular, changes in the structure of
mining unionisation over the past few years have caused multiple, often
violent disruptions to production, with the most recent example being the
record-length and ongoing platinum-sector strike. These events have been
Figure 31 Growth in electricity supply and

real GDP in the upward phase

of the business cycle

Electricity (Sep 1999 – Nov 2007)

Real GDP (Sep 1999 – Nov 2007)

Electricity (Sep 2009 – Mar 2014)

Real GDP (Sep 2009 – Mar 2014)
Sources: Statistics South Africa and South African Reserve Bank

Quarters
Indices
Per cent
R billions


Figure 30 Trade and current accounts*

Balance on current account

Trade balance

Current account as a ratio of

gross domestic product (right-hand scale)
* Data are seasonally adjusted
Source: South African Reserve Bank


Figure 32 Formal non-agricultural-sector

employment and GDP*

Total

Private sector

Public sector

Real GDP excluding agriculture
* Data have been seasonally adjusted
Sources: Statistics South Africa, Quarterly Employment Statistics;
and South African Reserve Bank
Indices: 1st qr 2008 = 100
Monetary Policy Review June 2014

costly in several ways, depriving households of wage income and retailers
of customers, damaging exports, and ultimately compromising investment
and employment. The Chamber of Mines estimates the cumulative loss of
wages from the mining strike to be R9 billion.
Conclusion
The MPC faces difficulty in determining policy options in the rising
inflation–slow growth environment that persists. The inflation outlook has
deteriorated and inflation is expected to remain outside the target for an
extended period of time. The exchange rate remains a significant source
of upside risk to the forecast, and although these pressures have abated
somewhat compared to the start of the year, there are stronger indications
of pass-through.
The policy rate has been adjusted upwards, but it is rising from very low
levels, so the monetary policy stance remains supportive of South Africa’s
recovery. Domestic demand pressures have weakened in recent months. The
domestic economy has also suffered a number of adverse supply shocks,
particularly from strike action and electricity shortages, culminating in
negative first quarter growth in 2014 – the economy’s worst performance
since the 2009 recession. Although the second quarter is expected to show
some improvement, the risks to the 2014 forecast are to the downside.
The world economy is back in the start phase of what has been a stopstart recovery, as the Fed has started tapering its extraordinary stimulus
measures. As a consequence, international capital flows have become more
erratic, creating new pressures on emerging markets. Monetary policy is
in a rising interest rate cycle and will align to the speed of global policy
normalisation. It will do so, however, within a flexible inflation-targeting
framework that allows MPC decisions to remain sensitive to changing data
and the fragility of the domestic recovery.

Monetary Policy Review June 2014
Appendix 1: The Bank’s fan charts
This appendix is intended to assist in interpreting the growth and inflation
fan charts. The MPC uses fan charts to focus the discussion of risks lying
ahead and their impact on the inflation and growth forecasts.
Fan chart projections are based on assumptions and are subject to uncertainty.
These graphical representations reflect the MPC’s collective judgement
(a single view of the probability) of the most likely path of inflation and
growth outcomes in the future. However, there is no mechanical link
between either the central projection or the distribution at the forecast
horizon and the setting of monetary policy.
Fan charts reflect the MPC’s view of uncertainty associated with the
projections at different horizons through a range of confidence intervals.
The mode – darkest band at the centre of the fan chart – represents the
most likely 10 per cent of the probable outcomes, including the central
projection. Moving away from the central projection, the area covered by
each successive band, shaded slightly lighter and added on either side of the
central band, adds a further 10 per cent to the probability, until the whole
shaded area depicts a 90 per cent confidence interval.8 The width of the
coloured confidence bands is an indication of the estimated uncertainty.
The fan becomes progressively wider and flatter as the projection extends
into the future, reflecting increased uncertainty. The MPC also takes a view
on the balance of risks. The probability distribution will be symmetrical if
risks are viewed as evenly spread. If risks are viewed as not evenly spread
then the probability distribution will be asymmetrical and skewed. A
skewed probability distribution reflects a higher likelihood of outcomes in
one direction (above or below the central projection). An upward bias is
reflected by a slightly larger shaded area covered by the upper bands and a
downward bias by a slightly larger shaded area covered by the lower bands.

Actual inflation and growth outcomes are therefore expected to be somewhere within the fan on 90 out of 100
occasions. For the remaining 10 out of 100 occasions inflation and growth can be anywhere in the area outside
the shaded range.
Monetary Policy Review June 2014

Statement of the Monetary Policy Committee
29 January 2014
Issued by Gill Marcus, 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 expected
cutback in quantitative easing by the United States (US) Federal Reserve (the Fed) has
begun. Although the initial response in global financial markets was generally fairly muted,
emerging markets have subsequently experienced a high degree of turbulence, particularly in
the wake of renewed fears of a slowdown in China. While the Fed action signals a recovery
in the US, and the United Kingdom (UK) economic outlook is also improving, it does not
mean that the global financial crisis is over. Rather, we are now entering a phase of the crisis
that is creating new challenges for emerging-market economies.
In the longer run a sustained recovery in the US should be positive for the global economy
in general, but the adjustment to the withdrawal of quantitative easing is likely to create
significant short- to medium-term challenges. How to respond to a combination of sharply
depreciating currencies, capital outflows, slowing growth, rising inflation, significant current
account and/or fiscal deficits and deteriorating confidence is posing policy challenges and
very difficult trade-offs for many emerging markets.
The rand exchange rate has been one of the currencies affected by these developments,
and the recent depreciation of the rand, if sustained, will raise significantly the risk to the
inflation outlook. Our inflation forecast shows a marked deterioration, despite the absence
of clear evidence of domestic demand pressures.
The recent inflation data reflect positive outcomes that belie the incipient risks, largely from
the depreciation of the currency, that our forecasts highlight. The year-on-year inflation rate
as measured by the consumer price index (CPI) for all urban areas measured 5,3 per cent
in November 2013 and 5,4 per cent in December, resulting in an average annual inflation
rate of 5,7 per cent for 2013. Food and non-alcoholic beverage price inflation continued to
moderate from a recent peak of 7,1 per cent in August, to 3,8 per cent in November and
3,5 per cent in December. The contribution of this category to the average CPI increase was
0,5 percentage points in December compared with 0,6 percentage points in the previous
month. The petrol price, which was the main contributor to the higher overall inflation in
December, increased at a year-on-year rate of 10,0 per cent, up from 7,7 per cent in November.
Core inflation, which excludes food, petrol and electricity, has been unchanged at 5,3 per
cent for the four months to December, while administered price inflation excluding petrol
measured 6,8 per cent. The headline producer price inflation for final manufactured goods
measured 5,8 per cent in November, compared with 6,3 per cent in October.
The headline inflation forecast of the Bank has deteriorated since the previous meeting of the
MPC, mainly as a result of revisions to the assumptions regarding the rand exchange rate.
The forecast average inflation rate for 2014 is 0,6 percentage points higher at 6,3 per cent,
and 0,6 percentage points higher at 6,0 per cent in 2015, with inflation expected to average
5,9 per cent in the final quarter of that year. Inflation is expected to breach the upper end
of the target range in the second quarter of 2014, and to reach a peak of 6,6 per cent in the
final quarter of the year, before declining to 6,0 per cent in the second quarter of 2015.
Core inflation, which averaged 5,2 per cent in 2013, is expected to average 5,8 per cent in
2014, compared with 5,6 per cent in the previous forecast, while the forecast for 2015 has
increased from 5,3 per cent to 5,9 per cent. The deterioration in this measure of underlying
inflation continues to be driven primarily by the lagged effects of the depreciation of the
rand exchange rate.

Monetary Policy Review June 2014
Inflation expectations appear to have remained relatively anchored at the upper end of
the target range. According to the survey conducted in the fourth quarter of 2013 by the
Bureau for Economic Research at Stellenbosch University, average inflation expectations of
respondents measured 6,1 per cent for both 2014 and 2015, and have remained more or less
unchanged since 2011. There is, however, some divergence between the average expectations
of respondents, which range between 5,6 per cent and 6,4 per cent in 2014, and 5,5 per
cent and 6,5 per cent in 2015. Financial analysts have the lowest forecasts, which are also
reflected in the latest Reuters survey that indicates expectations of 5,6 per cent and 5,5 per
cent in 2014 and 2015 respectively.
While the economic growth outlook for a number of emerging-market economies has
deteriorated somewhat in recent months, the prospects in the advanced economies have
improved, particularly in the US and the UK. However, the recovery remains uneven and not
without risks. In the US, growth is being driven by a recovery in the housing market, robust
private-sector demand, and a dissipation of the negative impulse from fiscal consolidation.
In its latest World Economic Outlook (WEO) update, the International Monetary Fund
(IMF) forecasts growth of 2,8 per cent in 2014 for the US, compared with 1,9 per cent in
2013. The outlook for the eurozone remains fragile and uneven, particularly in the southern
periphery where the risk of deflation, strong fiscal consolidation and weak banking sectors
are constraining the recovery. Eurozone growth in 2014 is expected to remain subdued at
around 1,0 per cent.
The Japanese economy has maintained its positive growth, but there are still doubts about
its sustainability in the absence of continued fiscal stimulus. The outlook for the Chinese
economy is increasingly uncertain, given the challenge of containing the excessive increase
in credit extension without adversely impacting on growth. Although a growth rate of
around 7,5 per cent is still generally expected, the latest Purchasing Managers’ Index
(PMI), which suggests a contraction of industrial production, indicates some downside risk
to this outlook. This uncertainty has contributed to increased risk aversion and volatility
in financial markets of emerging economies in recent weeks, and is also likely to impact
negatively on commodity prices.
Significant currency depreciation and weaker growth prospects are also evident in a number
of other large emerging economies, particularly Brazil, Russia and Turkey, while the outlook
for the Indian economy appears to have improved somewhat.
Global inflation remains benign despite abundant liquidity. However, spillover effects from
increasingly divergent monetary policies are creating a difficult and volatile environment
for emerging markets. There is still some uncertainty regarding the pace of tapering by the
Fed in the coming months, and although market expectations are that the US policy rate is
unlikely to increase before at least mid-2015, long-term bond yields have increased to around
2,8 per cent from around 1,6 per cent in May 2013. A further sustained improvement
in UK growth and employment trends has brought forward the prospect of monetary
tightening by the Bank of England. However, monetary policy is expected to remain highly
accommodative in Japan and the eurozone where the risk of deflation persists.
The expectation of tapering by the Fed since May 2013 resulted in significant outflows from
emerging economies’ domestic bond and equity markets, putting pressure on exchange rates
and long-term bond yields, particularly in those countries with sizeable current-account
deficits. Some countries, including Brazil, Turkey, Indonesia and India, responded by
tightening monetary policy, either in reaction to inflationary pressures or in an attempt to
stem the depreciation. Since May 2013, cumulative interest rate increases have amounted to
300 basis points in Brazil and 75 basis points in India. The most recent instance has been
Turkey which raised its overnight interest rate (MFR) by 425 basis points to 12 per cent.
Monetary Policy Review June 2014

The impact of these developments on the rand exchange rate has resulted in a marked
increase in the upside risk to the inflation forecast, despite the relatively muted pass-through
to date. Since the previous MPC meeting, the rand has depreciated by about 7,4 per cent
against the US dollar, by 9,0 per cent against the euro and by 8,0 per cent on a tradeweighted basis. Year to date the rand/dollar depreciation has been about 3,5 per cent.
In the final two months of 2013, total net sales by non-residents of South African domestic
government bonds and equities amounted to R21,0 billion and R19,4 billion respectively.
These flows effectively reversed the inflows that occurred during the earlier part of the year,
with net purchases of bond and equities for 2013 by non-residents amounting to R1,3 billion,
compared with R85,2 billion for 2012. Year-to-date net sales of equities and bonds have totalled
R19,3 billion, of which R15,6 billion were bonds.
While the recent rand weakness is part of a general emerging-market phenomenon, it has
been reinforced by idiosyncratic factors including declining terms of trade, ongoing labour
disputes, and the higher-than-expected current-account deficit in the third quarter.
Although to date the current account has been slow to react to the depreciation of the rand,
the trade surplus of R0,8 billion recorded in November may signify a possible narrowing
of the current-account deficit in the fourth quarter of 2013. However, given the volatility
of the monthly trade data, it is too early to assess whether or not this is the beginning of
a sustainable trend. The extent to which the strikes in the mining sector and resulting
decline in exports are likely to impede the current-account adjustment further will depend
on the duration of the strikes and the extent to which lost output can be compensated for by
running down inventories.
The economic growth outlook remains subdued amid continued low business confidence.
Growth in the fourth quarter of 2013 is estimated to have recovered somewhat from the low base
of 0,7 per cent in the third quarter, and annual growth in 2013 is estimated to have been around
1,9 per cent. Although an improved outcome is forecast for 2014, growth is still expected to
remain below estimated potential output of between 3,0 and 3,5 per cent. The Bank’s forecasts
for growth in 2014 and 2015 have been revised to 2,8 per cent and 3,3 per cent respectively,
down from 3,0 per cent and 3,4 per cent in the previous forecast round. The Bank’s composite
leading business cycle indicator continues to trend sideways, and was marginally negative
in November.
The mining sector is expected to remain under pressure in the face of work stoppages in
the major platinum mines, with the risk of these disruptions spreading to the gold mines.
Mining output recovered somewhat in the fourth quarter of 2013 from the September lows,
and the sector is expected to have made a positive contribution to fourth-quarter growth.
The manufacturing sector is also expected to have exhibited stronger growth in the final
quarter, following the strike-induced contraction in the third quarter. However, the sector
has yet to exhibit a meaningful response to the weaker exchange rate, and the Kagiso PMI
declined to just below 50 index points in December, for the first time since April 2013.
The construction sector presents a mixed picture. The FNB/BER building confidence index
remained unchanged at 48 index points in the fourth quarter of 2013, the highest level in
5 years. However, the upward trend in the real value of building plans passed observed in
the earlier part of 2013 has levelled off, and there was a notable decline in November by
12,5 per cent on a month-to-month basis, and a 14,5 per cent decline on a year-on-year basis.
The outlook for civil construction, by contrast, appears to be more favourable.
These restrained developments in the real sector have contributed to the slow pace of
employment creation in the economy, and continued job losses in the private sector remain
a concern. According to the Quarterly Employment Statistics (QES) survey of Statistics

Monetary Policy Review June 2014
South Africa, formal-sector employment increased by 13 400 in the year to the third quarter
of 2013, or by 0,2 per cent. In the third quarter of 2013, employment losses were most
pronounced in mining and construction.
Growth in consumption expenditure by households moderated from 2,8 per cent
in the second quarter to 2,3 per cent in the third quarter, and is expected to remain
relatively constrained by disappointing employment growth and a modest rise in credit
extension. Slow growth was particularly evident in the consumption of non-durable
goods and services. Real expenditure on durable goods remained strong, with growth of
9,3 per cent. Nevertheless, domestic new vehicles sales appear to be under pressure,
having contracted by 3,3 per cent on a quarter-to-quarter basis in the final quarter of
2013. Although retail trade sales increased by 1,2 per cent on a month-to-month basis
in November 2013, they increased only marginally, by 0,1 per cent, when the three
months to November are compared to the previous three months. Consumer confidence,
as reflected in the FNB/BER consumer confidence index, remained at a low level
of -7, a marginal improvement from the previous quarter.
Growth in credit extension by the banking system to the private sector continued to
lose momentum. Twelve-month growth in total loans and advances to the private sector
moderated to 7,4 per cent in November, with credit extension to households measuring
5,9 per cent, compared with 10,4 per cent at the same time in 2012. Twelve-month growth in
general loans to households, mainly unsecured lending, measured 8,1 per cent in November,
the lowest rate of growth since April 2009, while annualised growth over three months
showed a contraction of 0,8 per cent. Although there has been an increase in commercial
mortgage credit extension, growth in outstanding residential mortgages remains subdued
at 1,3 per cent. Instalment sale credit and leasing finance has continued to be relatively
brisk, but could moderate if motor vehicle demand continues to decline. Household debt
as a percentage of household disposable income declined slightly from 75,8 per cent in the
second quarter to 75,5 per cent in the third quarter of 2013.
Wage settlement rates, as measured by Andrew Levy Employment Publications, measured
7,9 per cent during 2013. However, according to QES data, growth in nominal remuneration
per worker declined from 8,8 per cent in the year to the second quarter of 2013, to
6,6 per cent in the year to the third quarter. For the economy as a whole, despite a small
decline in labour productivity growth, unit labour cost growth declined over the year from
6,9 per cent in the second quarter to 4,9 per cent in the third quarter. However there are
important sectoral differences. For instance, unit labour cost growth in the manufacturing
sector accelerated from 5,6 per cent to 6,9 per cent during the same period, while nominal
remuneration per worker in the mining sector increased by 9,0 per cent.
Food prices have been the main contributor to the downside surprises in inflation in the
past two months, with prices increasing by 3,5 per cent in December. Global food prices
generally declined during the year amid improved wheat and maize harvests. The rand
exchange rate, coupled with disappointing domestic harvests due to drought in some areas,
has impacted adversely on the domestic maize and wheat prices in recent weeks, with the
spot prices of maize increasing by about 12 per cent during January, following increases of
around 20 per cent between August and December 2013. These pressures have not as yet
been observed in the producer price index where cereal and other crop prices declined by one
per cent over the year in November. Persistent drought conditions in a number of regions
have resulted in the culling of cattle, leading to extremely low meat price inflation since
September (0,1 per cent in December). However, these favourable food price outcomes are
not expected to persist as higher spot grain prices work through to consumer prices.
Although the exchange rate pass-through has generally been relatively muted to date, the
impact on the petrol price has been almost immediate. International oil prices have been
Monetary Policy Review June 2014

fairly stable, with Brent crude oil trading in a range of between US$106 and US$109 during
January. In December and January the domestic petrol price was increased by a cumulative
55 cents per litre, and a further significant increase, in excess of 30 cents per litre, can be
expected in February, primarily as a result of the weaker exchange rate. Sustained upside
pressure from petrol prices on inflation can therefore be anticipated should the rand continue
to depreciate.
The MPC carefully considered the economic challenges facing South Africa and the
appropriate policy response. On the one hand, inflation forecasts indicate the possibility
of being out of the target range for an extended period, largely due to the impact of the
depreciating currency. The risks to the inflation forecast are seen to be significantly on the
upside. Large adjustments to the exchange rate will inevitably impact on inflation, even in
conditions of relatively low pass-through such as we have been experiencing.
On the other hand, the growth outlook remains of concern. Credit extension is low and
declining, few jobs on a net basis are being created, and gross fixed capital formation,
particularly from the private sector, is significantly below what is required.
Capital outflows and a current-account deficit exacerbate the difficulties that lie ahead.
Exchange rate pressures are expected to intensify as markets adjust to the new pattern
of global capital flows. Although monetary policy in the advanced economies remains
accommodative, the process of normalisation has begun, and the spillovers have implications
for our own monetary policy.
The primary responsibility of the Bank is to keep inflation under control and ensure that
inflation expectations remain well anchored. The depreciation experienced so far could
improve our international competitiveness, provided that it is not eroded through higher
wage and other input prices.
In the light of these circumstances and taking account of policy trade-offs, the MPC has
decided to increase the repurchase rate by 50 basis points to 5,5 per cent per annum as of
30 January 2014. The MPC is of the view that, notwithstanding this increase in the repo
rate, monetary policy remains accommodative. Further moves in the repo rate will be highly
data-dependent. We will continue to monitor developments closely and will not hesitate to
act as required in keeping with our mandate.

Monetary Policy Review June 2014
Statement of the Monetary Policy Committee
27 March 2014
Issued by Gill Marcus, 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 global economic
environment has remained challenging, notwithstanding some improvement in sentiment.
Key factors affecting the environment include the possibility of an earlier-than-expected
increase in the United States (US) policy rate in 2015, further evidence of a slowdown in
China, and geo-political tensions arising from the situation in Ukraine.
The domestic economic outlook remains subdued amid continued strikes in the platinum
sector and uncertainty regarding a stable and sufficient electricity supply in the coming
months. While the most recent inflation forecasts suggest marginal improvements in the
medium term, upside risks to the inflation outlook persist despite the recent appreciation of
the rand, which remains vulnerable to shifts in global risk sentiment and adverse domestic
developments. Together with downside risks to growth, this continues to pose a dilemma
for monetary policy.
The year-on-year inflation rate as measured by the consumer price index (CPI) for
all urban areas measured 5,8 per cent and 5,9 per cent in January and February 2014
respectively, up from 5,4 per cent in December 2013. This marked upward trend was
in line with the forecasts of the South African Reserve Bank (the Bank). Food and nonalcoholic beverage price inflation reversed its previous downward trend, measuring
4,3 per cent and 5,4 per cent in the past two months, compared with the recent low of
3,5 per cent in December. The contribution of this category to the overall CPI inflation
increase was 0,8 percentage points in February 2014, compared with 0,5 in December
2013. The petrol price, which was the other main contributor to the higher CPI inflation
in February, increased at a year-on-year rate of 14,0 per cent. Core inflation, which excludes
food, petrol and electricity, was unchanged at 5,3 per cent, the sixth consecutive month at
this level. This was despite upward pressures from exchange rate sensitive categories such
as clothing and footwear, and motor vehicle inflation, which were offset to some extent by
a lower rate of increase in medical insurance costs. Administered price inflation excluding
petrol measured 6,9 per cent. The headline producer price inflation for final manufactured
goods measured 7,7 per cent in February, compared with 7,0 per cent in January.
The Bank’s forecast of headline inflation is unchanged for 2014 and is expected to average
6,3 per cent, with the peak of 6,6 per cent still expected in the fourth quarter. The forecast
average inflation for 2015 declined from 6,0 per cent previously to 5,8 per cent, with inflation
expected to average 5,6 per cent in the final quarter of that year, compared with 5,9 per cent
previously. This improvement is mainly the result of the lagged effect of the repurchase
(repo) rate increase. Inflation is still expected to breach the upper end of the target range in
the second quarter of 2014, and to return to within the target range in the second quarter of
2015, when it is expected to measure 5,9 per cent.
The outlook for core inflation has improved and is expected to average
5,6 per cent in both 2014 and 2015, compared with the previous forecast of 5,8 per cent
and 5,9 per cent for these two years respectively. Notwithstanding this improvement, the
upward pressures continue to be seen to be coming from the lagged effects of the exchange
rate depreciation. The MPC still assesses the risks to the inflation outlook to be skewed to
the upside, as extended periods of overshooting of the exchange rate remain a possibility in
the current uncertain global environment. There is also a risk that the current low level of
pass-through may not persist.
Monetary Policy Review June 2014

Inflation expectations as measured by the survey conducted by the Bureau for Economic
Research (BER) in the first quarter of 2014, remained unchanged at an average of 6,1 per
cent for both 2014 and 2015, with inflation of 5,9 per cent expected in 2016. Although the
2014 expectations of analysts increased to 6,1 per cent from 5,6 per cent in the previous
survey, the expectations of business people declined to 6,2 per cent from 6,4 per cent, with
trade union expectations unchanged at 6,1 per cent. Analysts expect inflation to moderate
during the next two years to within the target range, while business and labour respondents
expect inflation to remain steady at just over 6 per cent, indicating that expectations continue
to be relatively well anchored, albeit at the upper end of the target band.
The Reuters survey of economic analysts conducted in March 2014 shows that inflation
expectations of economists are more or less unchanged since the previous survey and also
remain, on average, anchored at the upper end of the band. The expectation is that inflation
will breach the upper end of the target range in the third and fourth quarters of 2014 at an
average rate of 6,1 per cent before returning to within the target range.
The global economic recovery continues to be uneven, with a first quarter slowdown in
growth in the advanced economies compared with the fourth quarter of 2013, due in part to
severe weather conditions, particularly in the US. Nevertheless, the underlying US growth
prospects remain relatively favourable despite a slower pace of employment growth, amid
positive investment and consumption indicators. The United Kingdom economy continues
to show signs of sustained improvement, with declining inflation and unemployment rates as
well as a buoyant housing market. The eurozone’s growth prospects remain weak, although
there are signs of a modest recovery, and the unemployment rate appears to have peaked.
Japanese economic growth in the fourth quarter of 2013 was lower than expected, and there
are indications that the recovery could be losing momentum.
The global outlook is, however, overshadowed by unfolding developments in the Ukraine
and Russia regarding Crimea, although to date contagion effects have been limited to
those countries with direct trade and financial links with the region. The other downside
risk factor relates to a deteriorating outlook in a number of the larger emerging market
economies, including Brazil, Russia and China. Recent short-term data from China indicate
that economic growth could decline below the government’s target of 7,5 per cent, at a time
of increased risks in the banking sector.
The slowdown in China is expected to maintain downward pressure on global commodity
prices, particularly industrial commodities, while there are upside risks to some commodities,
particularly oil and grains, from the tensions in Crimea.
Global inflation pressures remain benign, particularly in the advanced economies. Since the
previous meeting of the MPC, the US has continued its steady path of tapering, although
the financial markets now believe that the first interest rate increases may occur earlier in
2015 than previously expected. Over the same period, monetary policy has been tightened
in New Zealand, Brazil and Russia, and loosened in Israel, Thailand, Chile and Hungary.
The exchange rate of the rand has been relatively volatile since the previous meeting of
the MPC, having fluctuated in a wide range between R10,60 and R11,39 against the US
dollar. There has been an appreciating trend over this period, in line with an improving risk
sentiment towards emerging markets. Since the previous meeting of the MPC, the rand
has appreciated by about 2,4 per cent against the US dollar, and by 2,2 per cent on a tradeweighted basis.
While the risk to the inflation outlook from the exchange rate may have moderated somewhat
since the previous meeting, these risks are still assessed to be on the upside. The MPC is of
the view that the exchange rate will continue to be highly sensitive to both domestic and
global developments, remaining prone to further bouts of volatility and protracted periods
of overshooting.

Monetary Policy Review June 2014
The current account of the balance of payments narrowed significantly, from 6,4 per cent
of gross domestic product (GDP) in the third quarter of 2013 (revised down from 6,8 per
cent previously) to 5,1 per cent of GDP in the following quarter, with a deficit for the year of
5,8 per cent. The contraction of the trade account was a result of both a 3,6 per cent decline
in the value of merchandise imports and a 0,9 per cent increase in export earnings. Although
we expect the current account to respond to the depreciated exchange rate, this adjustment
is likely to be gradual and some widening of the trade deficit is expected in the first quarter
of 2014. Constraining factors include the protracted nature of the strike in the platinum
sector and the relatively inelastic import demand, particularly with respect to imported
capital equipment. Promisingly, net exports made positive contributions to GDP growth in
the final two quarters of 2013.
Tapering by the US Federal Reserve and the expectation of US interest rate normalisation
continued to impact on the pattern of global capital flows and financial market volatility. The
domestic yield curve flattened since the previous MPC meeting, as the short end increased
in response to monetary tightening, while the long end of the curve shifted downwards.
In contrast to emerging markets in general, South Africa experienced net inflows into the
equity markets in February and March 2014 totalling R11,6 billion, following net sales of
R25,1 billion between November 2013 and January 2014. Non-residents remained net sellers
of bonds but at a slower pace: net sales of bonds amounted to R46,0 billion over the same
three-month period, but moderated to R1,2 billion in February 2014, and net purchases of
R2,1 billion in March to date.
The domestic economic growth outlook remains subdued. Despite a rebound in the fourth
quarter of 2013, when an annualised growth rate of 3,8 per cent was recorded, economic
growth is expected to remain below potential of between 3,0 per cent and 3,5 per cent in
2014, with a consequent widening output gap. The Bank’s forecast for economic growth has
declined marginally to 2,6 per cent in 2014, compared with 2,8 per cent previously, while
the forecast for 2015 has been revised down from 3,3 per cent to 3,1 per cent. The risks to
this forecast are seen to be on the downside, given the protracted strike in the platinum
sector and electricity supply constraints. This deterioration comes amid continued low
levels of business confidence, with the RMB/BER Business Confidence Index declining to
41 index points in the first quarter of 2014, the fourth consecutive month at a level below
the neutral 50 index points. The sideways movement of the composite leading business cycle
indicator of the Bank also points to a restrained outlook.
The growth outcome in the fourth quarter of 2013 was led by strong growth in the
manufacturing sector in particular, following the strike-induced contraction in the previous
quarter. In January 2014, a 2,5 per cent year-on-year rate of growth in manufacturing
output was recorded. According to the BER manufacturing survey, business confidence in
the sector remains low despite increasing to 41 index points in the first quarter of the year,
from 36 previously. There are, however, some positive signs in the sector, with the Kagiso
Purchasing Managers’ Index (PMI) increasing to 51,7 index points in February, and the
BER’s indicators for manufacturing export sales and orders improving further in the first
quarter of 2014, to their highest level in ten years.
Despite strong performance in the fourth quarter of 2013, the outlook for the mining
sector remains bleak: mining output contracted at a month-on-month rate of 1,1 per cent
in January of this year, and the ongoing strike in the platinum sector is likely to impact
adversely on mining output and exports.
Growth in real gross fixed capital formation accelerated to 4,7 per cent in 2013, compared
with 4,4 per cent in the previous year. During the past year, real capital outlays by the
private sector increased by 5,5 per cent, while public corporations and general government
investment increased by 3,1 per cent and 3,5 per cent respectively.
Monetary Policy Review June 2014

Consistent with moderate economic growth, employment growth has remained weak.
According to the Quarterly Employment Statistics (QES) of Statistics South Africa,
employment levels in the formal non-agricultural sector increased marginally at a seasonally
adjusted rate of 0,2 per cent in the fourth quarter of 2013, or by 5 100 employment
opportunities. In the year to the fourth quarter of 2013, the increase was 0,5 per cent or 40
900 jobs, with the public sector contributing 39 000 of these jobs. Overall, private-sector
employment declined during the fourth quarter of 2013, with losses most pronounced in the
gold mining, construction and electricity sectors.
The weakening trend in the growth in household consumption expenditure continued into
the final quarter of 2013, with growth of 2,0 per cent recorded, and its contribution to
GDP growth declining from 2,3 percentage points in 2012 to 1,7 percentage points in
2013. Growth for the year averaged 2,6 per cent, while consumption expenditure by general
government averaged 2,4 per cent. Household spending on durable goods remained firm,
but grew at a slower pace of 6,9 per cent, and is likely to moderate further as vehicle sales
come under increasing pressure. Total domestic new vehicle sales declined in February 2014
by 2,6 per cent on a month-to-month basis and by 3,1 per cent year on year. Although
real retail trade sales exceeded market expectations in January following a month-to-month
increase of 0,8 per cent and a 6,8 per cent increase year on year, the outlook for consumption
expenditure is expected to be constrained by slow employment growth, high debt levels of
consumers, slow rates of growth in credit extension and the higher interest rate environment.
Growth in government consumption expenditure is expected to be contained. According
to the recent budget, the expenditure cap has been maintained and a consolidated budget
deficit of 4,0 per cent of GDP is estimated for 2014/15, in line with that of the past fiscal
year. A faster pace of fiscal consolidation is indicated, with the deficit-to-GDP ratio expected
to decline to 2,8 per cent in 2016/17.
Bank credit extension to the private sector has maintained its weak underlying trend,
particularly with respect to credit extended to households, reinforcing expected pressures on
household consumption expenditure. By contrast, credit extension to the corporate sector
was relatively robust, with growth rates of around 10 per cent. Although twelve-month
growth in total loans and advances to the private sector increased from 6,4 per cent in
December 2013 to 7,6 per cent in January 2014, credit extension to households increased by
5,5 per cent and 5,6 per cent in these two months respectively. This probably reflects both
supply- and demand-side considerations. Mortgage lending remained weak, with twelvemonth growth of 2,1 per cent in January, amid moderate house price growth. Twelve-month
growth in general loans to households (mainly unsecured lending) continued its downward
trend, measuring 5,0 per cent in January, the lowest rate of growth since February 2005.
Instalment sale credit and leasing finance has remained buoyant but is growing at a more
moderate pace, in line with declining vehicle sales.
The trend in wage settlements has remained relatively unchanged. According to Andrew Levy
Employment Publications, the overall average wage settlement rate in collective bargaining
agreements measured 7,9 per cent in 2013, compared with 7,6 per cent in 2012. Data from
Stats SA show that the growth in nominal remuneration per worker increased from 6,7 per
cent in the year to the third quarter of 2013 to 7,0 per cent in the fourth quarter. Once the
slight increase in productivity growth is accounted for, this translates into a unit labour cost
increase of 5,2 per cent in the fourth quarter. While this appears to be relatively contained,
there are wide variations across sectors, and the outcome of wage negotiations during the
year in an unsettled labour relations environment will be an important determinant of
inflation pressures.
As anticipated, the favourable trend of food prices in the CPI has reversed, and pressures
are expected on headline inflation from this source despite the moderation of prices at the
global level. Having reached a recent low of 3,5 per cent in December 2013, consumer food

Monetary Policy Review June 2014
price inflation increased to 4,3 per cent and 5,6 per cent in the subsequent two months.
Final manufactured producer food price inflation accelerated to 7,6 per cent in February
2014, and further pressures are evident in the agricultural producer price inflation for cereals
and other crops which accelerated from -8,2 per cent in August 2013 to 27,6 per cent in
February 2014. This contributed to the 7,4 per cent increase in bread and cereals prices at
the consumer price level in February. The wheat and maize prices reflect exchange rate
pressures and domestic drought conditions. Although futures prices indicate some possible
moderation in the coming months following the recent rains, near-term pressures remain.
International oil prices have been relatively unaffected by the Crimean crisis, and the price
of Brent crude oil fluctuated between a relatively narrow range of US$106 and US$111 per
barrel since the previous meeting. The exchange rate has been the main driver of the rand
petrol price, which increased by a cumulative 75 cents per litre in February and March.
The recent appreciation of the rand has resulted in the current over-recovery in the petrol
price, and this is expected to offset in part the 20 cents per litre fuel levy increase due to be
implemented in April.
The MPC is acutely aware of the policy dilemma of rising inflation pressures in a subdued
economic growth environment. Despite a marginal improvement in the medium-term
inflation forecast, the trajectory remains uncomfortably close to the upper end of the target
range.
The main upside risk to the forecast continues to come from the exchange rate, which,
despite the recent relative stability, remains vulnerable to global rebalancing. The expected
normalisation of monetary policy in advanced economies is unlikely to be linear or smooth,
and the timing and pace is uncertain.
The rand is also vulnerable to domestic idiosyncratic factors, including protracted work
stoppages, electricity supply constraints, and the slow adjustment of the current-account
deficit. Pass-through from the exchange rate to prices has been relatively muted to date but
there is some evidence that it is accelerating. However, the forecast already incorporates a
higher pass-through than has been experienced up to now.
At the same time, the domestic economic outlook remains fragile, with the risks assessed
to be on the downside. Demand pressures remain benign as consumption expenditure
continues to slow amid weakening credit extension to households and high levels of
household indebtedness. The upward trend in the core inflation forecast is assessed to reflect
exchange rate pressures rather than underlying demand pressures.
Given the lags with which monetary policy operates, the MPC will continue to focus on the
medium-term inflation trajectory. The committee is aware that too slow a pace of tightening
could undermine inflation expectations and may require more aggressive tightening in the
future. Consistent with our mandate, a fine balance is required to ensure that inflation is
contained while minimising the cost to output.
The real policy rate is currently below what can be considered normal in the long run and is
likely to increase over the medium term. The pace of tightening will depend on a number of
factors, including projected inflation, inflation expectations, the state of the economy and
global developments. At this meeting, the MPC decided to keep the repo rate unchanged at
5,5 per cent per annum.
We wish to reiterate that even though we are in a tightening cycle, there will not necessarily
be a change in the stance at every meeting, and that the increments may not always be of
the same magnitude.
Monetary Policy Review June 2014

Statement of the Monetary Policy Committee
22 May 2014
Issued by Gill Marcus, 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), inflation has
breached the upper end of the target band and is expected to remain outside the target for
some time. This development was in line with the inflation forecast of the South African
Reserve Bank (the Bank), which is more or less unchanged since the previous meeting of the
MPC. The exchange rate has appreciated somewhat since its lows in January in response to a
more benign global monetary policy environment, moderating some of the near-term upside
risks to inflation. Nevertheless, risks to the inflation outlook remain skewed to the upside.
Despite a more favourable global growth environment, the domestic economic growth
outlook has deteriorated markedly. There is still no end in sight to the protracted strike in
the platinum sector, and the economic and social costs are escalating and are potentially
devastating. Both the mining and manufacturing sectors appear to have contracted in the
first quarter of the year, with electricity supply constraints adding to the weak outlook.
Against this backdrop, monetary policy faces an increasingly challenging scenario.
The year-on-year inflation rate, as measured by the consumer price index (CPI) for all urban
areas, came to 6,0 per cent and 6,1 per cent in March and April 2014 respectively, up
from 5,9 per cent in February. Food and non-alcoholic beverage price inflation accelerated
significantly, measuring 7,0 per cent and 7,8 per cent in the past two months, compared
with a recent low of 3,5 per cent in December 2013. The contribution of this category to
headline inflation was 1,2 percentage points in April, compared with 0,8 percentage points
in February. The categories of food, housing utilities and transport together accounted for
3,7 percentage points of the inflation outcome in April. Core inflation, which excludes food,
petrol and electricity, measured 5,5 per cent in both March and April after six consecutive
months at 5,3 per cent. Administered price inflation excluding petrol continued its gradual
decline, measuring 6,5 per cent in April from 6,7 per cent in March. The headline producer
price inflation for final manufactured goods measured 8,2 per cent in March compared
with 7,7 per cent in February, driven mainly by food prices, and is indicative of further
upside pressures on CPI inflation in the near term.
The Bank’s forecast of headline inflation changed marginally since the previous meeting.
Inflation is expected to average 6,2 per cent in 2014 compared with 6,3 per cent previously,
with the peak of 6,5 per cent (previously 6,6 per cent) expected in the fourth quarter. The
forecast average inflation for 2015 remained unchanged at 5,8 per cent. The forecast horizon
has been extended and inflation is expected to average 5,5 per cent in 2016 and 5,4 per cent
in the final quarter of that year. Inflation is still expected to remain outside the target band
from the second quarter of 2014 until the second quarter of 2015.
The outlook for core inflation is also largely unchanged. This measure is expected to average
5,6 per cent and 5,7 per cent in 2014 and 2015 respectively, compared with the previous
forecast of 5,6 per cent for both years, moderating to 5,5 per cent in 2016. The upward
pressure is assessed to be a response to the lagged effects of the exchange rate depreciation
rather than evidence of strong domestic demand pressures. The MPC still sees the risks to
the inflation forecast to be skewed to the upside, and remains concerned that the current low
level of pass-through may not persist.
The Reuters survey of inflation expectations of economic analysts conducted in May is more
or less unchanged since the previous survey. Inflation is expected to average 6,3 per cent in
the second quarter and 6,2 per cent in the final two quarters of 2014 before returning to
within the target at an average of 5,8 per cent in the first quarter of 2015. Annual inflation is

Monetary Policy Review June 2014
expected to average 6,2 per cent in 2014, and 5,6 per cent and 5,4 per cent in the subsequent
two years respectively, somewhat lower than the Bank’s forecast.
The global economic outlook remains mixed. Growth in the United States (US) stalled in
the first quarter as a consequence of the severe weather conditions, while retail sales in April
were below expectations. Despite the downside risk to growth from the housing market, the
recovery is expected to remain on track, although at a lower rate than that forecast earlier
in the year. While the US Federal Reserve (the Fed) expects growth of between 2,8 and
3,0 per cent for 2014, the market consensus is closer to 2,5 per cent. Economic recovery in
the United Kingdom (UK) also appears to be resilient, despite some slack in the economy.
By contrast, the eurozone continues to lag, following a lower-than-expected annualised
growth rate of around 0,8 per cent in the first quarter.
The annualised growth rate of 5,9 per cent recorded by the Japanese economy in the first
quarter of this year is not expected to be sustained as higher consumption taxes take effect,
and consensus forecasts are for annual growth of around 1,5 per cent. The Chinese economy
grew at an annualised rate of 5,8 per cent in the first quarter of 2014 amid weakening trends
in industrial production and retail sales. Although an annual growth rate of between 7,0 per
cent and 7,5 per cent is still generally expected, there are concerns that the loss of momentum
in the property market and declining credit growth could pose downside risks to growth.
The shift in global growth dynamics towards the advanced economies has been reinforced,
with a number of emerging markets facing a more challenging outlook. Low growth is
expected in a number of the larger economies, including Brazil, Russia, Argentina, Turkey
and Thailand, but some analysts have revised upwards their growth forecasts for India.
More positively, growth in sub-Saharan Africa is expected to average 5,4 per cent, but this is
vulnerable to weaker commodity prices in the event of slower growth in China.
Global inflation remains benign amid relatively stable food and energy price trends.
Financial markets appear to have priced in continued steady tapering of quantitative easing
in the US, and recent guidance from the Fed appears to have reduced the degree of volatility
and uncertainty in financial markets regarding the pace and timing of monetary policy
normalisation. Policy rates look set to increase at a moderate pace in both the US and the
UK during 2015, while the possibility exists of further easing in Japan and the eurozone
where the risk of deflation persists. Since the previous meeting of the MPC, monetary policy
has been tightened in New Zealand, Brazil and Russia in response to inflation pressures or
exchange rate concerns, but was eased slightly in Hungary.
With global financial markets pricing in a slower pace of US policy normalisation, global risk
appetite has improved. Apart from sizeable outflows from Russia in the wake of the crisis in
the Ukraine, capital flows to emerging markets have resumed or outflows slowed, resulting
in generally appreciating emerging-market currencies and declining long bond yields. This
improved sentiment has also impacted on the rand exchange rate, which appreciated by 3,3 per
cent against the dollar and by 3,1 per cent on a trade-weighted basis since the previous meeting
of the MPC. During this period, the rand traded in a range of between around R10,29 and
R10,70 against the US dollar.
Portfolio flows to South Africa have been in line with general global trends. Following
cumulative net sales of South African government bonds and equities by non-residents
of R71 billion from November 2013 to the end of January 2014, net purchases of bonds
and equities since the beginning of February have totalled R8,3 billion and R29,9 billion
respectively. Year-to-date net inflows into bonds and equities total R7,6 billion.
While recent exchange rate developments have afforded some near-term respite from further
inflation risks from the exchange rate, the MPC is mindful of the sensitivity of the rand to
both global and domestic factors.
Monetary Policy Review June 2014

The rand is expected to remain vulnerable to changing global perceptions of US monetary
policy and associated capital flows. However, while the recent appreciation is more a
reflection of changing global risk perceptions rather than a specific reassessment of South
African fundamentals, domestic factors have also impacted on the rand. The exchange rate is
likely to remain sensitive to domestic factors, including developments in the current account
of the balance of payments and perceptions of its sustainability. In particular, the ongoing
strike in the platinum sector is expected to begin to have a significant negative impact on
exports now that inventories are reaching low levels, and a further extension of the strike
could impede the required current-account adjustment process.
The domestic economic growth outlook has deteriorated markedly, with the reversal of a
number of the tentative positive signs observed at the beginning of the year. The Bank’s
forecast for economic growth for 2014 has been revised down, from 2,6 per cent at the
previous meeting to 2,1 per cent, implying a further widening of the negative output gap.
The forecast for 2015 remains unchanged at 3,1 per cent, and growth in 2016 is expected to
average 3,4 per cent. However, the risks to these forecasts are increasingly to the downside
against the renewed possibility of electricity load-shedding, among other factors. The Bank’s
leading indicator of economic activity declined marginally in February, and the sustained
sideways movement confirms the subdued outlook amid weak business confidence. The
RMB/BER Business Confidence Index declined by 2 index points to 41 index points in the
first quarter of 2014.
The first quarter growth outcome was negatively affected by contractions in both the mining
and manufacturing sectors. In the first quarter of 2014, the physical volume of mining
production declined by 6,8 per cent (not annualised) when compared with the previous
quarter. This decline was not confined to the platinum group metals, with production
declining in seven of the twelve mining subcomponents, and expectations are for this
negative trend to continue.
The physical volume of manufacturing production declined by 1,6 per cent (not annualised)
in the first quarter of the year. This contraction was also broad-based and the outlook for
the sector remains subdued, as reflected by the marked decline in the Kagiso Purchasing
Managers’ Index (PMI) to 47,4 index points in April. This follows two consecutive months
when the index was above 50 points. The new sales orders component of the PMI remained
well below 50 points for the second consecutive month. There appears to be continued
underutilisation of manufacturing production capacity, particularly with respect to durable
goods production.
The favourable trend in the real value of building plans passed during the past two years has been
maintained in keeping with the rising levels of building confidence. The real value of building
plans passed increased by 13,6 per cent on the 3-month-to-3-month basis in March 2014 and by
5,9 per cent on a year-on-year basis.
The unemployment rate remained elevated at 25,2 per cent in the first quarter of 2014 in a
declining growth environment. This follows a decline in employment in the first quarter of
2014 of 122 000 jobs, although on a seasonally adjusted basis the decrease was 32 000 jobs.
Consumption expenditure by households is expected to remain constrained in the face of
continued weakness in credit extension, rising inflation, high consumer indebtedness, as
well as the knock-on effects of the mining strike, where the cumulative loss of wages is
estimated to have exceeded R8 billion. Real retail sales grew by 0,6 per cent on a quarter-toquarter basis in the first quarter of this year, having declined in March by 1,4 per cent on a
month-to-month basis. New vehicle sales declined by 0,7 per cent on a 3-month-to-3-month
basis in April, and by over 10 per cent on a year-on-year basis, while the National Association

Monetary Policy Review June 2014
of Automobile Manufacturers of South Africa expects new vehicle sales to contract over the
year. Although the FNB (First National Bank)/BER Consumer Confidence Index improved
marginally in the first quarter of 2014, it remained at a low level of -6.
Growth in bank credit extension to households continued to moderate, while that to
companies has remained relatively robust. The twelve-month growth in total loans and
advances to the private sector measured 8,2 per cent in March 2014, driven by a 12,7 per
cent increase in credit extension to companies related in part to the awarding of a new
round of renewable energy contracts. By contrast, growth in credit extension to households
moderated further to 4,8 per cent, as unsecured lending continued its downward trend.
Growth over twelve months in general loans to households, mainly made up of unsecured
lending, measured 3,5 per cent in March, the lowest rate of growth since 2005. Growth
in mortgage advances to households remained below 3 per cent, in line with the relatively
subdued volume growth in the housing market. While growth in instalment sale and
leasing finance recorded annual growth of 10,1 per cent in March, it is on a declining trend,
particularly with respect to households. These trends in credit extension are expected to
remain a constraint to consumption expenditure growth.
The trend in wage settlements is more or less unchanged. According to Andrew Levy
Employment Publications, the overall average wage settlement rate in collective bargaining
agreements was unchanged from the previous year, at 7,9 per cent in the first quarter of
2014. However, the main wage negotiations are yet to be completed, in particular the renegotiation of a new multi-year agreement in the Steel and Engineering Bargaining Council.
The outcome of this, as well as the impasse in the platinum sector, could have an important
bearing on the general trend of wage settlements.
Food prices remain a risk to the inflation outlook although the risk may have moderated
somewhat following the sharp reversal in domestic maize prices in recent weeks. Having
reached a peak of almost R3 800 per ton in March, maize prices declined in May to around
R2 000 per ton and an 8 per cent decline over the year. This was in response to an upward
revision of the domestic maize crop forecast, now expected to be 11 per cent higher than last
year, which has resulted in a move from import to export parity prices. This development, if
sustained, could help ameliorate the considerable pipeline pressures that have been evident
in the producer price index since the beginning of the year. Final manufactured producer
food price inflation accelerated to 9,1 per cent in March, and further pressures are evident in
the agricultural producer price inflation for cereals which measured 26,5 per cent in March,
although this is expected to moderate in response to lower spot prices.
The international oil price has remained within the range of US$105 to US$111 for some
time. The domestic price of petrol has benefited from the stronger trend in the exchange
rate over the past weeks. In May, the price of 95-octane petrol declined by 15 cents per
litre, following a 7 cent per litre increase in April. Should current trends continue, a further
reduction can be expected in June.
The MPC continues to face the difficult dilemma of dealing with upside risks to inflation
and a deteriorating domestic economic growth outlook. Although the breach of the upper
end of the inflation target band was in line with the Bank’s forecast, the risks to the forecast
remain on the upside. The policy dilemma is increased by the fact that inflation is seen
to be driven primarily by supply-side factors, while demand conditions in the economy
remain subdued.
Although the immediate pressures from the exchange rate are lower than was the case earlier
in the year, the exchange rate remains a significant source of upside risk to the forecast. The
respite from the stronger exchange rate could be temporary and respond quickly to changes
Monetary Policy Review June 2014

in both domestic and external conditions. Although the pass-through from the exchange
rate to inflation is still relatively low, there are indications of some acceleration. In addition,
food prices are expected to add further upside impetus to inflation in the near term, but
this risk may have moderated to some extent given the sharp decline in maize prices and low
global food inflation.
As indicated earlier, the Bank’s economic growth forecast for 2014 has been revised down
significantly to 2,1 per cent, and the first quarter growth outcome is anticipated to be the
lowest quarterly growth rate since the recession in 2009. Although growth in the second
quarter is expected to improve somewhat, the risks to the 2014 growth forecast are strongly
on the downside, with developments in the mining sector an ongoing cause for concern. The
demand side of the economy is also weakening: household consumption expenditure growth
continues to moderate amid slower credit extension to households, high levels of consumer
debt levels and moderate job growth. However, the weak state of the economy cannot be
resolved through monetary policy actions alone.
The committee continues to hold the view that we are in a rising interest rate cycle, and
interest rates will have to be normalised in due course. We embarked on this process with
our first move in January 2014. At this stage, the pace and timing of normalisation in the
advanced economies appears to have been pushed out further and may be more moderate
than previously believed. We are also aware that this can change very quickly.
Accordingly, the MPC decided to keep the repurchase rate unchanged at 5,5 per cent per
annum at this stage.
Future actions will be data-dependent and determined by developments in the inflation
outlook and inflation expectations. Inflation is currently at uncomfortable levels, and a
marked deterioration in the outlook may require action that we will not hesitate to take. The
MPC reiterates that a rising interest rate cycle does not mean that rates will be raised at each
meeting or by the same amount each time.

Monetary Policy Review June 2014
Abbreviations
CPI

consumer price index
CPIX
consumer price index excluding mortgage interest cost for metropolitan
and other urban areas
GDP
gross domestic product
MPC
Monetary Policy Committee
MPR
Monetary Policy Review
NAB
non-alcoholic beverages
NEER
nominal effective exchange rate
PMI

Purchasing Managers’ Index
PPI

producer price index
REER
real effective exchange rate
repo

repurchase [rate]
Stats SA
Statistics South Africa
the Bank
South African Reserve Bank
the Fed
United States Federal Reserve
UK

United Kingdom
US

United States
Monetary Policy Review June 2014

Glossary
Accommodative monetary policy: These are monetary policy-related actions intended to
stimulate economic activity by lowering interest rates, increasing the quantity of money or
by keeping already low interest rates stable in the economy.
Administered prices: These prices are set according to government’s policy rather than
determined by market supply and demand forces (usually because the product is related to
social welfare). These prices may or may not have an economic regulator.
Advanced economies: Advanced economies are highly industrialised countries with high
levels of GDP per capita.
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.
Bond yield: This refers to the return on an interest-bearing instrument accruing to its owner.
The yield-to-maturity takes into account the price of the bond, all coupon cash flows, and
the remaining term to maturity.
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.
Capacity utilisation: The percentage utilisation of production capacity in the manufacturing
industry is a measure of the use of manpower, plant and machinery in manufacturing. The
degree of capacity constraint experienced in the manufacturing industry is determined by
obtaining indications from large manufacturing enterprises regarding skills shortages and
other reasons, such as downtime due to maintenance, changes in productivity and seasonal
factors. The measure is used to assess the degree of capacity constraint experienced in the
manufacturing industry.
Capital flow reversals: These indicate the movement of portfolio investment in bonds and
equities from a recipient country back to the country of origin.
Central projection: This is the most likely outcome for the variable of interest over the
period, according to South African Reserve Bank forecasts.
Commodity prices: Commodities can refer to food, oil or precious metals. 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: This is inflation excluding food and energy (including petrol) prices, which
is considered a better reflection of the trend underlying inflation.
Crude oil price: This is the price, in US dollars, per barrel of 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.

Monetary Policy Review June 2014
Developing economies: Developing economies have not reached a significant level of
industrialisation, have less-developed infrastructure, and have lower standards of living and
literacy compared to developed nations.
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.
Fiscal consolidation: These are government policies aimed at reducing budget deficits
through decreases in government spending, increases in taxation, or a combination of the
two. Other terms used to refer to fiscal consolidation include ‘fiscal austerity’ and ‘fiscal
reform’.
Flexible inflation targeting: This refers to inflation-targeting regimes that consider changes
in inflation and other variables affecting the real economy in the short term. Under strict
inflation targeting only inflation matters, but flexible inflation targeting takes into account
other variables, such as output.
Forecast horizon: This is the future period over which the Bank generates its forecasts,
typically between two and three years.
Gross domestic expenditure: This refers to the total value of expenditure on goods and
services within the country plus expenditure on imports less exports.
Gross domestic product (GDP): GDP is the total market value of all goods and services
produced in a country. It includes total consumption expenditure, capital formation,
government consumption expenditure and the value of exports less the value of imports.
Gross fixed capital formation: Value of acquisitions of capital goods (e.g., machinery,
equipment and buildings) by firms, adjusted for disposals, constitutes gross fixed capital
formation.
Headline consumer price index (CPI): Headline CPI refers to CPI for all urban areas that
is released monthly by Stats SA. Headline CPI is a measure of price levels in all urban areas.
The 12-month percentage change in headline CPI is referred to as ‘headline CPI inflation’
and reflects changes in the cost of living. This is the official inflation measure for South
Africa.
Household final consumption expenditure: This is the amount of money spent by
households on consumer goods and services.
Household disposable income: Household disposable income is defined as primary income,
net current transfers and social benefits, less taxes on income and wealth.
House price index: This is a measure of the prices at which residential dwellings are bought
and sold over time.
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.
Monetary Policy Review June 2014

Interest rate smoothing: This is the gradual decrease (increase) of the policy rate over the
business cycle. Policymakers target the medium term, thus they allow time for previous
changes to have an effect before making further changes (if necessary). Gradual interest rate
changes also permit economic stakeholders to adapt their expectations about future interest
rate changes.
Median: This is a statistical term used to describe the observed number that separates
ordered observations in half.
Mortgage: A mortgage is a form of secured loan extended for the purchase of real estate.
Nominal effective exchange rate (NEER): NEER is an index that expresses the value of
a country’s currency relative to a basket of other 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 in brackets:
euro (34,82), US dollar (14,88), Chinese yuan (12,49), British pound (10,71) and Japanese
yen (10,12). Index: 2000 = 100.
Net exports: See ‘current account’.
Nominal variables: Nominal variables are stated in current prices and represent the cost of
an item.
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. The most common measure is
labour productivity.
Purchasing Managers’ Index (PMI): This index shows the sentiment of purchasing
managers in the manufacturing sector, indicating the broader economic health of the sector.
Quantitative easing: QE is an unconventional monetary policy tool implemented largely in
the US, the UK, the euro area and Japan. QE involves the central bank purchasing bonds
on the open market so as to inject liquidity into the economy. This also leads to a markedly
higher level of money supply in the economy.
Real effective exchange rate (REER): The REER is the NEER adjusted by relative consumer
prices in South Africa and its main trading partners.
Real variables: These variables are adjusted for inflation and hence are expressed in constant
prices (of some base year) and represent the volume of an aggregate.
Real repo rate: This is the nominal repurchase (repo) rate, as set by the Monetary Policy
Committee, adjusted for expected inflation.
Repurchase rate (repo rate): This is the rate that commercial banks pay to borrow money
from the South African Reserve Bank.
Terms of trade: These refer to the ratio of the value (in price terms) of exports to the value
(in price terms) of imports. If this ratio is below one, then the value of imports exceeds that
of exports.
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: Loans extended without any collateral (guarantees or underlying assets) as
security to protect the value of the loan are called ‘unsecured loans’.