South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
26 March 2015


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank

Since the previous meeting of the Monetary Policy Committee the near-term inflation
outlook has deteriorated with the partial reversal of the recent petrol price declines,
emerging upside pressures on food and possible further electricity tariff increases.
The rand exchange rate has depreciated further, adding to upside inflation risks,
against the backdrop of the expected, but uncertain, tightening of US monetary
policy. The domestic economy, however, remains weak amid electricity supply
constraints, and relatively subdued domestic demand.

The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 4,4 per cent and 3,9 per cent in January and February
respectively. The lower trend in inflation was mainly due to lower petrol prices, but
recent oil price and exchange rate developments suggest that this is likely to be the
low point for the medium term inflation trajectory. The February outcome was
marginally above market consensus and the Bank’s forecast of 3,8 per cent, partly
as a result of higher than expected health insurance price inflation of 9,6 per cent.

Petrol prices declined by 26,6 per cent in February, while food price inflation
measured 6,5 per cent in February, down from 6,6 per cent in January. By contrast,
core inflation, which excludes food, petrol and electricity, remained near the upper
end of the inflation target range, having measured 5,8 per cent in both January and
February.

The favourable impact of the lower oil price was also evident in the headline
producer price inflation for final manufactured goods, which measured 3,5 per cent
and 2,6 per cent in January and February respectively compared with 6,5 per cent
and 5,8 per cent in the preceding two months. The downward trend is also expected
to reverse in the face of adverse fuel and food price developments.

According to the Bank’s latest forecasts, inflation is now expected to average 4,8 per
cent in 2015, compared with the previous forecast of 3,8 per cent. A first quarter
average of 4,2 per cent is now projected as the low point, compared with 3,5 per
cent previously. The strong base effects in the first quarter of 2016 are expected to
result in a temporary one-quarter breach of the inflation target during that quarter, at
6,7 per cent, with the average for the year expected to measure 5,9 per cent
compared with 5,4 per cent previously. Inflation is expected to average 5,5 per cent
in the final quarter of the year, compared with the previous forecast of 5,3 per cent.

The forecast for core inflation is more or less unchanged at 5,5 per cent and 5,2 per
cent in 2015 and 2016 respectively, the latter up marginally from 5,1 per cent. The
peak is still expected at 5,8 per cent in the first quarter of 2015. The deterioration in
the headline forecast is due to an expected acceleration in food price inflation, and

the impact of the higher fuel and Road Accident Fund levies on the petrol price, due
to be implemented in April. This is in addition to the current under-recovery on the
petrol price. The international oil price assumption remains unchanged from the
previous meeting, with a moderate increase over the next two years. The electricity
price assumption is also unchanged, with increases of 11,6 per cent assumed from
July 2015 and July 2016. However, there is a high possibility of significant further
electricity tariff increases.

Inflation expectations, as reflected in the Bureau for Economic Research (BER)
survey conducted in the first quarter of 2015, improved for all respondents for 2015,
but returned to levels around the upper end of the target range in the next two years.
On average, expectations for 2015 declined from 5,8 per cent to 5,4 per cent, with a
one percentage point decline in the expectations of analysts to 4,4 per cent, and a
0,2 percentage point decline in expectations of business people and trade union
officials to 6,0 per cent and 5,7 per cent respectively. However, expectations for
2016 and 2017 are higher, with expectations of the categories of respondents
ranging between 5,6 per cent and 6,2 per cent in 2016, and between 5,3 per cent
and 6,3 per cent in 2017.

The global economic outlook remains uncertain, with a moderate slowdown in the
US and China, and an improvement in the outlook and performance of the euro area
and Japan. The US grew at a rate of 2,2 per cent in the fourth quarter of 2014, down
from 5,0 per cent in the previous quarter, as the stronger dollar impacted negatively
on export growth and investment. Nevertheless, the longer term growth outlook
remains positive. By contrast, the weaker euro and accommodative ECB monetary

policy have contributed to improved growth prospects in the region, particularly in the
core countries. In the fourth quarter of 2014, euro area growth surprised on the
upside at 1,3 per cent and ECB forecasts for 2015 have been revised upwards by
0,5 percentage points to 1,5 per cent. The Japanese economy emerged from two
quarters of negative growth, recording a growth rate of 1,5 per cent in the fourth
quarter.

The larger emerging markets continued to be a drag on global growth. China’s
economic prospects remain relatively subdued with most domestic demand
indicators weakening since the beginning of the year. Consensus forecasts are for
both Russia and Brazil to record negative growth rates in 2015. The outlook for the
Indian economy, by contrast, is more positive.

Global financial markets continue to be dominated by changing expectations of the
timing and speed of normalisation of US monetary policy. Favourable labour market
data in the past weeks in the US resulted in a strong appreciation of the US dollar
against most currencies, as expectations of the start of policy tightening were
brought forward. However, these expectations were tempered following the March
FOMC meeting where the growth and inflation forecasts were downgraded.
Uncertainty persists regarding the timing of the first interest rate increase. The
FOMC has not only re-emphasised the gradual nature of the expected path of
interest rates, but the members’ individual expectations of the interest rate path were
also revised down significantly. In response to this guidance, the dollar weakened
somewhat against most currencies.

While the US prepares to tighten monetary policy, the global trend has generally
been towards policy easing or maintaining an accommodative bias. Both Japan and
the euro area have continued with their quantitative easing while a number of
countries have eased their policy further, amid benign inflation pressures and
concerns about deflation in some countries.

The volatile global trends were reflected in the high degree of volatility in the
rand/dollar exchange rate. Since the previous MPC meeting, the rand depreciated by
about two per cent against the US dollar, but traded in a wide band of around R11,27
and R12,52 against the dollar, with a marked recovery after the recent FOMC
meeting. Over the same period, the rand was more or less unchanged against the
euro. On a trade-weighted basis, the rand depreciated by 0,7 per cent. Although the
rand movement reflected US dollar strength to a large degree, the rand was also
negatively impacted by domestic factors including the weak January trade data, and
issues relating to Eskom and the domestic growth outlook.

The rand is expected to remain volatile while uncertainty regarding the outlook for
US monetary policy persists. The commencement of US interest rate increases,
when it happens, is expected to put the currency under pressure. The rand is also
expected to remain sensitive to developments on the current account of the balance
of payments. The marked narrowing of the trade account in the fourth quarter,
reflective of higher export volumes and lower import volumes, contributed to the
narrowing of the deficit to 5,1 per cent of GDP in that quarter, and to 5,4 per cent for
the year. At this stage it is unclear whether or not this represents the beginning of a
sustained compression of the current account, after a long period of real exchange

rate depreciation. While lower international oil prices are expected to continue to
impact favourably on the import bill, as oil imports account for just under 20 per cent
of merchandise imports, the wide trade deficit in January, should it persist, suggests
that the adjustment may remain slow.

Although the current account deficit to date has been relatively comfortably financed,
the global capital flow environment is increasingly challenging, particularly against
the backdrop of expected increases in US interest rates. During the fourth quarter of
2014, the deficit was financed primarily through flows into the banking sector. Year to
date, net sales of bonds and equities by non-residents as reported by the
exchanges, suggest that net portfolio flows on the financial account of the balance of
payments in the first quarter may be negative for the second consecutive quarter.

The outlook for the domestic economy remains overshadowed by the electricity
supply constraint, which appears to have had an adverse effect on recent economic
activity. This constraint is likely to persist for some time, and has resulted in a
downward revision of short-term potential output to between 2,0 and 2,5 per cent.
Nevertheless, some improvement on the 2014 growth rate of 1,5 per cent is
expected in 2015, in the absence of protracted work stoppages. The Bank’s growth
forecast for 2015 is unchanged at 2,2 per cent, and marginally lower at 2,3 per cent
for 2016. The Bank’s leading indicator of economic activity, which had followed a
moderately declining trend in 2014, also suggests a continuation of the sluggish
growth outlook.

Underlying this outlook is the continued weakness in growth of gross fixed capital
formation, which contracted by 0,4 per cent during 2014, with private sector fixed
investment contracting by 3,4 per cent, despite some recovery in the final quarter of
the year. The main contribution to fixed capital formation came from general
government, which accounts for a relatively small proportion of the total. With
business confidence subdued, and amid binding electricity supply constraints, the
prospects for a meaningful acceleration remain weak.

Initial high frequency data for 2015 are also a cause for concern, should the trends
persist. Both real mining and manufacturing output contracted on a month-on-month
basis in January; the Kagiso PMI declined sharply to below the neutral 50 level in
February; the RMB/BER business confidence index declined to below the neutral 50
level in the first quarter of 2015 to 49 points, with the decline most marked in the
manufacturing sector; and the building sector also shows signs of slowing, with both
buildings completed and new plans passed declining, along with lower confidence in
the sector, particularly with respect to residential construction.

Against this backdrop, employment growth has stagnated and likely to remain low:
according to the Quarterly Employment Statistics of Statistics South Africa, formal
sector non-agricultural employment contracted by 0,2 per cent over four quarters in
the final quarter of 2014, with growth in public sector employment more than offset
by job-shedding in the private sector.
Growth in final consumption expenditure by households increased marginally to an
annualised quarterly rate of 1,6 per cent in the fourth quarter of 2014, and measured
1,4 per cent over the year. Both retail trade and wholesale trade sales declined on a

month-to-month basis in January, and the outlook remains uncertain as the potential
boost to consumption from lower petrol prices has been partially reversed. However,
confidence of retailers, particularly of durable goods, remains relatively high. High
debt levels, low employment growth and continued tight credit conditions are likely to
constrain consumption expenditure growth in the absence of strong increases in real
disposable incomes or strong positive wealth effects.

Fiscal policy is set to continue on its consolidation path. As outlined in the recent
Budget Review, the projected deficit for both 2014/15 and 2015/16 is estimated at
3,9 per cent of GDP, despite lower GDP growth forecasts, and is expected to narrow
to 2,5 per cent of GDP by 2017/18. This is envisaged to be achieved through a
combination of lower expenditure compared with the 2014 budget estimate and
higher tax revenues. This is expected to exert a moderate constraining effect on
household consumption expenditure growth.

Trends in bank credit extension to the private sector have remained relatively
unchanged, with highly divergent patterns in loans granted to the corporate and
household sectors. While growth over twelve months in total loans and advances to
the private sector measured 8,3 per cent in January, credit extended to corporates
increased by 14,3 per cent while that to households increased by 3,5 per cent.
Growth across all the main categories of credit extension to households has
remained subdued in recent months, despite a slight increase in unsecured lending
off a low base. Both mortgage credit extension and instalment credit and leasing
finance reflected slow growth in housing and motor vehicle sales. Commercial
mortgages, by contrast, experienced buoyant growth.

The recent higher trend in wage settlements has the potential to put further upside
pressure on inflation. Nominal remuneration per worker over four quarters increased
by 7,7 per cent in the fourth quarter of 2014, and, after accounting for changes in
labour productivity, resulted in a unit labour cost increase of 6,2 per cent, up from
5,7 per cent in the previous quarter. The Andrew Levy Employment Publications
survey shows that during 2014, the average wage settlement rate in collective
bargaining agreements amounted to 8,1 per cent, compared with 7,9 per cent in
2013. The public sector wage settlement is still not agreed, and the outcome is
expected to have an important bearing on the general trend of wage settlements in
the economy in 2015.

The recent downward trend in consumer food price inflation is forecast to be
reversed in the coming months, following the severe drought in some of the maize
producing areas of the country. With drastically reduced maize crop estimates, South
Africa is expected to become a net importer of maize during the year, and spot
prices have moved closer to import parity. The spot price of white maize, for
example, has increased by around 30 per cent since the beginning of the year,
reinforced by a depreciating currency and despite moderating global prices. Meat
prices have also remained elevated.

International oil prices have been relatively volatile but at vastly lower levels than
those prevailing for much of 2014. Having reached a low of around US$45 per barrel
in January, Brent crude oil prices increased to around US$62 per barrel at the end of
February, before declining to current levels of around US$57 per barrel. The partial

recovery in the international oil price, in conjunction with the recent depreciation of
the rand against the US dollar, and the impending fuel and RAF levies, will have
reversed a large part of the favourable impact on domestic petrol prices, which had
declined by about R4 per litre between August 2014 and February 2015.

The respite to the headline inflation outlook from lower international oil prices
appears to have been short-lived. However, the expected breach of the target range
in 2016 is likely to be temporary and the main drivers of the deterioration of the
inflation forecast are exogenous. While the MPC will look through these
developments, the Committee remains concerned about the possible impact on
inflation expectations which remain at the upper end of the target range over the
longer term.
The rand exchange rate continues to be the main upside risk to the inflation outlook,
and remains highly vulnerable to the timing and pace of US monetary policy
normalisation. The extent to which US rate increases are priced into the exchange
rate remains uncertain. While the weaker euro has provided some offset, and
therefore a more moderate depreciation of the trade-weighted exchange rate, this
effect is partial. Furthermore, the rand will also remain sensitive to domestic
developments, including the slow pace of contraction in the deficit on the current
account of the balance of payments.
Wage and salary increases in excess of inflation and productivity growth also pose
an upside risk to inflation. The Committee assesses the risk to the inflation outlook to
be on the upside, with the possibility of further electricity tariff increases accentuating
this risk.

At the same time, the growth outlook remains constrained by electricity supply
concerns and low business confidence, and the risks to the growth forecast are
assessed to be moderately on the downside. Demand pressures on inflation remain
muted, reinforced by a moderately tighter fiscal policy stance.
In its previous statement the Committee noted that the more favourable inflation path
allowed for some room to pause in the process of domestic monetary policy
normalisation. The deterioration in the outlook suggests that this scope has
narrowed. However, given the uncertainties related to US policy normalisation and
the weak state of the domestic economy, the MPC has unanimously decided to keep
the repurchase rate unchanged for now.
The timing of future interest rate increases will be dependent, as before, on a range
of domestic and external factors. The MPC will remain vigilant and will not hesitate to
act in order to maintain the integrity of the inflation targeting framework.

Lesetja Kganyago

GOVERNOR

Contact person:
Candice Jeffreys
+27 12 313 4209