South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
29 January 2014


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Gill Marcus, Governor of the South African Reserve Bank

Since the previous meeting of the Monetary Policy Committee, the expected
cutback in quantitative easing by the US Fed has begun. Although the initial
response in global financial markets was generally fairly muted, emerging
markets have subsequently experienced a high degree of turbulence, particularly
in the wake of renewed fears of a slowdown in China. While the Fed action
signals a recovery in the US, and the UK economic outlook is also improving, it
does not mean that the global financial crisis is over. Rather, we are now entering
a phase of the crisis that is creating new challenges for emerging market
economies.

In the longer run a sustained recovery in the US should be positive for the global
economy in general, but the adjustment to the withdrawal of quantitative easing is
likely to create significant short to medium-term challenges. How to respond to a

MPC Statement January 29th 2014


combination of sharply depreciating currencies, capital outflows, slowing growth,
rising inflation, significant current account and/or fiscal deficits and deteriorating
confidence is posing policy challenges and very difficult trade-offs for many
emerging markets.

The rand exchange rate has been one of the currencies affected by these
developments, and the recent depreciation of the rand, if sustained, will raise
significantly the risk to the inflation outlook. Our inflation forecast shows a marked
deterioration, despite the absence of clear evidence of domestic demand
pressures.

The recent inflation data reflects positive outcomes that belie the incipient risks,
largely from the depreciation of the currency, that our forecasts highlight. The
year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 5,3 per cent in November 2013 and 5,4 per cent in
December, resulting in an average annual inflation rate of 5,7 per cent for 2013.
Food and non-alcoholic beverage price inflation continued to moderate from a
recent peak of 7,1 per cent in August, to 3,8 per cent in November and 3,5 per
cent in December. The contribution of this category to the average CPI increase
was 0,5 percentage points in December compared with 0,6 percentage points in
the previous month. The petrol price, which was the main contributor to the
higher overall inflation in December, increased at a year-on-year rate of 10,0 per
cent, up from 7,7 per cent in November. Core inflation, which excludes food,

MPC Statement January 29th 2014


petrol and electricity, has been unchanged at 5,3 per cent for the four months to
December, while administered price inflation excluding petrol measured 6,8 per
cent. The headline producer price inflation for final manufactured goods
measured 5,8 per cent in November, compared with 6,3 per cent in October.

The headline inflation forecast of the Bank has deteriorated since the previous
meeting of the MPC, mainly as a result of revisions to the assumptions regarding
the rand exchange rate. The forecast average inflation rate for 2014 is 0,6
percentage points higher at 6,3 per cent, and 0,6 percentage points higher at 6,0
per cent in 2015, with inflation expected to average 5,9 per cent in the final
quarter of that year. Inflation is expected breach the upper end of the target
range in the second quarter of 2014, and to reach a peak of 6,6 per cent in the
final quarter of the year, before declining to 6,0 per cent in the second quarter of
2015.

Core inflation, which averaged 5,2 per cent in 2013, is expected to average 5,8
per cent in 2014, compared with 5,6 per cent in the previous forecast, while the
forecast for 2015 has increased from 5,3 per cent to 5,9 per cent. The
deterioration in this measure of underlying inflation continues to be driven
primarily by the lagged effects of the depreciation of the rand exchange rate.

Inflation expectations appear to have remained relatively anchored at the upper
end of the target range. According to the survey conducted in the fourth quarter

MPC Statement January 29th 2014
by the Bureau for Economic Research at Stellenbosch University,
average inflation expectations of respondents measured 6,1 per cent for both
2014 and 2015 and have remained more or less unchanged since 2011. There
is, however, some divergence between the average expectations of respondents,
which range between 5,6 per cent and 6,4 per cent in 2014, and 5,5 per cent and
6,5 per cent in 2015. Financial analysts have the lowest forecasts, which are also
reflected in the latest Reuters survey that indicates expectations of 5,6 per cent
and 5,5 per cent in 2014 and 2015 respectively.

While the economic growth outlook for a number of emerging market economies
has deteriorated somewhat in recent months, the prospects in the advanced
economies have improved, particularly in the US and the UK. However, the
recovery remains uneven and not without risks. In the US, growth is being driven
by a recovery in the housing market, robust private sector demand, and a
dissipation of the negative impulse from fiscal consolidation. In its latest World
Economic Outlook (WEO) update, the IMF forecasts growth of 2,8 per cent in
2014 for the US, compared with 1,9 per cent in 2013. The outlook for the
Eurozone remains fragile and uneven, particularly in the Southern periphery
where the risk of deflation, strong fiscal consolidation and weak banking sectors
are constraining the recovery. Eurozone growth in 2014 is expected to remain
subdued at around 1,0 per cent.


MPC Statement January 29th 2014


The Japanese economy has maintained its positive growth but there are still
doubts about its sustainability in the absence of continued fiscal stimulus. The
outlook for the Chinese economy is increasingly uncertain, given the challenge of
containing the excessive increase in credit extension without adversely impacting
on growth. Although a growth rate of around 7,5 per cent is still generally
expected, the latest PMI, which suggests a contraction of industrial production,
indicates some downside risk to this outlook. This uncertainty has contributed to
increased risk aversion and volatility in financial markets of emerging economies
in recent weeks, and is also likely to impact negatively on commodity prices.

Significant currency depreciation and weaker growth prospects are also evident
in a number of other large emerging economies, particularly Brazil, Russia and
Turkey, while the outlook for the Indian economy appears to have improved
somewhat.

Global inflation remains benign despite abundant liquidity. However, spillover
effects from increasingly divergent monetary policies are creating a difficult and
volatile environment for emerging markets. There is still some uncertainty
regarding the pace of tapering by the Fed in the coming months, and although
market expectations are that the US policy rate is unlikely to increase before at
least mid-2015, long term bond yields have increased to around 2,8 per cent from
around 1,6 per cent in May 2013. A further sustained improvement in UK growth
and employment trends has brought forward the prospect of monetary tightening

MPC Statement January 29th 2014


by the Bank of England. However, monetary policy is expected to remain highly
accommodative in Japan and the Eurozone where the risk of deflation persists.

The expectation of tapering by the Fed since May 2013 resulted in significant
outflows from emerging economies domestic bond and equity markets, putting
pressure on exchange rates and long term bond yields, particularly in those
countries with sizeable current account deficits. Some countries, including Brazil,
Turkey, Indonesia and India, responded by tightening monetary policy, either in
reaction to inflationary pressures or in an attempt to stem the depreciation. Since
May 2013, cumulative interest rate increases have amounted to 300 basis points
in Brazil and 75 basis points in India. The most recent instance has been Turkey
which raised its overnight interest rate (MFR) by 425 basis points to 12 per cent.

The impact of these developments on the rand exchange rate has resulted in a
marked increase in the upside risk to the inflation forecast, despite the relatively
muted pass-through to date. Since the previous MPC meeting, the rand has
depreciated by about 7,4 per cent against the US dollar, by 9,0 per cent against
the euro and by 8,0 per cent on a trade weighted basis. Year to date the
rand/dollar depreciation has been about 3,5 per cent.

In the final two months of 2013, total net sales by non-residents of South African
domestic government bonds and equities amounted to R21,0 bn and R19,4bn
respectively. These flows effectively reversed the inflows that occurred during the

MPC Statement January 29th 2014


earlier part of the year, with net purchases of bond and equities for 2013 by nonresidents amounting to R1,3 bn, compared with R85,2 bn for 2012. Year-to-date
net sales of equities and bonds have totaled R19,3 bn, of which R15,6 bn were
bonds.

While the recent rand weakness is part of a general emerging market
phenomenon, it has been reinforced by idiosyncratic factors including declining
terms of trade, on-going labour disputes, and the higher-than-expected current
account deficit in the third quarter.

Although to date the current account has been slow to react to the depreciation of
the rand, the trade surplus of R0,8 bn recorded in November may signify a
possible narrowing of the current account deficit in the fourth quarter of 2013.
However, given the volatility of the monthly trade data, it is too early to assess
whether or not this is the beginning of a sustainable trend. The extent to which
the strikes in the mining sector and resulting decline in exports are likely to
impede the current account adjustment further will depend on the duration of the
strikes and the extent to which lost output can be compensated for by running
down inventories.

The economic growth outlook remains subdued amid continued low business
confidence. Growth in the fourth quarter of 2013 is estimated to have recovered
somewhat from the low base of 0,7 per cent in the third quarter, and annual

MPC Statement January 29th 2014


growth in 2013 is estimated to have been around 1,9 per cent. Although an
improved outcome is forecast for 2014, growth is still expected to remain below
estimated potential output of between 3,0 and 3,5 per cent. The Bank’s forecasts
for growth in 2014 and 2015 have been revised to 2,8 per cent and 3,3 per cent
respectively, down from 3,0 per cent and 3,4 per cent in the previous forecast
round. The Bank’s composite leading business cycle indicator continues to trend
sideways, and was marginally negative in November.

The mining sector is expected to remain under pressure in the face of work
stoppages in the major platinum mines, with the risk of these disruptions
spreading to the gold mines. Mining output recovered somewhat in the fourth
quarter of 2013 from the September lows, and the sector is expected to have
made a positive contribution to fourth quarter growth. The manufacturing sector is
also expected to have exhibited stronger growth in the final quarter, following the
strike-induced contraction in the third quarter. However, the sector has yet to
exhibit a meaningful response to the weaker exchange rate, and the Kagiso PMI
declined to just below 50 index points in December, for the first time since April
2013.

The construction sector presents a mixed picture. The FNB/BER building
confidence index remained unchanged at 48 index points in the fourth quarter of
2013, the highest level in 5 years. However, the upward trend in the real value of
building plans passed observed in the earlier part of 2013 has leveled off, and

MPC Statement January 29th 2014


there was a notable decline in November by 12,5 per cent on a month-to-month
basis, and a 14,5 per cent decline on a year-on-year basis. The outlook for civil
construction, by contrast, appears to be more favourable.

These restrained developments in the real sector have contributed to the slow
pace of employment creation in the economy, and continued job losses in the
private sector remain a concern. According to the Quarterly Employment
Statistics (QES) survey of Statistics South Africa, formal sector employment
increased by 13,400 in the year to the third quarter of 2013, or by 0,2 per cent. In
the third quarter of 2013, employment losses were most pronounced in mining
and construction.

Growth in consumption expenditure by households moderated from 2,8 per cent
in the second quarter to 2,3 per cent in the third quarter, and is expected to
remain relatively constrained by disappointing employment growth and a modest
rise in credit extension. Slow growth was particularly evident in the consumption
of non-durable goods and services. Real expenditure on durable goods remained
strong, with growth of 9,3 per cent. Nevertheless, domestic new vehicles sales
appear to be under pressure, having contracted by 3,3 per cent on a quarter-toquarter basis in the final quarter of 2013. Although retail trade sales increased by
1,2 per cent on a month-to-month basis in November 2013, they increased only
marginally, by 0,1 per cent, when the three months to November are compared to
the previous three months. Consumer confidence, as reflected in the FNB/BER

MPC Statement January 29th 2014


consumer confidence index, remained at a low level of -7, a marginal
improvement from the previous quarter.

Growth in credit extension by the banking system to the private sector continued
to lose momentum. Twelve-month growth in total loans and advances to the
private sector moderated to 7,4 per cent in November, with credit extension to
households measuring 5,9 per cent, compared with 10,4 per cent at the same
time in 2012. Twelve-month growth in general loans to households, mainly
unsecured lending, measured 8,1 per cent in November, the lowest rate of
growth since April 2009, while annualised growth over three months showed a
contraction of 0,8 per cent. Although there has been an increase in commercial
mortgage credit extension, growth in outstanding residential mortgages remains
subdued at 1,3 per cent. Instalment sale credit and leasing finance has continued
to be relatively brisk, but could moderate if motor vehicle demand continues to
decline. Household debt as a percentage of household disposable income
declined slightly from 75,8 per cent in the second quarter to 75,5 per cent in the
third quarter of 2013.

Wage settlement rates, as measured by Andrew Levy Employment Publications,
measured 7,9 per cent during 2013. However, according to QES data, growth in
nominal remuneration per worker declined from 8,8 per cent in the year to the
second quarter of 2013, to 6,6 per cent in the year to the third quarter. For the
economy as a whole, despite a small decline in labour productivity growth, unit

MPC Statement January 29th 2014


labour cost growth declined over the year from 6,9 per cent in the second quarter
to 4,9 per cent in the third quarter. However there are important sectoral
differences. For instance, unit labour cost growth in the manufacturing sector
accelerated from 5,6 per cent to 6,9 per cent during the same period, while
nominal remuneration per worker in the mining sector increased by 9,0 per cent.

Food prices have been the main contributor to the downside surprises in inflation
in the past two months, with prices increasing by 3,5 per cent in December.
Global food prices generally declined during the year amid improved wheat and
maize harvests. The rand exchange rate, coupled with disappointing domestic
harvests due to drought in some areas, has impacted adversely on the domestic
maize and wheat prices in recent weeks, with the spot prices of maize increasing
by about 12 per cent during January, following increases of around 20 per cent
between August and December 2013. These pressures have not as yet been
observed in the producer price index where cereal and other crop prices declined
by one per cent over the year in November. Persistent drought conditions in a
number of regions have resulted in the culling of cattle, leading to extremely low
meat price inflation since September (0,1 per cent in December). However,
these favourable food price outcomes are not expected to persist as higher spot
grain prices work through to consumer prices.

Although the exchange rate pass-through has generally been relatively muted to
date, the impact on the petrol price has been almost immediate. International oil

MPC Statement January 29th 2014


prices have been fairly stable, with Brent crude oil trading in a range of between
US$106 and US$109 during January. In December and January the domestic
petrol price was increased by a cumulative 55 cent per litre, and a further
significant increase, in excess of 30 cents per litre, can be expected in February,
primarily as a result of the weaker exchange rate. Sustained upside pressure
from petrol prices on inflation can therefore be anticipated should the rand
continue to depreciate.

The MPC carefully considered the economic challenges facing South Africa and
the appropriate policy response. On the one hand, inflation forecasts indicate the
possibility of being out of the target range for an extended period, largely due to
the impact of the depreciating currency. The risks to the inflation forecast are
seen to be significantly on the upside. Large adjustments to the exchange rate
will inevitably impact on inflation, even in conditions of relatively low pass-through
such as we have been experiencing.
On the other hand, the growth outlook remains of concern. Credit extension is
low and declining, few jobs on a net basis are being created, and gross fixed
capital formation, particularly from the private sector, is significantly below what is
required.
Capital outflows and a current account deficit exacerbate the difficulties that lie
ahead. Exchange rate pressures are expected to intensify as markets adjust to
the new pattern of global capital flows. Although monetary policy in the advanced

MPC Statement January 29th 2014


economies remains accommodative, the process of normalisation has begun,
and the spillovers have implications for our own monetary policy.
The primary responsibility of the Bank is to keep inflation under control and
ensure that inflation expectations remain well anchored. The depreciation
experienced so far could improve our international competitiveness, provided that
it is not eroded through higher wage and other input prices.
In the light of these circumstances and taking account of policy trade-offs, the
MPC has decided to increase the repurchase rate by 50 basis points to 5,5 per
cent per annum as of 30 January 2014. The MPC is of the view that,
notwithstanding this increase in the repo rate, monetary policy remains
accommodative. Further moves in the repo rate will be highly data dependent.
We will continue to monitor developments closely and will not hesitate to act as
required in keeping with our mandate.


Gill Marcus
GOVERNOR

Contact person:
Candice Jeffreys
+27 12 313 4209