South African Reserve Bank
Monetary Policy Review
December 2014
Monetary Policy Review
December 2014
Monetary Policy Review December 2014
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ISSN: 1609-3194
Monetary Policy Review December 2014
Preface
The primary mandate of the South African Reserve Bank (the Bank) is to achieve and
maintain price stability in the interest of balanced and sustainable economic growth.
Low inflation helps to maintain and improve competitiveness, protects the purchasing
power and living standards of all South Africans, and provides a favourable environment
for balanced growth, investment and employment creation. In addition, the Bank has a
complementary mandate to oversee and maintain financial stability. The Bank’s Monetary
Policy Committee (MPC) is responsible for monetary policy decisions, and comprises the
Governor as Chairperson, the deputy governors and senior officials of the Bank.
Price stability is quantified by the setting of an inflation target range by government after
consultation with the Bank. The Bank has instrument independence, with the commitment
to pursue a continuous target of 3 to 6 per cent for headline consumer price index inflation.
The MPC conducts monetary policy within a flexible inflation-targeting framework that
allows inflation to be temporarily outside the target range under certain circumstances.
The MPC takes into account a viable medium-term time horizon for inflation and considers
the time lags between policy adjustments and economic effects. This provides for interestrate smoothing over the cycle, and contributes towards more stable economic growth.
The repurchase rate decision reflects the MPC’s assessment of the appropriate monetary
policy stance.
The decision of the MPC, together with a comprehensive statement, is announced at a
media conference at the end of each bimonthly meeting. This announcement outlines the
MPC’s assessment of prevailing domestic and global economic conditions, as well as recent
outcomes and forecasts for inflation and real economic activity.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening
the understanding of the objectives and conduct of monetary policy. The MPR reviews
domestic and international developments that have affected inflation and that impact on the
monetary policy stance. It also provides an assessment of the factors determining inflation
and the Bank’s forecast of the future path of inflation and economic growth. The MPR
is presented by the Governor and senior officials of the Bank at Monetary Policy Forums
in various centres across South Africa in an effort to develop a better understanding of
monetary policy through direct interaction with stakeholders.
Contents


Boxes


Appendix

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

Statement of the Monetary Policy Committee

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


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


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


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

Monetary Policy Review December 2014
Executive summary
The repurchase (repo) rate was raised by 75 basis points in 2014 as part of a gradual rate-
hiking cycle. This is a response to a combination of a higher trajectory for headline inflation
and elevated risks to the longer-term inflation outlook. Headline inflation has been outside
the target for much of the year, peaking at 6,6 per cent in May and June, before falling to
just within the target range in September and October. Significantly lower oil prices and
moderating food price inflation have helped the near-term headline inflation outlook. Core
inflation, however, is stubbornly high, propelled by rand weakness, inertia in price and wage
setting and consistently high services inflation. Inflation expectations appear stable but are
above the upper end of the target range.
South Africa’s macroeconomic imbalances have grown more uncomfortable. The currentaccount deficit is large relative to historic norms and peer countries, and has been closing
only slowly. Policy adjustment through a lower inflation rate and gradual fiscal consolidation
will help over time to ease the current-account deficit to more sustainable levels, while
contributing to lower long-term costs of borrowing.
Global financial conditions have become less hospitable for countries with large external
financing requirements – a change emanating from a gradual normalisation of monetary
policy in the United States (US). This process has already delivered a bumpy ride for
South Africa, as it has for some other countries, with bouts of volatility (such as January
2014) interspersed with periods of uneasy calm (as in mid-2014). We cannot be sure how
normalisation will proceed, or how much additional easing by the European Central
Bank and the Bank of Japan will offset tightening by the US Federal Reserve (the Fed).
The overall process should be protracted, with world interest rates moving higher at
a slow and steady pace. Based on experience, however, it is unlikely that markets will
adjust smoothly despite the best efforts of policymakers to communicate their intentions
clearly. From this perspective, the rand exchange rate is likely to be intermittently volatile
and could weaken further.
Domestic economic performance has been disappointing, with growth forecasts for the year
reduced from 3 per cent (as of November 2013) to 1,4 per cent. This reflects a series of long-
and short-term supply shocks, including rising intermediate input and labour costs, costlier
and less reliable electricity, and severe strikes in the mining and manufacturing sectors.
Estimates of potential growth show it has fallen, and it may have deteriorated further this
year given the severity of these disruptions. Commodity prices have also declined, affecting
South Africa’s terms of trade. World economic growth has been subdued, owing in particular
to protracted weakness in the euro area and a broad-based emerging-market slowdown. It
is therefore unlikely that better export earnings will soon moderate South Africa’s external
financing requirements.
Growth is expected to pick up gradually over a two-year time horizon, approaching 3 per
cent as the global environment improves and the economy recovers from domestic shocks.
The monetary policy adjustment will ensure that inflation remains under control and
expectations of future inflation are lowered. On its own this should reduce uncertainty about
future economic prospects and support long-run investment. The current tightening cycle
has been slower and more moderate than previous cycles, and rates remain close to historical
lows, with the real repo rate still near zero – which supports growth in the economy over
the near term. Fiscal policy strikes a similar balance, with spending growth slowing but still
positive in real terms.
South Africa has the leeway to adjust quite gradually, protecting growth, thanks to two
factors. First, global conditions are still generally supportive, with interest rates very low
from a historical perspective and likely to stay that way for an extended period of time.
Second, South Africa entered the crisis period with crucial policy buffers, including low
Monetary Policy Review December 2014

debt levels and considerable policy credibility. These advantages have been exploited over the
past half-decade, tiding the country over an unusually difficult period in modern economic
history, and are not yet altogether exhausted. Provided that imbalances can be constrained
now, before they develop into more serious vulnerabilities, South Africa will remain an
attractive investment destination. We choose to adjust slowly so that we are not forced to
adjust fast.
This Monetary Policy Review is divided into four sections. First is a short, chronological
overview of the policy stance, followed by sections on inflation and the inflation outlook,
the world economic environment and domestic growth. These combine to provide a full
picture of monetary policy in South Africa, but may be read as stand-alone discussions on
each subject.

Monetary Policy Review December 2014
Policy stance
Inflation has been above target for much of the year and expectations of
future inflation stubbornly high. Economic growth, meanwhile, has been
weak and volatile, confidence low, and demand slowing. Although some
improvement in global growth is expected, the environment threatens
ongoing currency depreciation for emerging markets with large
macroeconomic imbalances, such as South Africa.
The monetary policy response to these challenges has been a gradual tightening
cycle. This is echoed in the themes of fiscal policy, with spending growth
still positive but slowing as budget deficits fall. Both these policy settings are
calibrated to reduce South Africa’s vulnerabilities, with a gradual adjustment
supportive of demand in the short term while ensuring the environment
remains conducive to longer-term growth.
As of mid-2014, when the previous Monetary Policy Review (MPR) was
published, the repo rate had been increased for the first time since 2008.
Inflation was above target and the breach was expected to last until the second
quarter of 2015. This forecast entailed a significant deterioration from the
outlook at the end of 2013, which had shown inflation staying within the
target range through 2014 and 2015, and growth rebounding to 3 per cent
by 2014.
The first reductions in the Fed’s asset purchase programme affected a number
of emerging-market currencies, including the rand. The nominal effective
exchange rate hit an all-time low in January 2014, with rand depreciation a
major inflation threat. Oil and food prices were also exerting pressure; food
costs in particular were rebounding from a brief decline towards the end of
2013. These factors risked second-round effects to wages and prices more
generally, as well as to inflation expectations, which were already grouped at
the high end of the target range.
The current MPR updates this narrative in a few important ways. Inflation
appears to have peaked sooner than anticipated, at 6,5 per cent in the second
quarter rather than 6,5 per cent in the last quarter of 2014, and has dipped
by more than expected to just below the target in September and October.
Electricity prices are set to increase sharply from the middle of next year,
but other supply factors have been favourable. Food prices have ebbed again
thanks to excellent harvests in many producer countries (including South
Africa). Oil prices have shifted abruptly lower as global supply expands
alongside weak demand forecasts. These positive supply shocks have brought
down the most recent inflation forecasts, lowering the 2014 number from
6,2 to 6,1 per cent and the 2015 number from 5,7 to 5,3 per cent.
As with negative supply shocks, however, it is important to look through the
first-round effects and focus on spillovers to underlying inflation and inflation
expectations. Here there is less scope for relief. Core inflation is close to the
top end of the target, having trended steadily upwards from 2011. It is forecast
at 5,6 per cent in 2014, 5,7 per cent in 2015 and 5,3 per cent in 2016. Inflation
expectations on average have remained relatively steady at just over 6 per cent,
outside the target range. Analysts’ expectations are within the target range,
but expectations for business and union leaders are slightly higher. Wage
increases have been correspondingly elevated.
Indices: 31 December 2012 = 100
Indices: 31 December 2012 = 100

Figure 2
Exchange-rate performance

against the US dollar

South African rand

Australian dollar

Canadian dollar

Indonesian rupiah

Mexican peso
Sources: Reuters and own calculations

Taper talk
Tapering
Taper talk
Tapering

Brazilian real

Indian rupee

Turkish lira

Chilean peso
Per cent
-2

Figure 1
Monetary policy and the prime

lending rate

Prime lending rate

Repurchase rate

Real repurchase rate*
* Nominal rate adjusted by Reuters one-year-ahead
CPI forecast
Sources: South African Reserve Bank and Reuters

Monetary Policy Review December 2014

Since January 2014, the exchange rate has fluctuated sharply on foreign and
domestic news but the overall trend has been quite flat, in contrast to the
secular depreciation of the preceding three years. The path of the currency
remains uncertain: it may be that markets have priced in appropriate
assumptions for the world and local economy, but there is ample scope
for miscalculation and surprises. The current-account deficit remains an
important vulnerability, with an unexpectedly favourable figure in the first
quarter supporting the rand while a worse-than-anticipated second-quarter
figure helped weaken it again. For most of the period since the financial
crisis, the global environment has actually been exceptionally supportive
of South Africa’s excess of expenditure over saving (reflecting the currentaccount deficit). But this climate is changing as a recovering US economy
diverts capital flows. A stronger US economy is also bolstering the dollar,
creating a divergence between the bilateral exchange rate and the broader
nominal effective rate.
Global growth has disappointed expectations, even from earlier in 2014, with
the International Monetary Fund (IMF) lowering its forecasts in October
and warning of mounting downside risks, particularly from geopolitical
instability. The euro area has fared worse than expected, with Italy in a
prolonged recession, France stagnant and even Germany faltering in the
second and third quarters. Emerging markets have in general slowed, partly
for structural and partly for cyclical reasons, and appear unlikely to recover
the growth levels seen before the crisis. The brightest spots in the global
economy are the US and United Kingdom (UK), where unemployment
levels have fallen sharply. Sub-Saharan Africa has also maintained high
growth rates, although some countries are exposed to financial stress and
a few West African countries are suffering a horrific outbreak of the Ebola
virus, which has already caused over 5 000 deaths.
Domestic output was seriously damaged by strikes lasting into the third
quarter of the year, forcing downward revisions of growth forecasts at each
Monetary Policy Committee (MPC) meeting. However, growth in nonstrike-affected sectors remained positive and leading indicators have picked
up as strikes ended, pointing to better economic performance from the third
quarter onwards. The forecast shows gross domestic product (GDP) growth
reverting towards potential in 2015, with the output gap closing over the
next few years as the economy recovers lost ground. With unit labour
costs rising by close to the inflation rate, however, there seems to be little
opportunity for stronger job creation. Strikes and electricity constraints may
also have detracted further from South Africa’s potential growth rate.
US dollars per barrel
Figure 3
Evolution of Brent crude oil

price forecasts

Note: This graph denotes selected forecasts of average
Brent crude oil prices since January 2012

Apr

Sep
Jan
Apr

Sep
Jan
Apr

Sep Oct
Jan

Source: Reuters monthly oil poll of industry analysts

Monetary Policy Review December 2014
In responding to the mix of disappointingly low growth and high inflation,
both worse than anticipated earlier in the year, the MPC raised the repo rate
by 25 basis points in July 2014 but left policy unchanged in September and
November. This marks gradual progress along the path to normalisation,
but progress has been delayed by strikes and feeble domestic and global
growth. The contrast with previous tightening cycles is striking: the repo
rate has so far been raised by 75 basis points over 11 months, compared with
500 basis points in 25 months between 2006 and 2008, 400 basis points
in nine months in 2002 and – in the pre-inflation targeting era – 695 basis
points in just five months.
Financial markets appear to have understood that this cycle is different:
forward rate agreements spiked upwards after the January rate increase but
have since moderated in line with Bank communications. The short end
of the yield curve has also been taking the brunt of the adjustment, at least
in 2014. After increases in May 2013 and again in January 2014, 10-year
government bond yields have declined over the year.
Box 1
Potential output: Towards a better real-time measure1
The output gap, defined as the difference between real GDP outcomes and the
economy’s non-inflationary production potential, serves as an indicator of inflationary
pressures in the real economy. An economy’s non-inflationary production potential
cannot be observed directly and needs to be estimated. Real GDP is decomposed into
two components: a trend and a cycle. The trend represents the economy’s level of
potential output and the de-trended cycle reflects a suitable measure of the output gap.
The Hodrick–Prescott (HP) filter provides a simple statistical methodology for this
decomposition, but because the filtered trend series gravitates towards the observed
data at the end of the sample, it often results in a biased estimate for the most recent
quarter. The need to revise the HP estimates limits the usefulness of the HP filter for
real-time policymaking.
To overcome this weakness, the HP filter is enriched with additional real-economy
information including growth in private-sector credit extension and the utilisation of
production capacity in the manufacturing sector. The inclusion of additional
information about the real economy improves the real-time output gap estimates, and
reduces the extent of future revisions.
The global financial crisis and the ensuing mediocre recovery contributed to a global
slowing in potential GDP growth. South Africa’s potential growth also slowed, with an
estimated decline from a pre-crisis peak of 3,9 per cent in 2006 to around 2,5 per
cent in 2014 (see Figure B1.1). This is similar to the IMF’s estimate for South Africa’s
potential growth, which is about 2,5 per cent for 2013–2014.2 The slowdown in postcrisis potential growth implies an output gap of about -1 to -2 per cent in 2012
and 2013.

For further technical details, see V Anvari, N Ehlers and R Steinbach. ‘A semi-structural approach
to estimate South Africa’s potential output’, South African Reserve Bank Working Paper WP/14/08,
November 2014.

See Y Wu, ‘IMF Selected Issues: Estimating South Africa’s potential growth’, internal IMF discussion
paper, forthcoming.
Per cent
Per cent

Figure 4
Money-market and forward rates,

and 10-year bond yield

Repurchase rate

3x6 Jibar (FRA)*

9x12 Jibar (FRA)*

Exchange rate (left-hand scale)
* FRA: Forward rate agreements
Sources: Bloomberg and Datastream

2008 2009 2010 2011 2012 2013 2014
Rand per US dollar

May
Jul
Sep
Nov

Nov

Jan
Mar

3-month Jibar

6x9 Jibar (FRA)*

10-year bond yield

-3
-2
-1

Per cent

12 13

Potential growth
Source: South African Reserve Bank Working Paper WP/14/08,
November 2014.

Real GDP growth
Figure B1.1 South Africa’s estimated

potential output growth,


Per cent of potential GDP
Source: South African Reserve Bank Working Paper WP/14/08,
November 2014.
Figure B1.2 South Africa’s estimated

output gap, 2000–2014

12 13
Monetary Policy Review December 2014

Fiscal policy complementarity
The October 2014 Medium Term Budget Policy Statement (MTBPS) heralds
a ‘turning point’ for fiscal policy. Government spending will continue to
grow in real terms, by 1,8 per cent a year, but this rate of increase is much
lower than in previous years, and will be strictly limited to ensure it supports
the economy instead of raising its vulnerability.
National Treasury’s growth projections are similar to the Bank’s, with the
outlook for 2014 cut from 2,7 per cent (in the February 2014 Budget) to
1,4 per cent. Lower growth reduces tax revenues, threatening greater debt
accumulation through larger deficits. South Africa’s government debtto-GDP ratio has increased by significantly more than its peer emerging
markets’. Fiscal deficits of about 5 per cent (for the main budget) have
become entrenched as growth repeatedly disappoints.1 US monetary policy
normalisation and credit ratings downgrades make additional debt more
expensive. Financing requirements will also rise in 2017, when debt issued
in the aftermath of the financial crisis matures.
Table 1 Public finance data


Consolidated
government* (R billions)
Outcome
Budget
MTBPS
estimates
Medium-term estimates

As a percentage of GDP

* Includes national government, provinces, social security funds and selected public entities
** National government
Note: Owing to a change in presentation of budget statistics, the budget balance now includes extraordinary receipts
and payments
Sources: National Treasury, Budget Review 2014 and Medium Term Budget Policy Statement (MTBPS), October 2014
The MTBPS sets out a strategy to narrow the fiscal deficit and stabilise
debt, aiming for it to peak at 45,9 per cent of GDP in 2017/18. One element
of this is higher revenue collection, but the major decisions on this subject
have been deferred to the 2015 Budget. The major, specific contribution
from the MTBPS, by contrast, is to set out a variety of spending limits.
State-owned enterprises have sporadically required large bailouts over the
past few years, putting unexpected pressure on the fiscus. To control these
costs, National Treasury will henceforth only enact bailouts if and when
needed through the use of deficit-neutral funding. The extra revenue will be
raised through the sale of non-core state assets.

National Treasury, Medium Term Budget Policy Statement,
mtbps/MTBPS%202014%20Full%20Document.pdf, p 20.

Monetary Policy Review December 2014
Expenditure will also be limited through the use of nominal spending
ceilings, which are binding on all non-interest main budget expenditure.
They were first adopted in 2012 and have been repeatedly lowered since,
including in the 2014 MTBPS. To ensure spending comes in under the
ceiling, the MTBPS withdrew funding for positions that have been vacant
for an extended period. It also aims to lower transfers to public entities and
limits expenditure growth on non-essential expenses such as consultants,
advertising and travel. Crucially, should these measures prove insufficient
to contain costs, the ceilings automatically require reductions elsewhere.
One important risk is the government’s wage bill, which is budgeted to rise
in line with inflation but is exposed to demands for much higher increases.
Another more general risk is higher inflation. National Treasury currently
expects headline inflation to average 6,2 per cent for the 2014/15 fiscal
year, falling to 5,3 per cent by 2017/18. Because the ceilings are nominal,
additional inflation that pushes expenditure to the limit will require
reductions in budget allocations. Monetary policy will make an important
contribution by controlling inflation and thereby help the state achieve its
spending priorities.
Monetary Policy Review December 2014

Inflation
Headline consumer price index (CPI) inflation cleared the top of the target
in April 2014, rising to a high of 6,6 per cent in May and June before
receding to 5,9 per cent in September and October. Food and petrol –
mediated by the exchange rate – have been instrumental in determining
which side of 6 per cent prices land: food prices have added over a full
percentage point to headline inflation in each of the past six months, while
petrol prices contributed nearly 1 percentage point to headline inflation in
May and June. More recently the effect has reversed, pulling CPI inflation
narrowly under 6 per cent earlier than anticipated.
Table 2 Contributions to targeted inflation
Percentage change over 12 months* and percentage points

Weights
4th qr
1st qr
May
Jun
Jul
Aug
Sep
Oct

Food and non-alcoholic beverages

Of which:

** CPI excluding food, non-alcoholic beverages, petrol and energy
Sources: Statistics South Africa and own calculations
Underlying the fluctuations from volatile components of the CPI are more
broad-based and persistent elements of inflation, described by various core
measures. All these indices have shown a slow upward trend since 2011,
from near the bottom of the target to the top. This rise in core inflation
has coincided with deteriorating growth and a negative output gap, with
little evidence of excessive demand. There are instead more plausible causes:
exchange-rate depreciation as well as food and energy price increases, which
generated indirect first- and second-round effects, and above-inflation wage
and salary adjustments.
Food prices
Earlier in the year the outlook for food prices was gloomy. Geopolitical
tension between Ukraine and Russia threatened production in one of the
world’s major grain belts, while meteorologists warned of a severe El Niño
event during the year, a phenomenon which typically reduces rainfall in
South Africa. These fears, however, proved unfounded: 2014 is instead
yielding bumper crops, both at home and abroad, suppressing food prices
as a result. The Food and Agriculture Organization Food Price Index has
Percentage change over 12 months
Figure 7
Core measures of inflation

Headline CPI

CPI excluding food and NAB* prices

CPI excluding food, NAB*, petrol and energy prices

CPI excluding administered prices

3–6 per cent inflation target range
* NAB: Non-alcoholic beverages
Source: Statistics South Africa

Percentage change over 12 months
Figure 5
Consumer price inflation:

Targeted inflation*

3–6 per cent inflation target range
* CPI for all urban areas
Source: Statistics South Africa

Proportion of headline
inflation
Percentage points

Figure 6
Contribution of petrol and food

prices to headline inflation*

Petrol: Estimated contribution

Food: Estimated contribution

Combined contribution (right-hand scale)
* Petrol and food prices have a combined weight of
almost 20 per cent in the basket and therefore have
a significant effect on headline inflation


Sources: Statistics South Africa, Department of
Energy and own calculations

Monetary Policy Review December 2014
declined to its lowest level since 2010, and the national Crop Estimates
Committee has revised its final production estimates for white and yellow
maize to 14,3 million tonnes for 2014 – which would be the second-largest
maize harvest in South African history. The outlook is also helped by falling
oil prices, given that oil is an important input to food production and also
a substitute for biofuels, making it perhaps the single most important longterm driver of food prices over the past ten years.2
Petrol prices
Petrol price inflation has fallen since May 2014, helped by both declining
world oil prices and a fairly stable exchange-rate trend. International crude
oil prices fell below US$100 in September, despite geopolitical instability
affecting important energy producers including Iraq and Russia. Prices
fell even further to November, with Brent crude at four-year lows of below
US$80 a barrel. Rand prices are correspondingly down but not as far down,
given exchange-rate depreciation since 2011, with the rand price of Brent
crude at a 17-month low in October 2014.
The decline in oil prices stems from three crucial factors: first, production
from the Organization of the Petroleum Exporting Countries has risen, with
Libyan output in particular rebounding sharply from instability-induced
lows. Second, the US shale revolution is reshaping world energy markets,
transforming the US into the world’s largest oil producer, ahead of Saudi
Arabia. (As a result, Nigeria has sold almost no oil to the US since July,
despite having previously been one of the US’s top five suppliers.) Third,
global demand forecasts have also fallen steadily alongside deteriorating
growth prospects for the world economy.
Core inflation and its drivers
The acceleration of food and petrol prices opened up a wedge between
headline and core inflation. This wedge has recently narrowed as headline
inflation comes down but core inflation continues its slow rise, and the
forecast shows core inflation overtaking headline in 2015. There are several
complementary explanations for core inflation’s protracted rise. One is that
price setters are catching up with the higher inflation they have experienced;
a demonstration of indirect effects from earlier supply pressures. This
applies particularly to services, a category which is strongly represented in
most core measures, filling more than half of these baskets. Because services
are generally non-tradeables, service price inflation is not simply a response
to higher costs from a depreciated exchange rate. These prices also tend
to be adjusted more infrequently than goods so they often lag headline
developments – which implies core inflation will ‘overshoot’ headline
inflation as food and oil prices fall.
A similar process affects wage deals, which reflect previous inflation outcomes
but also factor into firms’ costs, prompting corresponding increases in the
prices they charge. This effect is accelerated by a separate mechanism, in
which employees win above-inflation increases, resulting in further pressure
on production costs. Wages in South Africa tend to be downwardly rigid
in real terms and well-insulated from employment and growth conditions,
boosting inflation even in a lacklustre economy (see Box 2).

J Baffes and A Dennis, ‘Long-term drivers of food prices’, World Bank Policy Research Working Paper 6455,
May 2013.
Percentage change over 12 months
Figure 8
Consumer and producer

food prices

PPI: Final manufactured producer food prices

PPI: Agricultural producer prices

CPI: All food

CPI: Bread and cereals
Source: Statistics South Africa

-10
-5

Percentage change over 12 months
Figure 9
Targeted* inflation and

food inflation

All food items

Bread and cereals

Meat

Milk, cheese and eggs

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

-4

Cents per litre
Cents per litre


Figure 10 South African petrol price and

contributions to changes in the

basic fuel price


Exchange rate

Movement in international product prices

Price change

Gauteng price of 95 octane unleaded petrol

(right-hand scale)
Source: Department of Energy


Monetary Policy Review December 2014

Evidence for the ‘inflation plus’ approach is visible in quarterly releases of
the Andrew Levy Wage Settlement Survey, which show consistent real growth
in wage settlements since the crisis. This measure is limited by its coverage,
representing a relatively small fraction of the workforce, but it points to
consistent above-inflation wage increases, with average nominal wage
settlements of about 8 per cent.
Remuneration per worker, a more general measure, shows a slightly lower
growth rate, averaging 7,4 per cent between 2011 and the end of 2013.
The first half of the year saw a sudden decline in remuneration growth,
influenced by two factors. Strike action in the platinum-mining sector meant
workers were employed but not paid, forfeiting wages of approximately
R10,7 billion. Furthermore, a large number of temporary jobs were created
around the election, which lifted public employment but had a much
smaller effect on public-sector wages. The recent decline in remuneration
per worker therefore probably does not presage moderating wage pressures;
the longer-term average is more revealing.
Inflation expectations have been sticky around the upper end of the target
range for most of the post-crisis period. The survey conducted by the Bureau
for Economic Research (BER) provides expectations for three groups –
financial analysts, business people and trade union leaders – with financial
analysts typically anticipating less inflation than the other two categories
of respondents. Whereas analysts see inflation within the target for both
2015 and 2016, businesses and unions have consistently predicted inflation
narrowly above 6 per cent; the most recent predictions for 2015 are 6,4 per
cent and 6,2 per cent respectively. This is significant because businesses and
unions are price setters, and their actions will feed into core inflation even
as headline inflation declines.
Box 2
Wage rigidities, employment conditions and inflation
in South Africa
Like most economies, South Africa’s economic output was negatively affected by the
global financial crisis, but the recession was short-lived and relatively mild compared
to most of the other economies. By contrast, our employment response was among
the worst, with a loss of around one million private-sector jobs, or 7 per cent of the
employed labour force, in less than one year. South Africa’s inflation rate increased
comparatively sharply just before the crisis, leading unit labour costs (ULCs) to ratchet
higher as wage settlements matched the inflation rate. To test the reaction of ULCs to
changes in GDP and changes in inflation, Viegi (2014) estimates a Philips Curve
equation using South African data over various time frames.1
πw
t = a + γπ ̄ pt-1 + φ0ût + φ̂1 ût-1 + θt
Where πw
t is the measure of wage inflation (proxied by private-sector, non-agricultural
wage inflation or manufacturing unit labour costs inflation), π ̄ pt-1 is the measure of
inflation expectations (proxied by the previous period’s inflation outcome or by using
BER inflation expectations survey data) and ût is the deviation of employment or
unemployment from a long-term trend. A variety of estimations are done over the
periods 1970–2014, 1994–2014 and 2000–2014, according to data availability.
Per cent
Figure 11 Average annual inflation and

wage settlements

Average wage settlements

Average real wage settlements
* Data for 2014 are for the first nine months of the year
Sources: Andrew Levy Employment Publications, Statistics
South Africa and own calculations

CPI
1994 96
98 2000 02

08 2010 12
14 -2

*
Percentage change over four quarters
Figure 12 Remuneration per worker and

unit labour cost in the formal

non-agricultural sector


Nominal unit labour cost

Renumeration per worker
Sources: Statistics South Africa and South African
Reserve Bank

Annual average, per cent

4th qr 2013

2nd qr 2014

6 per cent upper limit of the inflation target range
Source: Bureau for Economic Research, Stellenbosch University

Trade
unions
Business
Analysts
Trade
unions

Business
Analysts
Figure 13
Medium-term inflation

expectations


1st qr 2014
3rd qr 2014

Monetary Policy Review December 2014
Exchange rate
Rand depreciation has contributed to the sustained rise in headline and core
inflation and remains a major risk to the inflation outlook. The threat to
inflation takes two forms: the rand could depreciate further, or the passthrough from depreciation could rise.
Over the course of the year, the exchange rate has been affected by distinct
external and internal factors. Internationally, a crucial development has been
US dollar strength. Robust growth in the US and the corresponding shift
Table B2.1 Estimated wage inflation: Private-sector wages

nt

nt-1

πt-1

*** denotes significance at the 1 per cent level, ** at the 5 per cent level and * at the 10 per cent level, standard
errors in parenthesis
Note: nt identifies the deviation of manufacturing-sector employment from its trend
Source: Viegi (2014)
The estimations show that the relationship between wage inflation and employment
has become weaker over time, and especially in the period since 1994. This suggests
that as the economy is buffeted by adverse economic shocks, wage and salary
increases are largely insensitive to employment conditions. By contrast, inflation
expectations feed into wage and salary inflation. This is corroborated when using
trade unions’ inflation expectations for the current year, the next year and two years
ahead, as published by the BER.
Table B2.2 Estimated wage inflation: Trade union inflation expectations
(1)
(2)
(3)
Eπt
Eπt+1
Eπt+2
ut

Eπt

2000 Q3–2013 Q4
*** denotes significance at the 1 per cent level and ** at the 5 per cent level, standard errors in parenthesis
Source: Viegi (2014)
Further analysis using a dynamic stochastic general equilibrium model confirms that
the domestic labour market exhibits pervasive wage rigidities, inducing rates of job
destruction greater than job creation.

This box is based on a paper titled ‘Labour Market and Monetary Policy in South Africa’ presented by
Nicola Viegi at the South African Reserve Bank Conference held in Pretoria on 30 and 31 October 2014.
Indices: 2008 Q1 = 100

Figure B2.1 Unit labour costs and

employment in South Africa

Manufacturing: Unit labour costs

Total employment in the non-agricultural

private sector (right-hand scale)
Source: South African Reserve Bank

Rand per euro
Rand per dollar

Figure 14 Bilateral exchange rates of

the rand

Rand per US dollar

Rand per euro (right-hand scale)
Sources: Bloomberg

Monetary Policy Review December 2014

to the normalisation of monetary policy by the Fed has boosted the dollar.
At the same time, weak growth and ever-looser monetary policy by the
next two largest central banks, the European Central Bank (ECB) and the
Bank of Japan (BOJ), has cheapened the euro and yen. Furthermore, rising
geopolitical risks and deteriorating world growth prospects have attracted
investors to dollar-denominated safe haven assets. As a consequence, the
dollar reached four-year highs at the end of November. The rand has
accordingly weakened against the dollar but not to other major currencies.
Domestic factors have also intruded on the exchange rate, especially the
large current-account deficit. The rand appeared to strengthen on a relatively
good number for the first-quarter deficit but weakened alongside a more
disappointing second-quarter number. Much of the difference between the
first and second quarter figures came from large dividend inflows, which
was a temporary effect. Strikes also depressed exports from the second
quarter, with a recovery setting in towards the end of the third quarter.
More fundamentally, South Africa’s terms of trade have been weakening
since 2011 as commodity prices decline, although they remain elevated from
a historical perspective. Domestic import penetration has also been rising.
The dynamics of exchange-rate pass-through are more obscure. Some passthrough is complete and nearly immediate, which is the case with the petrol
price, but for many other goods and services the link is less predictable.
Firms might choose to absorb additional costs imposed by the exchangerate change if they expect them to be temporary or believe raising prices
would reduce demand excessively. By contrast, they might shift costs to
consumers more readily if they judge depreciation will be permanent or
find their profit margins are being unacceptably squeezed. Since the crisis
pass-through appears to have been relatively low, perhaps because firms
have moderated mark-ups in response to subdued domestic demand. This
pattern may persist. However, there is a risk of pass-through reverting to its
previous rate.
Table 3 Measures of producer price inflation in 2014
Percentage change over 12 months
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct

Excluding:

Intermediate manufactured goods....

* Unit value indices use customs-level data to measure inflation in imported and exported commodities.
They are not comparable to the old PPI series for imported commodities.
Source: Statistics South Africa
Indices
Figure 15 Measures of developed- and

emerging-market risk aversion

CBOE Volatility Index®

South African volatility index

Emerging Markets Volatility Index (right-hand scale)
Sources: Bloomberg, JPMorgan, Chicago Board Options
Exchange (CBOE) and JSE Limited

2011 2012 2013 2014

Percentage change over 12 months

Figure 16 Inflation and the exchange rate

Headline CPI

Goods inflation

Nominal effective exchange rate of the rand

(right-hand inverted scale)
Sources: Statistics South Africa and South African
Reserve Bank
Depreciation
Appreciation


Percentage change over 12 months
Figure 17 Consumer and producer

price inflation

Headline CPI

CPI: Services inflation
Source: Statistics South Africa

CPI: Goods inflation

PPI: Final manufactured

goods

Monetary Policy Review December 2014
There is evidence of pressure on firms’ costs in producer price indices (PPIs),
which measure input price changes (at various stages of production) as
experienced by South African goods producers. Although the PPIs cannot
be interpreted as direct inputs into the CPI, there is close co-movement
between headline PPI – the PPI for final manufactured goods – and the
CPI for goods inflation. During the first four months of 2014, the PPIs
for both intermediate and final manufactured goods increased robustly,
owing to exchange-rate pressures (proxied by the import unit value index)
as well as high PPI food prices. However, by May this trend had reversed,
foreshadowing the moderation in headline CPI. PPI inflation nonetheless
remains high and well above CPI.
Domestic expenditure
The main expenditure drivers of the private-sector economy are household
final consumption expenditure and private-sector gross fixed capital
formation. Both these forces have been trending gradually weaker since
mid-2013, resulting in a negative output gap and therefore little inflationary
pressure from the demand side. New estimates of the output gap, described
in Box 1, suggest it may be smaller than previously estimated. The
implications of this adjustment for inflation are mostly in the future: with
a smaller output gap, the economy will reach full capacity sooner, at which
point demand pressures will start to generate inflation.
Table 4 Growth in expenditure on GDP

Per cent*

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

Exports of goods and services...

Imports of goods and services...

* Quarterly data refer to quarter-on-quarter growth at seasonally adjusted annualised rates at 2005 prices
Source: South African Reserve Bank
Final consumption expenditure by households is the single biggest component
of demand, accounting for more than 60 per cent of gross domestic
expenditure. Growth in this category has been weak for several reasons. Real
disposable income has increased only moderately and job creation has been
limited. Credit extension has been weak. Households are highly indebted and
are therefore deleveraging, which is necessary but constrains final demand.
House price growth has been muted. In this context, consumer confidence
is predictably low.
Percentage change over 12 months

Figure 18 Producer prices and the

exchange rate

Intermediate manufactured goods

Exchange rate (right-hand scale)
Sources: Statistics South Africa and South African
Reserve Bank

Percentage change over 12 months

Figure 19 Producer price pressures

Intermediate manufactured goods

Final manufactured goods

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


Source: Statistics South Africa

-6
-4
-2

Growth in real disposable income*

Repurchase rate

Debt to disposable income (right-hand scale)
* Percentage change over previous quarter at a
seasonally adjusted and annualised rate
Source: South African Reserve Bank

Figure 20 Household income and

debt levels
Per cent
Monetary Policy Review December 2014

Credit extension to households has followed a 22-month downward trend.
This pattern combines two factors: mortgage credit, which constitutes
most of the stock of household credit and which was a key growth driver
in the pre-crisis boom years, has contracted in real terms since the crisis.
Meanwhile, smaller volume, higher interest-rate categories of credit have
slumped after a period of strong growth. Instalment credit, which is mostly
used for vehicle purchases, has been expanding more slowly since May
2013. Unsecured lending, which is included in general loans, contributed
to improved household expenditure after 2009 but has fallen steeply since
the beginning of 2013. The aftermath of the African Bank Investments
Limited intervention may also be contributing to hesitance in unsecured
credit extension.
Rising asset-price developments have been somewhat more favourable
for households, supporting confidence and spending, but the gains have
been mostly in the equity market. Over the past two years, house prices
have staged a recovery after an extended period of weak, and, at times,
negative real growth. Real house prices have yet to regain their pre-crisis
peak, however, and the recovery is likely to remain subdued as interest-rate
increases raise the cost of debt.
The performance of the FTSE/JSE All-Share Price Index (Alsi) has been
more impressive, recovering from the crisis to record highs. In June 2014
the Alsi breached the 50 000 level for the first time, aided by non-resident
net purchases amounting to a cumulative R111 billion since the beginning
of 2009. It retreated sharply from the end of September to below 47 000
points, in line with global equity movements, but has since staged a partial
recovery. These broad developments have provided quite limited support to
household spending, however, as evidenced by indicators such as consumer
confidence. One explanation for this is that overall wealth gains from
investing in the equity market since 2007 remain muted when adjusted for
currency depreciation and inflation. A second explanation is that equity
ownership is quite concentrated in South Africa, such that wealth gains in
this sector have a limited impact on overall household demand.
Households are therefore not contributing significantly to inflationary
pressure, at least not through the demand channel. It is, however, quite likely
that households are feeding inflation indirectly through two channels. First,
stronger credit growth over the past few years has been seen in categories
with significant import intensities, especially for consumer durables such
as cars and household appliances. These have contributed to the currentaccount deficit and thereby weakened the exchange rate. The implication
is that the recent slowdown in these credit categories will benefit inflation
by moderating the current-account deficit. Second, debt accumulation has
evidently become a major burden on households, driven by strong postcrisis debt growth in credit categories with higher interest rates, notably
unsecured lending. Squeezed households are more likely to push for larger
wage increases to help rectify their balance sheets, which may help explain
high wage demands, protracted strikes and above-inflation wage settlements.
Percentage change over 12 months
-5

Figure 21 Bank credit to households

and retail sales

Credit excluding mortgage loans

General loans

Real total credit

Real retail sales (right-hand scale)*
* Smoothed average
Sources: Statistics South Africa, South African Reserve
Bank and own calculations

2013 2014

-5

Percentage change over 12 months


Figure 22 Real house and share prices

FTSE/JSE All-Share Price Index

Absa house prices (right-hand scale)
Sources: JSE Limited, Absa, Statistics South Africa
and own calculations

2013 2014

-15
-10
-5

Indices: 2 January 2007 = 100
Index

Figure 23 Share prices

JSE All-Share Price Index

JSE All-Share Price Index (US$)

S&P 500 price index

RMB/BER Business Confidence Index

(right-hand scale)
Sources: JSE Limited; Bloomberg; Bureau for
Economic Research; Stellenbosch University;
and own calculations

2013 2014

Monetary Policy Review December 2014
The other crucial driver of domestic spending, private-sector investment,
has been even more muted than household demand. Private gross fixed
capital formation contracted in the second quarter of 2014, for the first time
since 2009, echoing weak business confidence. The Rand Merchant Bank/
Bureau for Economic Research (RMB/BER) Business Confidence Index
had been below the 50-point neutral level for six consecutive quarters up to
the third quarter of 2014. Manufacturing capacity utilisation has also been
low, suggesting little scope for additional investment.
By contrast, credit extension to corporates has picked up recently, both
in terms of mortgage lending and general loans. This has supported
overall growth in total credit extension to the private sector from a low in
December 2013 to 8,8 per cent in September 2014. Nonetheless, this is
fairly unremarkable when compared to the 10-year average growth rate of
12,9 per cent.
The Bank’s inflation forecasts
After January 2014, inflation forecasts for this year have remained close
to but above the 6 per cent upper end of the target range. By contrast,
headline inflation forecasts for 2015 and 2016 have remained within
the target band, fluctuating between 5,3 per cent and 5,9 per cent over
successive MPC meetings. Positive developments in global food and oil
prices caused an improvement in the November outlook, especially for
2015 and 2016. However, core inflation looks set to continue its upward
trend until early 2015.
The 2015 headline inflation forecast has declined over time, assisted by
higher interest rates and more recently by the expectation of lower global
inflation. It increased briefly in July 2014, owing to a less favourable
food price forecast, but recovered in September as petrol prices weakened
and it became clear that excellent grain harvests were to be expected
both domestically and internationally. At the same time, the outlook for
electricity prices deteriorated when the National Energy Regulator of South
Africa announced that it would allow Eskom to recover revenue losses of
R7,8 billion by increasing its 2015 and 2016 prices by more than previously
announced. This news was incorporated into forecasts as an 11,6 per cent
increase in electricity costs in July of both these years, resulting in an upward
adjustment to the inflation forecast of approximately 0,1 per cent for 2015
and 0,2 per cent for 2016.
The Bank’s most recent inflation outlook as at November 2014 has improved
again following further petrol price cuts prompted by lower international
crude oil prices – which are also likely to further reduce food prices as the
two are highly correlated. As a result, headline inflation is now expected
to return to within the target at 5,9 per cent by the fourth quarter of 2014.
Inflation in 2015 is projected to average 5,3 per cent, which if realised would
be a four-year low.
Index
Percentage change
-30
-20
-10

Figure 24 Private-sector investment and

business confidence

Gross fixed capital formation of private

business enterprises*

RMB/BER Business Confidence Index

(right-hand scale)
* Percentage change over previous quarter at a seasonally
adjusted and annualised rate
Sources: Bureau for Economic Research; Stellenbosch
University; Rand Merchant Bank; and South African
Reserve Bank

Per cent
Figure 25 Evolution of the Bank’s targeted

inflation forecasts

Note: This graph denotes forecasts of average annual targeted
inflation as at each of the MPC meetings held since
November 2013

Jan
Nov
Mar

Jul
Sep
Nov
May

Source: South African Reserve Bank
Figure 26 Targeted inflation* forecast
Per cent
3–6 per cent inflation target range
* CPIX for metropolitan and other urban areas until the end
of 2008; CPI for all urban areas thereafter
Source: South African Reserve Bank

Monetary Policy Review December 2014

The outlook for core inflation3 has developed less favourably. Core inflation
is forecast to overtake headline inflation in 2015, averaging 5,7 per cent for
the year, with a peak in the first quarter of 2015 at 5,9 per cent. This should
mark the high point of a long upward trend in core inflation dating back
to 2011 – evidence of sustained, broad-based inflationary pressure which
has been a significant concern for the MPC. The outlook for 2016 is more
favourable, however, with this year’s interest-rate hikes and lower oil prices
contributing to more moderate underlying inflation of about 5,3 per cent.
The risks to headline inflation have evolved such that there is now an
equal probability of outcomes above or below the central projection,
that is, the risks are balanced. The key upside risk factors remain the
exchange rate and the interaction between high wage settlements and
prices. However, headline inflation could surprise on the low side
if food and petrol prices decline further. In particular, the oil price
assumption is above the lows reached in November. It is very difficult
to forecast both oil and food prices and the exchange rate, as the review
of previous forecasts in Box 3 attests, creating significant uncertainty in
the inflation outlook.

The measure of core discussed here is CPI excluding food, non-alcoholic beverages, energy and petrol prices.
Percentage change over 12 months


Figure 27 International food and crude

oil prices*

FAO Food Price Index

Brent crude oil price (right-hand scale)
* Prices are in US dollars
Sources: International Monetary Fund, Food and
Agriculture Organization (FAO), Reuters and own
calculations


Per cent
Figure 28 Evolution of the Bank’s core

inflation forecasts

Jan
Nov
Mar

Jul
Sep
Nov
May

Note: This graph denotes forecasts of average annual core
inflation as at each of the MPC meetings held since
November 2013
Source: South African Reserve Bank
Per cent
Figure 29 Targeted and core inflation

forecasts

Targeted inflation

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

Core inflation
Box 3
Inflation forecast accuracy
In a forward-looking inflation-targeting framework, monetary policy decisions require
forecasts of key economic variables, including inflation. To evaluate the accuracy of these
inflation forecasts, they are contrasted to actual outcomes using specific error statistics.
The accuracy of the forecasts obtained from the chosen error measures are then
compared to outside forecasters’ accuracy. For the purposes of this analysis, accuracy
is evaluated over two periods. The first period (P1) is up to and including the worst of the
financial crisis – the sample begins in the first quarter of 2003 and ends in the third
quarter of 2009. The second period (P2) is after the crisis nadir and stretches from the
fourth quarter of 2009 until the second quarter of 2014.
Two common error statistics are used, namely the average forecast error and the root
mean square error (RMSE).1 The error statistics are calculated for both the Bank and
Reuters consensus forecasts, after subtracting the inflation outcomes from their
projections. The average forecast error measures projection bias in terms of systematic
over- or underestimation. Meanwhile, the RMSE gives an indication of both the size and
the variability of the errors.
Both the Bank and Reuters’ average errors are negative for most of the forecast quarters
during period P1 and thus biased downwards. This suggests that these projections have
underestimated the actual outcome of headline CPI inflation, on average, before and
during the crisis. However, the opposite is true for period P2 where the pattern of the
average forecast error is largely reversed. Here, the bias is to the upside, which indicates
that both the Bank and the average of Reuters’ forecasts overestimated the outcomes of
inflation, on average, for most of the quarters over the post-crisis period.

Monetary Policy Review December 2014
The RMSE (Figure B3.2) gives an approximation of the magnitude of the errors. This
measure shows that the Bank’s forecast is marginally more accurate than the Reuters
consensus forecast for all seven forecast quarters over the period up to and including the
crisis, and for the first four quarters in the post-crisis period. In period P1, the RMSE for
the four-quarters-ahead inflation forecast of the Bank is 2,0 percentage points, while that
of the Reuters average is 2,4 percentage points. For the period P2, the RMSEs of the
Bank and Reuters decline by 1,2 and 1,4 percentage points to 0,8 and 1,0 percentage
points, respectively. This post-crisis improvement in forecasting accuracy largely relates
to the relative stability of inflation over this period, as opposed to the high variation of
inflation rates that were seen in the pre-crisis period.
Sizeable inflation forecast errors result from South Africa being a small and open
economy, subjected to a number of large external shocks. This was particularly evident
during the period up to and including the financial crisis. These shocks mostly emanate
from significant movements in international oil and food prices which transmit quickly to
inflation. The free-floating rand exchange rate also moves rapidly at times and has a
marked effect on the price of imports. These large price movements pose significant
challenges to forecasting inflation. As the forecast horizon extends into the future, the
uncertainty surrounding future shocks increases and, as a result, the forecast accuracy
tends to worsen.

The root mean square error is the square root of the average of squared forecast errors.


0,4
Percentage points

Core P1

Core P2
Sources: Reuters consensus and own calculations

Reuters P1

Reuters P2
Figure B3.1 Average forecast error
Quarters ahead


Percentage points

Core P1

Core P2
Sources: Reuters consensus and own calculations

Reuters P1

Reuters P2
Figure B3.2 Root mean square error
Quarters ahead
Monetary Policy Review December 2014

Global economic assessment
Forecasts for world economic growth have fallen in 2014, as indeed they
have every year since 2011. The outlook for 2015 is for improved growth,
albeit just over 3 per cent, which is a lower level than in previous forecasts
for the coming year and also much closer to the average growth rates of the
past three years. Put more simply, forecasts have now caught up with the
disappointing realities of the recent past.
Advanced economies
In the advanced-economy universe, there is a marked divergence between
the US and UK, which are now growing strongly, and the euro area and
Japan, which have once again stalled.
At the end of 2013, most commentators were optimistic that the US
economy was about to experience a robust recovery after several false starts.
The first quarter instead delivered a large growth contraction, owing mostly
to unusually bad weather, and this predictably yielded a strong rebound
in the second quarter, for an overall inconclusive growth performance for
the first half of the year. The third quarter provided more encouraging
news with a better-than-expected 3,9 per cent growth rate (according to
the advance estimate), and leading indicators promise a strong finish to
the year, with the manufacturing Purchasing Managers’ Index (PMI) at a
44-month high.
Unemployment outcomes have been encouraging all year, with
unemployment slipping below 6 per cent in September and job creation
averaging nearly 230 000 monthly in 2014. Wage growth has been more
limited, however, and this, along with muted inflation and the low labour
force participation rate, suggests persistent labour market slack. The Fed
has judged this progress adequate to conclude its programme of quantitative
easing in October, as expected, but is only anticipated to move the policy
rate off the zero lower bound sometime in mid-2015, with rates increasing
gradually thereafter.
The UK has claimed the mantle of fastest-growing economy in the G-7
for 2014, a title only partly earned by the earlier weakness of its recovery.
Revisions to GDP data have altered the narrative of the crisis, with output
now seen to have fallen less and recovered sooner than originally thought.
In particular, the latest data indicates that the UK regained its pre-crisis
peak in the third quarter of 2013 instead of the second quarter of 2014.
Unemployment peaked at 8,5 per cent during the second half of 2011, but
has since declined much faster than expected, reaching 6 per cent at the
end of the third quarter of 2014 alongside an employment rate close to its
record high. Inflation, meanwhile, has fallen below the 2 per cent target
and might well drop below 1 per cent – which will likely postpone the first
rate increases since the crisis. An additional delaying factor is the British
recovery’s exposure to risks from the broader world economy, particularly
stagnation in the euro area and fraught relations with Russia.
In contrast to the US and the UK, the euro area’s prospects have deteriorated
over the year, with two developments of particular concern. The first is
the relocation of slow or negative growth from the periphery to the centre.
Of the two largest euro area economies, France and Germany, France
has been stagnant since mid-2012, with government spending sustaining
Per cent


Figure 30 Evolution of global real GDP

forecasts*

Actual GDP

March 2014

July 2014

November 2014
* Data weighted by market exchange rates
Source: Consensus Economics

January 2014

May 2014

September 2014


2,7
3,1
Index points
Figure 31 Selected advanced-economy

Purchasing Managers’ Indices

United States

Germany

United Kingdom
Source: JPMorgan
2007 2008
2011 2012 2013 2014
2009 2010

Euro area

France

Japan
Per cent of total labour force
Figure 32 Unemployment

Advanced economies

Euro area

Major advanced economies G-7

Other advanced economies*

United States

United Kingdom
* Advanced economies excluding the G-7 and euro area
Source: International Monetary Fund, World Economic
Outlook, October 2014

Monetary Policy Review December 2014
demand through large fiscal deficits alongside feeble private consumption
and investment. Germany, meanwhile, contracted in the second quarter of
the year. This dip could, in part, be blamed on weather effects, but deeper
risks to growth seem to underpin recent disappointing manufacturing data
– especially the slowdown in China and the effects of Russian sanctions and
counter-sanctions. Reflecting these weaknesses, the European Commission
slashed its November forecasts for 2015 growth in both these countries,
taking France from 1,5 per cent to 0,7 per cent and Germany from 2 per
cent to 1,1 per cent. These contrast unfavourably with the forecast for the
euro area as a whole, revised down from 1,7 per cent to 1,1 per cent – a
demonstration of the weakness of the centre.
The second problem is extremely low inflation. The Harmonised Index of
Consumer Prices grew a mere 0,4 per cent in October 2014, far below the
ECB’s 2 per cent target. Inflation expectations have also fallen, including
even expectations for five years ahead, threatening a deflationary experience
similar to Japan’s. The ECB has responded with a slew of initiatives including
negative rates, the creation of special loan facilities to banks to encourage
lending, and asset purchases. These policies are aimed at adding about
€1 trillion to the ECB’s balance sheet, restoring it to 2012 levels of about
a third of euro area GDP. The consequences for inflation have so far been
limited, although the new programmes remain in their infancy. The most
tangible gain so far has been a weaker euro, down 11 per cent against the
US dollar since May 2014, which may help raise inflation and support
expectations. This effect, however, is likely to be neutralised by falling oil
and food prices.
In Japan, growth in the first half of the year was volatile as consumers
brought spending forward to avoid a value-added tax (VAT) increase,
producing a large boost in the first quarter and an offsetting bust in the
second. Overall output dropped slightly from the beginning of the year to its
mid-point, and then fell further in the third quarter, indicating significant
economic fallout from the tax hike. Fiscal policy, originally one of the three
arrows of Abenomics, has thereby instead become a threat to short-term
growth. Monetary policy, however, has become even more aggressive, which
is an extraordinary shift given that the BOJ was already enacting the most
radical balance-sheet expansion of the big advanced-economy central banks,
having accumulated assets worth more than half of GDP – compared to
approximately a quarter for the Fed and the Bank of England. Under the new
policy, the BOJ will acquire even more government debt, shifting annual
purchases from ¥50 trillion to ¥80 trillion a year and also buying longer
maturities, extending its lead as the largest holder of Japanese government
bonds (with about 20 per cent of the total). It will also purchase stocks and
property funds. The goal of these policies is to achieve a 2 per cent inflation
target, and although inflation has turned positive and is in fact just over
3 per cent, much of this effect comes from the VAT increase and will therefore
drop out of the data in early 2015. What remains is inflation consolidated
around 1 per cent, which is a victory over deflation but not yet the target.
The broader problem for Japan is that higher inflation without corresponding
growth and wage increases will simply lower living standards. In this way,
a ‘one arrow’ strategy, lacking fiscal and structural reform components,
could be self-defeating. The result – protracted stagnation – would also be a
serious concern for the global recovery. In the pre-crisis period, world output
could flourish despite Japan’s weakness thanks to fast growth (sometimes
Per cent
-1

Figure 33 European Central Bank and

United States Federal Reserve

interest rates

ECB refinancing rate*

US Fed funds target rate*

ECB deposit rate
* Both forecasts are proxied by Consensus Economics
projections of three-month rates – the Treasury bill rate for the
Fed and Euribor rate for the ECB
Sources: Datastream, Consensus Economics and
own calculations

Per cent
Figure 34 Growth rates in advanced

economies

World

Japan

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

United States

Advanced economies

United Kingdom
-6
-4
-2

Indices: 2 January 2008 = 100
Figure 35 Central bank balance sheets*

US Federal Reserve

European Central Bank
* The calculations above are based on local currency values

of the selected countries’ balance sheets
** There is a break in the balance sheet disclosure by the Bank

of England from October 2014 in which bilateral operations are

excluded. As a result, from October 2014 the weekly reported

assets have been used
Sources: US Federal Reserve, Bank of England, European
Central Bank, Bank of Japan and own calculations

2011 2012 2013 2014 2015
2009 2010

Bank of England**

Bank of Japan
Monetary Policy Review December 2014

excessively fast) in the US and euro area, as well as in China and many
other emerging markets. But now much of this growth has abated and the
Japanese contribution is more visible for its absence.
Emerging markets
In the immediate aftermath of the crisis the world seemed to be experiencing
a two-speed recovery, with advanced economies stumbling and emerging
markets speeding ahead; as late as April 2013 the IMF could insist that,
“Emerging market and developing economies are still going strong...”.4
This position has now yielded to something close to its opposite, with hopes
for the world recovery centring on the US and other smaller advanced
economies, and emerging markets generally slowing.
That change in fortune has varying origins, with the Chinese experience
quite distinct from that of other large emerging markets. In China, the
surprise is not so much the slowdown as the fact that it took so long to
happen; as Larry Summers and Lant Pritchett have recently observed, no
other economy in history has grown so fast for so long.5 Slower growth is
appropriate as the Chinese economy matures, switching its growth drivers
from investment and exports to consumption. This will also be helpful for
the world economy as it will reduce current-account and savings imbalances
and bolster demand. In the short term, however, China’s transformation
poses a number of risks. It has become such a large economy that it cannot
reduce speed without also bringing down the world growth rate. Its appetite
for commodities has delivered windfall gains for commodity exporters, but
these countries are now also feeling their vulnerability to lower commodity
prices as Chinese demand wanes. It is also uncertain whether China can
manage to slow just the right amount; many observers have warned of the
possibility of a hard landing, a cliché that nonetheless describes a serious
risk. The property sector in particular has seen bubble-like conditions, with
excessive construction leading to large unsold inventories.
Through much of the fast-growth period, China has solved its economic
problems with more investment. This pattern has persisted through
2014, with stimulus packages following promptly on fears of below-target
growth. Over time, this model has delivered stellar GDP results but also
unprecedented levels of debt (217 per cent of GDP in 2013, excluding
financial sector borrowing, of which 168 per cent is private, according to
the Geneva Report) as well as investment (at around 50 per cent of GDP).6
Perhaps the overriding challenge for Chinese rebalancing is maintaining
growth without resorting to even more saving and investment – a recourse
that has almost certainly become unsustainable.
Other big emerging markets look quite different to China. Where China
runs a current-account surplus, and would like to reduce investment, the
average large emerging market reports a deficit and aims to raise savings
and investment. Chinese inflation has been very low and stable, but for
the average emerging market peer inflation has been rising, and many
central banks have responded with rate hikes (including Brazil, Indonesia,
Turkey, Russia and South Africa). China joins other emerging markets in

International Monetary Fund, World Economic Outlook, April 2013, page xiii.

L Pritchett and L H Summers, ‘Asiaphoria meets regression to the mean’, NBER Working Paper 20573,
October 2014.

L Buttiglione, P R Lane, L Reichlin and V Reinhart, ‘Deleveraging? What deleveraging?’ Geneva Reports on the
World Economy, No. 16, September 2014, p 12.
Index points
Figure 36 Selected emerging-market

economy Purchasing Managers’

Indices

Russia

South Africa

Brazil
Source: JPMorgan, Bureau of Economic Research;
Stellenbosch University; and Kagiso

China

India

Per cent
Figure 37 Growth rates in emerging-market

economies

World

Brazil

Emerging-market and

developing economies
Source: International Monetary Fund, World Economic
Outlook, October 2014

China

Nigeria

Sub-Saharan Africa
-3

Industrial production

Real GDP growth (right-hand scale)
Source: Bloomberg
2013 2014

Figure 38 Growth in China’s industrial

production and economic

activity
Percentage change
over 4 quarters
Percentage change
over 12 months

Monetary Policy Review December 2014
having experienced falling growth, but Chinese growth remains well above
levels seen elsewhere and Chinese policymakers are deliberately targeting a
reduced pace of expansion.
The current emerging-market slowdown has been surprisingly widespread
and protracted. Previous episodes aligned with crisis episodes (as in 1994,
1997–1998 and 2008–2009) and ended comparatively quickly.7 In this
instance, the culprit is elusive: different factors apply to different cases.
For commodity exporters, particularly in Latin America, declining terms
of trade damaged growth and pushed current accounts into deficit. Loose
monetary policies, aided by capital inflows from advanced economies,
powered credit booms that left balance sheets overstretched – typically
in the private sector – necessitating a period of consolidation. Easy credit
may have lulled policymakers into deferring structural reforms, lowering
potential growth. A weak world economy has also undermined export-led
growth, long a staple strategy of the most successful emerging markets. In
some instances, especially in the Middle East, North Africa, Russia and
Ukraine, geopolitical instability has profoundly affected economies.

G Fayad and R Perrelli, ‘Growth surprises and synchronized slowdowns in emerging markets – an empirical
investigation’, IMF Working Paper WP/14/173, Washington: IMF, September 2014. See
external/pubs/ft/wp/2014/wp14173.pdf.
Per cent
Figure 39 Policy rates

India

Malaysia

Chile
Source: Bloomberg
2007 2008
2011 2012 2013 2014
2009 2010

Indonesia

Brazil
Monetary Policy Review December 2014

Domestic growth outcomes
South Africa’s economic performance has been seriously damaged by strikes
in 2014. The economy contracted by 1,6 per cent during the first quarter
of 2014 – the first contraction since 2009. This was followed by a weak
recovery of 0,5 per cent in the second quarter, rising to 1,4 per cent in the
third quarter.
Table 5 Real domestic growth rates
Per cent*
Sector

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


Finance, real-estate and

* Quarterly data refer to quarter-on-quarter growth at seasonally adjusted annualised rates at 2010 prices
Sources: Statistics South Africa and own calculations
Given the timing of and the sectors affected by strikes, it is no surprise
that losses have been concentrated in mining and manufacturing, and
particularly in the first half of the year. The economy began to recover
in the third quarter, and some platinum producers returned to full
capacity by October, earlier than expected, suggesting that the primary
sector will support fourth-quarter growth.
Other sectors of the economy have fared better. Agriculture and services
have been positive throughout the year. An ample maize harvest (noted in
the inflation section) has bolstered growth in the primary sector, and the
tertiary sector has continued to expand, with financial and business services
the outstanding contributor. The wholesale and retail trade sector, however,
experienced a contraction in the second quarter of 2014.
Leading indicators suggest an economy picking up from strike disruptions.
The PMI has been rising since July and cleared the 50-point level (denoting
expansion) in October, promising better growth in the fourth quarter.
Consumer confidence has risen from extremely low levels in late 2013
and early 2014 (worse even than during the 2008–2009 crisis), although
it remains significantly below its long-term average. The composite leading
business cycle indicator has been edging up from lows in the first half of the
year, but is still under 2013 levels. These data are consistent with forecasts
of higher, but not high growth.
Million days
Per cent

Figure 40 Real economic activity and

strike action

Final consumption expenditure by households*

GDP***

Work days lost to strike action

(right-hand scale)**
* Data for 2014 are for the first two quarters of the year
** Data for 2014 are for the first three quarters of the year
*** Growth in unadjusted GDP for the first three quarter of
2014 compared with the same period in 2013
Sources: Statistics South Africa, South African Reserve
Bank and Andrew Levy Employment Publications

1996 98 2000 02

-4
-2

Composite leading business cycle indicator

PMI neutral level (right-hand scale)

Purchasing Managers’ Index (right-hand scale)
Note: The direction of movements of the composite
leading business cycle indicator show the expected
movements in aggregate economic activity over the
next 6 to 12 months
* Data are seasonally adjusted
Sources: Bureau for Economic Research; Stellenbosch
University; Kagiso; and South African Reserve Bank

Figure 41 Forward-looking growth

indicators *
Index: 2010 = 100
Index

Monetary Policy Review December 2014
Given the distorting impact of strikes, 2014 is quite an unhelpful year for
understanding the economy’s trajectory since the crisis. Taking a longer
view, the economy has expanded, in real rand terms, by about 2,5 per cent
per year since 2009 and the second quarter of 2014. Growth in 2010 and
2011, which includes the inevitable post-crisis bounce, averaged 3,4 per cent.
Since then, average growth has slowed to just 2 per cent. Throughout, the
strongest contributor has been household consumption, which constitutes
the largest share of GDP. But the sustainability of this growth is threatened
by its reliance on debt and imports, exposing it to constraints from household
balance sheets and the current-account deficit.
Private-sector investment has been one of the great disappointments of the
post-crisis period. Although its growth has been positive since 2010, it has
been low at roughly half the rates achieved before the crisis – despite very
favourable monetary policy settings. The result has been not only lower
short-term growth, but also weaker foundations for long-term growth,
contributing to falling estimates for potential output. Lower potential
growth in turn means inflation picks up even at low growth rates, placing
a serious constraint on policy. A number of factors influence private-sector
investment decisions. Business confidence, one strongly correlated indicator,
has been volatile but usually below neutral over the period, with longer-term
components such as building and manufacturing indices particularly low.
This pattern has persisted through 2014 even as other indicators such as the
PMI and consumer confidence have picked up.
Table 6 Domestic economic sentiment indicators
Historic range
Most recent
As at MPR*
Low
High
Low
High
Jun

Dec


-8

-8
-1
* Improved/worsened since previous MPR
Sources: Kagiso Securities, Rand Merchant Bank, First National Bank, Ernst & Young and the Bureau for Economic
Research, Stellenbosch University
Government’s role as a source of counter-cyclical demand is visible in its
relatively large contributions to overall growth – almost a quarter of the
total expansion since 2009. As with household consumption, this has
provided welcome support to the economy but also created vulnerabilities,
particularly through an expanding debt burden. The public sector has also
accounted for all net job creation in South Africa since the crisis, whereas
private-sector employment has yet to regain 2008 levels.
Finally, the contribution from net exports has been negative since the
crisis (although positive in some quarters, such as at the start of 2014). Net
exports represent South Africa’s borrowing from abroad to fund imports of
consumer and investment goods above what exports can pay for. Because
this imbalance has become a significant vulnerability for the economy, it
merits a more extensive discussion.
Percentage points

Figure 42 Contributions to real gross

domestic product

Household consumption

Government expenditure**
* 2014 data are up to the second quarter at 2005 prices
** Government expenditure includes consumption and investment
expenditure of government
Source: South African Reserve Bank


Private-sector investment

Net exports
2012–2014*
2010–2014*
Figure 43 Formal non-agricultural

employment and GDP*

Total

Private sector

Public sector

Real GDP excluding agriculture
* Data are seasonally adjusted
** Public-sector employment increased temporarily in the
second quarter of 2014 due to elections
Sources: Statistics South Africa; Quarterly Employment Statistics;
and South African Reserve Bank
Indices: 2008 Q1 = 100
**
R billions
R billions

Figure 44 Real exports and imports of

goods and services*

Exports

Net exports (right-hand scale)
* Data are seasonally adjusted at an annualised rate
Source: South African Reserve Bank

Imports


Monetary Policy Review December 2014

The current account and slow growth
South Africa runs large current-account deficits during periods of growth,
as an expanding economy sucks in imports. Symmetrically, the current-
account deficit typically closes during periods of weak growth and crisis,
as investment flows abate and confidence fails, as in 2009. The change is
driven by the trade account, which swings between surplus and deficit. The
services, income and current transfer account, by contrast, is more stable
and always in deficit, reflecting our borrowing from foreign savers.
South Africa’s tendency to run a trade deficit whenever growth is healthy
is unsurprising. We are a small, open economy with a low savings rate, and
we benefit from importing advanced technology and scarce resources from
countries with better endowments of those goods. Historically, an increase
in the growth rate has been associated with more net imports, with 1 per
cent extra growth detracting about 1,4 per cent from the trade balance.
Since the crisis, however, significantly slower growth has not also produced
a much smaller trade deficit.
One explanation for the shift is that growth is also weak abroad, reducing
demand for our exports. In part, this has to do with a slowing, rebalancing
China consuming fewer commodities, as reflected in a falling terms of
trade. Another aspect is the protracted euro area crisis, which has flattened
consumption in a region that remains the single largest destination for
South African exports. Other advanced economies have also been weak,
although the US and UK are now rebounding.
Our export performance has also been hampered by competitiveness
problems. A sustained depreciation in our exchange rate should have made
our exports much more attractive in global markets (and supported importcompeting industries locally), helping to shift the trade account back towards
surplus through a J-curve. The actual adjustment, however, is proceeding
very slowly. Part of the problem is that the exchange-rate advantage has been
tempered by rising domestic prices, with inflation rates markedly above
our peers’. Electricity shortages and labour disruptions have also dragged
on the tradeables sector, which may explain why it has declined relative to
the non-tradeables sector (which is dominated by wholesale, retail, finance
and government). It is the tradeables sector that benefits from exchange-rate
depreciation; the smaller and weaker it is, the slighter the depreciation benefit
to growth and net exports.
South Africa’s import appetite, by contrast, remains robust. There are
several explanations for this pattern. One is that low pass-through softens
incentives to avoid imports, moderating inflation but also flattening the
J-curve. Another is that capital goods imports are necessary for longstanding
investment plans which cannot be easily deferred. Similarly, South Africa
imports inputs into other goods and services for which there may not be
readily available domestic substitutes. The structure of South African
imports is approximately 20 per cent consumer goods, 20 per cent capital
goods and the remainder intermediate inputs, of which roughly a third is oil.
Some relief from falling oil prices may be anticipated, but this could be
qualified by lower export prices for goods such as coal, platinum and
iron, which also respond to lower world growth prospects. Some import
compression may also be expected as credit extension slows.
Per cent
R billions
Figure 45 Trade and current accounts*

Balance on current account

Trade balance

Current account as a ratio of GDP

(right-hand scale)


* Data are seasonally adjusted
Source: South African Reserve Bank


Indices: 2005 = 100
Figure 46 South Africa’s exports and

consumption expenditure

of selected export partners

South Africa’s volume of merchandise exports

United States nominal consumption expenditure

United Kingdom nominal consumption expenditure

Euro area nominal consumption expenditure
Sources: South African Reserve Bank; Bureau of Economic
Analysis; ‘Personal income and outlays’, Eurostat; and the
Office for National Statistics

Indices: 2010 = 100

Figure 47 Nominal and real effective exchange

rates of the rand

Real effective exchange rate of the rand

Nominal effective exchange rate of the rand

(right-hand scale)
Source: South African Reserve Bank

Monetary Policy Review December 2014
In contrast to the fluctuating trade account, the services, income and current
transfer account is always in deficit. This is the natural consequence of
sustained current-account deficits: foreigners will own increasing stocks of
assets on which they will enjoy returns. As South Africa becomes increasingly
integrated with the rest of the world, following its period of forced isolation,
these holdings will rise towards the levels seen in other countries which are
financially open and invest more than they save. However, investment and
therefore ultimately income payments are not strictly one-way as evidence
by unexpectedly high inflows in the first quarter of 2014. In recent years,
South African companies have been expanding abroad, including into the
rest of Africa (see Box 4). Over time, these asset holdings will offset some of
the income outflows to foreign investors and so help reduce pressure on the
current-account deficit.
Figure 48 Non-resident purchases of

equities and bonds*
-100

1994 96
98 2000 02

* Data up to 25 November 2014
Source: JSE Limited
Cumulative net
equity purchases
Cumulative net
bond purchases
R billions
Figure 49 The disaggregated current-

account balance*


R billions

Current-account balance

Services, income and current transfer account
* Data are seasonally adjusted at an annualised rate
Sources: South African Reserve Bank and own calculations

Trade account
Box 4
Trends in international income flows
South Africa’s openness has increased following a period of extreme isolation ending in
the 1990s. This change is best represented by the current account; the magnitude of
the trade account and the services, income and current transfer (SIT) account totals
have increased dramatically, particularly in the past ten years, representing increased
trade and investment between South Africa and the rest of the world. Although this
openness is a source of volatility in our exchange rate and foreign capital flows, such
volatility is rarely transmitted to the real economy. More importantly, our openness
facilitates South Africa’s access to international markets, which is an essential factor for
long-run economic growth.
South Africa has repeatedly seen large net inflows of foreign capital, causing a
structural deficit in the SIT account. Within this deficit, the income component
dominates, comprising net dividend, interest and other1 receipts. Interest payments
related to foreign debt of the public and private sector increased substantially over the
quantitative easing periods from 2009 to 2014, yet equity purchases by non-residents
had been growing even before the crisis. Over the past ten years, net dividend
payments accounted for 77 per cent of net income payments, spiking to 95 per cent
in late 2007.
Integration has also enabled a steady rise in foreign assets and associated receipts,
particularly through dividends paid to South African holders of foreign equities. Despite
the post-crisis growth slowdown, the FTSE/JSE All-Share Price Index has reached new
highs over the past three years. Hassan and Paul (2014)2 analysed equity issued3 on
the JSE from 2012 to 2014.4 The amount of capital raised through equity issuances has
increased over each of the years, yet this was not related to increased domestic
investment activity or in anticipation of higher aggregate demand. Instead, the authors
found that by 2014 at least 46 per cent of these issuances had been raised for
investment abroad.5
Hassan and Paul’s findings indicate that South African firms are expanding abroad more
aggressively, although it will take time for this expansion to result in significant dividend
inflows to South Africa from new operations.6 At least some of this expansion continues
a trend of South African firms expanding into Africa, reinforcing the notion that Africa is
a particularly (and increasingly) important trade and investment partner for the country.

Percentage of GDP

Source: South African Reserve Bank
Receipts
Payments
Figure B4.1 Dividend payments

and receipts
Monetary Policy Review December 2014

The corollary of weak growth in South Africa’s trading partners has been
very loose monetary policy in those economies, lowering borrowing costs
and encouraging a search for yield. This has led to increased non-resident
demand for bonds and equities, purchases of which have financed most
of the current account deficit since 2010. Over the past five years, nonresidents have purchased net equities to the value of R38,3 billion and net
bonds worth R140,1 billion. However, South Africa’s substantial external
financing requirements create vulnerability to changing risk attitudes in
financial markets. South Africa saw dramatic capital outflows during the
May 2013 ‘taper tantrum’, and since then, non-residents have sold over
R62 billion of South African bonds (net).
The Bank’s growth forecasts
Since November 2013 the forecast for real GDP growth for 2014 has shrunk
to 1,4 per cent, lower even than 2013’s disappointing 2,2 per cent. Growth is
expected to pick up gradually in 2015 and 2016, but the pace of the recovery
is slower than previously anticipated, with growth still fractionally below
3 per cent in the second year of the forecast.
The main drivers of improved growth are really just returns to normalcy.
The world economy is expected to pick up from its current lows, led by
the US, thus raising exports. Similarly, the 2014 strikes were exceptionally
severe and are unlikely to be repeated. A more natural number of working
days will raise earnings and support consumer spending. Once this rebound
is effected, growth is expected to persist at levels above 2013 and 2014, but
below the pre-crisis period. Households are already heavily indebted which
will continue to suppress spending and confidence; household consumption
is therefore forecast to grow more slowly than overall GDP over the next
two years. Similarly, government’s need to consolidate its finances will also
depress demand growth. Investment from the public and private sector, is
expected to do better, especially in the outer years of the forecast as spending
plans by parastatals come to fruition and private-sector investment rebounds.
Larger flows and a structural deficit on the SIT account are not necessarily problematic.
This structural deficit cannot be considered in isolation; the macroeconomic context is
crucial. Thus the SIT-account deficit will be problematic if it is continuously accompanied
by a trade deficit (as large and persistent current-account deficits are undesirable) or if it
represents an unsustainable debt burden. However, alongside higher economic growth,
an offsetting trade surplus or real effective exchange-rate depreciation (encouraging a
trade surplus), a SIT-account deficit may be a sign of healthy investor attention and
domestic business activity.

Net other receipts were approximately 1 per cent of the total income component from 2004 to 2014, hence
they are excluded from discussion.

S Hassan and M Paul, ‘Recent capital raising by firms listed on the JSE: where is the money going?’, South
African Reserve Bank Economic Note EN/14/17.

Of the ten largest issuers, forming approximately 65 per cent of total equity issuances over the period.

Up to 4 August 2014.

For dual-listed firms, capital could be raised either through the JSE or the other exchange on which they
were listed, and not all firms specified the location of issuances.

Many large companies on the JSE are dual-listed, and the profit destination depends on the primary listing of
the company. Dividends will nonetheless flow to shareholders wherever they are resident.

2014**

R billions
Figure B4.3 Equity capital raised

by purpose*

Domestic purposes
* Excludes capital raised relating to share incentive schemes
** Data for 2014 are up to 4 August
Sources: Hassan and Paul (2014) and own calculations

Investment abroad

Percentage of GDP

Source: South African Reserve Bank
Receipts
Payments
Figure B4.2 Interest payments

and receipts
Per cent


Figure 50 Evolution of the Bank’s real

GDP forecasts

Actual GDP

January 2014

May 2014

September 2014
Sources: Statistics South Africa and South African Reserve Bank

2015 2016
2010 2011

November 2013

March 2014

July 2014

November 2014
1,4
2,5
2,9

Monetary Policy Review December 2014
Although the US remains the world’s largest economy, it will have little help
from other economies and will struggle to pull the world out of stagnation
by itself. Net exports for South Africa will therefore be constrained, both by
stronger investment (and therefore capital goods imports) and a paucity of
foreign demand.
Risks to growth
South Africa’s growth has long been constrained by deep structural factors,
with skills shortages and spatial legacies perhaps especially damaging.
These factors have lately been exacerbated by additional problems in the
form of dysfunctional labour relations and electricity shortages and these,
along with a struggling world economy, now pose the most acute risks to
resumed growth.
Strike action in 2014 has been unusually severe, carrying the threat of
longer and more violent strikes. Should these become the norm, the case
for investing in South Africa would be weakened and there would be
stronger incentives for substituting capital for labour. Large salary and wage
increases, in excess of productivity gains and inflation, are also a threat to
South Africa’s competitiveness. Such increases would potentially reverse real
exchange-rate gains and prolong the current-account deficit, high inflation
and weak growth.
Electricity-supply constraints have proven even tighter than originally
anticipated, presenting another barrier to investment, especially in the
manufacturing and mining sectors. Large new investments in capacity are
under way, particularly the Kusile and Medupi power stations, but even
once these come online existing capacity will be desperately in need of
maintenance and therefore electricity constraints will not be satisfactorily
lifted. November furnished an effective demonstration of the problem when
an accident at the Majuba power station in Mpumalanga forced rolling
blackouts, reminiscent of the electricity crisis of 2008.
Growth prospects are also at risk from external demand. A stronger US
economy should grow at around 3 per cent over the next two years, before
reverting to potential of about 2,1 per cent, but it has repeatedly failed to
achieve 3 per cent annual growth since the crisis. It is also unlikely that the
US can power a robust world recovery unaided. The euro area is expected
to see a moderate uptick in growth, but this is endangered by geopolitical
risks and weakness in the three largest economies, Germany, France and
Italy. China has so far managed a relatively smooth growth deceleration
but could still suffer a hard landing. Japan’s unexpected contraction in the
third quarter of 2014 suggests it will struggle to achieve a new era of growth,
especially if it also proceeds with VAT increases to improve its fiscal position.
Many emerging markets require difficult reforms to restore growth, and
some, including fast-growing sub-Saharan African countries, are exposed to
falling commodity prices and rising borrowing costs. In sum, global growth
confronts a host of risks and could quite easily fall below forecasts.
Figure 51 Real GDP growth forecast
Percentage change*


* At seasonally adjusted annualised rates
Source: South African Reserve Bank
Monetary Policy Review December 2014

Conclusion
Inflation has been high all year, either near the top end of the target or
above it. Expectations are clustered just above 6 per cent and core inflation
has persisted in its steady upward drift, from 3 per cent in early 2011 to
5,7 per cent in October 2014. However, positive oil and food price shocks
have recently lowered the headline inflation forecasts. Expected inflation
for 2015 has declined from 5,7 per cent to 5,3 per cent, and the risks to this
forecast appear quite evenly balanced.
Domestic growth has been weak. The economy has suffered a series of
short-term shocks, especially strikes. In addition, potential growth appears
to have declined. The output gap remains negative, although smaller than
previously estimated, and credit growth is slow, contributing to minimal
inflationary pressures from the demand side.
Domestic imbalances, meanwhile, are a source of vulnerability. Substantial
fiscal deficits since the crisis have expanded the state’s debt burden, and
growth is unlikely to rebound strongly enough that these deficits will fall
significantly without separate policy adjustments. The current account deficit
requires financing, exposing South Africa to changing risk assessments and
appetites in financial markets. This danger is mitigated by the floating
exchange rate, but further currency depreciation remains an inflation risk.
South Africa’s major macroeconomic settings are being adjusted. The pace
of fiscal consolidation has accelerated. Monetary policy has embarked on
a moderate rate-hiking cycle. This has so far taken the form of two rate
increases in six meetings, for a total of 75 basis points. The scale and timing
of future increases will depend on various factors, including inflation
expectations, wage developments and changes in the global financial
environment.

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

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

Statement of the Monetary Policy Committee
17 July 2014
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), the economic growth
outlook has deteriorated against the backdrop of protracted strike action in the mining
and manufacturing sectors. The economy contracted in the first quarter of 2014, and the
growth outlook for the rest of the year remains subdued amid low business confidence.
Compounding the MPC’s policy dilemma, inflation has breached the upper end of the
target range, driven primarily by the exchange-rate depreciation and rising food prices,
while a possible wage-price spiral resulting from recent wage settlements and wage demands
considerably in excess of inflation and productivity growth have added to the upside risk to
the inflation outlook.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas measured 6,6 per cent in May, up from 6,0 per cent and 6,1 2 per cent in March and April
2014 respectively. The main driver of this marked acceleration was food and non-alcoholic
beverage price inflation which measured 8,8 per cent in May compared with 7,0 per cent and
7,8 per cent in the previous two months respectively. This category contributed 1,3 percentage
points to the headline CPI outcome, compared with a recent low of 0,5 percentage points in
December 2013. The categories of food, housing utilities and transport together accounted for
4,2 percentage points of the inflation outcome in May, compared with 3,7 percentage points
in the previous month. The transport index increased at an annual rate of 8,9 per cent, from
6,8 per cent in April, despite a 15 cents per litre decline in the petrol price in May. Core
inflation, which excludes food, petrol and electricity, remained unchanged at 5,5 per cent for
the third consecutive month. Administered price inflation excluding petrol was unchanged
from the previous month at 6,5 per cent. The headline producer price inflation for final
manufactured goods moderated slightly from 8,8 per cent in April to 8,7 per cent in May,
driven in part by lower agricultural product inflation.
The marginal improvement in the Bank’s forecast of headline inflation at the previous
meeting has been more or less reversed, as recent food price developments surprised on
the upside. Inflation is now expected to average 6,3 per cent in 2014, compared with
6,2 per cent previously, with the quarterly peak of 6,6 per cent (previously 6,5 per cent)
still expected in the fourth quarter, following a slight moderation in the third quarter. The
forecast average inflation for 2015 increased to 5,9 per cent from 5,8 per cent, while the
forecast for 2016 increased marginally to 5,6 per cent, and to 5,5 per cent in the final quarter
of that year. Inflation is still expected to return to within the target band during the second
quarter of 2015 provided that there are no further shocks to the system, particularly from
possible higher tariff increases being granted to Eskom by the National Energy Regulator of
South Africa (Nersa) from 2015.
The forecast for core inflation is unchanged. This measure is expected to average 5,6 per
cent and 5,7 per cent in 2014 and 2015 respectively, moderating to 5,5 per cent in 2016,
with the moderate upward pressure coming from the lagged effects of the exchange-rate
depreciation rather than evidence of strong domestic demand pressures. As before, the MPC
sees the risks to the headline inflation forecast to be skewed to the upside.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic
Research (BER) at Stellenbosch University have remained anchored at the upper end of the
target band. The average inflation expectation of analysts, business people and trade union
officials for this year and next year has remained unchanged for six consecutive quarters at
6,1 per cent for both years, declining to 5,9 per cent in 2016. Within these categories, the
largest change was by business people for 2016, where expectations increased from 6,2 per

Monetary Policy Review December 2014
cent in the previous survey to 6,4 per cent. However, their expectation for 2015 moderated
slightly. Inflation expectations of households for 2014 declined from 6,7 per cent in the first
quarter to 6,3 per cent in the second quarter.
The Reuters survey of inflation expectations of economic analysts conducted in May
remained more or less unchanged since the previous survey, with a slight upward shift. The
outcome of the survey shows a divergence of views among analysts as to whether inflation
will peak in the second or fourth quarter of 2014. On average, the expectation is for inflation
to peak in the second quarter, at an average of 6,4 per cent, and to return to within the target
range in the first quarter of 2015. According to the survey, annual inflation is expected to
average 6,2 per cent in 2014, and 5,7 per cent and 5,5 per cent in the subsequent two years
respectively.
The global economy continues to exhibit mixed signals regarding the economic growth
outlook. Since the previous meeting of the MPC, consensus forecasts for growth in 2014
have been revised downwards for the United States (US) and the eurozone, but those for
Japan and the United Kingdom (UK) have been revised upwards. The earlier optimism that
the US would grow at around 3 per cent in 2014 has been moderated following the 2,9 per
cent annualised contraction in the first quarter, partly as a result of severe weather conditions
and a decline in expenditure on health care. Most analysts now expect US growth to be
closer to 2 per cent. This weaker growth is despite larger-than-expected improvements in
the unemployment rate. The outlook for the eurozone has also deteriorated, following weak
industrial output in Germany in May, and slowing growth in France and Italy. Real output
in Japan is expected to contract in the second quarter following the surge in expenditure in
the first quarter in advance of the increase of consumption taxes. The UK recovery, however,
appears to be sustained with growth of around 3 per cent expected in 2014.
The outlook for emerging markets remains relatively subdued, but some emerging Asian
economies have benefited from stronger US growth. The Chinese economy is expected to
grow by just under 7,5 per cent in 2014, although concerns about the shadow banking
system remain. Subdued growth is expected in a number of emerging markets, including
Brazil, Russia, Thailand and Argentina.
Global financial-market developments remain dominated by expectations of changes in
monetary policy in the advanced economies, amid concerns that the current low interest
rate and low volatility environment may encourage excessive risk taking and asset price
bubbles. By contrast to a number of emerging-market economies, inflation remains benign
in the advanced economies, although the risk of deflation in the eurozone persists. The UK
is expected to be the first advanced economy to raise interest rates, but at a moderate pace,
while the US is generally not expected to begin the process of normalisation before the third
quarter of 2015. However, the tapering of bond purchases by the US Federal Reserve (Fed)
is expected to continue at a steady pace. This process is fully discounted in the markets, and
is expected to be completed later this year.
By contrast, the European Central Bank (ECB) has recently announced a range of new
monetary policy measures aimed at stimulating the economy through encouraging bank
lending and preventing deflation, while Japanese monetary policy is expected to remain
highly stimulatory for some time. Since the previous meeting of the MPC, a number of
countries have reduced their policy rates, including the eurozone, Sweden, Mexico, Hungary
and Turkey, while the tightening cycle continued in New Zealand.
The exchange rate of the rand continues to pose an upside risk to the inflation outlook.
Having appreciated to a level of R10,29 against the US dollar soon after the previous MPC
meeting, the rand exchange rate followed a depreciating trend, reaching a new trading range
of between R10,60 and R10,80 since the beginning of June. Since the previous meeting, the
rand has depreciated by 2,6 per cent on a trade-weighted basis. The appreciation of the rand
Monetary Policy Review December 2014

in May was in response to more benign global factors as market participants absorbed the
forward guidance provided by the central banks in the advanced economies. This contributed
to lower risk aversion and renewed flows to emerging markets in general. Since the previous
meeting, non-resident net purchases of bonds and equities have amounted to R7,2 billion, and
R44,2 billion since the beginning of February.
Despite these inflows, since early June the rand has largely decoupled from its emergingmarket peers, and depreciated relative to most currencies, as it reacted to deteriorating domestic
fundamentals. These included the negative gross domestic product (GDP) growth rate, the
adverse reports from the ratings agencies, and the protracted nature of the platinum and metal
workers’ strikes. The impact of the platinum-sector strikes on exports began to be felt in April
and May, and it is estimated that during these two months the value of platinum group metals
(PGM) exports was around R20 billion lower than during the first quarter. This is likely
to put pressure on the current account of the balance of payments in the second quarter,
following a narrowing of the deficit in the first quarter to 4,5 per cent of GDP.
South Africa’s growth outlook has deteriorated since the previous meeting of the MPC,
compounded by continued labour disruptions. Following a contraction of 0,6 per cent in
the first quarter, the outlook for the second quarter is expected to be positive but subdued,
particularly in the light of weak mining and manufacturing data in May. The Bank’s latest
forecast, which assumes a speedy resolution of the metal workers’ strike, sees growth in 2014
at 1,7 per cent, compared with 2,1 per cent previously and 2,8 per cent at the beginning of the
year. Growth forecasts for the coming two calendar years have been reduced to 2,9 per cent
and 3,2 per cent, from 3,1 per cent and 3,4 per cent respectively. The Rand Merchant Bank
(RMB)/BER Business Confidence Index remained low and unchanged at 41 index points in
the second quarter of 2014, with a sharp decline particularly evident among manufacturers.
The Bank’s leading indicator of economic activity declined moderately, reflecting subdued
growth expectations.
The weak business confidence is mirrored in the 2,6 per cent growth in gross fixed capital
formation in the first quarter of 2014. Growth in fixed investment by the private sector,
which accounts for about two thirds of gross fixed capital formation, weakened further,
from 2,4 per cent in the fourth quarter of 2013 to 1,0 per cent in the first quarter of 2014.
The mining sector contracted by an annualised 24,7 per cent in the first quarter of 2014,
and although mainly driven by the strike-induced decline in PGM output, the contraction
was fairly broad-based across the sector. Despite a higher-than-expected performance in
April, the data for May show that the outlook for the second quarter is also bleak. In May
the physical volume of mining output declined by (a non-annualised) 3,1 per cent on a
month-to-month basis, and by 5,6 per cent on a three-month-to-three-month basis, with
PGM output declining by 34,1 per cent. While the strike is over and miners are returning
to work, PGM production is not expected to normalise for some time, and possible shaft
closures could reduce the longer-term potential of the sector.
The manufacturing-sector performance in the first two months of the second quarter has
also been disappointing, following the 4,4 per cent contraction in the first quarter. In May
manufacturing output declined by 3,7 per cent on a year-on-year basis, and by 2,0 per cent
on a three-month-on-three-month basis. The sector was negatively impacted by electricity
supply constraints and the platinum-sector strike, while the current strike by metal workers
is likely to undermine the outlook for the third quarter. The Kagiso Purchasing Managers’
Index (PMI) registered a slight improvement in June, measuring 46,6 index points, but has
remained below the neutral 50 index point level for three consecutive months.
Trends in employment growth are indicative of the weak private-sector investment. Although
formal non-agricultural employment increased for the third consecutive quarter in the first
quarter of 2014, all the gains were in the public sector. While overall employment increased
by 42 000 jobs in the year to the end of March, 49 000 jobs were created in the public sector

Monetary Policy Review December 2014
while the private sector shed jobs, particularly in the mining sector where almost 29 000
jobs were lost.
Final consumption expenditure by households remains the main driver of GDP growth,
but with a declining contribution of 1,2 percentage points in the first quarter of 2014.
Growth in household consumption expenditure, which measured 2,6 per cent in 2013,
declined to 1,8 per cent in the first quarter of 2014, with a marked moderation in the
growth of expenditure on durable goods and a contraction in spending on non-durable
goods. Real retail sales growth contracted by 0,8 per cent on a three-month-to-threemonth basis in May, and increased at a month-to-month rate of 0,8 per cent. Domestic
motor vehicle sales declined by 2,3 per cent on a year-on-year basis, but increased by
4,7 per cent on a month-to-month basis in June. Despite these weak trends, consumer
confidence surprised on the upside in the second quarter, with the FNB/BER Consumer
Confidence Index increasing from -6 to 4 index points, although respondents do not
deem the present time as appropriate to buy durable goods.
Growth over twelve months in total loans and advances to the private sector measured
8,2 per cent in May 2014, but the divergent trends in bank credit extended to households and
the corporate sector have continued. Growth in credit extended to the corporate sector has
been steadily increasing since the beginning of the year, measuring 13,3 per cent in May, due in
part to renewable energy contracts. By contrast, growth in credit extended to the private sector
has continued to trend downwards, to measure 4,3 per cent in May. Twelve-month growth in
general loans to households, mainly unsecured lending, declined to 2,8 per cent in May; its
lowest growth since February 2005. Mortgage credit extension remained within the 2 to 3 per
cent range observed since January 2013, and instalment sale credit and leasing finance also
continued to moderate from growth rates of around 13 per cent in the second half of 2013 to
8,6 per cent in May. These credit extension trends to households reflect a combination
of weakening household consumption expenditure and stricter bank lending criteria for
unsecured loans in particular. Household debt to disposable income remains elevated, but
declined marginally to 74,5 per cent in the first quarter of 2014.
The trend in wage settlements poses an upside risk to the inflation outlook, and these
pressures are likely to intensify in the current difficult labour relations environment.
According to Andrew Levy Employment Publications, the average wage settlement rate in
collective bargaining agreements increased from 7,9 per cent in the first quarter of 2014 to
8,1 per cent in the second quarter. However, increases over four quarters in nominal unit
labour costs in the formal non-agricultural sector declined from 5,9 per cent in the fourth
quarter of 2013 to 4,8 per cent in the first quarter of 2014. The MPC is concerned that
recent wage settlements in the mining sector and current demands in the metals sector
could set a precedent for wage demands more generally. Unless accompanied by higher
productivity, such settlements could generate a wage-price spiral, and are also likely to
have a negative impact on employment trends. While the focus has generally been on wage
demands, there is an imperative for attention to also be paid to excessive salaries and bonuses
of management and executives.
Food prices have been one of the main drivers of inflation since the beginning of the year
and have generally surprised on the upside in recent months. There are, however, some
tentative indications that we may be near the peak: in May manufactured food producer
price inflation moderated for the first time since October 2013 and measured 8,9 per cent,
down from 9,5 per cent in April. Agricultural producer price inflation declined from a
recent peak of 13,3 per cent in March to 6,7 per cent in May reflecting in part the sharp
decline in maize prices to export parity price levels. Prices of cereals and other crops declined
by 0,8 per cent in May, having reached a recent peak of 27,6 per cent in February. Global
food price pressures are also benign, with the year-on-year inflation rates as reflected in
the Food and Agriculture Organization (FAO) food price index being negative for twelve
Monetary Policy Review December 2014

consecutive months. Apart from weather-related risks, the overall trend in food prices will
remain highly sensitive to exchange-rate developments.
Despite recent geopolitical risks, particularly in Ukraine and Iraq, international oil prices
have remained relatively stable. Apart from a brief spike to a level of around US$115 per
barrel in June, the price of Brent crude oil has generally traded in a range of US$105 and
US$110 per barrel, and is currently at around US$105 per barrel. Domestic petrol prices
have therefore been driven primarily by exchange-rate changes. Following the appreciation
of the rand in April, the petrol price was reduced by a total of 37 cents per litre in May and
June, but this was largely reversed in July when the price increased by 31 cents per litre. If the
current trends persist, a further small increase in the petrol price can be expected in August.
The MPC remains concerned about weak growth, the widening output gap and the negative
employment outlook. The strike in the platinum sector contributed to the downward
revision of the growth forecast, and the latest forecast has not factored in the possibility of a
protracted work stoppage by the metal workers, which would potentially have much wider
ramifications because of the direct linkages to other sectors of the economy. This weak
growth outlook, however, is not something that monetary policy can ameliorate.
The MPC is also increasingly concerned about the inflation outlook and the further upside
risks to the forecast. Although the exchange rate remains a key factor in this regard, the
possibility of a wage-price spiral, should wage settlements well in excess of inflation and
productivity growth become an economy-wide norm, has increased. Although the inflation
trajectory has not deteriorated markedly since the previous meeting, upside risks have
increased, and it is expected to remain uncomfortably close to the upper end of the target
range when it does eventually return to within the target. The upside risk factors make this
trajectory highly vulnerable to any significant changes in inflation pressures.
Although inflation expectations have remained relatively anchored, should inflation persist
outside the target band, these expectations risk becoming dislodged.
The MPC is, however, cognisant of the fact that the inflation pressures do not reflect excess
demand conditions in the economy. Household consumption expenditure remains weak
and credit extension to households is contracting in real terms. However, we do have to be
mindful of second-round effects of supply-side shocks.
The MPC faces an increasingly difficult dilemma of rising inflation and slowing growth.
The core mandate of the Bank remains price stability but, at the same time in achieving
this mandate, we have to be mindful of the impact of our actions on economic growth
and tread a fine line between acting effectively to address the inflation objective while not
undermining growth unduly.
The MPC has decided to continue on its gradual normalisation path and raise the repurchase
rate by 25 basis points to 5,75 per cent per annum, effective from Friday, 18 July. Given the
expected inflation trajectory, the real repurchase rate remains slightly negative and well
below its longer-term neutral level. The monetary policy stance remains supportive of the
domestic economy and, as before, any future moves will be gradual and highly datadependent.
We would like to reiterate that monetary policy should not be seen as the growth engine
of the economy. The sources of the below-par growth performance are largely outside
the realms of monetary policy. In the short term, an improvement in the interaction and
relationships between management and labour is essential to foster a climate of trust and
confidence, and get South Africa back to work. Given that the key headwinds preventing
a return to trend growth are structural, there is an urgent need to implement necessary
structural reforms, as envisaged in the National Development Plan, in order to achieve
higher and more inclusive growth.

Monetary Policy Review December 2014
Statement of the Monetary Policy Committee
18 September 2014
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy Committee (MPC), the domestic
inflation forecast has improved slightly, but the inflation trajectory remains uncomfortably
close to the upper end of the target range. At the same time, the domestic economic
growth outlook has deteriorated further, with declining growth in both consumption
expenditure and gross fixed capital formation, as confidence remains low. The combination
of stubborn inflation and a sluggish growth outlook continues to pose a difficult dilemma
for monetary policy.
The global environment has been characterised by increased financial market volatility
following heightened speculation relating to the timing and extent of United States (US)
monetary policy normalisation. This impacted on emerging-market currencies in general,
and on the rand in particular. This was further illustrated after yesterday’s Federal Open
Market Committee (FOMC) meeting which reaffirmed the gradual pace of US monetary
policy normalisation and its data-dependent nature. However, despite increased political
instability and significant risks in a number of regions, the international oil price has declined
along with continued weakness in global food prices, contributing to a more benign global
backdrop for the domestic inflation outlook.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas surprised on the upside at 6,4 per cent in August, having measured 6,6 per cent and
6,3 per cent in June and July 2014 respectively. The higher turnout was mainly due to higherthan-expected food prices, which had been anticipated to continue their recent downward
trend. Downward pressure was exerted by petrol prices which increased by 5,8 per cent, down
from 8,3 per cent in July. The categories of food, housing utilities and transport together
accounted for 3,8 percentage points of the inflation outcome in August, unchanged from
the previous month. Core inflation, which excludes food, petrol and electricity, increased to
5,8 per cent from 5,7 per cent in July, driven mainly by the impact of the weaker exchange
rate on some goods categories.
Administered price inflation excluding petrol measured 6,5 per cent, up from the 6,4 per
cent measured in July. The headline producer price inflation for final manufactured goods,
which reached a recent high of 8,8 per cent in April, measured 8,1 per cent and 8,0 per cent
in June and July respectively, driven in part by lower agricultural product inflation.
The Bank’s forecast of headline inflation is slightly more favourable than that presented
at the previous meeting, mainly a result of lower expected food and petrol price pressures.
Whereas for some time inflation had been forecast to peak at an average of 6,6 per cent in
the fourth quarter of this year, the peak now appears to have occurred in the second quarter,
at an average of 6,5 per cent. Inflation is now expected to average 6,2 per cent in 2014,
compared with 6,3 per cent previously, and 5,7 per cent in 2015 (5,9 per cent previously),
and to return to within the target range in the first quarter of 2015 instead of the second
quarter as previously forecast. The inflation forecast for 2016 increased to 5,8 per cent
from 5,6 per cent, mainly as a result of the revised electricity price assumption following
the review of Eskom tariffs by the National Energy Regulator of South Africa (Nersa). The
revised assumption makes provision for electricity price increases of 11,6 per cent from July
2015 and again from July 2016.
The forecast for core inflation is unchanged at an average 5,6 per cent and 5,7 per cent
in 2014 and 2015 respectively, reaching a peak of 5,8 per cent in the first quarter of 2015,
Monetary Policy Review December 2014

and moderating to 5,5 per cent in 2016. As before, the MPC sees the risks to the headline
inflation forecast to be skewed to the upside, with possible renewed pressure coming from
the exchange rate.
Inflation expectations, as reflected in the survey conducted by the Bureau for Economic
Research (BER) at Stellenbosch University in the third quarter of 2014, have again remained
more or less unchanged, and anchored at around the upper end of the target range. Inflation
is expected to average 6,2 per cent in 2014 and 6,1 per cent and 6,0 per cent in 2015 and 2016
respectively. As usual, there is a fairly wide dispersion of expectations between the different
categories of respondents. While business people expect inflation to average 6,4 per cent in
2015 and 2016, analysts’ expectations average 5,7 per cent and 5,4 per cent. Expectations of
trade unionists are for 6,2 per cent in both years, and all categories of respondents expect
inflation in the current year to average 6,2 per cent. Household inflation expectations for
2014 remained unchanged at 6,3 per cent.
The global growth recovery remains asynchronous amid sustained improvements in the
US and United Kingdom (UK), and deteriorating prospects in the eurozone and Japan.
Although growth in the US is not expected to exceed the 2,2 per cent achieved in 2013,
this is mainly a result of the contraction during the first quarter of this year. Real output
growth of 4,2 per cent was recorded in the second quarter of 2014, and consensus forecasts
are for growth rates of around 3 per cent in the next two quarters. Similar growth rates are
expected in 2015. At the same time, the unemployment rate has been declining at a faster
pace than previously anticipated. While the growth outlook for the UK remains positive,
possible downside risks could emerge should Scotland vote for independence from the UK.
Growth in the eurozone has remained weak, with the German economy also under pressure
following a contraction in the second quarter. Sanctions on Russia are expected to be an
additional constraint affecting the eurozone’s growth outlook. Although the Japanese
economy appears to be recovering from the value-added tax (VAT)-induced slump in the
second quarter, the recovery looks fragile.
While emerging Asia appears to be benefiting most from the US recovery, emerging markets
generally are facing increasing headwinds. Signals coming out of China continue to be mixed
amid a sharp slowdown in industrial production in August. Latin American economies
also face a challenging outlook, particularly in Argentina, Venezuela and Brazil, which are
currently experiencing a technical recession. Growth in sub-Saharan Africa is expected to
remain relatively strong, although commodity producers may be adversely affected by lower
commodity prices and possible spillover effects from the Ebola outbreak.
There is a continued absence of significant upside global inflation risks despite pressures
experienced in some emerging markets. The various indicators of US inflation remain well
contained below the 2 per cent level, while the fear of deflation in the eurozone persists.
Declining international oil and food prices, along with a number of other commodity prices,
are expected to reinforce the current benign global inflation environment.
The divergent growth outlooks in the advanced economies are likely to be the main drivers
of monetary policy developments. The UK is expected to tighten monetary policy early next
year. The stronger performance of the US labour market has led to heightened speculation
that normalisation may begin earlier than previously anticipated. These expectations resulted
in an appreciation of the US dollar against most currencies, as well as rising long-term US
Treasury yields ahead of yesterday’s FOMC meeting. At yesterday’s press conference, the
FOMC Chair reaffirmed the view that policy normalisation will occur gradually, but is
contingent on no surprises to employment growth or inflation in either direction.
The data-dependent nature of the forward guidance means that changes in the outlook for
inflation, unemployment and growth are likely to lead to bouts of global financial market
uncertainty in advance of FOMC meetings in the coming months.

Monetary Policy Review December 2014
At the same time, however, the European Central Bank (ECB) has loosened monetary
policy and has indicated its willingness to embark on some form of quantitative easing
should this be necessary. Monetary policy is also expected to remain accommodative for
some time in Japan. Since the previous meeting of the MPC, policy rates have been reduced
in the eurozone, Israel, South Korea, Chile and Hungary, and increased in Russia and
New Zealand.
Following a few weeks of relative stability, the rand exchange rate weakened in the past
few days in response to US dollar strength, as well as the widening deficit on the current
account of the balance of payments to 6,2 per cent of gross domestic product (GDP).
Since the previous meeting of the MPC, the rand initially traded in a range of R10,50 and
R10,75 against the US dollar, but has weakened since early September, reaching a low of
R11,07. On a trade-weighted basis, however, the rand depreciated by 0,4 per cent, having
appreciated against the euro and the British pound. The rand is expected to remain sensitive
to changes in sentiment regarding possible changes in US policy which will affect the
appetite for emerging-market assets generally, as well as to possible impacts from geopolitical
risks and domestic factors.
Since the previous MPC, non-residents have been net sellers of bonds to the value of
R29,3 billion, but this has been offset in part by net purchases of equities to the value of
R16,2 billion over the same period. In the year to date, there have been net outflows of
bonds and equities to the value of R6,3 billion. These trends indicate that the financing of
the current account through portfolio inflows is likely to become increasingly challenging.
The current-account deficit in the second quarter of 2014 was wider than generally expected
by the markets, following the 4,5 per cent of GDP recorded in the first quarter. This widening
was a result of increased dividend outflows, lower dividend inflows following a large one-off
inflow during the first quarter, and weak export growth, impacted to some extent by the
platinum strike. Export growth in the third quarter is expected to remain constrained by
the slow return to full capacity production by the platinum mines and the strike in the steel
and engineering sector in July, which had significant spillover effects on the manufacturing
sector in general. The current account is anticipated to narrow gradually over time.
The domestic economic growth outlook remains weak following growth rates of -0,6 per
cent and 0,6 per cent in the first and second quarters of the year respectively. These growth
rates are well below potential output growth and indicative of a widening output gap. Partly
as result of this outcome, as well as the expected impact of the metal workers strike in July,
the Bank’s forecast for GDP growth for 2014 has been revised down further to 1,5 per cent,
from 1,7 per cent previously, with the risks still assessed to be on the downside. The forecasts
for both 2015 and 2016 have been revised down by 0,1 percentage points to 2,8 per cent and
3,1 per cent respectively. The Bank’s leading indicator of economic activity continues to trend
sideways, consistent with a subdued growth outlook. Business confidence, as reflected in the
Rand Merchant Bank/Bureau for Economic Research (RMB/BER) Business Confidence
Index, remains negative despite a 5 index point increase to 46 in the third quarter. Adding
to prevailing concerns are indications from Eskom that electricity supply constraints may be
more severe and endure for longer than previously expected.
The near-term outlook for mining remains subdued, with platinum production not expected
to return to full capacity before the end of the year. In July, mining production recorded
a broad-based year-on-year decline of 7,7 per cent, but a 0,9 per cent increase on a monthto-month basis. Manufacturing output declined significantly in July, recording year-onyear and month-to-month contractions of 7,9 per cent and 5,4 per cent respectively, largely
due to the impact of the four-week strike in the steel and engineering subsector. Capacity
utilisation in the sector declined from 82,1 per cent in the first quarter of 2014 to 80,6 per
cent in the second quarter. More positively, the Kagiso Purchasing Managers’ Index (PMI)
reflected some improvement in sentiment in August, with the index rising 3,1 index points
Monetary Policy Review December 2014

to 49, marginally below the neutral level, while the construction sector has recorded growth
rates of 5 per cent in the first two quarters of the year.
Growth prospects have been constrained by the weakening trend in gross fixed capital
formation which grew at an annualised rate of 0,5 per cent in the second quarter. Real fixed
capital expenditure by both the public corporations and the private sector contracted during
the quarter. Of particular concern is the continued downward trend over the past three
quarters in private-sector investment, despite higher capital outlays in the manufacturing
sector. This has been reflected in the continued slow pace of employment creation in the
private sector and the rise in the unemployment rate to 25,5 per cent in the second quarter
of 2014.
Consumption expenditure by households also continued its moderating trend which began
in the first quarter of 2012 amid declining real disposable income growth. Annualised
growth of 1,5 per cent was recorded in the second quarter of 2014. The slowdown was
particularly marked in the durable and semi-durable goods categories, probably impacted
by the prolonged strikes in the mining and manufacturing sectors. Retail trade sales
contracted by 0,9 per cent in June on a month-to-month basis, but increased by 1,2 per
cent in July, higher than generally expected. Wholesale trade sales contracted by 5,2 per
cent month-to-month in July, and by 4,6 per cent year-on-year. Domestic vehicle sales
have also slowed. Given the above, somewhat surprisingly the First National Bank/Bureau
for Economic Research (FNB/BER) Consumer Confidence Index increased from -6 to
+4 in the second quarter.
Trends in credit extension to households are consistent with the weak growth in household
consumption expenditure, showing a further divergence between credit extension to
households and to the corporate sector. Growth in total loans and advances over the year
measured 9,7 per cent in July, with lending to the corporate sector increasing by 17 per cent
and to households by 4,1 per cent. The latter reflects continued sluggish growth in mortgage
credit extension and tighter credit criteria for unsecured lending in particular. Twelve-month
growth in general loans to households, which is mainly unsecured lending, reached a low
of 0,2 per cent in July, while growth over three months exhibited an annualised contraction
of 2,5 per cent. This decline is across all income groups, but more pronounced at the lower
levels. A positive development is that household debt to disposable income moderated from
74,4 per cent in the first quarter to 73,5 per cent in the second quarter.
Growth in corporate-sector borrowing during the first half of the year was dominated by the
agricultural sector, electricity supply (renewable energy projects) as well as the wholesale and
retail trade sectors. The cost of bank funding appears to have increased recently as a result
of changed regulatory requirements relating to the implementation of Basel III, the impact
of the bail-in of certain African Bank Limited creditors and the consequent rating action by
Moody’s Investors Service, all of which could result in tighter funding conditions.
No new wage and unit labour cost data have been released since the previous meeting of
the MPC, although settlements in the steel and engineering sector and the clothing sector
have been well above current and expected inflation rates. The MPC remains concerned
about the apparent delinking of wage demands and some wage settlements from underlying
inflation and productivity growth trends, as well as the possible impact of forthcoming
wage negotiations, including in the public sector. These concerns relate to settlements at all
levels, including executive pay. Excessive wage settlements could have adverse impacts on
employment, inflation, the general competitiveness of the economy, and the profitability
and viability of small businesses in particular.
Notwithstanding the 9,5 per cent increase in July, food price inflation is expected to slow
over the coming months. Pipeline pressures from agricultural prices continue to moderate
following sharply lower maize prices since March, while manufactured food price inflation

Monetary Policy Review December 2014
declined to 8,5 per cent in July, compared with 9,5 per cent in April. International food
prices, as reflected in the Food and Agriculture Organization (FAO) international food
price index, declined for the fifth consecutive month in August 2014 in response to positive
maize and wheat supply conditions. These developments are expected to impact favourably
on domestic consumer prices, although base effects are likely to interrupt the declining yearon-year trend in the final months of the year.
International oil prices declined in recent weeks, having traded in a range of between
US$105–US$114 per barrel for the year to the end of July. Since August, the price has fallen
below this range and is currently trading at around US$98 per barrel. This is despite rising
tensions and instability in the Middle East and conflict in Ukraine, events that in the past
would likely have resulted in an oil price spike. As a result of this lower price, the domestic
petrol price was reduced by 67 cents per litre in September, having been unchanged in
August. At this stage there is an average over-recovery on the petrol price due to the lower
international price, but the favourable impact is being partially offset by continued rand
weakness.
Despite the slight near-term improvement in the inflation outlook and the relatively stable
inflation expectations, the MPC is concerned that the forecast remains uncomfortably close
to the upper end of the target band. Given the upside risks to the forecast, the proximity
to the upper end of the band makes the inflation outcomes highly vulnerable to changes in
inflationary pressures.
A key upside risk is the exchange rate, which is vulnerable to the slow pace of adjustment
to the current-account deficit, as well as to the uncertainty surrounding the future path of
monetary policy in the advanced economies. At this stage it is difficult to assess the extent
to which normalisation of US monetary policy is already priced in to the rate.
The MPC remains concerned about the risks of a wage-price spiral, should settlements
well in excess of inflation and productivity growth become the economy-wide norm. Such
developments could also undermine South Africa’s international competitiveness and delay
the current-account adjustment.
The deterioration in the longer-term inflation trajectory relative to the previous forecast is
a result of the revised tariff increases granted to Eskom by Nersa. The view of the MPC is
that such relative price adjustments should not be reacted to automatically. However, while
the focus of monetary policy should be on the second-round effects of these increases, this
is complicated given the multi-year nature of the adjustment.
While inflation is the primary focus of the Committee, the MPC is also mindful of the
anaemic state of the domestic economy, rising unemployment and the downside risk to its
growth forecast. Domestic expenditure has deteriorated further, particularly private-sector
fixed capital formation and, together with continued moderation in household consumption
expenditure, is indicative of the lack of demand pressures in the economy.
The MPC is still of the view that interest rates will have to normalise over time. However,
given the slightly improved inflation outlook notwithstanding the upside risks, the stable
inflation expectations and the downside risks to the weak growth outlook, the MPC has
decided that the repurchase rate will remain unchanged at 5,75 per cent per annum.
Despite the 75 basis point increase so far this year, monetary policy remains accommodative,
and will continue to be supportive of the domestic economy subject to achieving its primary
inflation-targeting objective. Future decisions will, as always, be highly data-dependent.
Monetary Policy Review December 2014

Statement of the Monetary Policy Committee
20 November 2014
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 sharp decline
in international oil prices has contributed to a more benign global inflation environment.
This development may also ameliorate the deteriorating growth outlook in some regions by
providing a boost to consumption expenditure. Lower oil prices have also had a favourable
impact on domestic headline inflation, with the medium-term forecast improving relative
to the previous forecast. However, the underlying inflation pressures, as reflected in core
inflation, persist.
The domestic growth outlook remains challenging, but after two quarters dominated by
the fall-out from extended strikes, some recovery is expected, but demand remains subdued.
The coming quarters are expected to see an improved performance in the mining and
manufacturing sectors, but the outlook is inhibited by domestic structural constraints, as
well as by a weak global economy and the continued declining trend in non-oil commodity
prices. Growth next year is expected to remain weak.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban
areas measured 5,9 per cent in both September and October, having measured 6,4 per cent
in August. Downward pressure on inflation in October came from continued moderation
in food and petrol prices. Food price inflation continued its downward trend, measuring
8,0 per cent in October, down from 8,7 per cent previously, while petrol prices increased
by 2,4 per cent. Core inflation, which excludes food, petrol and electricity, moderated to
5,6 per cent in September from 5,8 per cent in August, but measured 5,7 in October,
reflecting primarily continued exchange-rate pass-through to some goods categories.
Administered price inflation excluding petrol measured 6,4 per cent in October, down from
6,5 per cent in September. Headline producer price inflation for final manufactured goods,
which reached a recent high of 8,8 per cent in April, measured 7,2 per cent and 6,9 per cent
in August and September respectively, driven in part by lower food and fuel price inflation.
The Bank’s forecast of headline inflation has improved since the previous meeting of the
MPC, mainly due to the impact of declining international oil prices. Having reached a
peak of 6,5 per cent in the second quarter of this year, inflation is now expected to average
5,9 per cent in the final quarter of 2014, and average 6,1 per cent for the year, compared
with 6,2 per cent previously. The downward trend is expected to continue into next year,
with inflation forecast to reach a low of 5,1 per cent in the second quarter, and to average
5,3 per cent for the year, compared with 5,7 per cent previously. The forecast for 2016 has
been revised down from 5,8 per cent to 5,5 per cent, and is expected to measure 5,4 per cent
in the final quarter of the year.
The forecast for core inflation, by contrast, is more or less unchanged at an average 5,6 per
cent and 5,7 per cent in 2014 and 2015 respectively, reaching a peak of 5,9 per cent in the
first quarter of 2015 (previously 5,8 per cent), and moderating to 5,3 per cent in 2016, down
from 5,5 per cent previously. The MPC assesses the risk to the headline inflation forecast to
be broadly balanced.
The results of the fourth quarter inflation expectations survey of the Bureau for Economic
Research (BER) will only be released in December. Market-based surveys, as reflected in
the Reuters Econometer survey, however, show that the median CPI inflation expectation
of analysts has remained unchanged over the past two months at 5,7 per cent and
5,5 per cent for 2015 and 2016 respectively. Break-even inflation rates (the yield differential

Monetary Policy Review December 2014
between conventional government bonds and inflation-linked bonds) declined since the
previous meeting and reflect expectations within the target range for 5-year maturities, and
marginally above the upper limit of the inflation target range at 10-year maturities.
The United States (US) and the United Kingdom (UK) remain the main drivers of global
growth although more broadly, global growth may get some impetus from lower oil and
food prices, which should provide some boost to consumers. US economic growth was
better than expected in the third quarter with the first advanced estimate of 3,5 per cent,
and the unemployment rate declining to 5,8 per cent – the lowest level since June 2008.
The UK recorded growth of 2,8 per cent in the third quarter, while the unemployment rate
was unchanged at 6,0 per cent. The Japanese economy contracted for a second consecutive
quarter during the third quarter, and has prompted a reconsideration of a further valueadded tax (VAT) increase next year. The response to the further additional monetary
stimulus announced recently remains uncertain amid a tighter fiscal policy stance. The
eurozone outlook also remains bleak, including in the core countries such as France and
Germany, although lower food and oil prices, coupled with further monetary easing, may
have a positive impact.
The outlook for emerging markets is mixed, with emerging Asian economies expected to
benefit most from the positive spillovers from the US recovery. This is expected to offset
in part the adverse impact of the slowdown in China, where growth is expected to be
lower than in the past few years, as the economy rebalances away from investment towards
consumption. This moderation is expected to continue to impact negatively on commodity
prices. The Indian economy is showing signs of sustained recovery, while the other BRICS
partners, Russia and Brazil, face significant growth headwinds. Oil exporters generally are
expected to face challenges from international oil price weakness.
Global inflation is expected to moderate in the face of benign food price inflation and
falling international oil and other commodity prices. While this is welcome in the higher
inflation regions, particularly emerging markets, it does aggravate deflationary risks in some
of the advanced economies, particularly in the eurozone and Japan. Monetary policy stances
are expected to remain ultra-loose in these two regions, with a significant stimulus package
announced recently in Japan, and the European Central Bank (ECB) is anticipated to
conduct further asset purchases. The US Federal Reserve (the Fed) has ended its programme
of quantitative easing, but at this stage it is not contracting its balance sheet and proceeds
from maturing assets are being reinvested. Although the general expectation is that the
Fed will begin raising interest rates in mid-2015, there are also some expectations that the
more benign inflation outlook could delay this. Forward guidance from both the Bank of
England and the Fed is that any adjustment is likely to be gradual, and policy rates may be
lower than their estimated long-run normal rates for some time despite the improved growth
outlooks. Since the previous meeting of the MPC, policy rates have increased in Brazil,
Russia and Indonesia, but reduced in Sweden, South Korea, Chile and Poland.
The exchange rate of the rand has been relatively volatile since the previous meeting in
response to external and domestic factors, including changing expectations of the timing
of the first US interest-rate increase as well as the downgrade of South Africa’s credit rating
by Moody’s Investors Service. Although the rand initially weakened sharply against the US
dollar, at one stage reaching a level of R11,36 against the US dollar, this move has since
largely been reversed. Since the previous meeting of the MPC, the rand has depreciated
marginally against the US dollar, but appreciated by 2,1 per cent and 3,5 per cent against
the euro and sterling respectively, and by 1,8 per cent on a trade- weighted basis.
The rand is expected to remain susceptible to sudden shifts in sentiment regarding changes
in monetary policy stances in the advanced economies, and the continued uncertainty
regarding the extent to which US normalisation is already priced in to the exchange rate.
The asynchronous nature of advanced economy monetary policies is expected to complicate
Monetary Policy Review December 2014

the outlook and outcomes. However, the rand is likely to remain more sensitive to changes
in financial conditions in the US than in Japan and the eurozone. The persistently slow
adjustment of the current-account deficit also makes the rand vulnerable to swings in
sentiment that raise concerns about the financing of this deficit. Although the lower oil
prices should reduce the oil import bill, its positive impact on the deficit may be limited by
further declines in other commodity prices.
The volatility in portfolio capital flows is indicative of fickle global investor sentiment. Net
bond sales by non-residents amounted to R12,6 billion in September and R2,1 billion in
October and a further R1,5 billion to date in November. In the equities market, having been
marginal net sellers in September, non-residents were net buyers to the value of R5,7 billion
in October but net sellers of R6,3 billion to date.
The domestic growth outlook remains subdued. Although an improved growth outcome is
expected in the third quarter, following the 0,6 per cent growth in the second quarter, this
is off a low base following prolonged strikes in the mining and manufacturing sectors. The
Bank’s forecast for gross domestic product (GDP) growth in 2014 has declined marginally
from 1,5 per cent to 1,4 per cent, and forecasts for 2015 and 2016 have been revised down
from 2,8 per cent and 3,1 per cent to 2,5 per cent and 2,9 per cent respectively. This
restrained outlook is consistent with the Bank’s composite leading indicator of economic
activity which continues to trend sideways, with a slight upward move recently. The Rand
Merchant Bank/Bureau for Economic Research (RMB/BER) Business Confidence Index
improved in the third quarter but, at 46 index points, remains below the neutral level of 50.
The mining sector appears to be recovering to some extent from the strike-affected first half
of the year, and is expected to contribute positively to third-quarter growth, following two
consecutive quarters of contraction. The physical volume of mining production increased
by 0,7 per cent in the third quarter compared with the second quarter, and further increases
can be expected in the final quarter, as platinum output is still below pre-strike levels. By
contrast, although the physical volume of manufacturing production increased in September,
the month-long strike in the steel and engineering industry in July contributed to a quarterto-quarter contraction of 1,3 per cent in the third quarter. Sentiment indicators suggest that
the outlook for the sector remains bleak, with the manufacturing confidence index still at
very low levels and capacity utilisation rates back at 2011 levels. More positively, the Kagiso
Purchasing Managers’ Index (PMI) edged above 50 index points in October for the first
time since March, driven mainly by the inventory and new sales orders subindices.
The outlook for the construction sector is more positive, with the real value of building plans
passed increasing for the fourth successive month in August. On a three-month-to-threemonth basis, an increase of 9,8 per cent was recorded. However, while the various building
confidence indices have generally improved, they remain below the neutral level.
The weak pace of economic growth is mirrored in the unemployment rate which, according
to the Quarterly Labour Force Survey published by Statistics South Africa measured
25,4 per cent in the third quarter, compared with 24,5 per cent a year earlier. Total
employment increased at a year-on-year rate of 0,5 per cent in the quarter. At the same time,
the number of discouraged workers increased sharply, by almost 100 000, and now total
2,5 million.
Consumption expenditure by households has remained relatively subdued, but there are
signs of a moderate increase in the quarterly growth rate, as the negative effects of the
protracted strikes on consumption dissipate. Consumption expenditure could be positively
impacted by lower petrol prices. Although retail sales growth declined by 0,8 per cent (nonannualised) in September, quarter-to-quarter growth of 0,9 per cent was recorded in the
third quarter, and 2,3 per cent year on year. Similarly, wholesale trade sales contracted in
the third quarter, but increased by 5,9 per cent on a year-on-year basis. Motor vehicle sales

Monetary Policy Review December 2014
have also shown some signs of recovery, although domestic sales are expected to be lower
this year than in 2013. Retail-sector confidence improved, with the BER reporting retailer
confidence above the neutral level for the first time in two and a half years. Consumer
confidence, however, declined significantly in the third quarter following an unexpected
increase in the second quarter.
Trends in bank credit extension to the private sector have remained characterised by declining
growth in advances to households, while advances to corporates have been buoyant. Total
loans and advances grew at a twelve-month rate of 8,8 per cent in September, but excluding
mortgages the growth rate was 13,5 per cent, compared with a recent high of 18,6 per cent in
December 2012. Credit extension to the household sector grew by 3,7 per cent in September,
as unsecured lending remained weak despite a reversal of the negative growth trend in the
month, but credit to the corporate sector grew by 15,3 per cent. Twelve-month growth in
mortgage advances to households remained at levels below 3 per cent, while instalment sale
credit and leasing finance continued its downward trend with growth of 6,9 per cent. These
trends are likely to constrain consumer demand in the coming months.
According to the October Medium Term Budget Policy Statement, government remains
committed to its policy of fiscal consolidation in order to prevent an increase in the debt
ratio to unsustainable levels. The fiscal deficit is expected to decline from a projected 4,7 per
cent of GDP in the current fiscal year to 3,0 per cent in 2017/18.
This is expected to be achieved through adherence to a nominal expenditure growth ceiling
and increased tax revenues. The ability to achieve the nominal expenditure targets will be
determined to an important degree by the public-sector wage settlement.
Wage trends have remained broadly unchanged since the previous meeting of the MPC.
According to Andrew Levy Employment Publications, wage settlement rates averaged
8,0 per cent in the first nine months of the year. Nominal remuneration per worker as
well as productivity trends in the formal non-agricultural sector were distorted by the
significant increase in temporary employees by the Independent Electoral Commission,
which contributed to the decline in the year-on-year increase in remuneration from
6,3 per cent to 3,5 per cent, while productivity declined by 1,6 per cent. The net result was
a marginal increase in unit labour costs of 5,2 per cent in the second quarter from 5,1 per
cent previously.
Food price inflation remains a major driver of inflation, but is expected to continue to
moderate in the coming months. Food price inflation appears to have peaked at 9,5 per
cent in August, and has since moderated to 8,0 per cent in October as lower producer prices
of crops and cereals, which declined by 6,3 per cent in September, are beginning to have
an impact at the consumer price level. Restocking of herds following the drought in 2013,
however, has kept meat price inflation elevated. Food price pressures also remain benign at
the global level, with the Food and Agriculture Organization international food price index
declining for seven consecutive months to its lowest level since August 2010.
International oil prices have declined markedly since their recent peak in June 2014
of around US$115 per barrel to current levels of below US$80 per barrel. This decline
reflects a combination of factors, including increased supply coming from the US and
Libya, moderating demand from China in particular, and changes in the internal dynamics
within the Organization of the Petroleum Exporting Countries (OPEC) cartel. The general
expectation in the market is that these lower prices could persist for some time. Although
some of the advantage of lower international oil prices has been offset to some extent by a
weaker rand exchange rate, domestic petrol prices have declined by a cumulative R1,17 per
litre since August and, should current trends continue, a further decline of around 70 cents
per litre can be expected in December.
Monetary Policy Review December 2014

The marked decline in international oil prices has had a significant impact on the mediumterm outlook for headline inflation in the global economy and in South Africa. At this stage
it is unclear whether this is a temporary shock, or if it will be sustained or decline further. As
with an oil price increase, we would look through the impact effect and focus on the possible
second-round effects of this decline. The possibility that oil prices are sustained at current
levels introduces a degree of downside risk to the inflation forecast.
The domestic growth outlook remains challenging, and the risks to the forecast are assessed
to be moderately on the downside. The MPC does not see significant signs of excess
demand pressures that are impacting on the inflation outlook and household consumption
expenditure is expected to remain constrained.
At the same time, despite its recent relative stability, the exchange rate remains an upside risk
to the inflation outlook, vulnerable to changing perceptions of the timing of global monetary
policy adjustments, and the slow pace of contraction in the current-account deficit. The
extent to which policy normalisation is already priced into the exchange rate is also unclear.
A further upside risk to the inflation forecast comes from a possible increase in wage
settlement rates in excess of inflation and productivity growth in the coming year.
In light of this assessment, the MPC sees the overall risk to the headline inflation forecast
to be more or less balanced. However, given the elevated level of core inflation and the fact
that headline inflation is expected to increase later in the forecast period as the first-round
effect of the oil price decline dissipates, the Committee remains vigilant and will continue
to monitor developments closely.
The Committee remains of the view that interest rates will have to normalise over time.
However, given the lower trajectory of headline inflation and the continued weak state of
the economy, the MPC has unanimously decided to keep the repurchase rate unchanged at
5,75 per cent per annum at this stage.
The timing of future interest-rate increases will be dependent on a range of factors, including
the evolution of inflation expectations, the speed of normalisation of monetary policy in the
US and the state of the domestic economy.

Monetary Policy Review December 2014
Abbreviations
Alsi

FTSE/JSE All-Share Price Index
BER

Bureau for Economic Research
BOJ

Bank of Japan
CPI

consumer price index
CBOE
Chicago Board Options Exchange
ECB

European Central Bank
FRA

Forward rate agreements
GDP

gross domestic product
HP

Hodrick–Prescott [filter]
IMF

International Monetary Fund
JSE

JSE Limited
MPC

Monetary Policy Committee
MPR

Monetary Policy Review
MTBPS
Medium Term Budget Policy Statement
NEER
Nominal effective exchange rate
PMI

Purchasing Managers’ Index
PPI

producer price index
REER
Real effective exchange rate
repo

repurchase [rate]
RMB
Rand Merchant Bank
RMSE
root mean square error
SIT

services, income and current transfer [account]
the Bank
South African Reserve Bank
the Fed
United States Federal Reserve
VAT

value-added tax
UK

United Kingdom
ULC

unit labour cost
US

United States
Monetary Policy Review December 2014

Glossary
Administered prices: These prices are set according to government’s policy rather than
determined by market supply and demand forces (usually because the product is related to
social welfare). These prices may or may not have an economic regulator.
Advanced economies: Advanced economies are highly industrialised countries with high
levels of GDP per capita.
Balance of payments: This is a record of transactions between the home country and the
rest of the world over a specific period of time. It includes the current and financial accounts.
See also ‘current account’ below.
Budget deficit: A budget deficit indicates the extent to which government expenditure
exceeds government revenue (a budget surplus occurs when revenue exceeds expenditure).
Business and consumer confidence: These are economic indicators that measure the state
of optimism about the economy and its prospects among business managers and consumers.
Capacity utilisation: The percentage utilisation of production capacity in the manufacturing
industry is a measure of the use of manpower, plant and machinery in manufacturing. The
degree of capacity constraint experienced in the manufacturing industry is determined by
obtaining indications from large manufacturing enterprises regarding skills shortages and
other reasons, such as downtime due to maintenance, changes in productivity and seasonal
factors. The measure is used to assess the degree of capacity constraint experienced in the
manufacturing industry.
Central projection: This is the most likely outcome for the variable of interest over the
period, according to South African Reserve Bank forecasts.
Commodity prices: Commodities can refer to food, oil or precious metals. Major South
African-produced commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication of aggregate price changes
in the domestic economy. The index is calculated using a number of categories forming a
representative set of goods and services bought by consumers.
Core inflation: This is inflation excluding food and energy (including petrol) prices, which
is considered a better reflection of the trend underlying inflation.
Crude oil price: This is the price, in US dollars, per barrel of unrefined (North Sea) oil.
Current account: The current account of the balance of payments consists of net exports
(exports less imports) in the trade account, as well as the services, income and current
transfer account.
Demand pressures: Demand pressures refer to price pressures from increased consumption
in the domestic or foreign economy.
Emerging-market economies: Emerging-market economies are those with low to middle
income per capita. They are advancing rapidly and are integrating with global (product and
capital) markets.
Exchange-rate depreciation (appreciation): Exchange-rate depreciation (appreciation) refers
to a decrease (increase) in the value of a currency relative to another currency.

Monetary Policy Review December 2014
Exchange-rate pass-through: This is the effect of exchange-rate changes on
domestic inflation (i.e. the percentage change in domestic CPI due to a 1
per cent change in the exchange rate). Changes in the exchange rate affect
import prices, which in turn affect domestic consumer prices and inflation.
First- and second-round effects: A price shock has direct as well as indirect
first-round effects; for example, higher oil prices leading to increased petrol
prices (direct) and then higher prices for goods and services for which petrol
is an input (indirect). This shock may also have a second-round effect if it
causes an additional change in inflation expectations, wage settlements or
underlying inflation.
Flexible inflation targeting: This refers to inflation-targeting regimes that
consider changes in inflation and other variables affecting the real economy
in the short term. Under strict inflation targeting only inflation matters,
but flexible inflation targeting takes into account other variables, such as
output.
Forward rate agreement (FRA): A contract that determines the rate of
interest to be paid or received on an obligation beginning at a future start
date.
Forecast horizon: This is the future period over which the Bank generates
its forecasts, typically between two and three years.
Gross domestic expenditure: This refers to the total value of expenditure
on goods and services within the country plus expenditure on imports less
exports.
Gross domestic product (GDP): GDP is the total market value of all
goods and services produced in a country. It includes total consumption
expenditure, capital formation, government consumption expenditure and
the value of exports less the value of imports.
Gross fixed capital formation: Value of acquisitions of capital goods (e.g.
machinery, equipment and buildings) by firms, adjusted for disposals,
constitutes gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers to CPI for all
urban areas that is released monthly by Stats SA. Headline CPI is a measure
of price levels in all urban areas. The 12-month percentage change in
headline CPI is referred to as ‘headline CPI inflation’ and reflects changes
in the cost of living. This is the official inflation measure for South Africa.
Household final consumption expenditure: This is the amount of money
spent by households on consumer goods and services.
Household disposable income: Household disposable income is defined
as primary income, net current transfers and social benefits, less taxes on
income and wealth.
House price index: This is a measure of the prices at which residential
dwellings are bought and sold over time.
Import penetration: This ratio shows the degree to which domestic demand
is satisfied by imports. It is calculated as imports divided by domestic
demand (where domestic demand is gross domestic product minus exports
plus imports).
Monetary Policy Review December 2014

Import unit value indices (UVI): This measures inflation in imported
commodities. The average value changes are calculated by dividing the
value of imported goods per category with the respective amount of the
goods. The Statistics South Africa import UVI is calculated as a five-month
moving average using customs data as a proxy for inflation in imported
commodities.
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.
Interest-rate smoothing: This is the gradual decrease (increase) of the policy
rate over the business cycle. Policymakers target the medium term, thus
they allow time for previous changes to have an effect before making further
changes (if necessary). Gradual interest-rate changes also permit economic
stakeholders to adapt their expectations about future interest-rate changes.
J–curve: The path followed by a country’s trade balance in response to
currency depreciation. A delayed reaction of more expensive imports and less
valuable exports will initially worsen the trade balance before it improves,
tracing a path that looks like a letter “J”.
Median: This is a statistical term used to describe the observed number that
separates ordered observations in half.
Mortgage: A mortgage is a form of secured loan extended for the purchase
of real estate.
Nominal effective exchange rate (NEER): The NEER is an index that
expresses the value of a country’s currency relative to a basket of other
currencies. An increase (decrease) in the effective exchange rate indicates
a strengthening (weakening) of the domestic currency with respect to the
selected basket of currencies. The weighted average exchange rate of the
rand is calculated against 20 currencies. The weights of the five major
currencies are in brackets: euro (29,26), Chinese yuan (20,54), US dollar
(13,72), Japanese yen (6,03) and British pound (5,82). Index: 2010 = 100.
Non-tradeables: Goods and services produced and consumed domestically
that are not close substitutes to goods and services that are imported or
exported.
Output gap/potential growth: Potential growth is the rate of GDP growth
that could theoretically be achieved if all productive assets in the economy
are employed in a stable inflation environment. The output gap is the
difference between actual growth and potential growth. If this is negative,
then the economy is viewed to be underperforming and demand pressures
on inflation low. If the output gap is positive, the economy is viewed to be
overheating and demand pressures inflationary in nature.
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.

Monetary Policy Review December 2014
Productivity: Productivity indicates the amount of goods and services
produced in relation to the resources utilised in the form of labour and
capital. The most common measure is labour productivity.
Purchasing Managers’ Index (PMI): This index shows the sentiment of
purchasing managers in the manufacturing sector, indicating the broader
economic health of the sector.
Quantitative easing (QE): is an unconventional monetary policy tool
implemented largely in the US, the UK, the euro area and Japan. QE
involves the central bank purchasing bonds on the open market so as to
inject liquidity into the economy. This also leads to a markedly higher level
of money supply in the economy.
Real effective exchange rate (REER): The REER is the NEER adjusted by
relative consumer prices in South Africa and its main trading partners.
Real variables: These variables are adjusted for inflation and hence are
expressed in constant prices (of some base year) and represent the volume of
an aggregate.
Real repo rate: This is the nominal repurchase (repo) rate, as set by the
Monetary Policy Committee, adjusted for expected inflation.
Repurchase rate (repo rate): This is the rate that commercial banks pay to
borrow money from the South African Reserve Bank.
Terms of trade: This refers to the ratio of export prices to import prices.
Tradeables: Goods or services that are imported or exported.
Unit labour costs: A unit labour cost is the labour cost to produce one
‘unit’ of output. This is calculated as the total wages and salaries in the
non-agricultural sector divided by the real value added at basic prices in the
non-agricultural sector of the economy.
Unsecured loans: Loans extended without any collateral (guarantees or
underlying assets) as security to protect the value of the loan are called
‘unsecured loans’.
VIX®: The Chicago Board Options Exchange Market Volatility Index
(VIX®) measures the implied volatility of S&P 500 index options and serves
as a popular indicator of investors’ perception of risk.