Monetary Policy Review
April 2019
South African Reserve Bank
Monetary Policy Review
April 2019
Monetary Policy Review April 2019
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Monetary Policy Review April 2019
Preface
The primary mandate of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. In addition, the SARB has a complementary mandate to oversee and maintain
financial stability.
Price stability helps to protect the purchasing power and living standards of all South Africans. It provides a favourable
environment for investment and job creation, and also helps to maintain and improve international competitiveness. The goal
of price stability is quantified by the setting of an inflation target range after consultation with government. The SARB has full
operational independence. Monetary policy decisions are made by the SARB’s Monetary Policy Committee (MPC), which is
chaired by the Governor and includes the Deputy Governors as well as other senior officials of the SARB.
The MPC conducts monetary policy to keep inflation within a target range of 3–6%. This inflation-targeting framework is
flexible, meaning that inflation may be temporarily outside the target range, under certain circumstances. The MPC takes
into account the time lags between policy adjustments and economic effects. This provides for interest rate smoothing over
the cycle and contributes towards more stable economic growth. The decision of the MPC, together with a comprehensive
statement, is communicated at a media conference at the end of each meeting.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening public understanding of the
objectives and conduct of monetary policy. The MPR covers domestic and international developments that impact on the
monetary policy stance. It takes a forward-looking approach, in contrast to the Quarterly Bulletin which records and explains
recent economic developments. The MPR is presented by senior officials of the SARB at monetary policy forums in various
centres across South Africa in an effort to develop a better understanding of monetary policy through direct interactions
with stakeholders.
Monetary Policy Review April 2019
Contents


Boxes


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

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review April 2019
Foreword
Over the past five years, inflation outcomes have been mixed. Commodity prices have generated volatility: lower inflation in
2015 came from a collapse in oil prices; higher inflation in 2016 was partly due to the drought that pushed up food prices.
A more sustained theme has been fluctuating global financial conditions, mostly driven by United States monetary policy,
and transmitted to South Africa through the exchange rate and bond yields.
An underlying determinant of inflation is the broad expectations among South Africans for inflation in the upper end of the
target range, based on past outcomes. These expectations explain why underlying inflation has not fallen further despite the
weak economy, with targeted inflation never dropping below our 3–6% target range.
The South African Reserve Bank (SARB) is not comfortable with expectations close to 6%, and we would prefer to see
inflation expectations anchored closer to 4.5% (the midpoint of the inflation target range). Sustained inflation outcomes
close to the middle of the 3–6% target range will contribute to broader macroeconomic stability. Inflation of about 4.5% will
also help with the cost of living and, by bringing the domestic inflation rate closer to that of our trading partners, improve
competitiveness over the long term.
In recent years, we have stressed this preference in our communications. The SARB has also adopted the Quarterly
Projection Model, with a midpoint target at its heart. This policy approach is gaining traction with South Africans.
For instance, surveys of inflation expectations have shown expectations moderating. Actual inflation has been coming in
close to 4.5% for two years now. We welcome this shift and would like to see inflation stay around the middle of our target
range on a more sustained basis.
It is too soon, however, to claim that inflation is already permanently lower. A large part of the improved inflation performance
recently is due to positive shocks – low food price inflation, a broadly flat exchange rate trend over several years, and a lower
level of world oil prices and general global inflation. Indeed, due to positive surprises, inflation outcomes have actually been
below the midpoint in some recent months.
Although our inflation discourse sometimes privileges the short run, central banks must focus on the medium-term outlook,
which is the time frame that can be influenced by monetary policy. This means looking through the first-round effects of
supply shocks and focusing on possible second-round effects – a test which applies equally to positive and negative supply
shocks. Short-run volatility aside, the SARB’s latest inflation forecast tells us inflation will ultimately stabilise at 4.5% by the
end of 2021, as actual inflation outcomes and the SARB’s communications convince wage and price setters that inflation will
stay lower than it has been historically. That shift is the central theme of this Monetary Policy Review.
E L (Lesetja) Kganyago
Governor of the South African Reserve Bank
Monetary Policy Review April 2019

Towards permanently
lower inflation
Introduction
The second half of 2018 was difficult for emerging markets,
given tighter global financial conditions as well as higher oil
prices. Conditions have eased in early 2019, however, mainly
because the United States (US) Federal Reserve (Fed) has
stopped raising rates sooner than expected. In South Africa,
inflation has slowed again, staying close to the 4.5% midpoint
of the 3–6% target range, although service price inflation is
still around 5%. The projected repurchase (repo) path ensures
inflation stabilises at 4.5% by the end of the forecast period
(2021). South African growth outcomes remain volatile around
a low trend, reflecting chronic growth challenges.
Most forecasters expected world growth to slow after the
2017/18 upswing, but the global deceleration has been
sharper than expected. Major central banks, particularly the
Fed and the European Central Bank (ECB), have responded by
deferring rate increases – an adjustment facilitated by belowtarget inflation. In emerging markets, Turkey and Argentina
have fallen into severe recessions following sudden stops of
capital flows, but fears of a broader emerging market crisis
have receded.
In China, recent data have surprised on the downside.
The fourth quarter gross domestic product (GDP) number was
the lowest in 10 years, and economic activity trackers showed
worse growth than the official data. Private sector debt defaults
have increased and credit growth has faltered, although
parastatal firms have continued to benefit from an implicit
government guarantee. Trade tensions are also having an effect,
although the sharp downturn in the February export numbers
was exaggerated by Chinese Lunar New Year disruptions. The
authorities have responded to disappointing data with stimulus
measures, including lower reserve requirements for banks.
These interventions are expected to ensure growth stays just
above 6% for 2019.
European growth has slowed abruptly in recent quarters. One
contributing factor has been falling demand from China, which
has affected exports. Another has been Brexit uncertainty,
which has prompted a slump in British growth and generated
some negative spillovers to the continent. These problems
have been exacerbated by a range of temporary shocks,
including protests by the yellow vests movement (mouvement
des gilets jaunes) in France and export disruptions related to
new pollution standards in Germany. The net result has been
a surprisingly sharp fall in euro area growth. Projections for
2018 have been revised down from 2.1% six months ago to an
estimate of 1.8% now, and the 2019 forecasts have been cut
from 2.1% to 1.2%.
Percentage change over four quarters

Headline inflation
Sources: Stats SA and SARB

Actual

Mar 2019 MPC forecast

Midpoint

3–6% inflation target range
Percentage change over 12 months
Inflation in advanced economies

US
Euro area

PCE

Core PCE
PCE: personal consumption expenditure
HICP: Harmonised Index of Consumer Prices
Source: Haver

HICP

Core HICP

Percentage change
Real GDP growth*

US
* Dotted lines indicate forecasts
Sources: Bloomberg and Haver
Euro area
China
(right-hand scale)

Monetary Policy Review April 2019
The US maintained strong growth throughout 2018, despite
slowdowns elsewhere. Annual growth for 2018 was 2.9%,
which was above the 2.2% growth recorded in 2017. Robust
growth and job creation persuaded the Fed to raise interest
rates four times during the year, bringing the federal funds
rate to 2.375% – its highest level since February 2008. Fed
communications indicated rates would rise further in 2019
to achieve the ‘normal’ policy settings appropriate for an
economy at full employment. The Fed’s messaging has since
changed, however, given weaker inflation data and risks to the
US growth outlook, including from falling world growth. This
course correction has been very effective in loosening financial
conditions again, both in the US and internationally. Markets
have switched from pricing in two rate increases in 2019 to
expecting rate cuts. US 10-year Treasury bonds have slipped
back to 2.6%, from 3.2%, while residential 30-year mortgage
rates have fallen from a peak of 4.8% to 4.2%. The Fed’s
tightening cycle may now be over – a shift that has taken
pressure off many borrowers, including emerging markets.
Excluding China, emerging markets are expected to
accelerate in 2019 and 2020, bucking the global trend.
India is likely to remain the best-performing large economy,
with growth close to 7%. Brazil and Russia are also forecast
to improve, although their growth rates are coming off low
bases; 2019 forecasts are for 2.4% and 1.5% respectively.
Forecasts for emerging markets (excluding China) have been
revised down somewhat over the past six months, but this
is mostly due to a few idiosyncratic cases. Iran’s economy is
likely to contract by around 3.6% following the reimposition
of sanctions. Venezuela’s economy will shrink further in the
context of hyperinflation and political crisis; it is now almost
50% smaller than it was five years ago. Both Argentina and
Turkey have made rapid current account adjustments following
capital outflows last year, but these were achieved largely via
import compression and have come at the cost of recessions.
South Africa’s economic outlook
Like many of its emerging market peers, South Africa is
expected to achieve moderately better growth over the
medium term. The headline numbers are not impressive: 1.3%
for 2019, 1.8% for 2020 and 2.0% for 2021 – all three below the
long-run growth rate of 2.5%.1 The outlook is nonetheless an
improvement on 2018’s disappointing 0.8% growth outcome.
The South African Reserve Bank’s (SARB) growth forecasts
had previously indicated a V-shaped recovery, with a trough
in 2016 and a rebound thereafter. Growth was slightly better
than expected in 2017, at 1.4%, with most of the positive news
in the second half of the year. The forecast narrative held
that this momentum would be sustained by better business
and consumer confidence. Instead, the economy slumped
in the first half of 2018, recording a technical recession.

50-year average.
Percentage change

Global and emerging market economic growth


Emerging markets (excluding China)

Global
Source: World Bank
Forecast
Monetary Policy Review April 2019

The SARB’s projections now indicate a W-shaped recovery,
with dips in both 2016 and 2018; the pace of the recovery has
also been marked down.
It is not yet obvious why the economy slowed again in
2018. Confidence rebounded, dramatically so in the case of
households. Global growth started the year at long-term highs.
Inflation was low, especially in the first part of the year. Repo
rate cuts should also have helped, on the margin. Agriculture
is part of the explanation – 2018 failed to repeat the unusually
favourable weather conditions experienced in 2017 – but the
slowdown was not confined to this sector.
It is becoming clearer, however, that the damage done by
‘state capture’ is worse than previously understood. Capital
expenditure, especially by state-owned enterprises, has been
less productive than anticipated. To take one highly visible
example, the economy has less electricity than it had a decade
ago, despite massive Eskom investments in new generating
capacity. Repairing the state, and parastatals, is also proving
expensive, requiring higher administered prices and taxes.
These adverse conditions seem to be blocking a stronger
rebound in growth. Indeed, there are risks that electricity
shortages could cause even lower growth rates than currently
projected. (See Box 1.)
South Africa’s potential growth rate is at long-term lows,
estimated at only 1.3% this year, rising to 1.5% by 2021. Despite
low potential, recent shortfalls in actual growth outcomes
– for 2016 and 2018 in particular – mean the output gap is
still negative, at an estimated -1.1% of potential GDP. The
forecasts indicate output will only realign with the economy’s
supply capacity in 2021. Under these circumstances, demandside inflationary pressure is likely to stay muted.
There have been significant changes to the SARB’s inflation
forecasts over the past six months. In understanding these
shifts, it is important to disentangle the short-run and longerrun changes. The near-term adjustments are mostly due to
shocks. In particular, oil prices have moderated from over
US$80 per barrel in October 2018 to US$63 for the first quarter
of 2019. The exchange rate has recovered from levels over R15
to the US dollar in October to R14.01 for the first quarter. This
is still more depreciated than the 2018 average of 13.25 to the
US dollar; nonetheless, the rand’s recovery is likely to contain
inflationary pressures from its depreciation phase late last year.
Finally, food prices have remained relatively low, below their
longer-run averages. Together, these factors explain much
(nearly two-thirds) of the decline in the 2019 inflation forecasts,
from 5.5% as of November 2018 to 4.7% as of March 2019.
(The balance is from services prices.)
By contrast, the long end of the forecast is now down to 4.5%
(for the final quarter of 2021). Although forecasts for 2021 were
published for the first time this year, making direct comparisons
impossible, longer-run SARB projections have always been in
the upper end of the target range, typically in a narrow range
of 5.3–5.5%. Having the long end of the forecast converge
Percentage change

South African growth forecasts*


Actual

Mar 2018

Mar 2019
* Dotted lines indicate forecasts
Sources: Stats SA and SARB

Percentage change

Potential GDP


Potential growth*

Underlying trend growth
* Adjusted for supply shocks
Source: SARB

Percentage change over four quarters

Evolution of the SARB’s inflation forecasts*


Actual

Nov 2018

Mar 2019
* Dotted lines indicate forecasts
Sources: Stats SA and SARB

Monetary Policy Review April 2019
on the 4.5% midpoint of the target range is an important
change. It reflects confidence that monetary policy, supported
by lower inflation from the shocks already mentioned, can
stabilise inflation at the middle of the target range over a threeyear horizon.
Inflation expectations are the principal determinant of longerrun inflation, at least in conventional modelling frameworks
such as the Quarterly Projection Model (QPM). This is not
a claim that other factors, such as fuel and food prices, are
immaterial. Rather, these variables tend to move randomly
in response to shocks such as droughts, which are difficult
to project over long time horizons. By contrast, expectations
mainly affect underlying inflation. Expectations are formed by
past inflation experiences, but are also influenced by views of
future inflation as well as the credibility of the central bank’s
target. Ultimately, a central bank succeeds when expectations
are anchored at the target, meaning the target is the best
predictor of long-term inflation.
Inflation expectations in South Africa have moderated, but
they remain above the 4.5% midpoint. The latest survey by
the Bureau for Economic Research (BER) indicates two-yearahead expectations are down to 5.4%, from a recent peak of
6.2% in the fourth quarter of 2015. The same survey shows
expectations over the next five years have fallen to 5.2%, from
a recent high of 6.1% in the first quarter of 2016. Relatively high
inflation expectations are reflected in service price inflation,
which is now at 5.2% (having averaged 5.1% in 2018). The fact
that petrol, food and other goods are all lower means headline
inflation has dipped below the 4.5% target in some months,
but this should not – yet – be interpreted as permanently lower
inflation. The inflation forecast only stabilises in line with the
target when expectations are anchored there, which the
model indicates will have happened by the end of 2021.
The QPM’s repo rate projection has moderated. As of
the November 2018 Monetary Policy Committee (MPC)
meeting, it showed four rate increases over the medium term.
One of these was implemented at that meeting. Of the
three remaining hikes, only one remained in the January
and March forecasts. This change reflects two factors.
First, lower inflation directly reduces the upward pressure on
rates. The policy rule targets inflation three to five quarters
ahead: this number has fallen from 5.5% as of November 2018
to 5.3% as of March 2019. Second, lower inflation also raises
the real interest rate, which adjusts the model’s policy stance
even in the absence of nominal rate changes. The November
2018 forecast projected the real policy rate to average
1.6% in 2019; the latest forecast projects a rate of 1.9%. The
model now sees the 6.75% repo rate as slightly expansionary,
generally just below the estimated neutral rate, and has the
repo rate moving to 7% by 2021 to complete the normalisation
process. (The steady-state value is 7%, based on a real neutral
rate of 2.5% plus a 4.5% inflation target.)

Nov 2018

Mar 2019
Per cent

QPM inflation expectations*

* A blend of short-term model
expectations and medium-term
BER expectations
Source: SARB
Per cent

Repurchase rate and forecast*


Actual

Nov 2018

Mar 2019
* Dotted lines indicate forecasts
Source: SARB
Per cent

Real repurchase rate and forecast*

Source: SARB

Real repo (Nov 2018)

Real repo (Mar 2019)

Neutral real repo (Nov 2018)

Neutral real repo (Mar 2019)

* Dotted lines indicate forecasts
Monetary Policy Review April 2019

The monetary policy stance
Over the three MPC meetings covered in this edition of the
Monetary Policy Review (MPR), the MPC raised rates once
(in November 2018) and then left rates unchanged twice (in
January and March 2019).
The November rate hike came in the context of intensifying
inflation pressure. Inflation was still below 6%, but it was
straying from the 4.5% midpoint of the target range. Meanwhile,
growth had stabilised, following a bad performance in the first
half of the year. These factors suggested the rate cut of six
months earlier could be reversed. A further consideration
was that global interest rates had moved higher over the year,
implying a higher neutral rate for small open economies such
as South Africa. This posed a normalisation challenge for
monetary policy, with risks of a more expensive adjustment
if dealt with later rather than sooner. The decision was finely
balanced, however, with three members of the MPC preferring
an unchanged stance.
By the January 2019 meeting, inflation risks had eased
considerably, given the changes described earlier (lower oil
prices and a more dovish Fed). This permitted a no-change
decision – which was forecast correctly by all 31 analysts in the
Reuters survey. The March decision was similar. Although there
was some market speculation about a rate cut, this dissipated
as it became clear that the January dip in inflation to 4.0%
would be short-lived. The MPC again left rates unchanged,
once again correctly anticipated by all the respondents in the
Reuters survey. Both the January and March decisions were
unanimous.
Box 1 Estimating the economic impact
of electricity shortages
South Africa is once again experiencing load-shedding, or scheduled
electricity outages, to manage shortfalls in supply. This is the third
episode of protracted load-shedding since 2007. The first lasted
around three months, from late 2007 into early 2008. The second
occurred between late 2014 and late 2015, with sporadic loadshedding over a 100-day period. The current episode began in
November 2018 and is likely to be the most severe yet, with loadshedding affecting 26 days up to the end of March 2019. Should
these interruptions continue throughout 2019, it is likely to reduce
growth by 1.1 percentage points.
Load-shedding has been necessary because a substantial
portion of Eskom’s generating capacity is not functioning. Total
installed capacity is 48 gigawatts (GW) or 48 000 megawatts (MW).
Operational capacity is slightly lower at 44.6 GW. During 2017/18,
actual availability was at 37.5 GW. So far this year it has been lower,
at about 30.3 GW. This implies that the electricity availability factor
is currently around 63%, down from nearly 80% in 2017/18.
Load-shedding is implemented in stages, depending on the scale
of the electricity shortage. Stage 1 means dropping 1 000 MW from
Per cent

Electricity availability factor


* Year to date
Sources: Eskom and RMB Morgan Stanley

Monetary Policy Review April 2019
the grid. Stage 4, which has been the most common in 2019,
removes 4 000 MW of demand. Above Stage 4, load-shedding
would occur outside scheduled times, although South Africa has
not yet reached this stage.
The economic effects of load-shedding are not linear. Moving from
Stage 1 to Stage 4 is more than four times worse, because it
involves larger disruptions to economic activity. For instance, it might
require shutting down mines entirely, requiring the evacuation of all
staff followed by safety inspections before production can restart.
Similarly, small businesses are more likely to lose perishable goods
or close their doors during extended outages than briefer ones. By
analogy, doing without electricity is like going without oxygen –
longer periods of deprivation have worse consequences than shorter
periods.
Consistent with this non-linearity, the estimates reported here are
based on two possible shocks: (i) a decline in energy availability from
70% to 65%; and (ii) a further decline from 65% to 60%. Model
estimates indicate that the estimated gross domestic product
growth loss is 0.4 percentage points for the first shock and a further
0.7 percentage points for the second – a total of 1.1 percentage
points – relative to baseline 2019 forecasts.1 This would eliminate
almost all growth for the year, which would be the worst output
performance since 2009.
Under these circumstances, employment is likely to be lower by
an estimated 125 000 jobs, with around 48 000 jobs lost to the
first shock and 77 000 to the second. (By contrast, Eskom’s entire
workforce is just under 49 000 employees, up from about 35 000
employees a decade ago.) Job losses would be concentrated
among workers with lower levels of education, given the sectors
most affected (mining, manufacturing, and wholesale and retail
trade), which would also exacerbate inequality.
These estimates are broadly comparable to those of other analysts
and institutions. The average across all available estimates is a
growth loss of 0.8 percentage points, with a range between
0.4 percentage points and 1.3 percentage points. Although there is
variation among these estimates, with some referring to the effects
of a 10% power supply cut and others specifically to 2019 growth
losses, collectively they provide a reasonable range for the likely
growth costs of extended load-shedding.
The estimates described here are subject to several caveats. First,
and most crucial, they assume load-shedding will persist at high
levels for the entire year. There is not yet enough information to take
a strong position on the validity of this assumption. For this reason,
the SARB’s baseline growth forecast only incorporates first-quarter
effects, as captured by near-term models. Second, these estimates
are for 2019 only, and therefore do not incorporate longer-term
costs, such as foregone investment or additional damage to
government finances (given lower tax revenues as well as larger
bailout demands from Eskom). Finally, it is unclear to what extent
firms and households have now made their own plans to manage or
avoid their reliance on Eskom, which could mitigate growth costs
while also exacerbating Eskom’s financial sustainability challenge.

These estimates are derived from a dynamic computable general
equilibrium model, calibrated to South African data using empirically
estimated elasticities. Factor substitution elasticities and factor
mobility are higher in the first scenario. The productivity declines
are 1.2 percentage points for the initial shock and 1.8 percentage
points for the second.
Estimated GDP growth response to power supply cuts
* Estimate is for the first half of 2019
Percentage points
GDP lost in 2019
10% power cut loss
Free Market Foundation*
Old Mutual
Goldman Sachs
SARB
National Treasury
NWU (2014)
RMB Morgan Stanley (2019)
Cameron & Rossouw (2012)
HSRC (2008)

Sources: Various institutions and SARB. The ‘10% power cut loss’
estimates are drawn from A Masia and M Curtis, ‘Winter has come,’
RMB Morgan Stanley South African Economics and Strategy.
21 March 2019.
Monetary Policy Review April 2019

The global economy:
a synchronised downturn?
The global economy enjoyed a synchronised upswing
through late 2017 and early 2018; it now appears to be in a
synchronised downswing. Euro area growth disappointed
throughout 2018, China’s economy has slowed abruptly in
recent quarters, and the US economy is decelerating as
stimulus effects fade. Forecasts indicate growth will stabilise
in 2019, close to historical averages, with the assistance of
policy support. In particular, subdued inflation leaves space
for advanced economy monetary policies to stay looser than
previously expected. For emerging markets, trade conditions
are more difficult but financing has become cheaper again,
mitigating what had been a major source of stress for many of
these countries in 2018.
The global economy has clearly decelerated. The question is
whether this slowdown marks the end of a cyclical recovery
and a return to normal growth, or something more severe.
The International Monetary Fund (IMF) has once again revised
its world growth forecasts lower (as of the April 2019 World
Economic Outlook), but global growth still averages 3.3% and
3.6% in 2019 and 2020 respectively, close to the 3.4% average
of the past 10 years.
The main sources of weakness and uncertainty for the
global outlook are the euro area and China. Among the large
economies, these two had the largest downward growth
revisions, and the risks around these projections remain
substantial. China and the euro area are relatively more
important as trading partners for South Africa than they are for
the world economy as a whole, making developments in these
economies even more important for the local economy.
Euro area growth peaked at nearly 3% in the third quarter
of 2017, but it has since slipped back to just 1.1% as of the
final quarter of 2018 – a 20-quarter low. The IMF forecasts
for euro area growth have been revised down substantially
from six months ago (by 0.6 percentage points for 2019 and
0.2 percentage points for 2020 to 1.3% and 1.5% for those
two years respectively). This has also had a meaningful
effect on the world economic outlook. Using trade weights, a
1 percentage point decline in euro area growth subtracts almost
0.3 percentage points from South African trade-weighted
global growth (which is approximately twice the direct effect of
China and nearly three times the direct US effect).
From the demand side, net exports were the weakest
component of euro area growth. Some of the blame goes to
temporary factors: German exports, which account for nearly
60% of the region’s exports, declined sharply in the second
half of 2018 due to a change in pollution emission regulations.
The slowdown in China also had an impact, which is likely to
be more persistent (the Chinese economy now rivals the US as
the euro area’s most important export market).
Index

Global composite PMI

Sources: Haver, JPMorgan and IHS Markit

Others

Italy

France

Germany

Total*

Percentage points
Euro area real GDP growth

* Percentage change over four quarters
Source: Haver


Percentage change over four quarters

Evolution of euro area real GDP growth forecasts*
Source: SARB GPM

* Dotted lines indicate forecasts

Nov 2018

Mar 2019

Monetary Policy Review April 2019
Political risks have also increased. In Italy, proposals for
a large increase in the budget deficit caused government
borrowing costs to spike, with the spread of 10-year bonds
over equivalent German instruments at around 2.7 percentage
points for the second half of 2018. Under these circumstances,
Italian growth faded to just 0.5% year on year in the last
quarter of 2018, a four-year low. French growth has also been
subdued in 2018, declining to 1% year on year in the fourth
quarter, in part because of the mouvement des gilets jaunes
protests – although in this case the slowdown was already well
entrenched before political disruptions intruded.
Over the near term, the euro area may enjoy better growth
news as temporary shocks dissipate. Unemployment rates
have also edged steadily lower, reaching new post-crisis lows,
which should support household consumption. The downside
risks are pressing, however, including the possibility of a
disorderly Brexit as well as an intensification of global trade
tensions. Given weaker growth and core inflation that is stuck
stubbornly around 1%, the ECB has walked back its plans for
raising interest rates. It has also announced a new package
of concessional loans in the form of a third round of targeted
long-term refinancing operations (known as TLTRO-III).
China’s economy has been on a relatively smooth glide path
for the past two years, with growth easing towards more
sustainable levels. In late 2018, however, new data began
to indicate that growth was decelerating more abruptly than
expected. Purchasing Managers’ Indices (PMIs) fell below
the 50 neutral level in December 2018, for the first time since
July 2016. Defaults on corporate bonds also spiked in 2018,
prompting lenders to pull back on credit to riskier borrowers
(chiefly private firms without implicit or explicit government
guarantees). Official GDP data indicate that GDP growth
slowed to 6.4% in the fourth quarter – a 10-year low – while
alternative measures of economic activity indicate a more
abrupt slowdown.
Policymakers responded with stimulus measures, including
reductions in required reserve ratios and fiscal measures.
These steps were effective in reducing lending costs and
bolstering credit growth. Their effects on real economy data,
however, have not yet become clear. Export data surprised
badly to the downside in February, although at least some of
this underperformance was due to the timing of the Lunar New
Year. March data were also disappointing, with factory output
at 17-year lows. The baseline scenario is still that stimulus
measures will stabilise growth at around 6% over the forecast
period, in line with the lower bound of the 6.0–6.5% growth
target for 2019 that was announced in March. (By contrast, the
2018 target was 6.5%.) Credit and trade risks, however, could
generate significantly worse outcomes.
The US economy outperformed its advanced economy peers
in 2018, growing by 2.9% over the year, compared with a
Group of Eight (G-8) average of 1.6%. On a quarterly basis,
the US economy has slowed, from a peak growth rate of 4.2%
Percentage of labour force

Euro area unemployment rate
Source: Haver

Number of defaults

Chinese onshore corporate bond defaults
Source: Haver

Percentage change over four quarters

Chinese economic activity and growth

Goldman Sachs Current Activity Indicator*

Real GDP (official)

SARB GPM forecast
* Month on month, annualised (three-month moving average)
Sources: Bloomberg and SARB
Monetary Policy Review April 2019

in the second quarter of 2018 to 2.6% in the fourth quarter.
It is likely to slow further as the effects of stimulus spending
fade, with growth averaging 2.3% in 2019 and 1.9% in 2020
(according to the IMF). Given the Congressional Budget Office
estimates of potential growth of around 2% for 2019 to 2021,
this implies the US economy will be operating close to its
underlying potential for this period. Despite this – and the fact
that unemployment is at its lowest levels in 50 years – inflation
appears unlikely to breach the US Fed’s 2% target, with core
personal consumption expenditure (PCE) inflation having
once again slipped below 2% as of August 2018. (Meanwhile,
headline PCE inflation fell to 1.7%, with the help from petrol
prices.) The combination of slowing growth and low inflation
persuaded the Fed to change its policy plans for 2019 – as
discussed in the financial markets chapter of this MPR.
For the other large advanced economies, Japanese growth has
been volatile but low, while the United Kingdom (UK) has been
absorbed by Brexit. The UK economy actually held up better
than expected in the immediate aftermath of the Brexit vote,
supported by lower interest rates from the Bank of England
(BoE) as well as a more competitive exchange rate. Over the
past year, growth has slowed markedly, however, with only
0.7% recorded in the fourth quarter – a two-year low. The IMF
forecasts indicate a mild acceleration in 2019 and 2020 (with
growth of 1.2% and 1.4% respectively), but these numbers
are extremely uncertain given the range of possibilities around
Brexit.
Meanwhile, the principal feature of the Japanese growth
outlook is a value-added tax (VAT) increase scheduled for the
fourth quarter of 2019. As per the 2014 precedent, this will
raise inflation for a year and probably also create some shortterm growth through pre-emptive purchases. Both growth
and inflation will then fall back again as households adjust to a
higher tax rate on consumption.
In the emerging market space, India remains the standout
growth story. The economy suffered some disruptions in
the second half of 2018, mainly from turmoil in the shadowbanking sector, but annual growth was still 7.4% – up from
6.9% for 2017. (The quarterly growth rates were 8.1% and
8.0% in the first two quarters of 2018, and 7.0% and 6.6% in
the final two quarters.) Growth is expected to stay at around
7.5% over the medium term, maintaining India’s status as the
fastest-growing major economy. Indonesia is also growing
rapidly, with economic output up 5.2% in 2018 – a rate that
is likely to be sustained over the medium term (the consensus
forecasts from Bloomberg are for 5.1% in both 2019 and
2020). Indonesia’s current account deficit has widened to
3.0% of GDP and the authorities, mindful of the risks of capital
outflows, have tightened policy to prevent this deficit from
expanding much further. Inflation fell to 2.6% in February – a
10-year low – which is somewhat below the central bank’s
3.5% target. Meanwhile, the remaining large and fast-growing
emerging market of recent years, Turkey, has fallen into
recession, with output contracting in both the third and fourth
Percentage change over four quarters

Evolution of Chinese real GDP growth forecasts*
Source: SARB GPM


Nov 2018

Mar 2019

* Dotted lines indicate forecasts
Percentage change from quarter to quarter*

Evolution of US real GDP growth forecast
* Seasonally adjusted and annualised rates
Sources: Haver, Bloomberg and SARB GPM


Actual growth

Consensus forecast

SARB GPM forecast

Percentage change
Growth of selected emerging markets
Source: Bloomberg
India
Indonesia
Turkey
Brazil
Russia
South
Africa

-1

Monetary Policy Review April 2019
quarters of 2018. Last year’s currency crisis forced Turkey to
close its current account deficit very quickly, given a sudden
stop in financing. This adjustment has now been achieved.
The current account balance swung from -7.2% of GDP to
1.1% of GDP between the first and fourth quarters of 2018, but
it required painful import compression. The rapid depreciation
of the Turkish lira and an unmooring of inflation expectations
has also produced much faster inflation (a little over 20%
currently), necessitating high interest rates (the policy rate is
at 24%). Forecasts indicate growth will turn positive again in
2020, with inflation edging lower to about 13% by 2020.
Among the other large emerging markets, growth has generally
stagnated over the past half-decade. For instance, since
2013, Russia’s economy has expanded by a cumulative 2.4%,
South Africa’s economy also by 2.4% and Nigeria’s economy
by 10.3%, while Brazil’s economy has contracted by -4.2%.
By comparison, India’s economy has grown by 43.9% over the
same period. These disappointments all have country-specific
causes, such as sanctions on Russia or electricity shortages
in both Nigeria and South Africa. They also have common
dimensions that reflect these economies’ shared exposure
to commodity prices and global financial conditions. Growth
rates generally bottomed out in 2016 but have been stronger
since – a trend that is expected to persist over the medium
term. None of these countries are expected to achieve rapid
growth, however, and all are several percentage points down
from their best recent performances. Growth forecasts have
also been revised lower in recent months.
Emerging market monetary policies had a tightening bias in
2018, owing to higher rates in the US, capital outflows and
the spectre of contagion from Argentina and Turkey. Given the
marked changes in the outlook for US interest rates, emerging
market central banks might have been expected to reverse their
course as rapidly. However, Bloomberg forecasts for policy
rates still indicate that, among the major emerging markets, the
modal central bank will be tightening policy in 2019, although
a few more countries are expected to lower rates – especially
in the second half of the year – and not as many are projected
to leave rates unchanged, relative to six months ago. For this
sample, the average inflation rate is likely to be 5.5% in 2019
and 4.6% in 2020. Excluding a few outliers (Argentina, Turkey
and Nigeria), these rates are expected to be just below 3% for
both years, which is low relative to history and evidence of the
success of many emerging markets’ central banks in getting
control of their countries’ inflation processes.

Hiking
Number of countries
Emerging market* policy rates and forecasts
Second half 2019
First half 2019
Second half 2018

On hold

Cutting
* Including Argentina, Brazil, Chile, China, Colombia, Hungary, India,
Indonesia, Malaysia, Mexico, Nigeria, Peru, Philippines, Poland,
Romania, Russia, South Africa, Thailand and Turkey
Sources: Bloomberg and SARB
Percentage change over 12 months

Emerging market inflation
* Including Argentina, Brazil, Chile, China, Colombia, Hungary, India,
Indonesia, Malaysia, Mexico, Nigeria, Peru, Philippines, Poland,
Romania, Russia, South Africa, Thailand and Turkey
Sources: Haver and SARB

Average emerging markets*
Average emerging markets (excluding
Argentina, Nigeria and Turkey)

Monetary Policy Review April 2019

Box 2 The disinflation experience: evidence from
Brazil and India

D Tarullo, ‘Monetary policy without a working theory of inflation’,
Hutchins Center Working Paper No. 33, October 2017.
brookings.edu/wp-content/uploads/2017/10/es_wp33_tarullo.pdf.
India and Brazil are both in the advanced stages of disinflation
strategies. This box reviews the two countries’ experiences, which offer
some lessons for South Africa.
India adopted inflation targeting in 2014, with an intermediate
target of 8% and a final target of 4% plus or minus 2% from 2017
onwards. Brazil began targeting inflation much earlier, in 1998, but it
has recently lowered its targets. After an extended (11-year) stretch
of aiming for inflation of 4.5% plus or minus 2%, the government
specified targets of 4.25% for 2019, 4% for 2020 and 3.75% for 2021.
(The desired endpoint appears to be 3%, in line with peers such as Chile
and Mexico.)
Both countries have come to these targets after long histories of higher
inflation. Between 2010 and 2016, Indian inflation averaged 7.8%,
while Brazil’s was 6.8%. Looking further back, India’s 30-year inflation
average was 7.4%, while Brazil’s was 332.9% – pushed up by three
hyperinflations in the 1980s and early 1990s.
Given these backgrounds, it might seem overambitious for either
country to aspire to low single-digit inflation. Inflation has nonetheless
come down in line with the new targets. In India it has declined to 2.5%
(as of February 2019), given favourable food price shocks; the average
outcome for the 4% target period is 3.5%. Similarly, Brazilian inflation
is now at 3.9% (as of February 2019), slightly below the 2019 target.
Some of this success can be attributed to fortuitous disinflationary
shocks. A sterner test for monetary policy is whether longer-run
expectations will shift to align with the targeted inflation rates. Strikingly,
surveys of professional forecasters in both India and Brazil have shown
expectations converging on the new targets, from substantially higher
levels previously. This testifies to the credibility of the Reserve Bank of
India and the Central Bank of Brazil: well-informed observers believe
the new targets will be achieved. That said, surveys of non-specialists
do not reveal comparably clear-cut results. In India, household inflation
expectations have declined following the introduction of inflation
targeting, but they remain at elevated levels, having fallen from around
13% before inflation targeting to just below 9% currently. Similarly, in
Brazil, consumer inflation expectations have fallen from around 11% in
early 2016 to 5.4% currently.
Inflation expectations are sometimes accused of being more important
for the theory of monetary policy than its practice.1 One direct and
practical application, however, is their effect on bond rates: lower
inflation means investors require less inflation compensation, so bond
yields should fall. Consistent with this theory, Brazilian 10-year yields
have trended lower, reaching 9% as of February 2019. Indian bond
yields have also fallen: the latest number is 7.6%. By way of comparison,
the equivalent South African yield is at 9.3% – the first time on record
that South Africa’s 10-year rate has been above Brazil’s. (South African
yields have also usually been below India’s, by an average of 59 basis
points over the past 10 years.) This is despite South Africa actually
having the lowest government debt-to-output ratio of these countries,
at 56%, compared with 88% for Brazil and 70% for India (using 2018
estimates from the International Monetary Fund).
Percentage change over 12 months

Indian and Brazilian headline inflation
Source: Haver
India
Inflation
Inflation
Tolerance band
Tolerance band
Target
Target
Brazil

Per cent
Inflation expectations*

India **
Sources: Haver and RBI
Brazil

* One-year-ahead inflation expectations
** Survey of professional forecasters

Per cent

Government bond yields*
Sources: Bloomberg, Haver and SARB

Brazil

South Africa

India

* 10-year government bond yields

Monetary Policy Review April 2019
Risks to the outlook
The two most pressing risks to the global outlook, at least
based on the attention they receive in policymaking circles, are
trade tensions and tighter financial conditions. Uncertainty over
future trade policies threatens to disrupt investment in global
value chains, and has already created costs for both producers
and consumers in the most affected economies.2 Should this
uncertainty crystallise into a conviction that global trade will be
significantly curtailed in future, several countries will find their
development strategies compromised, while many others will
lose out due to lower productivity levels.
The problem of tighter global financial conditions is different.
The Fed reprieve was significant and markets are confident it
will last. However, this narrative has moved very rapidly in just
a few months, and could well shift again. The Fed has already
succeeded in loosening US financial conditions, and the
economy remains healthy, with unemployment at 50-year lows.
This suggests US policy rates should be at or above neutral
levels. If this is indeed the end of the US interest rate cycle, it
implies a neutral real rate of little more than 0%, which is very
low from a historical perspective. By contrast, a few months ago
policymakers thought the neutral rate was around 1%, which
justified another year of interest rate increases. It is possible
that higher estimates could still prevail, once again tightening
global financial conditions. It is also disconcerting how many
emerging markets suffered stress simply because US real
rates were expected to reach 1% (approximately equivalent to
the long-run real average of 1.2% for the past 50 years).
This points to excessive reliance on easy money in emerging
market growth models.

M Amiti, S J Redding and D Weinstein, ‘The Impact of the 2018 trade war
on US prices and welfare’, CEPR Discussion Paper No. 13564, March 2019.

Regarding growth, it is difficult to disentangle the consequences of
disinflation from other factors. Brazil’s disinflation comes in the wake
of a severe recession. India’s, however, coincides with a period of
higher growth. In both cases, disinflation was probably not crucial for
the observed growth outcomes, either good or bad. In future, however,
both countries will enjoy the benefits of permanently lower inflation,
including structurally lower interest rates, which will likely benefit longrun growth rates.
Per cent
Brazil
India
Brazilian and Indian average economic growth
Source: Haver
2010Q1–
2017Q2
2017Q3–
2018Q4
2010Q1–
2013Q4
2014Q1–
2018Q4

Percentage change
World trade growth
Sources: CPB Netherlands Bureau for Economic Policy Analysis
and SARB
Post crisis average
2018Q4

Monetary Policy Review April 2019

Financial markets: a rebound
and risks
Riskier assets fared poorly in the second half of 2018, given
deteriorating global growth prospects and rising US interest
rates. The losses were broad-based, affecting global equities
as well as emerging market bonds and currencies. However,
a more dovish tone from the Fed has underpinned a global
market recovery in early 2019. It has also supported the rand,
and contributed to markets anticipating a flatter path for the
SARB’s policy rate.
The second half of 2018 was an unusual period in the history
of global financial markets. Losses were widespread, affecting
both equities and bonds as well as other asset classes. The
net decline in wealth exceeded US$5 trillion – the largest fall
since the global financial crisis. Much of this has since reversed
in 2019, however, despite slowing global growth. Credit for
this shift goes mainly to the big central banks, especially the
US Fed.
The Fed raised rates nine times between 2015 and 2018, with
four increases in 2018 alone. Since 2017 it has also reduced
the size of its balance sheet, unwinding its quantitative easing
policies. Both these factors have tightened financial conditions.
Fed communications, however, have convinced markets that
additional interest rate increases are now unlikely. Market
pricing currently indicates that the next US interest rate move
will be down, with the probability of a cut rising to around
60% in the wake of the Fed’s March meeting. This contrasts
sharply with expectations six months ago, which still indicated
two rate increases in 2019. The Fed has also indicated that it
could end quantitative tightening as soon as the second half of
2019, leaving its balance sheet unusually large relative to its
historical levels.
Parts of the US yield curve have inverted: 1-year Treasury
yields are higher than 5-year yields, and the 10-year rate has
dropped below the 3-month rate. Yield curve inversion is often
interpreted as a leading indicator of recessions. However, while
a US slowdown is widely expected, the odds of a full-blown
recession are still quite low. For instance, the New York Fed’s
recession model, which is based on the yield curve, estimates
the probability of a recession by December 2019 at 23.6% (as
of late March 2019). Analysts’ forecasts also indicate lower
but positive growth over the medium term. Perhaps the most
important message of US yield curve inversion is that current
short-term rates are now higher than the short rates that are
likely to prevail over the medium term, meaning the market
thinks monetary policy normalisation is complete and the Fed
has space to cut rates again.
Among
other
advanced
economies,
monetary
policy
normalisation has proceeded more slowly. The BoE has lifted
its policy rate twice from its 2017 low of 0.25%, but at 0.75%
the rate remains deeply negative in real terms. (UK inflation
was 1.8% in February.) With GDP growth and inflation slowing
Per cent

Market-based expectations for US interest rates
Source: Bloomberg


Federal funds futures (31 Oct 2018)

Federal funds futures (8 Apr 2019)
Percentage of GDP

Central bank balance sheets

US

Japan

Euro area
Source: Haver

Index: 2 Jan 2006 = 100

US dollar nominal effective exchange rate*
Source: Bloomberg
* US Fed broad trade-weighted average

Monetary Policy Review April 2019
alongside heightened Brexit uncertainty, the BoE has chosen
to keep rates on hold since August 2018. However, its forward
guidance suggests that gradual policy rate increases are likely
over the medium term, based on forecasts for rising growth
and inflation.
The ECB halted its balance sheet expansion in December
2018 as a first step toward normalising its policy settings.
However, market expectations indicate that its main policy rate
is unlikely to rise from 0% for at least another year, which is
later than previously expected. The ECB has also announced
a third round of its bank lending programme (TLTRO-III), which
provides cheap funding for qualifying banks and is designed
to ensure monetary policy stimulus transmits effectively
throughout the euro area. Meanwhile, the Bank of Japan
(BoJ) continues to expand its balance sheet, mainly through
government bond purchases designed to keep the 10-year
yields near 0%. Its communication indicates that the policy
rate is set to remain at -0.1% for an extended period of time.
The BoJ’s balance sheet has grown to approximately 100%
of GDP – up from 20% at the start of the global financial crisis
– making its recent monetary stimulus one of the largest in
modern history.
Notwithstanding recent caution from the Fed, the US dollar
has remained strong, with the trade-weighted US dollar index
about 15% above its 10-year average. US interest rates are
not especially high, but they are elevated relative to those of its
peers, and this differential has kept the US dollar appreciated.
(By contrast, the US dollar weakened in 2017, not so much
because of US-specific factors, but rather because a euro area
recovery made rate hikes by the ECB more likely.)
Emerging market currencies have nonetheless staged
rebounds against the US dollar since the start of the year. This
mostly reflects recoveries from weak starting points. Emerging
market currencies have also benefitted from a broad-based
rebound in commodity prices as well as some optimism over
a potential US–China trade deal. More broadly, contagion
effects from last year’s currency crises in Argentina and Turkey
were contained. Policy frameworks held up well, with flexible
exchange rates absorbing most of the initial shock and credible
inflation targets anchoring expectations. The real-world stress
test of late 2018 therefore exposed resilience rather than
fragility, clearing the way for currency recoveries as the initial
shock dissipated.
Positive sentiment has also affected bond and equity markets.
The JPMorgan Emerging Market Bond Index Plus (EMBI+) has
regained most of the ground lost in 2018, climbing by 4.7%
on a year-to-date basis. Similarly, the MSCI Emerging Markets
Equity Index has risen by 8.5%, making up about half of its
losses since the start of 2018, while the equivalent index for the
US is up by 18%, close to its 2018 peak.
However, the financial market rally of 2019 may be on shaky
ground as it comes at a time of fading growth momentum.
Indeed, bullish sentiment is largely a function of policy

2019 year to date
Per cent
Emerging market currencies against the US dollar
Sources: Haver and SARB
Argentina
Turkey
Russia
South Africa
Brazil
Chile
India
Indonesia
Philippines
China
Mexico
Thailand


US$ billions
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Cumulative total non-resident portfolio inflows
to emerging markets

Sources: Haver and IIF
-50

Index: 1 Jan 2018 = 100

Jun
Sep
Sep
Dec
Dec
Mar
Mar
Jun
Emerging market bond yields
Sources: Haver and SARB

EMBI+ (total return)
Monetary Policy Review April 2019

responses to new downside growth risks which have
prompted central banks to postpone or cancel normalisation
plans. Political and policy risks are also unusually elevated,
particularly around Brexit and trade tensions. Meanwhile, debt
levels are generally elevated, while valuations for many fixed
income and equity instruments look stretched. In the US, for
example, corporate bond spreads are unusually low, while the
stock of debt as a share of GDP is at an all-time high. Priceearnings ratios for the S&P 500 Index remain well above longerterm averages. Emerging market corporate debt levels are also
elevated, although they have moderated somewhat over the
past year or so. Some jurisdictions have seen rapid growth in
foreign currency debt, which carries lower interest rates but
also makes balance sheets more vulnerable to exchange rate
movements. (By contrast, in South Africa total foreign currency
debt remains low at 22% of GDP; the corporate debt-to-GDP
ratio has also fallen since the global financial crisis.)
Local market developments
Amid significant price volatility, South African assets have
recovered modestly in recent months. Over the six-month
period since the publication of the October 2018 MPR, the
rand has appreciated by 2.7% against the US dollar. It has also
gained against the euro, Japanese yen and British pound, by
5.9%, 1.7% and 1.9% respectively over that time frame.
As is usually the case, the improvement in the currency
was accompanied by a downward move in the forward rate
agreement (FRA) curve. FRA contracts provide a market for
investors to trade expectations of future domestic interest
rate movements. At the end of October 2018, the market was
pricing in 100 basis points of interest rate increases over the
coming two years. Following a 25 basis point rate hike in late
November, and subsequent evidence of moderating domestic
inflation, the market shifted and is currently pricing in a flat
interest rate path over the next two years.
The rest of the yield curve has also rallied, with the benchmark
All Bond Index producing a 2.2% total return3 so far in 2019.
This performance is reflected in compression across the curve,
with yields for both longer- and shorter-dated instruments
moderating. (This may be related to a generalised fall in
inflation expectations, as discussed in Box 3.) The shape of
the yield curve has remained steep, however, with a spread
of 2.85 percentage points between the 2-year and 30-year
instruments, which is higher than 87% of the observations
since 2000. This relatively high-term premium is indicative,
among other of factors, of longer-term fiscal and inflation risk.
Indeed, the credit default swap spread for South Africa (the
cost of insuring against a sovereign default), at about 180 basis
points, is higher than that of some countries with lower credit
ratings, such as Brazil, which suggests markets are pricing in
a further rating downgrade for South Africa.

The total return includes both the asset price gains as well as the income
generated through interest/dividends.

Index: 1 Jan 2018 = 100
Jan

Apr
Jul
Oct
Jan
Apr
Global equities
Sources: Bloomberg and SARB

MSCI US Index

MSCI World Index

MSCI Emerging Markets Index

Ratio
Per cent

US asset price valuations
Source: Haver

GZ credit spread (right-hand scale)
Shiller cyclically adjusted S&P
price to earnings (inverted scale)
Per cent
31 Oct 2018
8 Apr 2019
South African forward rate agreements


* FRA contracts are priced off 3-month Jibar. The 1x4 contract is the
expected 3-month Jibar in one month’s time. Similarly, the 3x6 is the
expected 3-month Jibar in three months’ time.
Source: Bloomberg
21x24
15x18
12x15
9x12
6x9
3x6
1x4

Maturities*

Monetary Policy Review April 2019
Box 3 Bond yields under 4.5% inflation

This calculation uses break-even inflation rates, which reflect the
difference between nominal government bond yields and inflation-
protected equivalents. The inflation risk premium is proxied as the
difference between break-even rates and survey-based inflation
expectations. There are no survey data for inflation expectations
10 years ahead, but the inflation risks associated with a longer time
horizon can be estimated by augmenting the 5-year inflation risk
premium with the average spread between the 10-year and 5-year
break-even rate.
If the South African Reserve Bank (SARB) can anchor inflation
expectations at 4.5%, where will bond yields trade? The complexities
of the bond market make it difficult to answer this question exactly.
However, by decomposing the yield on long-term government bonds,
it is possible to estimate the contribution from inflation compensation,
and therefore the possible reduction in yields from lower inflation. The
results suggest that inflation expectations have already moderated,
offsetting some upward pressure on yields, mostly from a higher
sovereign risk premium. There is nonetheless scope to reduce
inflation compensation further.
As a rule of thumb, yields should reflect real yields, plus the inflation
target, plus an inflation risk premium. For example, over the past halfdecade, the real South African bond yield has averaged approximately
3.0%, based on average yields less average inflation. The inflation
premium, which provides compensation for inflation surprises, has
been around 0.6%. Had inflation expectations been at 4.5% for
this period, then nominal bond yields should have averaged 8.2%.1
(In fact, they averaged 8.6%.) However, the spread between actual
bond yields and this rule-of-thumb estimate has narrowed recently. The
implication is that the bond market is pricing in a lower inflation rate.
Everything else being equal, this should have reduced borrowing costs.
Yet this effect appears to have been offset by other factors, mainly
higher sovereign risk. Had inflation expectations not declined, bond
yields would be around 1⁄2 a percentage point above current levels.
An alternative estimate can be derived from global rates.
This methodology treats the South African bond yield as equal to the
sum of a long-term average of the nominal 10-year United States (US)
Treasury yield, the South African credit default risk spread, an expected
inflation differential with the US, and the inflation risk premium used
above. This approach suggests an equilibrium long-term bond yield
under a 4.5% inflation target would be somewhat lower – around 7.6%
– compared to just over 8.0% under the first methodology.
Both these calculations point to benefits in terms of lower borrowing
costs from a credible 4.5% target. There is evidence inflation
compensation has already fallen, closer to 4.5%. Bond yields have
nonetheless risen, which is mainly due to a higher sovereign risk
premium. Lowering this component of yields would require fiscal
consolidation as well as renewed growth to moderate long-term credit
risk. It may also be possible to reduce South Africa’s inflation risk
premium, by enhancing the credibility of the midpoint target and by
concluding the debate on the SARB’s independence and mandate.
Per cent

Bond yield estimates with 4.5% inflation
Sources: Bloomberg and SARB

Estimated bond yields (method 1)

Estimated bond yields (method 2)

10-year bond yields
Yield decomposition (five-year average outcomes,
except for inflation targets)
* Inflation risk premium
Sources: Bloomberg and SARB

Actual yield
Second method
First method
0.6*
Midpoint
SA real yield
US nominal
yield
2.2
SA CDS
spread
2.5
US-SA target
differential
Monetary Policy Review April 2019

In a significant reversal of fortune, the equity market has been
South Africa’s best-performing asset class so far in 2019, with
the JSE All-Share Index (Alsi) up by 6.3%. These gains have
been driven primarily by resource stocks on the back of rising
commodity prices, although the industrial and financial indices
have also gained. Notwithstanding the recent rally, the Alsi is
down slightly on a year-on-year basis, given a disappointing
performance in late 2018. Domestic equity valuations remain
cheap, with the price-earnings ratio of the Alsi currently at 17,
well below its 5-year average of 22.
Conclusion
Global financial markets have recovered from their slump in late
2018, helped in particular by policy changes from the major
central banks. However, risks abound, including stretched
valuations in key markets, political uncertainty, high debt levels
and slower global growth. By contrast, South African equities
are not overvalued in relative terms. Financial stability risks
also appear to be well contained. Nevertheless, South African
asset markets are exposed to changes in global sentiment,
given strong linkages with the rest of the world. Continued low
growth will also constrain asset prices.

Per cent
South African yield curve

31 Oct 2018

8 Apr 2019

Source: Bloomberg
Basis points

South Africa and Brazil’s five-year CDS spreads
Source: Bloomberg

Brazil

South Africa

Index: 1 Jan 2018 = 100
Jan

Apr
Jul
Oct
Jan
Apr
South African bonds and equities
Sources: Bloomberg and SARB
* Total return

JSE All-Bond Index*

JSE All-Share Index*

Monetary Policy Review April 2019
Real economy: waiting for
the recovery
South Africa’s growth rate has once again undershot
expectations. After a rebound in 2017, GDP growth fell to just
0.8% last year – its second lowest level since the financial crisis.
The economy will likely achieve moderately better growth over
the forecast period, although forecasts have once again been
marked down given challenges such as electricity shortages
and slower global growth.
Weak growth in 2018
South Africa’s weak 2018 performance came as a surprise.
The year started optimistically, with household confidence
indicators reaching their highest levels on record. Domestic
inflation declined to a seven-year low of 3.8% in March 2018,
bolstering household purchasing power. Furthermore, the
global economy began the year in the middle of a synchronised
boom. In this context, the SARB revised up its estimates
for 2018 growth, from 1.2% as of the November 2017 MPC
meeting to 1.6% as of the March 2018 meeting. The MPC also
noted upside risks to these forecasts at the March and May
2018 meetings (the only upside risk assessments on record).4
By the middle of 2018, it was clear that even this rather tepid
enthusiasm was overdone. Data from the mining and agriculture
sectors showed that output would contract in the first quarter
of the year – a view incorporated in the May 2018 forecasts.
The PMI peaked in February at 50.8, barely above the neutral
50 level, before dipping to 46.9 in March. Business confidence
stayed subdued. Total growth for the year was ultimately 0.8%,
half the level projected in March.
Excluding the primary sector, this 0.8% growth rate would have
been 0.3 percentage points higher. The decline in agriculture
was largely due to adverse weather conditions, compounded
by base effects from 2017’s bumper crop. There was no
comparably clear-cut explanation for the minerals sector,
but rand appreciation diminished the local currency value of
export commodities, and the sector also spent much of the
year dealing with policy uncertainty (with a new Mining Charter
promulgated in October 2018).
For the rest of the economy, the biggest disappointment was
in the finance, real estate and business services component.
This sector has traditionally been a stable growth driver for
the economy, with an average growth rate of 2.6% over the
post-crisis period (the equivalent GDP growth rate is 1.7%).
It slowed unexpectedly to 1.8% in 2018, from 2.1% the year
before, for reasons that are still unclear. Had this subsector
achieved its post-crisis average, GDP growth would have been
0.2 percentage points higher.

See Box 4 for details.
Mar

Jul
Jul
Nov
Nov
Mar
Jul
Nov
Mar
Mar
Evolution of 2018 real GDP forecast
Sources: Stats SA and SARB
Date of meeting
Percentage change

Mar 2018
1.7%
Nov 2017
1.2%
Actual
0.8%
Percentage change over four quarters

Real GDP growth and forecast
Sources: Stats SA and SARB
-1

-1

Percentage change

Real GDP growth
Sources: Stats SA and SARB


Actual GDP

GDP excluding primary sector

Mar 2018 GDP forecast
Monetary Policy Review April 2019

From a demand-side perspective, the main growth shortfall
came from investment. Following a broad-based decline in
2016, investment recovered in 2017 but then unexpectedly
contracted again in 2018. Initial data showed the private sector
subcomponent contracting the most, which encouraged
speculation that plans for land reform via ‘expropriation
without compensation’ were to blame, presumably via
a weak confidence channel. However, a comparison of
the Agribusiness Confidence Index (Agbiz) and the BER
Business Confidence Index provides little indication that
agriculture businesses – which would be most affected by
land reform – experienced a greater loss of confidence than
their counterparts in other sectors. Subsequent data releases
have also rewritten this history, with private sector investment
now marked up to growth of 2.1%, from a forecast of -0.5%
based on previously available data. By contrast, investment by
both government and public corporations was revised sharply
lower. This is consistent with scarcer fiscal resources, with
investment being crowded out by government consumption
(mainly wages and interest payments). It also reflects legacies
of mismanagement at state-owned enterprises, which are
hampering new investment projects.
Medium-term outlook
Forecasts for GDP growth envision a slight improvement over
the medium term. Growth will likely reach 1.3% this year, and
then accelerate moderately to 1.8% in 2020 and 2.0% in 2021.
Since the previous MPR, the growth trajectory has been
lowered by 0.6 percentage points for 2019 and 0.2 percentage
points for 2020 (there was no 2021 forecast six months ago).
These revisions reflect new information from a wide range
of data affecting all the major components of GDP. Despite
this complexity, it is possible to identify three overarching
reasons for these adjustments. In the short term, output is
suffering from load-shedding – scheduled electricity outages
to reconcile demand with supply – which returned in an
unexpectedly intense form in the first quarter of 2019. While
measuring the full economic consequences of these power
cuts is difficult, especially given uncertainty over how long
they will last, they have clearly disrupted the first quarter of the
year. Model estimates for first-quarter growth indicate a range
of 0–1%, based on preliminary data, including both hard and
soft indicators; in particular, business confidence fell to 2009
levels in the first-quarter survey, which was most likely due to
electricity shortages. (For a more detailed analysis of the loadshedding impact, see Box 1.)
Second, South Africa’s expected growth rate has been pared
back on account of a weaker global economy, as discussed
in the section on the global economy in this MPR. This implies
weaker demand for South African exports, a factor which has
lowered both the 2019 and 2020 growth projections by around
0.2 percentage points for 2019 and 0.1 percentage points
for 2020.
Percentage points
Primary
Secondary
Tertiary

Change in contribution to GDP growth, 2017–18
* Total value added at basic prices. Totals do not add up to 100 due
to rounding off.
Sources: Stats SA and SARB
10.5% of
output
20.9% of
output
68.5% of
output
Index

Google trends: ‘Expropriation without compensation’
Source: Google
-10

Before revisions
(Jan 2019 forecast)
After revisions
(Actual)
Gross fixed capital formation: 2018 estimates
versus actual
Sources: Stats SA and SARB
Percentage change


General government

Public corporations

Private businesses

Total

Monetary Policy Review April 2019
Third, and more technically, the growth forecast has been
affected by Statistics South Africa’s (Stats SA) data revisions
going back to 2015. The historical numbers have changed by
small amounts; for example, 2016 growth is now 0.4% versus
0.6% previously, while 2017 growth is now 1.4% versus 1.3%
previously. Using the new data for the potential growth estimate
generates a slightly lower trend across the forecast period, by
0.08 percentage points on average, which also changes the
output gap estimates.
Expenditure components of real GDP
Annual percentage change
Actual
SARB forecast


Gross fixed capital formation....

Note: data used for the October 2018 MPC are in brackets. Historical figures
changed due to Stats SA revisions.
Sources: Stats SA and SARB
Household consumption
Expenditure by households accounts for about 60% of output,
and has historically been the largest contributor to GDP growth
(from a demand-side perspective). Household consumption
growth decelerated to 1.8% in 2018 and it is likely to slow
further to 1.1% in 2019, given higher taxes. However, real
wage growth is expected to pick up over the forecast period,
which will support a modest acceleration in consumption to
1.4% in 2020 and 1.8% in 2021. This upward trend will be
reinforced by two additional factors, namely wealth effects,
which are presently subtracting from household consumption,
given depressed asset prices and are likely to become slightly
more supportive over the forecast period, and credit growth,
which has finally turned positive, in real terms, after a four-year
contraction.
-2
-1

Percentage points
Contributions to GDP growth

Sources: Stats SA and SARB

Net exports

Inventories and residual

Gross fixed capital formation

Government consumption

Household consumption

GDP growth (percentage change)

Real salaries

Transfers

Property

Direct personal taxes

Disposable income
(percentage change)
Percentage points
Household disposable income

Sources: Stats SA and SARB
Forecast
-3
-2
-1

Index

Business confidence
Optimistic
Pessimistic
1980 1985 1990
Source: BER

2000 2005 2010 2015 2020

Monetary Policy Review April 2019

Investment
The SARB projects weak but positive growth in gross fixed
capital formation over the forecast horizon. Investment,
excluding inventories, which tend to be volatile, will likely
be unchanged in 2019 – an improvement from the 1.4%
contraction in 2018. It is then expected to pick up to 2% in
2020 and 2.5% in 2021, which are modest growth rates by
historical standards. Business confidence remains weak – in
the first quarter of 2019 it slumped to levels comparable to
those reached during the 2009 financial crisis – which makes
a stronger rate of private sector investment growth unlikely.
Meanwhile, the state and parastatal sectors will remain
constrained by budget and capacity problems, permitting only
marginally positive investment contributions.
Government consumption and
net exports
Government consumption is expected to grow by 1.2% across
the forecast horizon, which is below the GDP growth rate, in
line with fiscal consolidation efforts. This will contribute around
0.2 percentage points to output growth for each forecast
year. The net export contribution is similarly modest, at about
0.1 percentage points annually. Imports will increase slightly
given a mild investment recovery. Exports will also expand, but
the slower global economy means these growth rates will be
substantially lower than for previous forecasts.
Percentage change over 12 months

Credit extended to households
Sources: Stats SA and SARB


* Deflated with headline CPI inflation

Nominal

Real*

Public corporations

General government

Private business

enterprises

Total gross fixed capital

formation (percentage

change)
Percentage points
Contributions to gross fixed capital formation growth

Sources: Stats SA and SARB


Box 4 Assessing the accuracy of the South African Reserve Bank’s growth forecasts
Each Monetary Policy Review (MPR) includes an accuracy
assessment for an aspect of the South African Reserve Bank’s
(SARB) economic forecasts. For instance, the October 2018
MPR reviewed the food price forecasts, while the April 2018
MPR investigated recent headline inflation errors. This exercise
promotes accountability. It also helps enhance the quality of
future forecasts by ensuring lessons are learned from past errors.
This MPR assesses the SARB’s growth forecasts. The data
show that these have been inaccurate over long periods of time,
with persistent biases (i.e. the mistakes were consistently in
one direction instead of being randomly distributed). The global
financial crisis stands out as a large error, but this is relatively
unsurprising – it was a massive, unexpected shock. More
interesting is that there were also sustained errors on either side
of the crisis. Between 2003 and 2006, 90% of the forecasts
were below actual outcomes (defined as the average of one to
six quarters ahead). In the post-crisis period, the bias reversed.
Every growth forecast from late 2010 to late 2015 was too high.
Only since the start of 2016 have the forecasts become relatively
accurate, with smaller and more random errors.
The recent improvement in the accuracy of the forecasts
mainly reflects a more realistic assessment of potential
growth. The forecasts up to 2015 all assumed that potential
growth was at around 3%, which implied a large negative
output gap and an imminent growth recovery, boosted by
stimulatory monetary and fiscal policies. As it became clearer

Monetary Policy Review April 2019
Percentage points
SARB GDP average errors
-2
-1

Sources: Stats SA and SARB

Overestimated
Underestimated
The precise scale of the errors is also very similar: the root
mean square errors are identical at one and six quarters
ahead (at 0.4 and 2.0 percentage points respectively), and
nearly the same at four quarters ahead (at 1.3 percentage
points for the SARB, and 1.5 percentage points for the
Reuters average). This shows that the SARB’s forecasts
did not, at least, underperform relative to other forecasts.

The MPC did not explicitly and consistently identify risks to the growth outlook previously.
In contrast to the forecasts, events have largely vindicated the
Monetary Policy Committee’s (MPC) risk assessments, at least
for the post-crisis period.1 Of the 55 MPC statements published
between January 2010 and January 2019, 85% noted downside
risks to growth. Over this entire period, upside risks to growth
have only appeared twice, at the March and May 2018 meetings.
(There were also six ‘balanced’ assessments.)
that South Africa was suffering from something over and above
weak demand, the SARB began reworking its fundamental
assessment of the economy. This revision process curtailed
the growth forecast errors. It has not completely eliminated
the problem, however; the 2018 growth forecasts were
once again too high, as the economy failed to sustain the
2017 rebound.
Although the SARB’s growth forecasts have been inaccurate,
this was not a unique mistake. The private analysts’ forecasts
collected by the Reuters Econometer survey show a very similar
pattern of errors to the SARB’s: too low before the crisis, and
too high afterwards.
Percentage points
GDP average error six quarters ahead

SARB

Reuters
-2
-1

Sources: Stats SA and SARB

Overestimated
Underestimated
Monetary Policy Review April 2019

The SARB’s growth forecasts have been significantly less accurate
than the inflation forecasts. The absolute errors for inflation have
been smaller, as have those for bias. (For the post-crisis period,
the average absolute error is 0.8 percentage points for growth and
0.5 for inflation; the bias measure (average error) is 0.7 percentage
points for growth and 0.2 for inflation, where zero represents no
bias.) Among other things, this demonstrates how much more
difficult it would be for the SARB to target a variable such as
nominal GDP instead of inflation.
Percentage points
SARB GDP and CPI average errors
GDP
CPI


Sources: Stats SA and SARB
Overestimated
Underestimated

2003 2004

Macroeconomic drivers of
weak growth
In understanding weak growth, observers are often quick to
identify either short-term factors (such as strikes, electricity
outages or bad weather) or deep structural contributors
(including skills shortages and spatial problems). However,
it is important to appreciate the macroeconomic aspects of
South Africa’s growth problems, not least because they better
explain medium-term phenomena such as a five-year growth
slump compared to the alternative classes of explanation.
One macroeconomic key to the problem is the combination
of historically low growth rates and a relatively large current
account deficit. A second key is the mix of low growth and
rising long-term interest rates. Both are symptoms of a deeper
problem: severe resource misallocation that produced large
macroeconomic imbalances and undermined confidence.
South Africa’s current account tends to be cyclical. In boom
phases it becomes more negative, principally because of rising
capital imports for investment. During weak growth episodes
it tends to narrow again, mainly because imports contract.
The current account has maintained this behaviour during
the current downswing in the business cycle, narrowing from
-5.9% of GDP in 2013 to -3.6% in 2018. A current account
deficit of this magnitude, however, is still relatively large, both
by global standards and by historical South African averages.
Based on the IMF’s April 2019 World Economic Outlook


Percentage of GDP
Current account balance

Sources: Stats SA and SARB

Other income

and transfers

Interest

Dividends

Trade balance

Current account

Monetary Policy Review April 2019
forecasts, South Africa’s current account deficit will be the
second largest in the Group of Twenty (G20) this year, as a
share of GDP (after the UK). It also compares unfavourably with
the post-1994 domestic average of 2.5% of GDP. The forecasts
indicate the deficit will be roughly stable over the medium term
(3.3% of GDP in 2019, 3.4% in 2020 and 3.5% in 2021), given
relatively unchanged terms of trade.
An important reason for the persistence of the current account
deficit is that investment has stayed quite high through much
of the latest downswing, at least relative to historical averages.
South African investment rates are structurally low, barely
approaching emerging market averages in the best investment
years. The average investment rate since 1994 has been just
18.3% of GDP. Since 2013, when the latest downward phase
of the business cycle started, investment has averaged 19.6%
of GDP. Relatively elevated investment levels require larger
current account deficits because they tend to be importintensive. They also require financing, because South Africa’s
domestic savings rate is low, which entails matching inflows of
foreign savings through the capital account.
By this account, the question is why growth has been low
relative to investment. A simple answer is that investment
affects growth with a lag, particularly when it consists of large
capital projects that only become productive after most of the
spending has already been recorded. But this explanation is
no longer satisfactory: as time has passed, it has become
clearer that there is something wrong with the investments
themselves. A simple growth accounting exercise shows that
with normal productivity levels, South Africa’s capital and
labour stocks should be returning GDP growth rates of around
2.9%. To reconcile this with observed, lower growth rates
requires negative productivity growth. Specifically, the residual
or total factor productivity number is -0.4% for 2017 compared
with a longer-run average of around 1.5–2% for most of the
pre-crisis period.
Emerging evidence from the Commission of Inquiry into
Allegations of State Capture, as well as other sources, offers
some insight into how this could be possible. The proportion
of national investment derived from the state and parastatals
was unusually high in the post-crisis period (around 37% of
total investment, up from 25% or so before the crisis); it now
appears that a substantial portion of this investment spending
was not actually used for productive investment.
Private sector investment has been more muted in recent
years – closer to two-thirds of total investment than the usual
three-quarters. If public sector investment during this period
was partly captured for consumption purposes, it becomes
clearer why it did not crowd in private sector investment.
Instead, the private sector would have been facing a future with
higher tax rates and more supply-side constraints, for instance
through electricity shortages (rather than abundant supply, as
implied by massive new investments in generation capacity).
These prospects would naturally have disincentivised
Percentage of GDP
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Sources: Stats SA and SARB

Gross fixed capital formation
Post-democracy average
Percentage change

Factors of production
Sources: Stats SA and SARB
-2
-1

Labour force (working age population)

Capital stock

Implied total factor productivity
Percentage of total gross fixed capital formation
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Sources: Stats SA and SARB

Gross fixed capital formation by general
government and public corporations
Monetary Policy Review April 2019

private sector investment, which is consistent with observed
outcomes. The private sector would also have been competing
with the public sector for scarce savings – savings that were
scarcer because of large-scale government borrowing.
Although both the current account deficit and investment rates
have stayed higher than might have been expected during a
severe downturn, savings ratios have fallen sharply to 70-year
lows, mainly due to government dissaving.
The combination of low growth and rising long-term interest
rates operates via a similar mechanism. In standard Keynesian
models, during cyclical downturns government deficits do not
crowd out the private sector because productive resources
are sitting idle, including capital. This means long-term interest
rates remain low despite large deficits. In turn, large fiscal
deficits provide the demand growth that attracts new private
sector activity, which permits the government to reduce its
deficits as growth becomes self-sustaining again.
In the South African experience, however, the private sector
does appear to have been crowded out as fiscal metrics
deteriorated. The government’s debt-to-GDP ratio has risen to
long-term highs,5 and National Treasury expects it will exceed
60% of GDP before trending lower again, with the peak in
2023/24. South Africa has lost its investment grade rating from
two of the three major credit rating agencies. Credit default
swap (CDS) spreads – a measure of sovereign risk – indicate
that South Africa’s risk premium is high relative to its peers’
(such as Brazil, Russia, Mexico and Indonesia). In line with
these developments, long-term interest rates have trended
steadily higher over the decade, from an average of 7.1% in
2012 to 9.3% so far in 2019. (They would likely have climbed
even higher had inflation expectations not declined – see
Box 3.)
Government’s debt-service costs have grown rapidly, reaching
3.5% of GDP. (As a matter of interest, budgeted debt payments
are running at R4 860 per second for 2019.) Because a large
portion of government and parastatal debt has been sold to
foreigners, higher payments through the income account of
the balance of payments have also made the current account
deficit more negative. More precisely, interest payments to
foreigners for government and parastatal debt explain 1.6%
of GDP of this deficit, or approximately half the total current
account balance.
To ensure fiscal sustainability, the authorities have been obliged
to raise taxes, both on incomes (mainly via bracket creep as
inflation pushes more of people’s earnings into higher tax
brackets) and on consumption (mainly through a higher VAT
rate, but also through higher taxes on fuel and other specific
goods). Quasi-fiscal tax increases have been more extreme,
most visibly through higher electricity prices (up nearly 300%
since January 2008 – more than triple the change in the overall
consumer price index).

Real-time debt to GDP measured in the mid-1990s indicated a higher level
of debt, around 60% of GDP, but these figures were later revised lower.
Basis points
Five-year CDS spreads*
Source: Bloomberg

* 2019 year to date
Thailand
Indonesia
Brazil
Russia
Chile
China
Colombia
Malaysia
Mexico
South Africa
Turkey
Argentina
Percentage of GDP
General government total gross loan debt
Sources: Stats SA and SARB

Per cent

South Africa’s long-term borrowing costs*
Source: Bloomberg
* 10-year government bond yields; 9-year yields used where
10-year yields were unavailable


Monetary Policy Review April 2019
These measures have squeezed consumption and created
a challenging environment for business. In turn, this makes
it more difficult for the private sector to deliver the growth
that would recreate fiscal space. Indeed, to some extent the
private sector had to cut back to permit overall current account
sustainability. It was not possible for South Africa to borrow
nearly 6% of GDP from the world each year, as it did in 2013,
and because the government did not change its savings
substantially, the private sector had to adjust.
Potential growth and the output gap
From a narrow monetary perspective, the question is how
much growth remains possible given these macroeconomic
constraints. The SARB’s estimate of potential growth is at a
long-term low of 1.3% for 2019, rising slowly to 1.5% in 2021
as supply-side shocks fade.
Despite a low potential rate, South Africa has a negative output
gap of around 1.1% of potential GDP, meaning demand is
still below potential supply. Over the forecast horizon, growth
accelerates enough to close this gap by 2021, some 13 years
after it first opened. (Previously, the gap was projected to close
in 2020, but recent growth disappointments have pushed this to
seven quarters later.) Although different methods of estimating
the output gap tend to give somewhat different answers, with
quite large variations over the post-crisis period, all available
methods indicate that the gap is negative at the moment.
This is consistent with very low growth rates in 2016 and 2018,
and other indicators of slack such as manufacturing capacity
utilisation.
Conclusion
South
African
growth
remains
disappointingly
weak.
The forecasts are not optimistic from a historical perspective,
but still imply an acceleration from current lows. Previously,
although it was not the baseline forecast, it seemed possible
that growth outcomes could improve quite rapidly as
reform measures were implemented. It has since become
clearer, however, that the legacy of state capture, of which
load-shedding is one symptom, will constrain growth for a
longer period.


Percentage of GDP
Fiscal balances

Source: National Treasury

Primary balance

Interest payments

Budget balance
Percentage change


Evolution of potential growth estimates*
* Dotted lines indicate forecasts
Source: SARB


Sep 2018

Jan 2019

Mar 2019
Percentage of potential GDP

Evolution of output gap estimates*
* Dotted lines indicate forecasts
Source: SARB


Sep 2018

Mar 2019
Monetary Policy Review April 2019

Box 5 Inflation experiences of different income groups in South Africa
1 M Oosthuizen, ‘Consumer price inflation across the income distribution in South Africa’, DPRU Working Paper No. 07/129, Development Policy Research Unit,
University of Cape Town, November 2007.
2 A Deaton, ‘Getting prices right: what should be done?’, Journal of Economic Perspectives 12(1): 37–46, 1998.
html?pdf=Getting_Prices_Right.pdf; M Izquierdo, E Ley and J Ruiz-Castillo, ‘The plutocratic gap in the CPI: evidence from Spain’, IMF Staff Papers No. 50(1),
2003.
3 Narrower inflation baskets are more susceptible to shocks, such as droughts, which move relative prices more than overall prices. For this reason, diversified
inflation baskets improve inflation signals.
Different income groups have different inflation experiences. The
consumption baskets of lower-income people are filled mostly with
essentials, such as food and shelter. Those of higher income people
are more diverse.
The headline consumer price index (CPI) inflation figure reported by
Statistics South Africa (Stats SA) is calculated using so-called plutocratic
weights. These reflect the total rand amounts spent on different
goods and services across the entire economy – not the average
expenditure per household. However, in a highly unequal country like
South Africa, a relatively small number of people have a large share
of total consumption. For this reason, headline CPI inflation typically
tracks the inflation experience of a comparatively rich household
– on average, one at the 95th percentile of the income distribution.1
(By comparison, in the United States the representative household lies
around the 75th percentile; in Spain it is at the 61st percentile.2)
Among statistical agencies, it is standard practice to use plutocratic CPI
weights. These are more accurate for country-level inflation because
they match the structure of economy-wide expenditure. They also tend
to be more useful for central banks, which focus on general changes in
price levels across the economy (i.e. inflation) rather than movements
in relative prices.3
Nonetheless, it is useful to understand the biases in the headline inflation
measure, and to quantify gaps with alternative measures. To this end,
South African Reserve Bank staff have calculated a democraticallyweighted inflation index. This measure averages the proportional
expenditure on goods and services across households, drawing on
the Stats SA weights from the December 2016 reweighted basket. As
expected, this measure corresponds with the inflation experiences of
people between the lowest- and middle-income categories (the first to
the fifth deciles), instead of the richest decile.
Comparing the democratic and plutocratic measures shows that
inflation for the former has been typically slightly higher at 5.7% over
the past decade, compared to 5.5% for the latter measure. Over the
120 months in the sample, the democratic measure was higher twothirds of the time. However, over the past two years the pattern has
flipped. (In fact, inflation for the poorest South Africans hit an all-time
low of 1.3% in March 2018.) This was mainly due to the larger weights
for food and electricity in the democratic inflation basket, and the fact
that inflation for these categories has been relatively muted lately. (Food
inflation averaged 3.3% in 2018 and electricity averaged 5.2%, versus
post-crisis averages of 6.2% and 10.4% respectively.) As electricity
price inflation accelerates over the next two years, inflation for poorer
South Africans is likely to rise above headline CPI inflation once again.
Per cent
Plutocratic versus democratic weights (2017)

Democratic

Plutocratic
Sources: Stats SA and SARB

Health
Education
Communication
Restaurants and hotels
Clothing and footwear
Household contents, equipment
and maintenance
Recreation and culture
Alcoholic beverages and tobacco
Transport
Miscellaneous goods and services
Food and non-alcoholic beverages
Housing and utilities
Percentage change over 12 months

Inflation rates and the plutocratic gap
Sources: Stats SA and SARB
-4
-2

Plutocratic gap (percentage points)

Plutocratic CPI inflation

Democratic CPI inflation
3–6% inflation target range

Monetary Policy Review April 2019
Price developments: settling
at the midpoint
Headline inflation has been close to the middle of the target
range recently, averaging 4.6% over the past 12 months.
Inflationary pressures have eased, with oil prices well below
recent highs and the exchange rate closer to its estimated
fair value. Food prices have remained subdued, despite
repeated projections that they would pass a turning point and
accelerate. Wage growth has also moderated. Under these
circumstances, inflation is likely to remain contained close to
the centre of the 3–6% target range for at least the duration of
2019. Over the medium term, the forecast anticipates that this
will become a new normal, as inflation expectations, wages
and services prices adjust to the 4.5% price anchor.
Fuel price disinflation for 2019
Fuel price inflation is expected to be low in 2019, at 1.3%,
following inflation of 14.4% in 2018 and 7.7% in 2017. This
welcome development reflects three factors. First, international
oil prices have moderated again, and the forecast assumes
they will remain stable at current levels. Second, the exchange
rate has recovered, relative to the second half of 2018. Third,
taxes and levies have also increased less than expected.
The stability of the forecast contrasts starkly with the recent
past. Oil price volatility was elevated around the November
2018 forecast, with a US$35 a barrel peak-to-trough
adjustment in just three months. As prices rose in the first three
quarters of 2018, the near-term oil price forecast followed. The
assumptions had oil prices falling again, but the decline was
larger and faster than anticipated. Combined with exchange
rate appreciation, this sharply reduced fuel prices, which is the
single most important reason why near-term inflation undershot
recent projections, and particularly why January 2019 inflation
was as low as 4.0%.
Oil price volatility is a perennial forecasting challenge. Its impact
on final fuel prices is being reduced, however, by a growing
contribution from taxes and margins. This administered
component has been rising steadily as a share of the pump
price, and now stands at 56% of the total – up from 38% a
decade ago. The 2019 Budget increase of 20 cents per litre
was actually lower than the SARB forecast of 38 cents per
litre. The general fuel levy will increase by 15 cents per litre and
the Road Accident Fund levy will increase by 5 cents per litre.
There is, however, also an addition of a carbon tax this year
(9 cents per litre on petrol and 10 cents per litre on diesel),
which will come into effect in June 2019.
Food and non-alcoholic beverages
inflation: waiting for the turning point
Domestic food and non-alcoholic beverages (NAB) inflation has
decelerated, from an average of 6.9% in 2017 to 3.6% in 2018
– an eight-year annual low. The 2018 forecasts consistently

3–6% inflation target range
Percentage change over four quarters
Headline inflation forecast*

* The bands around the central projection show confidence intervals
of 10%, 30%, 50% and 70%.
US$ per barrel

Evolution of crude oil price forecasts*
* Dotted lines indicate forecasts
Source: SARB

Actual

Mar 2018

Nov 2018

Jan 2019

Mar 2019
Standard deviation in US$ oil price

Oil price volatility between MPC meetings
Mar
May
Jul
Sep
Nov
Jan
Mar
Sources: Reuters and SARB

Monetary Policy Review April 2019

anticipated a turning point in food prices, which failed to
materialise. The turning point has now been deferred to early
2019. At 2.9% as of February 2019, food inflation is well below
its longer-term average (of 6.1% since 2010). It is expected to
average 4.0% in 2019, rising to 5.7% in 2020 and then slipping
back to 4.6% in 2021, which is still quite low relative to historical
norms. This outlook reflects three key factors: domestic grains
prices have stopped falling, but inflationary pressure from this
category is likely to be contained over the forecast period;
meat prices are expected to remain muted; and world food
price forecasts indicate stable prices in 2019, with a slight pickup in 2020 and 2021.
The bread and cereals category exited deflation in November
2018. Grains prices are rising, especially for maize, with initial
crop estimates at 10.5 million tons for this season compared
to 12.5 million tons in 2017/18. The western parts of South
Africa’s maize belt have suffered from rainfall shortages and
are likely to record poor harvests.
Although new production will be lower, existing stocks should
suffice to meet local demand, which will make it unnecessary
to import maize and therefore prevent domestic prices from
jumping to import parity.
Meat price inflation was lower than expected throughout
2018. It has decelerated further in the first two months of
2019, reaching -0.5% in February – a 105-month low. Meat
prices may decelerate further, given the recent outbreak of
foot and mouth disease, which has prompted export bans and
therefore raised the supply of meat available to the local market.
Meat constitutes just under a third of the food basket, so
subdued inflation in this category has large effects on overall
food price inflation.
Consumer food price inflation (March 2019 forecasts)
Percentage change over four quarters, September 2018 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–18*
2018*
2019*
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4
Food and non-alcoholic beverages


* Annual average percentage change
Sources: Stats SA and SARB
-2

Percentage change over 12 months

Meat price forecasts*
Sources: Stats SA and SARB

Nov 2018

Jan 2019

Mar 2019

Actual
* Dotted lines indicate forecasts
Percentage change over four quarters

Evolution of food and NAB inflation forecasts*
* Dotted lines indicate forecasts
Sources: Stats SA and SARB

Actual

Sep 2018

Nov 2018

Jan 2019

Mar 2019

Monetary Policy Review April 2019
World food price forecasts have been lowered repeatedly since
March 2018, in line with lower outcomes. The upside forecast
errors were mainly due to a breakdown in the traditional
correlation between food and energy prices. Oil prices moved
higher during 2018, but food prices did not follow, which was
apparently due to large grain stocks holding prices down,
among other factors. World food inflation, as measured by the
United Nations (UN) Food and Agriculture Organization (FAO)
Food Price Index, is now expected to average -0.1% in 2019,
3.5% in 2020 and 1.0% in 2021.
Electricity inflation
The latest tariff ruling by the National Energy Regulator of South
Africa (NERSA), announced on 7 March 2019, granted Eskom
increases of 9.4%, 8.1% and 5.2% for July 2019, July 2020 and
July 2021 respectively. Coupled with the regulatory clearing
account clawbacks and municipal adjustments, electricity
prices for consumers are now expected to rise by 13% for the
12 months from July 2019, 9% for the 12 months after that,
and 6% from July 2021. (For the calendar years, the figures
are 10.2% for 2019, 10.9% for 2020 and 7.4% for 2021; the
forecast does not extend beyond 2021.) These assumptions
are higher than those used for earlier forecasts: the September
2018 forecast used 8% across the forecast horizon, while the
January 2019 forecast reflected electricity inflation at 12% for
12 months, followed by 6% for the remainder of the forecast
period. Based on the latest forecasts, electricity prices
will contribute 0.4 percentage points to headline inflation
in both 2019 and 2020, and 0.3 percentage points in 2021.
Had electricity inflation been at 4.5% inflation instead, in line
with the model target, then its contribution would have been
only 0.2 percentage points throughout the forecast period
(given its weight of 3.75% in the CPI basket).
Core inflation
Core inflation has been close to the middle of the target range
over the past two years, averaging 4.7% in 2017 and 4.3%
in 2018. It is expected to accelerate somewhat during 2019,
averaging 4.8% for the year, as the goods portion of core
inflation returns to more normal levels and services tick slightly
higher. Core inflation is then expected to slow for the rest of
the forecast period, finishing 2021 in the middle of the target
range again.
Core goods inflation has been under 3% since the second half
of 2017. Inflation developments in the core goods category
tend to follow the exchange rate, which helps explain why price
increases have remained subdued. Although the rand has
been volatile over the past three years, its underlying trend line
has been tilted in the direction of currency appreciation. (The
average rand to dollar exchange rates for the past three years
are R14.70, R13.30 and R13.20 respectively. The average for
2019 is projected at R14.10 to the US dollar.) This is a marked
departure from the sustained depreciation trend of the 2011–
2016 period, during which core goods inflation accelerated
from around 1% to more than 6%.
Percentage change over four quarters

Evolution of electricity price forecasts*
* Dotted lines indicates forecasts
Sources: Eskom and SARB

Sep 2018

Jan 2019

Mar 2019

Actual

Percentage change over four quarters

Core inflation and its components
Sources: Stats SA and SARB

3–6% inflation target range
Midpoint
Forecast

Core inflation

Core goods

Services

Implied rand/US$ exchange rate

Exchange rate projections*
* Dotted lines indicate forecasts
Source: SARB


Sep 2018

Nov 2018

Jan 2019

Mar 2019

Actual
Monetary Policy Review April 2019

From an exchange rate gap perspective, which reflects the real
exchange rate relative to an estimated equilibrium, the rand is
1.3% below fair value for the first quarter of 2019. This implies
reduced inflationary pressure relative to previous forecasts; six
months ago, the first quarter gap was expected to be -6.2%.6
The rand’s subsequent appreciation trend will probably
have headed off pass-through from the 2018 depreciation
by convincing price and wage setters to write off recent rand
weakness as volatility rather than a new trend.
The core goods category has also been helped by low import
price inflation. Since 2017, import prices as measured by
unit value indices (UVIs) have declined by an average of 5%
annually.7 This is not a measure of foreign prices expressed
in rand terms using an exchange rate. Instead, it reflects the
prices of actual imports as invoiced in domestic currency. Low
import price inflation could be due to various factors, including
exchange rate hedging by importers as well as favourable
pricing by foreign exporters. The role of low import price
inflation in mitigating exchange rate pressure is an unjustly
neglected subject, rivalling the importance of the much betterstudied topic of exchange rate pass-through.
The big exception to the persistently low inflation rule for core
goods is the alcoholic beverages and tobacco category, which
accounts for a quarter of this basket. Although inflation for this
component slowed to a 45-year low of 2.8% in early 2017, it has
accelerated to around 6% since, making it the single largest
contributor to core goods inflation. The most obvious driver
of higher inflation in this category is sin taxes – the average
increase for alcohol and tobacco products in the 2019 Budget
was 7.5%.8 It is possible, however, that actual consumer prices
for these goods are not matching Stats SA’s measurements,
given how ubiquitous illicit and grey-market substitutes are
becoming as sin tax rates rise. (One study, for example,
estimated that 42% of the cigarette market is supplied with
untaxed products.)9
Core goods only accounts for a third of the core inflation basket;
the remaining two-thirds are services. Inflation for services has
been basically stable over the past nine months, close to 5%,
which compares favourably with the post-crisis average rate
of 5.9%. Services prices are strongly correlated with inflation
expectations, which contextualises their decline: both series
are adjusting, gradually, to lower headline inflation rates.

This gap has been narrowed mainly by nominal exchange rate movements,
but also by inflation and a re-estimation of the equilibrium exchange rate.

The UVI includes items not in core goods, but sub-indices that closely
match the core goods CPI component have a similar deflation rate: -5.7%
since 2017.

This is a weighted average; the simple average is 7.6%.

IPSOS is a market research house that was commissioned by the Tobacco
Institute of Southern Africa (TISA) to conduct this study. The study defines
‘illicit’ as a product trading at a retail price below the minimum tax due to
the South African Revenue Service for the product which was R17.85 for a
pack of 20 cigarettes at the time.
Percentage change over 12 months

Core goods inflation and its related UVI
Sources: Stats SA and SARB
-15
-10
-5

All items UVI

Core goods UVI

Core goods CPI
Percentage points
-2

Contributions to core goods inflation

Alcoholic beverages and tobacco

Household contents

Other core goods

Clothing

Vehicles

Sources: Stats SA and SARB
2015 2016 2017 2018 2019

2010 2011 2012 2013
Forecast

Core goods (percentage change over 12 months)
Percentage change over four quarters

Services inflation and inflation expectations*
* Average of labour, business and analyst expectations
Sources: BER, Stats SA and SARB

Five-year-ahead inflation expectations

Two-year-ahead inflation expectations

Services inflation

Inflation target range midpoint
Forecast

Monetary Policy Review April 2019
The fact that both services prices and inflation expectations
remain in the upper half of the target range, however, also
shows why inflation cannot yet be said to have stabilised at the
target midpoint, in line with the SARB’s preference.
Within the services category, there is naturally some variation.
Public transport inflation (with a weight of 4.5% in services) has
risen abruptly, from 0.9% in January 2018 to 8.9% in February
2019. This is likely due to lagged fuel costs, which implies
prices will ease again now that fuel prices have moderated.
Administered services prices (15.2% of the services basket)
have also been high lately at 7.7%, which is mainly due to rates
and taxes rising in Johannesburg after a property revaluation
exercise. Insurance premiums (19.6% of services) remain a
significant source of inflationary pressure, consistent with
a global trend towards rising insurance costs, especially for
medical aids. Insurance services inflation is expected to
average 6.5% in 2019. (Without its insurance component,
overall services inflation would have dipped below the midpoint
on some occasions in 2018.)
The main offsetting factor to these higher inflation services
categories is housing, which is also the single largest
component of services CPI (with a weight of 32.8%, combining
both rentals and owners’ equivalent rent). Inflation in this broad
category is at 4.1% currently and is expected to average 4.2%
in 2019, compared with a five-year average of 4.8%. The
Western Cape and Gauteng in particular now appear to have
an oversupply of stock, given that building completion rates
have trended higher even as economic growth has slowed.
This dynamic is likely to keep housing inflation at relatively low
levels over the forecast period.
Finally, services inflation has also benefitted from more
moderate tertiary education fee increases, which have
decelerated from levels of around 9% to 5.2% for 2017 and
5.4% for 2018. The ‘fees must fall’ campaign appears to have
been the main driver of this development, which has not been
replicated for primary and secondary school fees. (The weight
of education in services is 4.9%.)

Services

Services excluding insurance

Percentage change over 12 months

Services inflation
Sources: Stats SA and SARB
Inflation target range midpoint
Thousand square metres per annum
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Sources: Stats SA and SARB


Buildings completed

Gauteng

Western Cape

Other

KwaZulu-Natal
Percentage change over 12 months

Education inflation
Sources: Stats SA and SARB

Primary and secondary

Tertiary

Total education

2010–2018 average
Monetary Policy Review April 2019

Box 6 Inflation and the business cycle

T Mahedy and A Shapiro, ‘What’s down with inflation?’, Federal Reserve
Bank of San Francisco Economic Letter No. 2017(35), San Francisco:
Federal Reserve Bank of San Francisco, November 2017. https://
www.frbsf.org/economic-research/indicators-data/cyclical-and-acyclicalcore-pce-inflation/.

This extended period covers eight business cycles. Although data
limitations preclude finer delineation into modern subcategories (such
as owners’ equivalent rent and rentals), including the older data permits
more robust results. Restricting the study to the inflation-targeting or postcrisis periods, by contrast, would provide only one significant episode of
economic overheating.
Some components of inflation are sensitive to the business cycle, rising
and falling in line with growth. Others are less responsive to economic
conditions; that is, they are acyclical. The distinction is helpful in
forecasting inflation. Demand-pull inflation should follow the growth
outlook, which need not be true for inflation stemming from other
sources. For policymakers the distinction is also useful – not all kinds of
inflation require the same policy response.
Demand-side inflation is usually described by means of crude
approximations, such as core consumer price index (CPI) inflation.
However, it is possible to be more precise about which consumer
prices are responsive to economic cycles. This box presents an
attempt to do so with South African data, drawing on a methodology
developed for the United States.1 Core CPI inflation is disaggregated
into subcomponents, of which 21 can be identified for the period since
1970.2 Each component is then tested for its correlation with the
output gap, after controlling for inflation persistence and expectations.
This generates cyclical and acyclical inflation baskets.
The results indicate that both the cyclical and acyclical components of
core inflation have moderated recently: since the final quarter of 2016,
cyclical inflation has slowed from 5.3% to 4.4%, and acyclical inflation
from 6.3% to 4.5%. The most important cyclical item is housing inflation,
which has indeed eased substantially in recent years (as discussed in
previous editions of the Monetary Policy Review). The acyclical basket
is more varied: its three biggest components are health, recreational
activities, and vehicles.
Although both the cyclical and acyclical inflation rates have slowed, the
total contribution from the demand-sensitive component is relatively
small. This is because it has a fairly low weight in core inflation (37%,
versus 63% for the other categories). Specifically, moderating cyclical
inflation explains around 0.3 percentage points of the decline in core
inflation over the past two years. By contrast, acyclical factors account
for 1.2 percentage points. (The total decline is 1.4 percentage points,
from 5.7% to 4.3%; the unexplained portion is due to roundingoff errors.) These results corroborate the Quarterly Projection Model
interpretation of price developments, which is that the lower inflation
experienced recently is partly, but not mainly, due to weak demand.
Unexpectedly, when this test is applied to headline inflation, both fuel
and grains show up as important cyclical factors – even though these
two items are usually treated as paradigmatically acyclical, given their
responsiveness to exogenous factors (such as fracking technologies or
drought). The solution to this puzzle may be that these items follow a
global cycle, which shapes the South African economic cycle (a case
of omitted variable bias). The role of the global output gap in shaping
South African inflation is a promising area for future research.
Percentage points

Contributions to core CPI inflation


Cyclical components

Acyclical components
Sources: Stats SA and SARB
2014 2015


Percentage change over 12 months

Cyclical and acyclical inflation rates

Cyclical components

Acyclical components
Sources: Stats SA and SARB
2014 2015

Monetary Policy Review April 2019
The inflation outlook
Headline inflation is projected to accelerate from 4.9% in the
fourth quarter of 2019 to 5.7% in the first quarter of 2020,
before fading back to 4.5% by the end of 2021. This bump in
inflation reflects three factors. The most prominent is a swing
in fuel price inflation from -3.1% in the fourth quarter of 2019 to
10.9% in the first quarter of 2020 (mostly due to a base effect).
Second, core goods inflation is also projected to trend higher,
from 2.5% in the fourth quarter of 2018 to 4.9% in the first
quarter of 2020.
Finally, food and NAB price inflation is projected to rise from
3.2% in the first quarter of 2019 to a peak of 5.6% in the second
quarter of 2020.
Less mechanical, and more interesting from a monetary
policy perspective, is the subsequent decline in inflation back
towards the model target. This target reversion is a deliberate
feature of models such as the QPM, which incorporate policy
rules that adjust to achieve inflation targets over the medium
term (two to three years). The interesting part is how this feeds
into actual inflation. The forecast relies on two related drivers,
namely inflation expectations and unit labour costs (ULCs).
To project inflation expectations, the forecast uses a blended
rate of model-consistent expectations plus the BER’s
Headline inflation (March 2019 forecasts)
Percentage change over four quarters; September 2018 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–18*
2018*
2019*
2018Q3
2018Q4
2019Q1
2019Q2
2019Q3
2019Q4

Annual average percentage change
**
CPI excluding food, non-alcoholic beverages, fuel and electricity
***
Combines actual rentals and owners’ equivalent rent
Sources: Stats SA and SARB
Per cent

Surveyed inflation expectations*
* Average of labour, business and analyst expectations
Sources: BER and SARB

Current year

One year ahead

Two years ahead

Five years ahead
3–6% inflation target range
Midpoint
Monetary Policy Review April 2019

two-year-ahead survey result. Model-consistent expectations
are simply the model’s own near-term inflation projections
(specifically, for one quarter ahead). The BER measure starts
with the latest actual survey reading, with future expectations
then moderating over the forecast period, roughly consistent
with the trend of the past three years. In this sense, the QPM
inflation expectations are a mix of backward- and forwardlooking expectations – backward from the survey, and forward
from the forecasts.
This blended expectations rate moves gradually lower over
the forecast period, ultimately settling at 4.5%. It takes time to
get there for two reasons. First, the starting point is elevated:
surveyed expectations are just above 5%, while breakeven inflation rates – a market-based measure of inflation
expectations – are at 5.8% for the 10-year measure and 5.0%
for five years. Second, the model treats inflation expectations
as sticky, forgoing stronger assumptions such as rational
expectations and fully attentive agents. (Those assumptions
would deliver expectations of 4.5% immediately.) Instead,
expectations are projected to adjust gradually as the public
becomes convinced that inflation will be around 4.5% in future,
rather than close to 6%.
ULCs reflect wage pressures on inflation. The intuition behind
ULCs is that only wage increases in excess of productivity
gains are inflationary: ULC growth can therefore be reduced
through wage moderation or higher productivity, or some
mix of the two. Over the post-crisis period, nominal ULC
growth was generally around 7%. This was due to relatively
high wage growth (an average of 8% from 2013 to 2017)
and declining labour productivity, consistent with weak and
slowing GDP growth. However, the forecast indicates a mild
growth recovery, which will improve productivity. There is
also mounting evidence that wage growth has decelerated,
even if some of the data are volatile. According to the national
accounts calculated by Stats SA, average wage growth was
4.1% in 2018, with private sector wage growth at just 3.1%. (By
contrast, public sector wages were up 6.4%.) The combination
of reduced salary growth and better productivity is expected
to close the real ULC gap by the beginning of 2021, which will
permit inflation to stabilise at 4.5%.
Conclusion
Inflation in South Africa has declined to around 4.5%. The
QPM indicates a path to stabilise it there over the medium
term, below the post-crisis average rate of nearly 6%. The
main risks to this outlook are, first, that new inflation shocks will
intervene and prevent inflation expectations from moderating
further, and second, that ULCs will fail to moderate over the
next two years. In principle, both these factors could be offset
by monetary policy adjustments. If the growth/inflation tradeoff deteriorates, however, policymakers might prefer to avoid a
tight policy stance, in which case inflation will not stabilise at
4.5% by 2021.
Per cent

Inflation and market-based inflation expectations
Source: Bloomberg and Stats SA

Headline inflation

5-year break-even rate

10-year break-even rate
Percentage points

Sources: Stats SA and SARB
Real unit labour cost gap


Forecast
Percentage change over four quarters

Sources: Stats SA and SARB
Average compensation of employees

Forecast

Monetary Policy Review April 2019
Box 7 Paying attention to household inflation
expectations

Household expectations were not included in the BER report for the first
quarter, owing to delays with the survey, but these data have since been
collected and will be published around mid-April.

S Kumar et al., (2015, Fall) ‘Inflation targeting does not anchor inflation
expectations: evidence from firms in New Zealand’ Brookings Papers on
Economic Activity, Fall 2015.
uploads/2016/07/PDFKumarTextFallBPEA.pdf.

O Coibion and Y Gorodnichenko. ‘Information rigidity and the expectations
formation process: a simple framework and new facts.’ IMF Working Paper
No. 12/296, 20 December 2012.
wp/2012/wp12296.pdf.
Economists, including those at the South African Reserve Bank
(SARB), tend to overlook household inflation expectations. Instead,
discussions of inflation expectations tend to focus on the views of trade
unions, financial analysts and business people, typically combined in
the aggregate measure reported by the Bureau for Economic Research
(BER). Household expectations are nonetheless available, having been
included in the quarterly BER survey since its inception.
There are reasons to pay attention to household expectations. One is
that this component covers far more respondents, relative to the other
categories. In the previous survey, for instance, the BER polled 2 654
households, compared with 9 unionists, 18 analysts and 150 business
people.1 Furthermore, there is a credible argument that price- and
wage-setters draw on their personal inflation experiences in making
decisions, which suggests that there is value in looking beyond ‘expert’
inflation opinions.2
One reason for neglected housing expectations is that these have been
implausibly high, at an average of 1 percentage point above average
expectations (and sometimes as much as 3 percentage points higher).
This ‘wedge,’ which is quite common in global surveys of household
inflation views, is usually attributed to behavioural biases, such as a
tendency to notice large price increases but overlook smaller ones.3
However, this is no longer a reason to discount household explanations
in South Africa, because these expectations have recently aligned with
average expectations. Whatever the explanation for the ‘wedge’, it is
not a problem currently.
The recent decline in household expectations probably reflects an
extended (roughly two-year) period of relatively subdued inflation. Both
the average and household series respond to actual inflation; the main
difference is that households respond more slowly. (The correlations
for this series are stronger with a four-quarter lag, whereas the fit
for average expectations is strongest without a lag.) By this theory,
household expectations converged on average expectations because
they had time to catch up, as inflation first declined (in the first half of
2017) and then stayed lower (to date).
The correlation analysis also yields several other interesting points:
--
Despite the historical wedge between household and average
inflation expectations, the two have tended to move together. This
suggests that changes in the two series are similar, even if the
levels are sometimes different, implying they respond to common
factors.
--
Perhaps unexpectedly, household expectations do not track
administered price inflation, suggesting ‘official’ prices do not have
disproportionate effects on household views of inflation, relative to
other kinds of prices. (The same is true for average expectations.)


Per cent

Inflation expectations, current year
* Average of labour, business and analyst expectations
Sources: BER and SARB
3–6% inflation target range

Households

Total*
Monetary Policy Review April 2019

--
There is no evidence that household expectations are more closely
connected to the inflation experiences of poorer households –
despite the plutocratic weights used for the Consumer Price Index
(CPI), which align CPI most closely with the inflation rates for upperincome earners (see Box 5). Statistics South Africa provides
inflation rates by income decile, but these inflation rates do not
correlate with household expectations more closely than either
normal headline or core inflation. The same is true of the
‘democratic’ CPI discussed in Box 5. This may be because the
BER provides survey respondents with previous headline inflation
rates, which probably shapes their responses.
One drawback of the household expectations series is that it only
provides expectations for the current year. Monetary policy typically
focusses on expectations over longer time frames, to exclude the
effects of temporary shocks. These tenors (one year, two years and five
years) are unfortunately only available for the other three categories of
respondents. It may be possible to adjust the survey to include these
questions in future. Should this data become available, it may also
be useful to combine all four categories of respondents in the ‘total’
measure.
Results of correlation analysis
Correlations
(lagged by 4 quarters)
Average
expectations
Headline
inflation
Core
inflation
Food
inflation
Administered
price inflation
Decile 1
inflation
Decile 3
inflation
Decile 5
inflation

Source: SARB
Percentage points

2016 2018
Household and total inflation expectations,
current year
-2
-1

Gap between household
and total* expectations
* Average of labour, business and analyst expectations
Sources: BER and SARB

Monetary Policy Review April 2019
Conclusion
South Africa’s real interest rates are comparable to its peers’,
but nominal interest rates are quite high. The difference is
relatively elevated inflation expectations, which prompt lenders
to demand generous inflation compensation. The paradox of
the situation is that high rates fuel demands for rate cuts. In
turn, a bias towards monetary easing sustains high inflation
expectations and therefore high interest rates.
The only way to break this vicious circle is to reduce inflation
expectations. With lower inflation, and reduced uncertainty
about the precise inflation target, lower inflation expectations
permit lower interest rates. If the inflation target in the QPM
were higher, at 6% instead of 4.5%, the steady-state repo rate
would be 8.5% instead of 7%. By contrast, if the target were
3% (as in Mexico or Chile), the steady-state rate would be at
5.5%. As Irving Fisher long ago demonstrated, higher inflation
produces higher interest rates, and the problem cannot be
solved by simply tolerating more inflation.
To escape this trap, the MPC has adopted a strategic goal
of anchoring expectations at the 4.5% midpoint of the 3–6%
inflation target range, over time. In the context of weak growth,
however, it has been reluctant to adopt a tight monetary
policy stance. Fortunately, inflation has moderated over the
past two years or so, with assistance from positive shocks.
It now appears that inflation will remain contained across the
forecast period, most likely close to the 4.5% midpoint of the
target range, but still below the 6% upper bound in adverse
scenarios. The output gap will also narrow over time, closing
in 2021.
The MPC has one tool, the repo rate, and therefore should not
be expected to achieve too many goals. In line with standard
Taylor rule prescriptions, policy is being set to achieve the
inflation target over the medium term, while making allowances
for a negative output gap. The forecast indicates inflation will
stay within the 3–6% target over the policy horizon, ending
at the 4.5% midpoint, which is somewhat below historical
averages. Growth is expected to be subdued over this period,
but this is largely a structural problem. Electricity shortages are
disrupting economic activity. Several key markets are overdue
for reforms. Fiscal policy continues to record large deficits.
Given these challenges, it will take time and a broad range of
interventions to get South Africa onto a higher growth path.
The scale of the challenge has also become clearer over the
past year, as growth has failed to rebound despite a burst of
optimism in early 2018. The best prospect for South Africa is
that reforms now will yield growth results later, and a structurally
lower inflation rate will be a useful contributor to that growth.
Emerging market policy rates

Turkey
Ghana
Nigeria
Zambia
Kenya
Mexico
Russia
South Africa
Brazil
Indonesia
Median
India
Botswana
China
Colombia
Malaysia
Chile
Peru
Thailand
Poland
Higher than median
Per cent
Emerging market real policy rates*
Per cent
-2

Turkey
Ghana
Mexico
Kenya
Russia
Brazil
Indonesia
China
Botswana
South Africa
Median
Nigeria
India
Colombia
Malaysia
Zambia
Thailand
Peru
Chile
Poland
Same as median
Sources: Bloomberg, Consensus Economics, Haver and SARB
* Nominal policy rates less
2020 CPI inflation forecast
Monetary Policy Review April 2019

Statement of the Monetary Policy Committee
22 November 2018
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy
Committee (MPC), the near-term inflation outlook has
improved; however, the longer-term risks to the inflation
outlook remain elevated. The weaker exchange rate and the
impact of higher oil prices have contributed to increasing
inflation since March 2018. At the same time, domestic
growth remains weak.
The year-on-year inflation rate, as measured by the
consumer price index (CPI) for all urban areas, was 5.1% in
October (up from 4.9% in September). Goods price inflation
was 5.1% in October (up from 4.8% in September), while
services price inflation decreased slightly, from 5.2% in
September to 5.1% in October. The South African Reserve
Bank’s (SARB) measure of core inflation – which excludes
food, fuel and electricity – was 4.2% in October. Producer
price inflation for final manufactured goods slowed to 6.2%
in September, from 6.3% in August.
The inflation forecast has improved marginally since the
previous meeting of the MPC. While remaining within the
inflation target range throughout the forecast period, the
SARB’s model projects an increase in headline inflation,
albeit slightly lower than the September projection. Headline
inflation is now expected to average 4.7% in 2018 (down from
4.8%), before increasing to 5.5% in 2019 (down from 5.7%)
and moderating to an unchanged 5.4% in 2020. Headline
CPI inflation is now expected to peak at around 5.6% in the
third quarter of 2019. The forecast for core inflation is 4.3% in
2018 (down from 4.4%), 5.3% in 2019 (down from 5.6%) and
5.5% in 2020 (unchanged since October). These inflation
projections are based on an interest rate path generated by
the SARB’s Quarterly Projection Model (QPM).
Following persistent increases in oil prices since February
2018, the assumptions for Brent crude oil in the QPM were
revised upwards by US$3 per barrel to US$73 for 2019 and
2020. Administered prices, including fuel, electricity and
water tariffs, are expected to increase at rates above the
upper end of the inflation target range.
The inflation expectations of market analysts in the
November Reuters Econometer survey are lower at 4.7% in
2018 (down from 4.8%), rising to 5.5% in 2019 (up from 5.3%)
and unchanged at 5.3% in 2020. Expectations implicit in the
break-even inflation rates (i.e. the yield differential between
conventional and inflation-linked government bonds) remain
sensitive to exchange rate movements. While five-year
break-even rates remain within the inflation target range, the
longer-term break-even rates remain above 6%.
The global economic outlook is expected to remain broadly
favourable over the short term. However, medium-term risks
are tilted to the downside due to less synchronised global
growth. This is amplified by elevated policy uncertainty
emanating from escalating trade tensions, tightening global
financial conditions and rising geopolitical risks. The global
inflation trajectory remains on a moderate upward path as
key advanced economies continue to grow above their
potential.
Since the September 2018 MPC meeting, the rand has
appreciated by 3.8% against the US dollar, by 6.6% against
the euro, and by 5.2% on a trade-weighted basis. The
implied starting point for the rand is R14.50 against the US
dollar compared with R14.20 at the time of the previous
meeting. At these levels, the QPM assesses the rand to still
be undervalued.
Tighter global financial conditions, financial market volatility
and the change in investor sentiment towards emerging
markets remain key external risks to the rand. Over the
medium term, it is likely that the rand, along with other
emerging market currencies, will remain volatile. However,
the pace of monetary policy normalisation in the advanced
economies continues to be gradual. Policy tightening by
the United States Federal Reserve (US Fed) is expected to
follow a measured path in the absence of significant inflation
or growth surprises, while the European Central Bank (ECB)
is expected to start a rate hiking cycle in late 2019. This
means that monetary policies in some advanced economies
will likely be tightening throughout the forecast period.
The domestic growth outlook remains challenging. Recent
monthly data on economic performance in key sectors
suggests a more moderate recovery in growth in the third
quarter than expected in September. The SARB now
forecasts growth in 2018 to average 0.6% (down from 0.7%
in September). The forecast for 2019 and 2020 is unchanged
at 1.9% and 2.0% respectively. At these growth rates, the
negative output gap is wider than at the time of the previous
MPC meeting. The output gap will narrow but will not close
by the end of 2020, as previously expected.
The SARB’s composite leading business cycle indicator has
been trending lower since February, reflecting the extent
of weakness in the economy. The year-on-year decrease
in September was the largest since July 2016, and mainly
reflected a significant decline in the number of building
plans approved and a reduction in job advertisement space.
The Rand Merchant Bank/Bureau for Economic Research

Monetary Policy Review April 2019
(RMB/BER) Business Confidence Index remains significantly
below the neutral level of 50 index points, broadly aligned
with weakness in gross fixed capital formation. Efforts by
the government to encourage private sector investment
could support longer-term growth.
While the First National Bank/Bureau for Economic Research
(FNB/BER) Consumer Confidence Index remains high,
household consumption expenditure has been constrained
by recent tax changes, weak employment growth and low
growth in credit extension to households. Over the forecast
period, consumption expenditure growth is expected to
remain below 2% in 2018 and 2019, and to reach 2.3% in
2020 on the back of increases in real wages and household
disposable income.
The MPC assesses the risks to the growth forecast to be
moderately on the downside. As previously highlighted, the
MPC remains of the view that the current challenges facing
the economy are primarily structural in nature and cannot be
solved by monetary policy alone. Prudent macroeconomic
policies are essential to ensure that growth is sustainable
and that the economy is more resilient to shocks. These
should be complemented by the implementation of credible
structural policy initiatives that make a marked impact on
the cost structure of the economy, potential output and
employment.
The MPC noted the rising inflation trajectory which, while
remaining within the target range, continues to deviate from
the midpoint of the target range.
The MPC continues to assess the risks to the longer-term
inflation outlook to be on the upside. These risks include
tighter global financial conditions, a weaker exchange rate,
higher wage growth, higher international oil prices, and rising
electricity and water tariffs. However, demand pressures
are still not assessed to pose a significant risk to the
inflation outlook.
The approach of the MPC is to look through the first-round
effects and focus on the possible second-round effects
of supply-side shocks. However, shocks of a persistent
nature such as extended periods of currency depreciation,
elevated oil prices and multi-year electricity price increases
make it difficult to disentangle these first- and second-round
effects.
The MPC had to decide whether to act now or later. Given
the relative stability in the underlying core inflation measure,
delaying the adjustment could give the MPC room to
reassess these unfolding developments in subsequent
meetings. However, delaying the adjustment could cause
inflation expectations to become entrenched at higher
levels and thus contribute to second-round effects, which
would require an even stronger monetary policy response in
the future.
Against this backdrop, the MPC has decided to increase
the repurchase rate by 25 basis points to 6.75% per year,
effective from 23 November 2018. Three members preferred
an increase and three members preferred an unchanged
stance.
The MPC continues to assess the stance of monetary
policy to be accommodative. Monetary policy actions will
continue to focus on anchoring inflation expectations near
the midpoint of the inflation target range in the interest of
balanced and sustainable growth. As previously indicated,
any future policy adjustments will be data dependent.
The implied path of policy rates generated by the QPM is
for four rate hikes of 25 basis points, with the repurchase
rate reaching 7.5% by the end of 2020. The forecasted
endogenous interest rate path is built into the MPC’s
growth and inflation outlook. As emphasised previously, the
implied path remains a broad policy guide which can, and
does, change in either direction between MPC meetings in
response to new developments and changing risks.

Per cent

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

90%

60%

30%

Repo rate


Monetary Policy Review April 2019

Summary of assumptions: Monetary Policy Committee
meeting on 22 November 2018*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 52 and 53.

Monetary Policy Review April 2019
Selected forecast results (annual)
Actual
Forecast


Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of South Africa’s three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa and the tradeweighted CPI of the euro area, the US and Japan).
3.
The real exchange rate gap signifies the extent to which the real exchange rate deviates from its estimated equilibrium level. A positive gap shows an
overvaluation of the currency, and vice versa.
4.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
5.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
6.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Summary of selected forecast results: Monetary Policy Committee meeting
on 22 November 2018
Selected forecast results (quarterly)
Year-on-year percentage change


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


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

Notes
1. Shaded areas indicate the forecasts of the Monetary Policy Committee.
2. The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2019

Statement of the Monetary Policy Committee
17 January 2019
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since November 2018, international developments have
been the major contributor to an improved inflation outlook.
Significant declines in international oil prices and a less
depreciated exchange rate have been key drivers of this
improved outlook. Domestic petrol prices decreased by
a cumulative R3.07 per litre (for 95 unleaded in Gauteng)
in December 2018 and January 2019. Lower food price
inflation also contributed to lower consumer price inflation.
The economy’s recovery from the technical recession in
the first half of 2018 is welcomed, but it remains modest,
with growth constrained by subdued demand as a result of
weaker levels of consumer and business confidence.
The year-on-year inflation rate as measured by the consumer
price index (CPI) for all urban areas was 5.2% in November
(up from 5.1% in October). Goods price inflation was 5.3%
in November (up from 5.1% in October), while services price
inflation remained unchanged at 5.1%. The South African
Reserve Bank’s (SARB) measure of core inflation – which
excludes food, fuel and electricity – was 4.4% in November
compared to 4.2% in October. Producer price inflation for
final manufactured goods slowed marginally to 6.8% in
November, from 6.9% in October.
The near-term inflation forecast generated by the SARB’s
Quarterly Projection Model (QPM) has improved significantly
since the previous meeting of the Monetary Policy Committee
(MPC). Headline inflation is now expected to average 4.6%
in 2018 (down from 4.7%) and 4.8% in 2019 (down from
5.5%), before increasing to 5.3% in 2020 (down from 5.4%)
and moderating to 4.8% in 2021. Headline CPI inflation is
now expected to peak at around 5.6% in the first quarter of
2020. Core inflation is expected remain unchanged at 4.3%
in 2018 and is forecast to average 5.0% in 2019 (down from
5.3%), 5.1% in 2020 (down from 5.5%) and 4.8% in 2021.
These inflation projections are based on an interest rate
path generated by the QPM.
Following a significant decline in oil prices since November
2018, the assumptions for Brent crude oil in the QPM were
revised down by around US$10 per barrel from US$73 to
US$62 for 2019, and US$65 for 2020 and 2021. Food price
inflation is expected to have bottomed out in the fourth
quarter of 2018, and to rise to 4.6% in 2021.
Average inflation expectations for both 2019 and 2020,
as reflected in the survey conducted by the Bureau for
Economic Research (BER) in the fourth quarter of 2018,
declined from 5.6% to 5.4%. Average five-year expectations
also came down from 5.5% in the previous survey to 5.3%.
The inflation expectations of market analysts in the January
2019 Reuters Econometer survey are also lower at 5.2% for
2019 (down from 5.5%), but unchanged at 5.3% for 2020.
Expectations implicit in the break-even inflation rates (i.e.
the yield differential between conventional and inflationlinked government bonds) remain sensitive to exchange rate
movements. While five-year break-even rates remain within
the inflation target range, the longer-term break-even rates
remain above 6%.
Global growth is expected to remain broadly favourable over
the near term, but to moderate over the medium term while
risks are tilted to the downside. The negative effects of tariff
increases are becoming more visible in economic data and
uncertainty arising from trade tensions remains. Other risks
include geopolitical developments and excessive financial
market volatility.
Recent communication from major central banks suggests
a slower pace of monetary policy normalisation in advanced
economies. In December, the United States Federal
Reserve (US Fed) signalled a more gradual pace of rate
hikes. Although the European Central Bank (ECB) ended its
asset purchase programme in December, it has indicated
that monetary policy would remain largely accommodative.
Since the November 2018 MPC meeting, the rand has
appreciated by 1.4% against the US dollar, by 1.5% against
the euro, and by 0.5% on a trade-weighted basis. The
implied starting point for the rand is R14.30 against the US
dollar compared with R14.50 at the time of the previous
meeting. At these levels, the QPM assesses the rand to be
less undervalued.
Emerging market currencies, including the rand, have
recently benefitted from a weaker US dollar and indications
of continued accommodative monetary policy in advanced
economies, but they remain vulnerable to changes in
investor sentiment. The rand also remains sensitive to
domestic growth prospects, political developments and
policy settings.
The domestic growth outlook remains sluggish. Although
gross domestic product (GDP) increased by 2.2% in the
third quarter of 2018, private sector fixed investment remains
weak and production in key sectors is volatile. The SARB
now expects growth in 2018 to average 0.7% (up from 0.6%
in November). The growth forecast for 2019 is 1.7% (down
from 1.9%), unchanged at 2.0% for 2020 and 2.2% for 2021.
At these growth rates, the negative output gap is expected
to close in the first quarter of 2021.

Monetary Policy Review April 2019
The Absa Purchasing Managers’ Index reached 50.7 index
points in December, driven by improved expectations
about new sales orders and business activity; however,
the employment sub-index has receded to its lowest
levels since 2014. Although the SARB’s composite leading
business cycle indicator increased somewhat in October,
it has been trending lower since early 2018. The Rand
Merchant Bank/Bureau for Economic Research (RMB/
BER) Business Confidence Index also remains significantly
below the neutral level of 50 index points, broadly aligned
with weakness in gross fixed capital formation. Sustained
growth in fixed capital formation is needed to raise potential
growth and to make inroads into unemployment.
Household consumption expenditure remains constrained
by weak employment growth. Over the forecast period,
consumption expenditure growth is expected to remain
around 2% on the back of moderate increases in real wages
and household disposable income.
The MPC assesses the risks to the growth forecast to be
on the downside. Weak business and consumer confidence
continue to weigh on fixed capital formation. This could be
exacerbated by the possibility of protracted electricity supply
constraints. Prudent macroeconomic policies are essential
to ensuring that growth is sustainable and the economy is
more resilient to shocks. Furthermore, the MPC remains of
the view that current challenges facing the economy are
primarily structural in nature. The implementation of credible
structural policy initiatives that make a marked impact on
potential output and employment, and lower the cost
structure of the economy, should be prioritised.
The MPC has taken note of the improved inflation outlook,
especially in the near term. Over the forecast period, inflation
is expected to remain within the inflation target range,
averaging 5.3% in 2020 and 4.8% in 2021.
The overall risks to the inflation outlook are assessed to be
moderately on the upside. The risks include administered
prices such as electricity and water tariffs, rising domestic
food prices in the outer years, changing investor sentiment
towards emerging markets, moderation in global growth,
and volatile international oil prices.
Against this backdrop, the MPC unanimously decided to
keep the repurchase rate unchanged at 6.75% per year.
The Committee continues to assess the stance of monetary
policy to be broadly accommodative. Monetary policy actions
will continue to focus on anchoring inflation expectations
closer to the midpoint of the inflation target, in the interest
of balanced and sustainable growth. The approach of the
MPC is to look through the first-round effects and focus on
the possible second-round effects of supply-side shocks.
As previously indicated, any future policy adjustments will
be data dependent.
The implied path of policy rates generated by the QPM
is for one hike of 25 basis points, with the repurchase
rate reaching 7.0% by the end of 2021. The forecasted
endogenous interest rate path is built into the MPC’s growth
and inflation outlook. As emphasised previously, the implied
path remains a broad policy guide which can, and does,
change in either direction between meetings in response to
new developments and changing risks.
Per cent
2013 2014 2015 2016 2017 2018 2019 2020 2021
Repurchase rate forecast
The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
The bands are symmetric and do not reflect any assessment of
upside or downside risk.
Source: SARB


90%

60%

30%

Repo rate


Monetary Policy Review April 2019

Summary of assumptions: Monetary Policy Committee
meeting on 17 January 2019*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 52 and 53.

Monetary Policy Review April 2019
Summary of selected forecast results: Monetary Policy Committee meeting
on 17 January 2019
Selected forecast results (annual)
Actual
Forecast


Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of South Africa’s three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa and the tradeweighted CPI of the euro area, the US and Japan).
3.
The real exchange rate gap signifies the extent to which the real exchange rate deviates from its estimated equilibrium level. A positive gap shows an
overvaluation of the currency, and vice versa.
4.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
5.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
6.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results (quarterly)
Year-on-year percentage change


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


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

Notes
1. Shaded areas indicate the forecasts of the Monetary Policy Committee.
2. The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2019

Statement of the Monetary Policy Committee
28 March 2019
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy
Committee (MPC), global growth concerns have increased,
with particular weakness visible in some of our major trading
partners. Domestically, electricity constraints, combined
with weakness in business and consumer confidence, are
weighing on the forecast. While inflation continues to show
near-term downside surprises, the medium-term outlook is
being impacted by higher energy tariffs as well as rising food
and fuel prices.
The year-on-year inflation rate as measured by the consumer
price index (CPI) for all urban areas was 4.1% in February
2019 (up from 4.0% in January). Goods price inflation was
3.0% (up from 2.8% in January), while services price inflation
remained at 5.2%. The South African Reserve Bank’s
(SARB) measure of core inflation – which excludes food, fuel
and electricity – was unchanged in February at 4.4% for the
fourth consecutive month. Producer price inflation for final
manufactured goods increased to 4.7% in February, from
4.1% in January.
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) has remained broadly unchanged
since the previous meeting of the MPC. Headline inflation
is expected to average 4.8% in 2019, before increasing to
5.3% in 2020 and moderating to 4.7% in 2021 (down from
4.8%). Headline CPI inflation is expected to peak at 5.7% in
the first quarter of 2020 and settle at 4.5% by the end of the
forecast period.
Previous MPC statements have highlighted the risks to
the forecast presented by volatile oil prices and food price
surprises. In light of recent developments, the assumptions
for Brent crude oil in the QPM were revised up by
US$2 per barrel from US$62 to US$64 per barrel for 2019.
The assumptions for 2020 and 2021 are unchanged at
US$65 per barrel. Fuel taxes and levies announced in
the 2019 Budget have been included in the forecast.
The turning point for food price inflation has also been
difficult to predict due to lower-than-expected meat
prices and weak demand. Food price inflation is expected
to bottom out in the first quarter of 2019 and to peak at
5.9% in the second quarter of 2020.
The forecast also takes into account the recent electricity
tariff increases announced by the National Energy Regulator
of South Africa. The assumption for electricity price inflation,
which takes into account municipal price adjustments, has
increased from 12% to 13% for 2019/20 and from 6% to
9% for 2020/21. Higher food, fuel and electricity prices are
expected to lift inflation over the medium term. However, this
is expected to be offset by lower core inflation as unit labour
costs and inflation expectations moderate.
The forecast for core inflation is lower at 4.8% in 2019 (down
from 5.0%), 4.9% in 2020 (down from 5.1%) and 4.5% in
2021 (down from 4.8%).
Average inflation expectations have been declining since the
end of 2017. Inflation expectations as reflected in the survey
conducted by the Bureau for Economic Research in the first
quarter of 2019 declined from 5.4% to 4.8% for 2019 and
from 5.4% to 5.2% for 2020. Average five-year expectations
also came down from 5.3% to 5.1%, which is the lowest
level since they were first surveyed in 2011.
The inflation expectations of market analysts in the March
2019 Reuters Econometer survey were also lower at 4.7%
for 2019 (down from 5.2%), but remained unchanged
at 5.3% and 5.2% for 2020 and 2021 respectively.
Expectations implicit in the break-even inflation rates (i.e.
the yield differential between conventional and inflationlinked government bonds) remain sensitive to exchange
rate movements. While still higher than the midpoint of the
inflation target range at 4.97%, the five-year break-even
rates are at their lowest level in four years.
Although global growth conditions remain benign, the pace
of growth is slower than previously anticipated. Business
confidence has softened amid increasing concerns about
weaker trade and production, ongoing trade tensions and
tariffs hikes, as well as country-specific factors. Global
gross domestic product (GDP) is expected to pick up over
the medium term, but risks remain tilted to the downside.
A further escalation of trade tensions, rising geopolitical
risks, including the possibility of a no-deal Brexit, and
renewed tightening of financial conditions could further
weaken growth in an environment with limited policy space.
A slower pace of monetary policy normalisation is expected
in advanced economies. Most of these economies are
growing at levels close to or above their potential, while
inflation remains below targeted levels. Inflation expectations
are contained and, in some instances, lower than targeted
inflation. Recent communications by the United States
Federal Reserve and the European Central Bank have
signalled that their monetary policy stances will remain
largely accommodative for now.

Monetary Policy Review April 2019
Emerging market currencies have generally benefitted from
indications of continued accommodative monetary policy in
advanced economies and low market volatility. Currencies
of countries with stronger macroeconomic fundamentals
are better placed to benefit from these developments. The
rand has been affected by idiosyncratic factors such as
domestic growth prospects, political developments and
policy settings.
Since the January MPC meeting, the rand has depreciated
by 6.4% against the US dollar, by 5.2% against the euro,
and by 6.1% on a trade-weighted basis. The implied starting
point for the rand is R14.00 against the US dollar compared
with R14.30 at the time of the previous meeting. At these
levels, the QPM assesses the rand to be less undervalued.
GDP increased by 1.4% in the fourth quarter of 2018,
averaging 0.8% for the year. Fixed capital formation remains
weak. This is largely due to declining investment by public
corporations and government as well as weaker business
confidence, as suggested by the most recent Rand
Merchant Bank/Bureau for Economic Research (RMB/BER)
Business Confidence Index.
The Absa Purchasing Managers’ Index moderated from
49.9 index points in January 2019 to 46.2 index points in
February, driven by a sharp decrease in business activity
and new sales orders. The SARB’s composite leading
business cycle indicator has trended lower since February
2018 and contracted further by 1.8% in January.
Household consumption expenditure has been stronger
than forecast, but remains constrained by low employment
growth, electricity price hikes and higher petrol prices.
Over the forecast period, growth in household expenditure
is expected to decline to 1.0% in 2019 and 1.4% in 2020,
before increasing to 1.8% in 2021.
The SARB now expects GDP growth for 2019 to average
1.3% (down from 1.7% in January). The forecast for 2020
is 1.8% (down from 2.0%), rising to 2.0% for 2021 (down
from 2.2%). This is as a result of the bigger-than-expected
slowdown in the global economy, declines in business
confidence, potential supply-side disruptions from loadshedding, and growing pressure on household disposable
income.
The MPC assesses the risks to the growth forecast
to continue to be on the downside. Electricity supply
constraints and weak business confidence will likely limit
near-term production and investment prospects. The MPC
remains of the view that current challenges facing the
economy are primarily structural in nature. Given current
economic vulnerabilities, prudent macroeconomic policies
combined with structural reforms that raise potential growth
and lower the cost structure of the economy have become
even more urgent.
The MPC has taken note of the recent inflation outcomes
and welcomes the moderation in inflation expectations.
The overall risks to the inflation outlook are assessed to
be more or less evenly balanced. Key upside risks are
rising administered prices, including electricity and water
tariffs, rising domestic food prices in the outer years, and
higher international oil prices. Downside risks include
lower global inflation and an extended period of monetary
accommodation in advanced economies.
Against this backdrop, the MPC unanimously decided to
keep the repurchase rate unchanged at 6.75% per year.
The Committee continues to assess the stance of monetary
policy to be accommodative.
Monetary policy actions will continue to focus on anchoring
inflation expectations closer to the midpoint of the inflation
target, in the interest of balanced and sustainable growth.
The MPC is of the view that there is little evidence of
demand-side pressures in the economy. Over the medium
term, cost-push factors could arise from higher electricity,
fuel and food prices. The approach of the MPC is to focus
on the possible second-round effects of supply-side
shocks. Any future policy adjustments will continue to be
data dependent.
The implied path of policy rates generated by the QPM is
for one hike of 25 basis points, with the repurchase rate
reaching 7.0% by the end of 2019. The endogenous interest
rate path is built into the growth and inflation forecast. As
emphasised previously, the implied path remains a broad
policy guide which could change in either direction from
meeting to meeting in response to new developments and
changing risks.

Per cent
2013 2014 2015 2016 2017 2018 2019 2020 2021
Repurchase rate forecast
The uncertainty bands for the repo rate are based on historical
forecasting experience and stochastic simulations in the QPM.
The bands are symmetric and do not reflect any assessment of
upside or downside risk.
Source: SARB


90%

60%

30%

Repo rate


Monetary Policy Review April 2019

Summary of assumptions: Monetary Policy Committee
meeting on 28 March 2019*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 52 and 53.

Monetary Policy Review April 2019
Summary of selected forecast results: Monetary Policy Committee meeting
on 28 March 2019*
Selected forecast results (annual)
Actual
Forecast


Notes
1.
The nominal effective exchange rate is based on the bilateral exchange rates of South Africa’s three largest trading partners (the euro area, the US and Japan).
The bilateral exchange rates are weighted by export trade weights.
2.
The real effective exchange rate is the nominal effective exchange rate deflated by the consumer price differential (between South Africa and the tradeweighted CPI of the euro area, the US and Japan).
3.
The real exchange rate gap signifies the extent to which the real exchange rate deviates from its estimated equilibrium level. A positive gap shows an
overvaluation of the currency, and vice versa.
4.
The forecast of the current account balance is obtained from the SARB’s Core Macroeconometric Model.
5.
Shaded areas indicate the forecasts of the Monetary Policy Committee.
6.
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results (quarterly)
Year-on-year percentage change


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


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

Notes
1. Shaded areas indicate the forecasts of the Monetary Policy Committee.
2. The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Monetary Policy Review April 2019

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

Monetary Policy Review April 2019
Domestic sector assumptions
1. The electricity price is an administered price measured
at the municipal level with a weight of 3.75% in the
headline consumer price index basket. Electricity price
adjustments generally take place in the months of July
and August of each year, and the assumed pace of
increase over the forecast period reflects the multi-year
price determination agreement between Eskom and the
National Energy Regulator of South Africa, with a slight
adjustment for measurement at the municipal level.
2. Fuel taxes and levies are the total domestic taxes and
costs included in the price of fuel paid at the pump. They
include the Road Accident Fund (RAF) levy, the fuel levy,
retail and wholesale margins, the slate levy, and other
minor levies. The two major taxes, which are set by the
Minister of Finance in the annual national Budget, are
the RAF levy and the fuel levy. The income generated by
the RAF levy is utilised to compensate third-party victims
of motor vehicle accidents while the fuel levy is used to
provide funding for road infrastructure.
3. Potential growth is derived from the South African
Reserve Bank’s (SARB) semi-structural potential output
model. The measurement accounts for the impact of the
financial cycle on real economic activity and introduces
economic structure via the relationship between potential
output and capacity utilisation in the manufacturing
sector (SARB Working Paper Series No. WP/14/08).
4. The inflation target range midpoint is the middle of the
official inflation target range of 3–6%.
5. The neutral real interest rate is the interest rate
consistent with stable inflation and output in line with
the economy’s potential. This variable is the basis for
judging whether a given policy stance is expansionary,
contractionary or neutral.
Monetary Policy Review April 2019

Glossary
Advanced economies: Advanced economies are countries
with high gross domestic product (GDP) per capita,
diversified exports, and close integration into the global
financial system.
Balance of payments: This is a record of transactions
between the home country and the rest of the world over a
specific period of time. It includes the current and financial
accounts. See also ‘Current account’ below.
Brent crude: Brent crude is a light and sweet blend of oil
from five different fields in the North Sea. The price of Brent
crude is one of the benchmark oil prices in international
markets.
Budget deficit: A budget deficit indicates the extent to which
government expenditure exceeds government revenue.
Business and consumer confidence: These are economic
indicators that measure the level of optimism about the
economy and its prospects among business managers and
consumers.
Commodities: Commodities can refer to energy, agriculture,
metals and minerals. Major South African-produced
commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication
of aggregate price changes in the domestic economy. The
index is calculated using a number of categories forming
a representative set of goods and services bought by
consumers.
Core inflation: Core generally refers to underlying inflation
excluding the volatile elements (e.g. food and energy prices).
The South African Reserve Bank’s (SARB) forecasts and
discussions refer to headline CPI excluding food, nonalcoholic beverages, fuel and electricity prices.
Crude oil price: This is the United States (US) dollar price
per barrel of unrefined oil. See also ‘Brent crude’ above.
Current account: The current account of the balance of
payments consists of net exports (exports less imports)
in the trade account as well as the services, income and
current transfer account.
Emerging markets: Emerging markets are countries with
low to middle income per capita. They are advancing rapidly
and are integrating with global (product and capital) markets.
Exchange rate depreciation (appreciation): Exchange rate
depreciation (appreciation) refers to a decrease (increase) in
the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange
rate changes on domestic inflation (i.e. the percentage
change in domestic CPI due to a change in the exchange
rate). Changes in the exchange rate affect import prices,
which in turn affect domestic consumer prices and inflation.
Forecast horizon: This is the future period over which the
SARB generates its forecasts, typically between two and
three years.
Gross domestic product (GDP): GDP is the total market
value of all the goods and services produced in a country.
It includes total consumption expenditure, capital formation,
government consumption expenditure, and the value of
exports less the value of imports.
Gross fixed capital formation (investment): The value of
acquisitions of capital goods (e.g. machinery, equipment
and buildings) by firms, adjusted for disposals, constitutes
gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers to
CPI for all urban areas that is released monthly by Statistics
South Africa (Stats SA). Headline CPI is a measure of price
levels in all urban areas. The 12-month percentage change
in headline CPI is referred to as ‘headline CPI inflation’ and
reflects changes in the cost of living. This is the official
inflation measure for South Africa.
Household consumption: This is the amount of money
spent by households on consumer goods and services.
Inflation (growth) outlook: This outlook refers to the evolution
of future inflation (growth) over the forecast horizon.
Inflation targeting: This is a monetary policy framework
used by central banks to steer actual inflation towards an
inflation-target level or range.
Monetary policy normalisation: This refers to the unwinding
of an unusually accommodative monetary policy. It could
also mean adjusting the economy’s policy rate towards its
real neutral policy rate.
Neutral real interest rate (NRIR): The NRIR is the level at
which the real interest rate will settle once the output gap is
closed and inflation is stable.
Nominal effective exchange rate (NEER): The NEER
is an index that expresses the value of a country’s
currency relative to a basket of other (trading-partner)
currencies. An increase (decrease) in the NEER indicates
a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted
average exchange rate of the rand is calculated against
20 currencies. The weights of the five major currencies are
as follows: the euro (29.26%), the Chinese yuan (20.54%),
the US dollar (13.72%), the Japanese yen (6.03%), and the
British pound (5.82%). Index: 2010 = 100. See also ‘Real
effective exchange rate’ on the next page.
Output gap/potential growth: Potential growth is the rate
of GDP growth that could theoretically be achieved if all
the productive assets in the economy were employed
in a stable inflation environment. The output gap is the

Monetary Policy Review April 2019
difference between actual growth and potential growth,
which accumulates over time. If this is negative, then the
economy is viewed to be underperforming and demand
pressures on inflation are low. If the output gap is positive,
the economy is viewed to be overheating and demand
pressures are inflationary.
Policy rate: A policy rate is the interest rate used by a central
bank to implement monetary policy.
Producer price index (PPI): This index measures changes
in the prices of goods at the factory gate. Stats SA currently
produces five different indices that measure price changes
at different stages of production. Headline PPI is the index
for final manufactured goods. PPI measures indicate
potential pressure on consumer prices.
Productivity: Productivity indicates the amount of goods
and services produced in relation to the resources utilised
in the form of labour and capital.
Real effective exchange rate (REER): The REER is the
NEER adjusted for inflation differentials between South Africa
and its main trading partners. See also ‘Nominal effective
exchange rate’ on the previous page.
Repurchase (repo) rate: This is the policy rate that is set
by the Monetary Policy Committee (MPC). It is the rate that
commercial banks pay to borrow money from the SARB.
Real repo rate: This is the nominal repo rate, as set by the
MPC, adjusted for expected inflation.
Terms of trade: This refers to the ratio of export prices to
import prices.
Unit labour cost (ULC): A ULC is the labour cost to produce
one ‘unit’ of output. This is calculated as the total wages
and salaries in the non-agricultural sector divided by the real
value added at basic prices in the non-agricultural sector of
the economy.
Monetary Policy Review April 2019

Abbreviations
Alsi

All-Share Index
BER

Bureau for Economic Research
BoE

Bank of England
BoJ

Bank of Japan
CDS

credit default swap
CPI

consumer price index
ECB

European Central Bank
FAO

Food and Agriculture Organization
Fed

United States Federal Reserve
FRA

forward rate agreements
G20

Group of Twenty
GDP

gross domestic product
GPM

Global Projection Model
GW

gigawatt
Haver

Haver Analytics
HSRC

Human Sciences Research Council
IIF

Institute of International Finance
IMF

International Monetary Fund
MPC

Monetary Policy Committee
MPR

Monetary Policy Review
MW

megawatt
NAB

non-alcoholic beverages
NEER

nominal effective exchange rate
NERSA

National Energy Regulator of South Africa
NRIR

neutral real interest rate
NWU

North-West University
PCE

personal consumption expenditure
PMI

Purchasing Managers’ Index
PPI

production price index
QPM

Quarterly Projection Model
RAF

Road Accident Fund
RBI

Reserve Bank of India
REER

real effective exchange rate
repo (rate)
repurchase (rate)
RMB

Rand Merchant Bank
SARB

South African Reserve Bank
Stats SA

Statistics South Africa
TLTRO-III
targeted long-term refinancing
operations (third round)
UK

United Kingdom
ULC

unit labour cost
US

United States
UVI

unit value index
VAT

value-added tax