Monetary Policy Review
October 2019
South African Reserve Bank
Monetary Policy Review
October 2019
Monetary Policy Review October 2019
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ISSN: 1609-3194
Printed by Publishing Section of the South African Reserve Bank
Monetary Policy Review October 2019
Preface
The primary mandate of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. In addition, the SARB has a complementary mandate to oversee and maintain
financial stability.
Price stability helps to protect the purchasing power and living standards of all South Africans. It provides a favourable
environment for investment and job creation, and supports international competitiveness. The goal of price stability is
quantified through an inflation target, which is set in consultation with government. The target is a range of 3–6%, which has
been in place since 2000. The SARB has full operational independence. Monetary policy decisions are made by the SARB’s
Monetary Policy Committee (MPC), which is chaired by the Governor, and includes the deputy governors and other senior
officials of the SARB.
This inflation-targeting framework is flexible, meaning that policymakers will seek to look through temporary shocks, thereby
avoiding excessive volatility in interest rates and economic output. The MPC takes a forward-looking approach to account for
the time lags between policy adjustments and economic effects. MPC decisions are communicated at a press conference at
the end of each meeting, accompanied by a comprehensive statement.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening public understanding of the objectives
and conduct of monetary policy. The MPR covers domestic and international developments that affect the monetary policy
stance. The MPR is presented by senior officials of the SARB at monetary policy forums at major centres across South Africa,
in an effort to develop a better understanding of monetary policy through direct interactions with stakeholders.
Monetary Policy Review October 2019
Contents


Boxes

Box 2 Getting the point: how the South African Reserve Bank’s 4.5% preference diffused to analysts


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

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review October 2019
Delivering on the mandate
in a world of risks
Executive summary and
overview of the policy stance
South Africa’s economy faces two large macroeconomic
risks. The first is global, a slowdown in trade growth that could
precipitate a global recession. The second is domestic, a
deteriorating fiscal situation linked to bailouts for state-owned
enterprises. Both could worsen an already difficult domestic
growth situation. The economy’s potential growth rate has
slumped to around 1% in the context of supply constraints
(especially electricity shortages) and depressed business
confidence. Demand has also weakened, in the face of
higher taxes and slowing wage growth, among other factors.
Inflation outcomes have been better, close to the midpoint of
the 3–6% target range, which has given policymakers some
space to reduce rates. Looking forward, the policy stance
aims to provide support to a weak economy while ensuring
inflation remains securely within the target range across the
forecast period, despite risks.
Trade tensions have been a feature of the global economy
since 2017, but their costs have become much clearer in 2019.
Global export growth has fallen to its lowest levels since the
2009 crisis. Manufacturing sectors are contracting worldwide.
Trade-exposed economies, such as Germany’s, have seen
sharp growth slowdowns. Many other economies, however,
have held up better. Unemployment rates across advanced
economies are unusually low, which has supported household
consumption. Relatedly, even as manufacturing sectors have
weakened, advanced economy service sectors have typically
remained in expansion territory.
In emerging markets, by contrast, conditions are more clearly
negative. Unemployment rates have generally trended higher,
while growth rates have slowed. The growth differential between
advanced economies and emerging markets – the key rationale
for investing in emerging markets – has fallen close to zero (and
would be zero, excluding China). As discussed in the global
economy chapter, weakness in emerging markets reflects a
range of idiosyncratic problems: slowdowns in India, Brazil,
China, Russia and elsewhere all have unique characteristics.
However, there are also general factors at work, of which the
most important appear to be excessive debt, dollar strength
(which raises the price of capital goods and discourages
capital flows), and the trade tensions already mentioned.
Given a combination of growth risks and subdued inflation,
major central banks have put aside interest rate normalisation
plans and lowered rates instead. A year ago, the United
States (US) Federal Reserve (Fed) was expected to raise
rates twice in 2019; instead, it has cut rates twice, in July and
Percentage change

2019*
World export volumes

* Year to date
Sources: CPB Netherlands Bureau for Economic Policy Analysis and SARB

Index

Global purchasing managers’ indices
Sources: Haver, IHS Markit and JPMorgan

Manufacturing

Services

PMI <50 = contraction

Upper-middle-income economies

High-income economies
Per cent

Unemployment rates in selected regions

Source: World Bank

Monetary Policy Review October 2019

September, and markets anticipate further reductions by yearend. Similarly, where the European Central Bank (ECB) was
previously expected to start hiking rates in the second half
of 2019, it has instead initiated a new round of policy easing,
cutting its deposit rate further into negative territory (-0.4% to
-0.5%) and restarting quantitative easing.
For investors, these global conditions create two contradictory
imperatives. Policy uncertainty and recession risks prompt
flights to safety, benefitting assets such as gold. Low or
negative returns on safe assets, however, also incentivise risktaking to achieve yield. In practice, the past six months have
been characterised by both risk-on and risk-off phases, with
risk-on sentiment strongest around July and weakening again
in August.
In these circumstances, the rand exchange rate has fluctuated
in a wide range over the past six months, with a low of
R13.25 and a high of R15.47 per US dollar (using daily data).
The bond market saw outflows in May, June, July and August,
as investors reduced their exposure to local assets. Ten-year
government bonds have returned 9% or more, for an inflation
adjusted return of around 4% – which is high relative to peers
and to history. Tellingly, long-term rates have stayed elevated
despite falling inflation expectations and lower short-term
rates, demonstrating that high rates are not a function
of monetary policy but rather a higher term premium (as
discussed in Box 5).
Since 2017, the Monetary Policy Committee (MPC) has
expressed a preference for inflation stabilising nearer the
middle of the 3–6% target range. Inflation, which averaged
6.3% in 2016 and 5.7% in 2017, has since moderated to 4.6%
in 2018, and is likely to be 4.2% in 2019. The disinflation
effort has benefitted from unusually low food price inflation,
as well as a flatter exchange rate trend over the past three
years, which has helped to stabilise import prices. Weak
demand has played a role, for instance in record-low housing
inflation, although housing supply has also grown rapidly.
Lower inflation expectations have also contributed, by
moderating the trend component of inflation, whereby price-
and wage-setters index to the consumer price index (CPI)
to protect the real value of their incomes. Lower inflation
expectations are visible in both survey- and market-based
measures. For instance, the latest Bureau for Economic
Research (BER) survey shows expectations are down to
4.6% for the current year and around 5% for the longer-term.
Although most expectations measures are still above 4.5%,
the direction of change remains favourable.

Oct 2018

Jan 2019

Sep 2019
Per cent

US Fed policy rate path*

Source: Bloomberg
* Bloomberg survey of analysts

Nominal

Real*
Per cent

South African 10-year government bond yields

Sources: Haver, BER and SARB

* Deflated by two years ahead inflation expectations

Current year

One year ahead

Two years ahead

Five years ahead
Per cent

Surveyed inflation expectations*

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

3–6% inflation target range
Midpoint

Monetary Policy Review October 2019
Over the forecast period, inflation is expected to peak at
5.3% in the first quarter of 2020, mainly due to base effects
from fuel prices. (Core inflation, which omits fuel, is projected at
4.6% in this quarter.) As the base effect falls away, the forecast
shows inflation reverting to 4.5%, in line with where it has been
through most of 2018 and 2019.
Based on the inflation fan chart, it is highly probable that
inflation will remain within the target range throughout the
forecast period. The implied probability of inflation above the
upper bound of the target range is just 6%; the probability of
a target undershoot is even smaller, at 2%. Within the target
range, inflation is somewhat more likely to be in the top half
of the range than the bottom: the probabilities are 53% and
39% respectively. The slightly higher probability of outcomes
in the top half of the band is consistent with external forecasts.
The median of the Reuters survey, for example, is at 4.8%
for 2021.
Over the past six months, gross domestic product (GDP)
growth outcomes have remained volatile around a low trend.
Growth surprised to the downside in the first quarter of the
year, at -3.1% (quarter on quarter, at a seasonally adjusted
annualised rate) – the single worst quarterly number since
2009. It then rebounded to 3.1% in the second quarter, this
time surprising on the upside. (The July MPC forecast had
anticipated a second-quarter rebound to 2.6%.) Annual
growth for 2019 is now expected to be 0.6%, recovering
somewhat to 1.5% and 1.8% in 2020 and 2021 respectively.
These medium-term growth forecasts have been revised
down since July, from 1.8% for 2020 and 2% for 2021,
given lower world growth, fiscal risks and lower business
confidence.
Although the forecasts indicate better growth than has been
achieved over the past three years, the projections nonetheless
reflect modest quarter-on-quarter numbers, mostly below 2%.
The annual figures are higher mainly because the forecast
features no first-quarter growth contractions, which have
outsize effects on annual growth rates (as discussed in the real
economy chapter). For this reason, the forecasts should not be
read as envisioning a robust growth recovery.
The output gap widened with the adverse first-quarter growth
outcome, reaching -2.1% of potential GDP, from -1.3% in the
preceding quarter. This was the most negative output gap since
1993.1 It narrowed again with the second-quarter rebound,
to -1.7% of potential GDP, but remains negative. A range of
data points support the case that the South African economy
is operating with a shortage of demand. These include slowing

The 2009 gap was smaller because the economy had previously been
overheating. Historical estimates of the output gap indicated more negative
numbers for much of the post-crisis period, below -4% of potential GDP
at some points; this claim refers to output gap estimates based on current
information and estimation techniques.
Percentage change over four quarters

Headline and core inflation
Sources: Stats SA and SARB

Headline inflation

Core inflation

Midpoint

3–6% inflation target range
Forecast

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

* The bands around the central projection show confidence intervals
of 10%, 30%, 50% and 70%.
Sources: Stats SA and SARB
Percentage change over four quarters

Real GDP growth*
-1

-1

* The bands around the central projection show confidence intervals
of 10%, 30%, 50% and 70%.
This chart shows seasonally-adjusted data, as used in the QPM
Sources: Stats SA and SARB
Monetary Policy Review October 2019

employee compensation, weak growth in the tertiary sector,
and repeated trade surpluses, achieved through import
compression. There has been no sudden shock to demand,
such as a financial crisis; demand nonetheless appears to
have wilted under sustained pressure from supply-side shocks
and persistent policy uncertainty.
Although the forecast is premised on a demand shortfall, recent
growth disappointments should not be assigned purely to low
demand. Growth has also suffered from temporary supply-side
problems, such as the electricity shortages and mining-sector
strikes that disrupted economic activity in the first quarter. In
addition, growth is being affected by low business confidence,
in part due to policy uncertainty, which is a different problem
to either demand shortfalls or supply-side constraints. In the
forecasting process, both the low trend and temporary shocks
are allocated to the economy’s potential growth rate. This is
now very low, at 1% for 2019, which compares unfavourably
with a longer-term average of around 2.5%. Low potential
growth remains the single most important aspect of South
Africa’s growth problem, which is why the South African
Reserve Bank (SARB) has repeatedly pressed for structural
reforms. That said, even with low potential growth, it is still
possible to have cyclical deviations from the trend, and these
deviations should be responsive to interest rate adjustments –
even if the larger growth problem, of low potential growth, is
beyond the powers of monetary policy.
Overview of the policy stance
Over the six months covered by this Monetary Policy Review
(MPR), there have been three policy rate decisions by the MPC,
one of which resulted in a reduction of the repurchase (repo)
rate by 25 basis points.
In the May 2019 meeting, the repo rate was left unchanged, a
decision fully anticipated by analysts2 and wholly priced in by
financial markets.3 The MPC judged that the growth forecast
risks lay to the downside, while the inflation forecast risks were
balanced, with both upside and downside risks in roughly equal
proportions. The implied policy rate path generated by the
Quarterly Projection Model (QPM) suggested an unchanged
policy rate through 2019, followed by a 25 basis point cut in the
first quarter of 2020 (the first rate cut in the forecast since the
QPM’s introduction in November 2017).
In the July meeting, the MPC opted to reduce the repo rate
by 25 basis points, as predicted both by a large majority of
analysts and in keeping with market expectations. The MPC
once again assessed the growth forecast risks as lying on the
downside, with the inflation forecast risks remaining balanced.
The QPM repo path showed the rate cut from the previous
meeting shifting one quarter earlier, to the fourth quarter of
2019, with no additional cut in the forecast. The MPC also

As surveyed by both Bloomberg and Reuters.

According to Forward Rate Agreements.
Percentage of potential GDP

Output gap*
Source: SARB


* Dotted line indicates forecast

Potential growth

Actual growth
Forecast
Percentage change over four quarters

Potential and actual real GDP growth*
* This chart shows seasonally-adjusted data, as used in the QPM
Sources: Stats SA and SARB
-3
-2
-1

Per cent

Evolution of the QPM repo path
Source: SARB


Actual

Mar 2019

May 2019

Jul 2019

Sep 2019
* Dotted lines indicate forecasts

Monetary Policy Review October 2019
considered a scenario in which the model ‘saw through’ the
temporary increase in inflation expected in early 2020, on the
grounds that this would come from a base effect, and was
therefore a technical matter rather than evidence of new price
pressure. This scenario showed the repo cut shifting earlier
to the third quarter, and therefore due at either the July or
September meeting.
In September, the MPC held the repo rate unchanged, at
6.50%. The QPM indicated a stable rate path, as the MPC
had already delivered the cut foreseen in the July forecast.
The decision was correctly anticipated by the large majority
of analysts (in the Bloomberg survey, for instance, 14 out of 18
economists saw no change), although markets had priced a cut
as probable, with a likelihood of around 75%. In assessing the
risks to the forecasts, the MPC characterised both the growth
and inflation risks as broadly balanced in the short term, with a
degree of downside risk to the medium-term growth trajectory,
and administered prices posing some upside risk to inflation.
Despite the 25 basis point decline in the nominal repo rate
during the July 2019 meeting, the overall policy stance has
changed little since the previous MPR. The real repo has
been somewhat higher than expected in the near term,
given downside inflation surprises. It is accommodative over
the medium term, however, which is the relevant horizon for
monetary policy, averaging 1.6% for 2020 and 1.9% for 2021.
This contrasts with a neutral rate estimated at 2.4% for both
2020 and 2021.
The neutral rate in the QPM comprises a global rate and a
country risk premium, as well as compensation for the expected
change in the real effective exchange rate (REER).4 Over the
past six months, neutral rate estimates have edged up slightly
(by an average of 0.1 percentage point in each forecast year).
This upward pressure has come from heightened country risk
and a more depreciated exchange rate projection (up about
0.4 percentage points, combined). Together, these factors
have more than offset a lower path for global rates (down
about 0.3 percentage points).
Importantly, in the neutral rate estimate, all these components
are equilibrium concepts, not actual outcomes. This means the
neutral rate does not change immediately and proportionately
to data shifts, such as the US Fed cutting rates, or the
market-implied South African risk premium spiking. Those
developments feed into other aspects of the forecast, and
thereby influence the projected policy stance, but they are not
incorporated directly in neutral.

This last factor is required to satisfy the uncovered interest parity (UIP)
condition, which holds that over time a higher-yielding currency will
depreciate to compensate for the interest rate differential with a lower
yielding currency. If the REER equilibrium is expected to shift, the neutral
rate equilibrium must also change so UIP holds. This component is not a
permanent feature of neutral, unlike the other two factors, because in the
long run the REER is stable.
Percentage points

Evolution of the QPM real repo gap
Source: SARB


Mar 2019

May 2019

Jul 2019

Sep 2019
Per cent

Real repo rate* and its neutral level

* Nominal repo rate deflated by a four-quarter moving average of
year-on-year headline inflation.
Source: SARB
Contractionary
Neutral rate
Real repo rate
Forecast
Accommodative

Percentage points


South African EMBI+ spread

Equilibrium risk in neutral
Sources: JPMorgan and SARB
* Dotted lines indicate forecast
South African risk premium*
Monetary Policy Review October 2019

The rationale for including country risk in the neutral rate is that
investors require compensation for holding local assets instead
of risk-free instruments. For emerging markets in particular,
even short-term investments can be affected by risk events
(with Nenegate the most dramatic example in recent South
African experience). This country risk is a separate concept to
the term premium, which by definition is the price paid for the
duration of a loan. The country risk premium applies across the
entire yield curve.
The risk premium incorporated in the model’s neutral rate is
derived from the JPMorgan Emerging Market Bond Index
Plus (EMBI+) spread for South Africa. This measure provides
clear evidence that South African risk has risen over the past
five years or so, and is now higher than for most emerging
market peers. As the neutral rate uses equilibrium risk, the
actual value in neutral is somewhat below the prevailing EMBI+
spread (2.3% versus 2.8%). The forecast therefore anticipates
the actual risk premium will moderate towards its equilibrium.
There is a chance, however, that risk will not ease as projected,
requiring further upward revisions in the equilibrium risk rate.
Furthermore, even at currently-estimated levels, South Africa’s
risk premium is elevated. This constrains monetary policy by
raising the interest rate needed to stabilise inflation. The crucial
policy message is that a lower risk premium, closer to historical
and peer averages, would give monetary policy space to cut
rates without compromising on inflation.
Basis points*
Risk premium: EMBI+
Sources: JPMorgan and SARB

1 000
* 2019 average
Croatia
Philippines
Peru
Hungary
Panama
Indonesia
Romania
Russia
Mexico
Brazil
South Africa
Turkey
Ukraine
Argentina
Box 1 Where is the repo going? Explaining the
evolution of the projected repo path
Each Monetary Policy Committee (MPC) forecast is premised on
a repurchase (repo) rate path that adjusts to changing economic
conditions over the forecast period – instead of just being fixed at the
last known rate, as per previous practice. This repo path is generated
endogenously in the Quarterly Projection Model (QPM), following a
Taylor-type rule. The repo projections are published alongside the
MPC statement, accompanied by the caveats that the MPC is not
bound to follow these forecasts, and that the repo path can and
will change from meeting to meeting. This box unpacks how these
changes occur.
The South African Reserve Bank Taylor rule comprises a smoothing
parameter, plus the standard Taylor-rule variables: a neutral rate,
inflation and growth.
--
The smoothing parameter has the single biggest weight, which
tethers the repo to its previous setting, reflecting the fact that
policy changes are rarely large or volatile.
--
Inflation is measured as the deviation of future inflation from the
4.5% midpoint of the 3–6% target range, with future inflation
defined as the average forecast inflation rate for three, four and
five quarters ahead. The rule uses future instead of current
inflation because policy only transmits with a lag, and therefore
must be forward looking.
--
Growth is expressed as an output gap, which is the accumulated
difference between actual and potential gross domestic product
(in levels).
Per cent

Repo rate path forecasts*
Source: SARB
* Dotted lines indicate forecasts
Actual
May 2019
Jul 2019
Sep 2019


Monetary Policy Review October 2019
--
Neutral is the estimated interest rate at which inflation is stable
and the economy is operating at potential. When the repo rate
is at its neutral level, there is no expansionary or restrictive
impulse from monetary policy. The neutral rate is the sum of the
inflation target (4.5%) and the real neutral interest rate (often
referred to as r*). As discussed above, r* in the QPM is made up
of the equilibrium global rate and the equilibrium country risk
premium, with a smaller, temporary contribution for expected
changes in the real effective exchange rate.1
The table below unpacks the evolution of the repo rate projections
across the past three MPC meetings. The May 2019 forecast
envisioned a rate cut in the first quarter of 2020. By July, this cut had
shifted to the fourth quarter of 2019. In September, with the MPC
having already reduced rates in July, the path flattened out.
Across these meetings, the negative output gap exerted consistent
downward pressure on the repo rate. The inflation gap became
less of an influence over time, with the 3–5 quarter ahead inflation
window initially catching the 2020 uptick in inflation, but then moving
1 To sense-check the QPM results, separate estimates of neutral are calculated
using a Laubach-Williams approach. This shows similar r* estimates to the
QPM, at around 2% for 2018 and 2019. See L Kuhn, F Ruch and R Steinbach,
‘Reaching for the (r)-stars: estimating South Africa’s neutral real interest
rate’, South African Reserve Bank Working Paper Series No. WP/19/01,
Pretoria: South African Reserve Bank, February 2019.
co.za/Publications/Detail-Item-View/Pages/Publications.aspx?sarbweb=
3b6aa07d-92ab-441f-b7bf-bb7dfb1bedb4&sarblist=21b5222e-71254e55-bb65-56fd3333371e&sarbitem=9097 (accessed 20 August 2019).
Repo rate path forecasts
Contribution to total (percentage points)
Parameter 2019Q1 2019Q2 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4
May MPC 2019
Repo rate (per cent)

Persistence

Neutral

Inflation gap

Output gap

July MPC 2019
Repo rate (per cent)

Persistence

Neutral

Inflation gap


Output gap

September MPC 2019
Repo rate (per cent)

Persistence

Neutral

Inflation gap

Output gap

Source: SARB
further out to a period where inflation is projected nearer 4.5% again.
The neutral rate estimates have been relatively stable over the three
forecasts, being pushed up by risk but down by global factors.
The QPM displays repo rate projections down to any number of
decimal places, but because the MPC moves in quarter-percentage
point increments, the timing of a rate cut is identified by rounding to
the nearest quarter-point threshold. For instance, the July forecast
recommended a cut from 6.75% to 6.5% in the fourth quarter, with
the endogenous repo at 6.62% – and not the third quarter, when it
was 6.68%. The current low point in the repo projection falls in the first
quarter of 2021, at 6.38%, just above the threshold for an additional
rate reduction. The endogenous repo rises in the following quarters,
however, so the close proximity to a rate cut is temporary.2
2 This also explains why the July MPC QPM repo of 6.36% for the last quarter
of 2020 was not flagged as a second rate cut: the QPM path rounds to
6.50% in the adjacent quarters, implying a rate reduction in November would
be immediately reversed at the following meeting.
Monetary Policy Review October 2019

In 2017, the Monetary Policy Committee (MPC) changed its
communication strategy around the inflation target. Previously, it
had not expressed a clear view about where inflation should settle
in the long run, or where inflation expectations should be anchored,
beyond citing the 3–6% target range. With actual inflation generally
close to 6%, and measures of inflation expectations also hovering
around 6%, that range appeared to have turned into a de facto
6% target. Having resolved through a process of internal deliberation
that this was a sub-optimal outcome, the MPC began communicating
a preference for inflation closer to the 4.5% midpoint of the target
range. This box explores how that message diffused to financial
analysts and the media – two crucial intermediaries for reaching a
broader audience.
The South African Reserve Bank’s (SARB) new messaging around
4.5% began to take shape in 2016, starting with speeches delivered
by the Governor. The first mention of the midpoint preference in
a general SARB publication was in the 2016/17 Annual Report,
published in June 2017. The MPC first referred to the midpoint in
the July 2017 statement. The objective has since been re-iterated
in many speeches, MPC statements, and across editions of the
Monetary Policy Review.
In media reports, there is evidence of terms such as ‘4.5%’ or
‘midpoint’ appearing in close proximity to the ‘SARB’ (or similar
markers, such as ‘Reserve Bank’ or ‘Resbank’) from 2017. These
became more common towards the end of 2017, and proliferated in
late-2018. The two most important events driving greater attention
Number of ‘midpoint’ references
2015H1
2015H2
2016H1
2016H2
2017H1
2017H2
2018H1
2018H2
2019*
2015H1
2015H2
2016H1
2016H2
2017H1
2017H2
2018H1
2018H2
2019*
2015H1
2015H2
2016H1
2016H2
2017H1
2017H2
2018H1
2018H2
2019*
Total number of references to 4.5% or related terms
* Year to date
Source: SARB
Governors’ speeches
MPR
MPC statements

Governor
Deputy Governors
Per cent

Proportion of surveyed analysts mentioning 4.5%
or related terms
Sources: JPMorgan, Citi Bank, Nedbank, Intellidex, Nomura,
Investec, HSBC, Standard Bank, Absa, Deutsche Bank,
RMB Morgan Stanley and SARB

Number of references

Total number of references to 4.5%
or related terms
Sources: JPMorgan, Citi Bank, Nedbank, Intellidex, Nomura,
Investec, HSBC, Standard Bank, Absa, Deutsche Bank,
RMB Morgan Stanley and SARB

Reuters
QPM
adopted
QPM
adopted
Number of articles
News articles mentioning SARB and 4.5%
or related terms
2019*

Business Day

Bloomberg news
* Year to date
Sources: Bloomberg, Business Day, Reuters and SARB
Box 2 Getting the point: how the South African Reserve Bank’s 4.5% preference diffused
to analysts and the media

Monetary Policy Review October 2019
to the midpoint appear to have been the adoption of the Quarterly
Projection Model (QPM), with its 4.5% model target, in November
2017, and the period of higher inflation risk, as well as a rate hike, in
the second half of 2018.
The spread of this message is also visible in analysts’ reports
following MPC meetings. As might be expected, given that analysts
are subject-matter experts, the 4.5% message appears earlier
and more often than it did in the press. Once again, the adoption
of the QPM stands out as a major event that prompted wider
recognition of the midpoint objective. By 2019, references to 4.5%
are commonplace in analysts’ reports.
These results provide evidence that sustained central bank
communication shapes media and analyst reporting on monetary
policy. The SARB was not clearly heard the first time its leadership
expressed a preference for steering inflation to the middle of the
target band, but over time, this message spread widely. It is also
interesting that the new communications strategy commenced with
the repurchase (repo) rate at 7%, and the subsequent diffusion of
the 4.5% message and the moderation of inflation expectations
was accomplished without policy tightening above this level. This
was contrary to initial, internal studies which suggested the repo
rate would have to go higher, reaching about 8.5%, to establish the
credibility of the midpoint objective.
Monetary Policy Review October 2019

Global economy: recession risks
Global prospects are clouded by trade tensions, which
have disrupted economic activity this year and could
precipitate a global recession. Trade aside, advanced
economy performances are generally healthy, with low rates
of unemployment and output close to potential. In emerging
markets, by contrast, growth has underperformed badly, for
reasons including excessive leverage and dollar strength, as
well as trade problems. Globally, inflation is contained or – in
many advanced economies – too low, with a few prominent
exceptions (such as Argentina, Turkey and Zimbabwe).
Global growth
Global growth is likely to average 3.3% in 2019, according to
the World Bank, below 2018’s 3.7%. Most analysts expected
a global slowdown in 2019, given the fading effects of fiscal
stimulus in the US, structurally lower growth in China, and
similar factors. The global deceleration has nonetheless
been worse than expected. Over the past six months, global
growth estimates for 2019 have been lowered by around
0.3 percentage points, with downward revisions split roughly
equally between advanced economies and emerging markets.
Forecast revisions have been largest for the euro area
(-0.4 percentage points) and emerging markets excluding
China (-0.5 percentage points), a reminder that although trade
tensions are clearest in the US–China relationship, growth
problems are larger elsewhere.
Advanced economies
In the US, unemployment remains at half-century lows, below
most estimates of its natural rate. Job creation has nonetheless
stayed robust, averaging 160 000 jobs per month for the year
to date. The quits rate is at an 18-year high, demonstrating
workers’ confidence that the gains to leaving jobs outweigh
the risks. Wage growth has also trended higher, with the
Atlanta Fed’s wage tracker showing growth of around 4% in
the middle of 2019.5 Inflation rates have nonetheless remained
quite muted, below the Fed’s 2% inflation target, although
forecasts still indicate inflation rising to the target in 2020.
US growth slowed to 2% in the second quarter of 2019, from
3.1% in the first quarter. This lower growth rate is nonetheless
consistent with estimates of potential, and the output gap
appears to be positive, which implies, at a highly aggregated
level, that there is no shortage of demand. Individual sectors
show greater weakness, however. Industrial production growth
has slowed, while manufacturing Purchasing Managers’
Indices (PMIs) have fallen sharply, in both cases apparently due
to trade tensions affecting supply chains. Farmers have also

This measure tracks wages for individual workers and therefore avoids
problems that can arise with simple aggregate measures. For instance, it
will not show lower wage growth where a well-paid person leaves the work
force through retirement – a pressing issue as the baby boomer generation
ages out of the workforce.
Index: Jan 2016 = 100*

Economic policy uncertainty

US

Global

China
* Six-month moving average
Sources: Haver, PolicyUncertainty.com and SARB
Percentage of potential GDP
G3* output gap
* G3 economies: US, Japan and euro area
Sources: IMF, OECD and SARB
Forecast


Percentage of total employment
US quits rate
Sources: US Bureau of Labor Statistics and Haver


Monetary Policy Review October 2019
suffered from trade policy problems, in this case from retaliatory
tariffs; accordingly, the US Department of Agriculture projects
agricultural exports will fall 6.2%, in dollar terms, between 2018
and 2019.
While in the US domestic consumption has so far compensated
for external weakness, more trade-exposed economies have
shown greater vulnerability. In the euro area, Germany, Italy
and the Netherlands have all decelerated this year, with the
German economy contracting in the second quarter. Inflation
in the euro area is lower than in the US, with core apparently
stuck around 1%, and inflation expectations have fallen further
from the ECB’s target during the year. (The ECB’s survey
of professional forecasters has two-year-ahead inflation at
1.5%; market expectations for longer-term inflation, from fiveyear five-year forward swaps, are down to 1.2%.) Much the
same holds for Japan, where growth has also been weak in
the context of slowing global trade; output is likely to expand
by 1.0% this year, from 0.8% in 2018 and 1.9% in 2017.
(Exports have contracted for eight consecutive months, up to
July 2019.) Inflation in Japan has also been stubbornly
low, despite extraordinary central bank measures to hit its
2% target, although a value-added tax (VAT) increase scheduled
for October 2019 is likely to raise inflation temporarily.
The United Kingdom (UK) stands out as the rare instance of
an advanced economy with inflation close to 2% (the July 2019
print was 2% exactly, although it moderated to 1.7% in August).
This is primarily a consequence of sterling depreciation, due to
Brexit, with inflation pressure particularly affecting tradeables
– more than offsetting the disinflationary effects of weak
demand.6 Given acute uncertainty, UK growth has been both
weak and volatile, with firms building up inventories before
Brexit deadlines and running them down again following
postponements.
Emerging markets
The most striking feature of the emerging market universe
at present is a large and widespread growth shortfall. In the
years immediately before and after the global financial crisis,
emerging market growth was typically 3–5 percentage
points above advanced economy rates. This meant emerging
market income levels were converging on those of advanced
economies, reversing a long period of divergence spanning the
late 1970s, 1980s and 1990s.7 Convergence has since stalled,
however, with the emerging market growth differential having
narrowed over the past five years or so, turning negative in
2016 and slumping again this year (to just 0.5 percentage
points, or zero percentage points, excluding China).

N Gerstein, B Hobijn, F Nechio and A Shapiro, ‘The Brexit spike’, FRBSF
Economic Letter No. 2019-20, San Francisco: Federal Reserve Bank of
San Francisco, 5 August 2019.
publications/ economic-letter/2019/august/brexit-price-spike/.

D Patel, J Sandefur and A Subramanian. ‘Everything you know about crosscountry convergence is (now) wrong’. Center for Global Development blog,
15 October 2018.
about-cross-country-convergence-now-wrong.
Percentage change over 12 months*
Industrial production
* Six-month moving average
Source: Haver


US

Euro area

Japan

Index
Purchasing managers’ indices
Sources: Haver, IHS Markit and JPMorgan
PMI <50 = contraction

Global

US

Euro area

Japan

Percentage change over a year
Targeted inflation in major advanced economies
Sources: Bloomberg and Haver

UK

US

Euro area

Japan
Forecast

Monetary Policy Review October 2019

This latest growth slowdown has affected most large emerging
markets, and many of the medium-sized ones. It has also
occurred in the absence of a single clear trigger, comparable
to the 2016 commodity price collapse.
There is no shortage of idiosyncratic explanations for slower
growth in individual country cases. Turkey and Argentina have
both suffered currency crises, prompting growth collapses.
India has lost its status as the fastest-growing large economy,
with growth slowing to 4.1% in the first quarter and 2.9% in
the second, amid balance sheet problems in the financial
sector as well as charges that even the high growth recorded
for recent years was partly due to statistical errors.8 Russian
growth has been persistently low, with rates under 1% in the
first half of the year, given sanctions and subdued oil prices.
In Brazil, business confidence has slumped again while
growth has slowed, hitting -0.3% in the first quarter, before
recovering to 1.8% in the second quarter. Meanwhile, China’s
growth rates have continued to trend lower, to 6.9% in the first
quarter and 5.5% in the second (or 6.2%, measured over four
quarters, marking a 27-year low). Stimulus initiatives from early
in the year have not transmitted strongly to the real economy,
reflecting both their more modest scope, relative to previous
rounds of stimulus, as well as limited interest by both savers
and lenders in yet more credit creation.
The fact that the emerging market downturn has been so
widespread, however, suggests that, in addition to country
specific factors, there are also likely some common causes, of
which three have attracted particular attention.
The first, trade tensions, has already been mentioned as a
problem for the global economy as a whole. Emerging market
trade volumes have deteriorated steadily since the start of the
year, with imports and exports declining by 0.9% and 0.4%
respectively – the worst trade contraction since the global
financial crisis. Some emerging markets have benefitted from
shifts in trade: examples include Bangladesh and Vietnam
taking over manufacturing share from China, or Brazil
increasing soy exports at the expense of US suppliers. Overall,
however, the effects have been negative for emerging markets.
Policy uncertainty has prompted firms to delay investments. It
has also not been easy to switch production out of China, as
other countries cannot offer the same expertise and flexibility
conferred by China’s dense networks of firms.9 Furthermore,
to the extent that uncertainty has become a new permanent
feature of the global economy, it has persuaded some firms
to shorten supply chains and automate, rather than invest in
lower-wage economies, create jobs, and trade.

A Subramanian, ‘India’s GDP mis-estimation: likelihood, magnitudes,
mechanisms, and implications’, CID Faculty Working Paper No. 354,
Center for International Development at Harvard University, June 2018.

papers/india-gdp-overestimate.

N Mandhana, ‘Manufacturers want to quit China for Vietnam. They’re
finding it impossible.’ Wall Street Journal, 21 August 2019.
wsj.com/articles/for-manufacturers-in-china-breaking-up-is-hard-todo-11566397989.
Percentage points

Emerging market* and advanced economy growth
differentials
-1

Sources: Haver and Citi Research
* Excluding China

Monetary Policy Review October 2019
Second, there has been a large increase in emerging market
debt levels, driven by very low world interest rates. On aggregate,
debt growth was concentrated in private sectors up until about
2016; subsequently, private sector firms have attempted to deleverage, but public sector borrowing has ramped up. The total
stock of emerging market debt has therefore increased over the
entire post-crisis period, relative to GDP, reaching all-time highs.
Debt can benefit long-run growth where it funds investment,
improving an economy’s productive capacity. However, where
it funds consumption, it serves only to move future income into
the present – implying a lower future capacity to consume. Debt
can also increase vulnerability to shocks, particularly when it is
short term or denominated in foreign currency. With emerging
market investment growth having slowed in recent years, and
productivity growth also very low, there is little evidence that
borrowing raised potential growth. It is clearer that debt growth
has compromised balance sheets, with many non-financial
corporates, and some sovereigns, uncomfortably exposed
to exchange rate depreciation. These problems have been
especially marked in sub-Saharan Africa, where debt levels are
returning to highs reached before debt relief in the early 2000s.10
Third, a persistently strong US dollar appears to have had net
negative effects for emerging market growth.11 In theory, the
effects of dollar strength on non-US growth are ambiguous.
A more appreciated dollar should enhance the competitiveness
of non-US producers, boosting exports (which is why some
countries have devoted huge resources to maintaining cheap
exchange rates). However, a stronger dollar also raises prices
of imported goods, especially capital equipment, making it
more costly for emerging markets to acquire technologies from
the productivity frontier.12 Dollar strength also creates financial
market frictions: because investment and trade financing in
emerging markets is disproportionately dollar-denominated,
dollar appreciation is disruptive because it dilutes or eliminates
returns on local currency loans, even with generous interest-rate
differentials. By contrast, where the dollar is weakening, returns
on emerging market currency loans are magnified, incentivising
further inflows, as in 2017. This mechanism helps explain why
dollar strength is correlated with weaker global trade activity, and
also correlated with weaker emerging market investment growth.
10 I Gill, K Karakulah and S Devarajan, ‘Stressful speculations about public debt
in Africa’. Brookings Institute blog, 19 June 2019.
edu/blog/future-development/2019/06/19/stressful-speculations-aboutpublic-debt-in-africa/.
11 For more on this subject, see A Carstens and H S Shin, ‘Emerging markets
aren’t out of the woods yet” Foreign Affairs, 15 March 2019. https://
www.foreignaffairs.com/articles/2019-03-15/emerging-markets-arentout-woods-yet; and H S Shin, ‘What is behind the recent slowdown?’
Presentation by Hyun Song Shin, Economic Adviser and Head of Research,
at the workshop arranged by German Federal Ministry of Finance and
Centre for European Economic Research, 14 May 2019.
org/speeches/sp190514.pdf (accessed 2 September 2019).
12 C Goncalves and M Rodrigues, ‘Exchange rate misalignment and growth:
a myth?’, IMF Working Paper Series No. 17/283, Washington: International
Monetary Fund, November 2017.
Publications/ WP/2017/wp17283.ashx (accessed 6 September 2019).
Percentage of GDP

Major emerging markets credit to non-financial
private sector

* Unweighted average of Argentina, Brazil, Czech Republic, Chile,
China, Colombia, Hungary, India, Indonesia, Malaysia, Mexico,
Poland, Russia, Saudi Arabia, South Africa, South Korea, Thailand
and Turkey
Sources: BIS and SARB

Emerging markets*

Emerging markets (excluding China)
Percentage of GDP

Emerging markets’ general government debt

Source: IMF
US$ billions
Percentage change over four quarters

Non-resident capital flows to emerging markets
and the exchange rate
-300
-200
-100

-5
-10

Sources: Bloomberg, US Fed, IIF and SARB

Net capital flows

Broad US$ index

(inverted right-hand scale)
Depreciation
Monetary Policy Review October 2019

While emerging market growth rates have deteriorated
severely, inflation performances have been more satisfactory.
The average emerging market (excluding Argentina and Turkey)
inflation rate has been 2.9% so far in 2019, below the postcrisis rate of 4.0%. With inflation generally close to, or below,
targets, emerging market central banks have had leeway to
lower interest rates (as discussed in the financial markets
chapter). For instance, Brazil’s inflation is likely to be 3.8% this
year, against a 2019 target of 4.25%. India’s inflation, at 3.2%,
is somewhat below the 4% target, although this is mainly due
to temporarily low food prices. China’s inflation rate is also low,
at 2.8%, against a 3% objective.
There have also been prominent exceptions to this lowinflation pattern, including Turkey and Argentina, where
inflation is in double-digits (around 15% in Turkey, and over
50% in Argentina). In both cases, the shock of a currency
crisis triggered a growth collapse, much higher interest rates
and a loss of control of inflation expectations. These adverse
conditions have also contributed to a more difficult political
environment, and therefore less chance of implementing better
policies. (In Argentina, for example, the downturn has boosted
the political fortunes of the opposition Peronists, exacerbating
the crisis to the extent that the government has implemented
capital controls and partially defaulted on debt.) These cases
demonstrate that weak policy frameworks can still generate
high inflation, even in a low-inflation world.
Conclusion
The global economy is suffering a trade recession, which
could become a broader global recession if trade tensions
intensify. For emerging markets, this would exacerbate already
poor growth situations. Advanced economies, by contrast, are
generally starting at a point of low unemployment and fairly
robust internal demand. It is unlikely that advanced economies
will accelerate from here. By contrast, emerging markets could
perform much better, but the headwinds of debt, dollar strength
and trade tensions will make growth recoveries difficult.
Percentage change over 12 months

Emerging market inflation

* Unweighted average of Argentina, Brazil, Chile, China, Colombia,
India, Indonesia, Malaysia, Mexico, Peru, Philippines, Russia, South
Africa, Thailand and Turkey
Sources: Haver and SARB

Emerging markets*

Emerging markets (excluding Argentina and Turkey)

Monetary Policy Review October 2019
Box 3 Including sub-Saharan Africa in the
South African Reserve Bank’s global
economic forecasts

Using the Litterman model. See R B Litterman, 1983. ‘A random walk,
Markov model for the distribution of time series’, Federal Reserve
Bank of Minneapolis Research Department Staff Report No. 84,
Minneapolis: Federal Reserve Bank of Minneapolis, January 1983.

The Monetary Policy Committee (MPC) forecasts incorporate global
developments using the Global Projection Model (GPM), a large model
of the world economy initially developed by International Monetary
Fund economists and now maintained by a network of central banks,
finance ministries and other practitioners. Unfortunately, this model
does not include any of South Africa’s regional trading partners. This
is a significant omission, for South Africa, because sub-Saharan Africa
(SSA) accounts for around a quarter of South African exports (26%
in 2018), close to the euro area share of 28%, and above the shares
for China (18%) and the United States (13%). This box describes an
initiative to include SSA in the South African Reserve Bank (SARB)
global forecasts, a change that was implemented for the May 2019
MPC meeting. The box also discusses how events in the region
have affected the world growth rate, as seen from a South African
perspective.
In its standard form, the GPM covers economies accounting for 60%
of South Africa’s exports. By including eight local trading partners
– Botswana, Democratic Republic of Congo, eSwatini, Lesotho,
Mozambique, Namibia, Zambia and Zimbabwe – this number can
be raised to 80%. (Including additional SSA countries would yield
diminished marginal returns: adding the next eight biggest trade
partners would only lift the export share to 84%.) The principal obstacle
to including these economies is data limitations. In particular, only one
of the eight countries mentioned (Botswana) publishes quarterly growth
rates. However, this limitation can be addressed by interpolating
quarterly data from annual data taken from the World Bank’s Global
Economic Monitor database.1
The old and new growth series are quite different for the post-crisis period.
The new series shows a higher growth rate between 2010 and 2014,
averaging 4.4% for the period, compared with 3.5% for the old series.
The new series also has a sharper growth deceleration, however, and a
weaker recovery in 2017/18. More recently, the new series has dipped
below the old series, indicating that regional conditions are somewhat
less favourable than broader global conditions. This gap chiefly reflects
shocks that have hit two local partners: an economic crisis in Zimbabwe
and two devastating cyclones (Idai and Kenneth) in Mozambique.
Both these events have also had effects on neighbouring countries.
Generally speaking, the regional growth rate is mainly a function of
South Africa’s economic performance, with relatively weak feedback
from the region to South Africa. This is attributable to the relative size
of South Africa’s economy, which is 21⁄2 times larger than the eight
identified SSA countries combined. The correlation between South
Africa’s growth and that of the eight SSA countries is 0.96. However,
these recent shocks are an apt reminder that local conditions can
exercise an independent influence on South Africa’s trade-weighted
global growth rate. For this reason, regional economic developments
are worth monitoring consistently, via the forecasting framework.
Percentage change

Growth in South Africa’s major trading partners
-2
-1

Source: SARB
Forecast

Old estimate

New estimate


Percentage of South African GDP
Billions of US$
Size of SSA economies and trade weights (2018)
Sources: IMF, SARS, Stats SA and SARB
Botswana
Namibia
Mozambique
Zambia
Zimbabwe
DR Congo
South Africa
Lesotho
Eswatini
GDP (right-hand scale)
Merchandise exports
Monetary Policy Review October 2019

Financial market developments:
risk on, risk off
Since the previous MPR, six months ago, global growth
prospects have deteriorated in the context of heightened policy
risks, including trade tensions and Brexit. At the same time,
inflation has remained subdued. In these circumstances, major
central banks have abandoned plans to raise rates to more
normal levels, pivoting instead to additional easing. Safe haven
assets have benefited handsomely, but the performance of risk
assets – including the rand, as well as local bonds and stocks
– has been more erratic.
Since the May 2013 ‘taper tantrum’, more than six years ago,
the US Fed has preoccupied global financial markets with its
plans to normalise monetary policy. All this has now changed,
with the Fed cutting rates and also stopping balance-sheet
reductions. It now appears the US monetary policy cycle will
have peaked with the federal funds rate at a high of 2.5%
(reached in December 2018) and the balance sheet at 25%
of GDP (as of late 2014). This compares with average cyclical
peaks of 6.6% for the Fed funds rate and 9.7% of GDP for
the Fed’s balance sheet, since 1980. Markets nonetheless
interpret the federal funds rate as high, relative to expected
future rates, for which reason the US yield curve has inverted
for the first time since 2007.
The UK yield curve has also dipped into inversion territory,
reflecting market expectations for looser policy by the Bank
of England (although UK prospects are highly uncertain,
given the erratic course of Brexit developments). Elsewhere
in Europe, yield curves are pinned down by negative rates at
the short end, but even here long rates have fallen, such that
the German, Danish and Swedish yield curves are now entirely
below zero. With investors looking for safety, the universe of
negative yielding debt has expanded to US$15 trillion, while
gold prices have reached six-year highs, above US$1 500 per
fine ounce. At the same time, low or negative returns on safe
assets have prompted a search for yield. In emerging markets,
investors have been particularly attracted to foreign currency
government bonds, with the Bloomberg Barclays Emerging
Markets Hard Currency Index gaining 9% over the year.
The EMBI+ spread13 has nonetheless widened, showing that
US Treasuries have performed better than the dollar bonds
of emerging market sovereigns. Corporate dollar bonds have
achieved better returns still, for both investment grade and
sub-investment grade instruments, fuelling a further rise in
corporate non-financial debt levels.14 Variations between these
asset classes highlight how even risk assets are being subject
to differentiation.
13 The EMBI+ spread reflects the difference in yields between emerging
market US-dollar denominated sovereign debt and US equivalents.
14 A Barura and P Buckley, ‘Rising corporate debt: should we worry?’, Deloitte
Insights: issues by the numbers, April 2019.
insights/us/en/economy/issues-by-the-numbers/rising-corporate-debtlevels.html (accessed 5 September 2019).
-100
-50

Basis points

Government bond yield spreads*
Sources: Bloomberg and SARB

US

UK
* Ten-year yields less two-year yields

Percentage change*
Selected asset class returns
* Year to date
Source: Bloomberg
-5

GBP/US$
US$/JPY
Bloomberg
US$ Index
EM FX
EM Local Bonds
Global HY Bonds
EM External
Bonds
US IG Bonds
Gold
US$ trillions
US$ per fine ounce

Negative yielding bonds and gold price
Source: Bloomberg


Negative yielding bonds

Gold price (right-hand scale)

Monetary Policy Review October 2019
Equity markets have steadied after sharp declines in May, at
the peak of US–China trade tensions. Major bourses are still up
year to date, with the US S&P 500 and NASDAQ both reaching
record highs at the end of July. Volatility has nonetheless been
more marked in 2019 than in previous years, with the Chicago
Board Options Exchange Volatility Index (VIX) trending above
its long-term average for most of 2019.
The US dollar has appreciated modestly this year (up 1.6% in
nominal effective terms). Its starting point was already elevated,
however, so even a slight uptick has been sufficient to take the
Fed’s broad dollar index to its highest level on record (i.e. since
1995). Dollar strength reflects a mix of safety and high interest
rates, relative to other hard-currency jurisdictions. In Europe,
by contrast, expectations of additional ECB easing have
caused the euro to weaken, by 3.9% against the dollar. Sterling
has also fallen, down 2.2% against the dollar, reaching a threeyear low, given levels of political risk normally associated with
emerging markets. Indeed, over the year to date sterling has
underperformed emerging market currencies, although this
category has also been quite weak. The third quarter of the
year was especially difficult for emerging markets, with the
JPMorgan Emerging Market Currency Index falling to four-year
lows in September.
Domestic financial market
developments
Domestic asset prices have been volatile due to a confluence
of external and domestic factors. The rand in particular has
moved sharply over the past six months, depreciating past
R15 to the US dollar on two separate occasions, with a price
recovery in between. The first depreciation episode was driven
primarily by domestic factors (including the ‘quantity easing’
debate of early June), and was followed by a rebound which
took the rand to R13.25 per dollar. The second weakness
phase was largely related to the global emerging market selloff, and has been more persistent, with the rand averaging
R14.65 for the third quarter of the year, comparable to lows last
seen during the emerging market contagion scare of late-2018.
The JSE Limited (JSE) All-Share Index reached a high for the
year in April, but has fallen back since, with its year-to-date
advance now in low single digits, and negative in US dollar
terms. On a sectoral basis, higher precious metals prices
have been supportive of mining shares. Industrials have also
achieved gains, supported by rand-hedge stocks, denoting
companies with limited domestic exposure. By contrast, banks
and retailers have underperformed, reflecting difficult local
operating conditions.
Domestic bonds strengthened through to June, but
subsequently lost most of their gains as the risk of negative
credit rating action intensified. Given greater fiscal risks, South
African bonds have underperformed relative to emerging
Index (both scales)

Equity performance
Source: Bloomberg


MSCI Emerging Markets

MSCI Developed Markets

(right-hand scale)

Index

Chicago Board Options Exchange Volatility Index
Sources: Bloomberg and SARB

Average
(2015–2019)


Cumulative percentage return since 1 Jan 2019
Jan

Mar
May
Jul
Sep
Feb
Apr
Jun
Aug
Oct
Emerging market currencies
Sources: Bloomberg and SARB

Rand/US$

Emerging Markets FX

Monetary Policy Review October 2019

market peers. The costs of insuring for sovereign default have
also risen, with South African credit default swaps (CDS) trading
at levels associated with sub-investment grade sovereigns.
(For instance, South Africa’s CDS spread has been above
Brazil’s spread for about a year, even though Moody’s
rates Brazil as Ba2, one notch below South Africa’s Baa3.)
Furthermore, the South African yield curve has steepened
sharply (as discussed in Box 5), while the domestic swap-bond
spread for longer-dated instruments has widened to record
levels, providing further evidence of fiscal pressure.15
At the short end of the yield curve, rates have declined.
Markets anticipated the July repo rate cut, given lower inflation,
a stronger rand and a disappointing first quarter growth
outcome. The forward rate agreements (FRA) curve continues
to price a probability of over 50% for an additional 25 basis
point repo rate reduction by year-end, although the likelihood
of this move declined somewhat as the rand depreciated in
the third quarter, while growth surprised on the upside again.
Conclusion
Overall, it has been a mixed performance in domestic financial
markets. Global investors have been incentivised to stretch
further for yield, given expectations of easing by major central
banks, which should be supporting risk assets. However, this
effect is being offset by heightened risks both internationally
(especially around trade) and domestically (concerning the
fiscus in particular). The rand has come under pressure, while
the JSE has been only modestly firmer, and bond yields have
stayed unusually high despite lower inflation expectations. As
usual in financial markets, there are elements of both signal
and noise in recent outcomes. Perhaps the clearest message
in the data is that investors are cautious of fiscal dynamics,
with long-run sustainability coming in to question.
15 Interest rate swaps are over-the-counter derivative contracts in which a
fixed payment is exchanged for a stream of Jibar-linked payments. These
create some counterparty risk, but not default risk, as no principal is
exchanged. Swap rates have fallen in the context of lower inflation and
lower rate expectations (in part because global rate expectations have
fallen), but bonds have stayed high because of strong bond issuance and
sovereign risk. Typically, swap yields are higher than bond yields, because
no counterparty should be safer than the sovereign, but this is not the case
in South Africa now.
Cumulative percentage return since 1 Jan 2019
Jan

Mar
May
Jul
Sep
Feb
Apr
Jun
Aug
Oct
JSE share prices
Sources: Bloomberg and SARB

Mining

Industrial

All-Share

Banking

Retail


-150
-100
-50

Basis points

South African bond yield less swap yield
Source: Bloomberg

7 year

30 year

15x18
12x15
9x12
6x9
3x6
1x4


Basis points
Forward rate agreement less three-month Jibar
Source: Bloomberg
25 basis points rate cut

Monetary Policy Review October 2019
Rand per US$
* July 2014 base year

Actual exchange rate versus implied value
without political uncertainity

Sources: Bloomberg and SARB

Implied*

Actual
Box 4 The impact of idiosyncratic shocks on the rand
In recent years, the rand has been buffeted by domestic political risks
and policy uncertainty. These shocks have deflected the exchange
rate from its usual course, of following global trends as well as a few
domestic fundamentals. This box attempts to quantify the size and
duration of these idiosyncratic shocks. The results show their effects
on the exchange rate have been substantial and persistent, if not
permanent.
The rand often functions as a proxy for emerging markets, given
South Africa’s comparatively sophisticated financial system. For
this reason, the rand exchange rate typically reflects and magnifies
broader emerging market currency trends. (In financial jargon, the
rand has a high beta.) In addition, the rand is responsive to domestic
economic fundamentals, including inflation, the terms of trade and
growth. Finally, from time to time the rand moves because of domestic
risk factors, which can be measured via credit default swap spreads
(in other words, the cost of insuring South African government debt
less the cost of comparable insurance for emerging markets more
broadly).
A model combining these factors clearly identifies risk-driven rand
underperformance culminating in ‘Nenegate’, the late-2015 removal
of the incumbent finance minister, Nhlanhla Nene. It also shows a
second, smaller period of idiosyncratic weakness between mid-2018
and mid-2019, an episode that appears to have commenced with the
‘expropriation without compensation’ announcement of July 2018,
and which has persisted through to the ‘quantity easing’ debate of
June 2019. This period also included a significant fiscal deterioration.
The Nenegate phase lasted about a year-and-a-half, and the rand
averaged R14.20 per dollar during this period, instead of a predicted
value of R13.40 (an undervaluation of 6%). The second phase covers
around a year, with an average exchange rate of R14.15, instead
of a model-implied R13.61 (an undervaluation of 4%). Perhaps
unexpectedly, the ‘Ramaphoria’ of late-2017 and early-2018 does not
show up as a period of rand over-performance, with South Africa’s risk
spread re-aligning with the emerging market average in the context of
a global risk-on phase. The sharp depreciation of the rand in August
2019 is also consistent with predicted rand values: it mostly reflected
emerging market-wide developments.
Although political shocks wear off, meaning the rand eventually
returns to trend, they are nonetheless costly. Of particular concern
for monetary policy is the inflation pressure produced by the weaker
rand, which constrains monetary policy. Higher risk also tends to
disincentivise investment. This is further evidence that political shocks
and policy uncertainty have worsened South Africa’s growth-inflation
nexus, contributing to the country’s adverse macroeconomic profile.
Monetary Policy Review October 2019

Box 5 Why is South Africa’s yield curve so steep?

As estimated following the method developed by T Adrian, R K Crump
and E Moench. ‘Pricing the term structure with linear regressions’,
Journal of Financial Economics 110(1), 2013, pp 110–138.
repec.org/a/eee/jfinec/ v110y2013i1p110-138.html (accessed 28 August
2019).

These estimates are drawn from L Soobyah and D Steenkamp, ‘Term
premium and rate expectation estimates from the South African yield
curve’, SARB Economic Note No. EN/19/18, Pretoria: South African
Reserve Bank, August 2019.
co.za/sites/Research/ResearchPapers/Lists/Economic%20Notes/
Attachments/175/EN%201918.pdf (accessed 20 September 2019).
South Africa’s yield curve is unusually steep. The two-year yield has
averaged 6.7% so far this year, while 10-year bonds have yielded
9.1%. This 2.4 percentage points gap is large relative to history: since
2000, the average distance between the two rates has been only
1.1 percentage points. It is also large relative to peers: so far this year,
for example, Brazil, Russia and India have had short rates at an average
of 0.9 percentage points below long rates. Why is South Africa’s yield
curve so steep? As this box shows, much of the steepening over the past
year has come from lower short-term rates, reflecting lower inflation and
weaker growth. Meanwhile, the longer end of the curve has stayed high,
due to fiscal risks.
One year ago, markets expected the South African Reserve Bank to raise
rates, in the context of increased pressure on emerging markets and a
deteriorating inflation outlook. A year later, global financial conditions have
loosened again, while domestic inflation has been well contained. The
disappointing first-quarter growth outcome further bolstered the case for
a looser policy stance. Because the short end of the yield curve is heavily
influenced by monetary policy, these factors prompted two-year rates to
decline, by 1.3 percentage points from September 2018 to date.
Meanwhile, long rates have increased slightly over the past year,1 in the
context of disappointing fiscal news (as discussed in the real economy
chapter of this Monetary Policy Review). In this context, the term premium
embedded in long rates has risen by an estimated 50 basis points over
the past year. The observed total increase in long rates has been smaller,
about 20 basis points, because of a simultaneous decline in expectations
for future short rates.2 In other words, investors expect the repurchase
rate to stay somewhat lower in future, but they now also require more
compensation for locking money down in long-term loans.
It is possible technical factors are contributing to yield curve steepness,
particularly Treasury’s switch auctions, which roll short-dated debt into
longer-term instruments. However, while switch auction announcements
have visibly moved the very short and the very long ends of the curve
(6 months and 30 years), they have not had comparable effects on the
2-year or 10-year instruments, the tenors where yield curve steepness
is most marked. The total amount of debt switched has also been
quite small relative to the stock – less than 2% of the total, for 2018.
This suggests technical factors are not the main drivers of the steep yield
curve.
Perhaps the main takeaway from these findings is that the sovereign’s
borrowing cost problem is not due to monetary policy. The usual sign of
a tight policy stance – a flat curve, as in 2007/08 – is nowhere in sight.
Furthermore, inflation expectations, which monetary policy can address
and which do feed into long rates, have declined, which should have
reduced long-term rates. Unfortunately, the benefits for the fiscus of a
lower short-term rate and lower inflation expectations have been offset
by other factors, which have kept long-term rates high.
Per cent
August 2018
August 2019
South African yield curves
Source: Bloomberg
30Y
25Y
20Y
15Y
3Y
2Y


Expected short rate

Term premium

Ten-year yield

Per cent
10-year yield decomposition

2019*
* Year to date
Sources: Bloomberg and SARB

Monetary Policy Review October 2019
Overview of the real economy:
supply shocks, demand
shocks and uncertainty
South African growth outcomes continue to display high levels
of volatility around a low trend. Over the past six months,
demand appears to have weakened, widening the output
gap. The economy’s potential growth rate remains very low,
however, around 1% for this year, which speaks to growth
constraints beyond the demand side of the economy. South
Africa’s fiscal metrics are deteriorating again due to bailouts for
state-owned enterprises. In turn, fiscal policy has become the
main driver of relatively large current account deficits.
The first half of 2019 has delivered volatile growth outcomes:
-3.1% in the first quarter, followed by 3.1% in the second quarter.
This volatility extends a trend of unusually large variations
in quarterly numbers. In the primary sector in particular, the
standard deviation of growth has increased sharply, from
4.6 percentage points pre-crisis to 11.7 percentage points postcrisis, and 12.2 percentage points from 2016 to date. Although
the primary sector is relatively small, accounting for about 10%
of overall output directly, these levels of volatility have been
high enough to shape overall GDP outcomes. Accordingly,
the standard deviation of GDP growth has also risen, from
1.7 percentage points pre-crisis to 2.1 percentage points postcrisis. This volatility has made it more challenging to assess the
economy’s underlying growth direction.
The first quarter of 2019 was blighted by supply shocks. Both
the primary and secondary sectors contracted, by more than
anticipated in previous forecasts.16 Drier weather conditions
reduced yields and delayed planting of summer grains and
oil seeds. In mining, a strike that started in the gold sector
spread to other sectors, while manufacturing was disrupted by
maintenance at two major oil refineries. In addition, electricity
shortages affected output in both the primary and secondary
sectors. Together, mining, agriculture and manufacturing
contributed -2.3 percentage points to the overall contraction
of -3.1% observed in the quarter. Given these shocks, potential
growth for the quarter was marked down to just 0.2%, in line
with the forecast practice of adjusting potential growth for
supply-side disruptions.17
Despite supply problems, the first quarter contraction also
showed signs of additional demand weakness. The tertiary
sector unexpectedly contracted, by -0.4%, its worst performance
since the start of 2017. Household consumption – which is the
largest component of output, at 60% – contracted by 0.5%.
Compensation growth (including wages and bonuses) declined
in real terms, sustaining a weakening trend dating from 2010.
16 Prior to the GDP release, the primary and secondary sectors were
expected to contract by 9.1% and 7.0% respectively; actual outcomes
were -11.4% and -7.4%.
17 B Botha, F Ruch and R Steinbach, ‘Short-lived supply shocks to potential
growth’, South African Reserve Bank Working Paper Series WP/18/02,
Pretoria: South African Reserve Bank, June 2018.
co.za/Lists/News%20and%20Publications/Attachments/8605/WP1802a.
pdf (accessed 5 September 2019) and Box 6, MPR October 2017.
Percentage change from quarter to quarter
Economic growth by sector*


Primary
Seasonally adjusted annualised rates
Sources: Stats SA and SARB
* Real gross value added at basic prices
Secondary
Tertiary
Total GDP

Monetary Policy Review October 2019

The second quarter rebound showed the economy had not
shifted to a markedly lower trend in the first half of the year.
The tertiary sector recovered, as did household consumption.
Agriculture contracted further, in line with worse rainfall
conditions, but supply-side volatility is typical of that sector.
Total output nonetheless remained below levels reached
in the second half of 2018, in seasonally-adjusted terms,
demonstrating that the second-quarter number was high
because of a base effect rather than new-found economic
strength.
The output gap widened in the first quarter to -2.1% of potential
GDP, a 25-year low. Some of this decline was reversed by
the second-quarter rebound. However, the potential growth
estimate for the quarter was also higher, in the absence of
supply shocks, at 1.1%. The output gap therefore remained
quite large, at -1.7% in the second quarter.
Not all data points have unambiguously signalled weaker
demand. Unemployment rose to 29% in the second quarter
of 2019, an 11-year high, but this was entirely driven by higher
labour force participation. The total number of employed
people increased, both in year-on-year and quarter-on-quarter,
seasonally-adjusted terms, a trend corroborated by both the
Quarterly Labour Force Survey (QLFS) (from which the official
unemployment rate is taken) and the Quarterly Employment
Statistics (QES) survey.
A second contrarian data point has been credit extension.
For monetary policy, credit growth is an important gauge
of demand. Contrary to a weak-demand diagnosis, credit
to households has been recovering over the past year, with
credit growth turning positive in inflation-adjusted terms in
late 2018 and expanding further since then. A disaggregation
of the credit data shows that mortgage lending has stopped
contracting, in real terms, with fractionally positive real growth
as of August. Most of the acceleration in credit growth,
however, has come from unsecured lending. Rather than
rising demand, this likely points to two other factors: first,
increased competition in the unsecured lending space, which
is pushing up supply, and second, households resorting to
borrowing to supplement income shortfalls.
Finally, there are some challenges in deciphering confidence
surveys. The BER’s household confidence indicator surged
in early 2018, reaching levels last seen during the 2000s
boom, apparently following domestic political developments.
It quickly subsided again, but has nonetheless remained in
positive territory, comfortably above its five-year average rate.
This is not an outcome easily reconcilable with strained
consumer finances and deteriorating demand. That said,
the sub-index that asks whether this is a good time to buy
durable goods remains low, providing at least some evidence
of consumer caution.

Total

Mortgages

Unsecured lending
Percentage change over 12 months

Real credit extended to households*
Sources: Stats SA and SARB
* Deflated with headline CPI inflation
-15
-10
-5

Percentage change over four quarters*

Wage trends
* Four-quarter moving average
Sources: Stats SA and SARB

Compensation of employees

Total salaries and wages
Millions
* Based on the QLFS
Millions

Employment trends*
Sources: Stats SA and SARB

Employed

Unemployed (right-hand scale)

Monetary Policy Review October 2019
The message from the BER’s business confidence survey has
been more straightforward. Like its consumer sibling, this index
recorded an early-2018 improvement and then deteriorated
again. However, for businesses, the net balance of sentiment
did not turn positive, even at its 2018 peak. The subsequent
decline in confidence has therefore taken firms deeper into
pessimistic territory; the latest readings are comparable to
historic lows.
These negative responses appear to reflect a mix of weak
demand and policy uncertainty. Conceptually, the two are
distinct. Weak demand should be responsive to interest
rate adjustments. Policy uncertainty, however, is a problem
larger than monetary policy. The evidence suggests that
these are both significant factors, but policy uncertainty is
likely the larger problem. Looking at the BER manufacturing
survey, a majority of businesses cite ‘insufficient demand’
and the ‘political climate’ as constraints, with both series on
a rising trend in recent years. (By contrast, only a minority
of respondents say interest rates are a constraint, and the
trend in this series has been stable since 2016.) The political
climate is a problem for a larger majority of businesses, and
the indicator is also near record highs, whereas the demand
indicator is closer to its post-crisis average. The evidence for
weak demand is nonetheless substantial. In particular, gross
operating surplus – a measure of profitability – has been
declining throughout the past decade, and is now at lows last
seen in the early 1990s.
-30
-20
-10

Index
Index

Business and consumer confidence
Sources: BER, FNB and RMB

Consumer confidence

Business confidence (right-hand scale)
Percentage of GDP
Gross operating surplus

Sources: Stats SA and SARB

GDP growth, potential GDP and output gap
Actual
Forecast
2019Q1
2019Q2
2019Q3
2019Q4
2020Q1
2020Q2
2020Q3
2020Q4
2021Q1
2021Q2
2021Q3
2021Q4
GDP (quarter-to-quarter
percentage change*)

GDP (year-on-year
percentage change)

Potential (year-on-year
percentage change)

Potential (quarter-to-quarter
percentage change*)

Output gap (percentage
of potential)

* Seasonally adjusted annualised rates
Sources: Stats SA and SARB
Monetary Policy Review October 2019

Over the forecast period, growth is expected to improve
modestly, nearing 2% in 2021. The output gap nonetheless
stays negative throughout the forecast period. This reflects
an intervention in the model to prevent the gap from closing
sooner, which would require implausibly high growth. The
projected annual growth rates for 2020 and 2021, at 1.5% and
1.8% respectively, are still higher than the 0.8% average of the
2016–2019 period.
An important (if technical) reason for higher annual growth rates
over the forecast period is that the outlook does not include
first-quarter contractions, which have large consequences for
annual growth rates. For instance, had the economy followed up
the -3.1% contraction that opened 2019 with three consecutive
quarters of 3% growth, annual growth would still have been
only 1%. Over the period 2016 to date, first-quarter growth
has been persistently negative, contributing to disappointing
annual growth rates. However, as there is no good economic
reason why first quarters should continue to disappoint, this
pattern is not replicated in the forecast, and the annual growth
projections are correspondingly better than recent outcomes.
The balance of payments
South Africa has been running a trade surplus averaging 0.8%
GDP since 2016 (albeit with some quarterly dips into deficits).
However, the broader current account – which comprises the
services, income and current transfers (SIT) account alongside
the trade balance – continues to record substantial deficits (an
average of -3.1% of GDP from 2016 to date). The gap between
the two is one of the most telling indicators of South Africa’s
complex and difficult macroeconomic situation.
South Africa’s trade surplus shows exports are larger than
imports, which has been achieved mainly by cutting back on
import volumes rather than exporting more. South Africa is
nonetheless a net borrower from the world, in order to fund
a substantial SIT account deficit (close to 4% of GDP). In turn,
a large and growing portion of these funds is being used to
cover interest payments on government debt held by nonresidents. The external accounts therefore tell a weak demand
story, but also speak to problems in the composition of growth
(not enough exports), as well as too much borrowing and
heightened external vulnerability (with South Africa’s current
account deficit one of the largest among major economies,
counting both advanced economies and emerging markets).
Movements in South Africa’s trade balance are closely related
to the domestic business cycle. The trade balance has
become more negative in every business cycle upswing in
history; it has also become more positive in every downswing.
In principle, both exports and imports can drive a trade
balance adjustment. However, in South Africa, adjustments
typically rely more on import compression than export growth,
which has once again been the case now. This also has the
Percentage of firms listing constraint to current
business activity*
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
* Four-quarter moving average
Sources: BER and SARB
Less constraining
More constraining

Constraints in the manufacturing sector

Insufficient demand

Short-term interest rates

Political climate
Percentage of GDP

Balance of payments
Source: SARB


Trade

Current account

Services, income and transfers
Percentage of GDP
Current account balance forecast*
Sources: IMF and SARB
-6
-4
-2

* 2019–2021 average
Taiwan
Turkey
Nigeria
France
China
Spain
Canada
Indonesia
Italy
Japan
Korea
Russia
Thailand
Germany
Netherlands
Saudi Arabia
Iran
Malaysia
Mexico
Bangladesh
Egypt
Brazil
Poland
South Africa
UK
US
India
Argentina
Australia
Philippines
Pakistan

Monetary Policy Review October 2019
implication that improvements in growth will cause the current
account to deteriorate, with heightened external vulnerability
then becoming a constraint on growth.
Since its 2013 trough, South Africa’s trade balance has
improved by roughly 2.5 percentage points. The bulk of the
adjustment – about 60% – has come from reduced imports
of machinery and equipment, paralleling a decline in overall
investment. The terms of trade have also contributed to current
account rebalancing, but this has reflected a normalisation of
commodity prices rather than windfall gains.
As discussed in previous MPRs, an important driver of South
Africa’s trade balance deterioration between 2011 and 2013
was a mismatch between falling export commodity prices
and stubbornly high oil prices (oil being South Africa’s most
important import commodity). Normally South Africa’s
commodity exports are significantly larger than commodity
imports, but this gap18 fell to unusually low levels in 2013. It
recovered with the oil price collapse of late 2014, helping the
broader current account to rebalance. In subsequent years,
the gap between the two has shifted back to longer-term
average levels, and the latest data are close to the longer-term
average, suggesting the terms of trade are neither flattering
nor weakening the trade balance. For this reason, South
Africa’s sustained trade surplus appears to be a relatively pure
case of import compression, rather than an artefact of global
commodity price movements.
South Africa’s SIT account continues to record large deficits
(-4.0% of GDP in 2018, for example), ensuring the current
account remains in deficit despite a trade surplus. The largest
deterioration in this account has been in the interest category,
with government payments to non-residents having nearly
quadrupled between 2010 and 2018, from 0.4% of GDP to
1.5% of GDP. This shift has offset improvements elsewhere in
the SIT balance, with the services balance having narrowed
on the back of reduced imports, and the dividends portion of
the current account also contracting as the economy slowed.19
Implications of fiscal developments
South Africa has run persistent budget deficits since the global
financial crisis. Between 2013 and 2018, the size of these deficits
moderated marginally, while the primary deficits (excluding
interest payments) shrank substantially. This adjustment was
achieved mainly through higher taxes; spending continued
to increase throughout this period, especially spending on
interest payments. However, since the previous MPR, the fiscal
18 Defined as exports of gold, iron ore, coal and platinum group metals less
imports of oil.
19 The change in net services is not large, relative to GDP: this deficit has
narrowed by 0.2% of GDP since 2013. Net dividends have averaged -1.3%
of GDP since 2014, less than half their boom-era peak (3% of GDP in
2007), and also somewhat smaller than they were in the 2010–2013 period
(an average of 1.6% of GDP). Not discussed here is the transfers portion of
the SIT account, which is chiefly explained by payments to SACU partners.
These have averaged 0.8% of GDP over the past five years, without a clear
trend higher or lower.
Percentage of GDP
Sep 61–Apr 65
Jan 68–Dec 70
Jan 66–May 67
Sep 72–Aug 74
Jan 78–Aug 81
Apr 83–Jun 84
Apr 86–Feb 89
Jun 93–Nov 96
Sep 99–Nov 07
Sep 09–Nov 13
May 60–Aug 61
May 65–Dec 65
Jun 67–Dec 67
Jan 71–Aug 72
Sep 74–Dec 77
Sep 81–Mar 83
Jul 84–Mar 86
Mar 89–May 93
Dec 96–Aug 99
Dec 07–Aug 09
Dec 13–current
The trade balance and the business cycle*
Source: SARB


* change in trade balance
from start to end of each
business cycle phase
Upward
Downward
Percentage of GDP (both axes)

Investment and capital goods imports
Sources: SARS, Stats SA and SARB

Total investment

Capital goods imports (right-hand scale)

Percentage of GDP

2016 2018
Trade in major commodities
* Gold; coal; iron ore and steel; chrome; platinum group metals
Sources: SARS, Stats SA and SARB

Major commodity exports*

Crude oil and petroleum products imports
Dotted lines indicate 2004–2018 average
Monetary Policy Review October 2019

situation has deteriorated sharply. The deficit is now expanding
again, mainly due to bailouts for Eskom. The ratings agency
Moody’s anticipates debt levels will reach 68% of GDP by 2021.
This MPR is published at the start of October, before the
Medium Term Budget Policy Statement (MTBPS), which is
due later in the month. The MTBPS will set out government’s
approach to tackling heightened fiscal challenges, leaving
fiscal analysis based on older policy statements outdated.
Furthermore, as a principle, the SARB avoids commenting on
fiscal policy, and government reciprocates by leaving monetary
policy adjustments to the SARB.20 Accordingly, the analysis
offered throughout this document, including this chapter, is
necessarily tentative, and restricted to factors that are directly
relevant to monetary policy, particularly fiscal effects on the
structure of interest rates (as detailed in the financial markets
chapter) and implications for inflation, potential growth and
aggregate demand (discussed here and in the prices chapter).
Over the past few years, fiscal policy has had both expansionary
and contractionary effects on output (a mix previously
characterised in this document as one foot on the brake and
one foot on the accelerator). By running persistent budget
deficits – even after adjusting for interest payments as well as
the economic cycle – policy has consistently contributed to
demand. Some components of spending have slowed or even
fallen, given targeted budget cuts. However, the aggregate has
grown steadily, faster than GDP in most years. Considering
accumulated differences, whereas real GDP has grown by a
total of 17% since the 2009/10 fiscal year, government interest
payments have grown by 109%; the government wage bill is
up by 39%; and transfers to provinces and municipalities have
increased by 28%.
At the same time, both direct and indirect taxes have increased.
Personal income taxes have risen through a new top income
bracket and, more significantly, through incomplete or zero21
adjustment of tax brackets for inflation. As a result, direct taxes
on household income and wealth have reached an all-time
high of 15.6% of gross income as of the latest data (2018),
1.3 percentage points above the post-crisis average of 14.3%.
20 See National Treasury, ‘Joint statement by the Minister of Finance, Tito
Mboweni, and the Governor of the South African Reserve Bank, Lesetja
Kganyago’. Media release, 4 July, Pretoria: National Treasury, 2019.
21 As in Budget 2019.
Index: 2009/2010 = 100

Real growth in selected expenditure items
Sources: National Treasury, Stats SA and SARB

Compensation of employees

Goods and services

Interest

Non-interest expenditure

Total expenditure

GDP

Real growth in selected expenditure items
Annual percentage change
Average
weight*

* Average proportion of total expenditure over the 2010/11 to 2018/19 period in percentage.
Sources: Stats SA, National Treasury and SARB

Monetary Policy Review October 2019
Indirect taxes have also increased, including through a higher
VAT rate (15% as of April 2018, from 14% previously), higher
taxes and levies on fuel, and sin tax on sugar, alcohol and
tobacco. The total South African tax to GDP ratio reached
25.3% in 2018, its highest level since 1990 (the average rate from
1990 is 22.9%). Tax revenues have nonetheless disappointed,
falling R57 billion below target in 2018/19, and another target
undershoot of about R35 billion expected in 2019/20.
Higher taxes affect demand by reducing the disposable
income of households. Where tax revenue is then spent by
government, there is no immediate reduction in aggregate
demand. Nonetheless, higher taxation causes deadweight
losses by reducing incentives to work and consume (indeed,
this is the primary rationale of sin taxes). These effects are
exacerbated where tax increases raise expectations of
additional taxation in future, which is plausible where higher
taxes are rationalised by the need to stabilise debt, and debt
levels repeatedly fail to stabilise. In addition, where tax revenue
is paid to non-residents, it represents a direct drain on demand.
For these reasons, a heavier tax burden has contributed to
South Africa’s demand problems.22
Fiscal problems have also contributed to South Africa’s mediocre
investment growth, which is a problem for near-term demand
(given investment’s substantial share in GDP) as well as longerterm potential growth. Investment spending tends to suffer during
periods of fiscal strain because it lacks vested supporters.23
Loose fiscal policy has also raised longer-term interest rates,
crowding out marginal borrowers and investment projects.
Conclusion
South Africa’s growth problem has several dimensions. In
some respects demand is too weak. But the economy has
also been buffeted by supply shocks and sentiment is suffering
from ongoing policy uncertainty. Where monetary policy
enjoys margin for manoeuvre, weak demand is a problem
that can be addressed with interest rates. Supply shocks
and policy uncertainty, however, are beyond the reach of the
SARB. Unfortunately, these factors have reduced potential
growth to extremely low levels, around 1%, a challenge which
requires a range of non-monetary interventions.24 The forecast
therefore indicates subdued levels of growth over the medium
term, which ultimately close the output gap in 2022. There
are risks to this forecast, however, both on the upside and the
downside, given attractive options for reform as well as high
costs to staying on an unsustainable path.
22 This analysis is consistent with the broader literature on the effects
of tax increases. See for instance C D Romer and D H Romer, ‘The
macroeconomic effects of tax changes: estimates based on a new
measure of fiscal shocks’. American Economic Review 100 (3), 2010,
pp 763–801 (accessed 15 August 2019).
23 C Breunig and M R Busemeyer, ‘Fiscal austerity and the trade-off
between public investment and social spending’, Journal of European
Public Policy 19(6), 2012, pp 921–938.
publication/263193814_
Fiscal_Austerity_and_the_Trade-Off_between_
Public_Investment_and_Social_Spending (accessed 28 August 2019).
24 As detailed in National Treasury, ‘Economic transformation, inclusive
growth and competitiveness: towards an economic strategy for South
Africa’, 27 August 2019,
press/2019/
Towards%20an%20Economic%20Strategy%20for%20SA.
pdf (accessed 28 August 2019).
Percentage of gross primary income
Household tax on income and wealth

Sources: Stats SA and SARB
Average:
1995–2009
12.4
Average:
2010–2018

14.3
Percentage of GDP
2010/11 2012/13 2014/15 2016/17 2018/19 2020/21
Evolution of public debt forecasts
Source: National Treasury Budget Reviews

Forecast
Percentage change
Gross fixed capital formation
Sources: Stats SA and SARB
-10
-5

Monetary Policy Review October 2019

Price developments: volatility
around 4.5%
Headline inflation has been close to the middle of the target
band for about two years. Fluctuations in food and fuel prices
have pushed some recent monthly outcomes below 4.5%,
with the result that inflation is likely to average 4.2% for 2019.
In 2020, by contrast, temporary factors are expected to raise
inflation, lifting the annual average rate to 5.1%. Core inflation
nonetheless remains in a narrow range of 4.2% to 4.8% across
the forecast horizon, supported by moderate wage increases,
lower inflation expectations and an exchange rate close to fair
value. Accordingly, headline inflation stabilises at 4.5% over the
medium term, in line with the model target.
Starting point
Inflation outcomes have been largely favourable in 2019.
Headline inflation has fluctuated around the target midpoint.
Food price inflation has stayed unusually low, averaging 3.3%
since the start of the year. Fuel price inflation has been higher,
averaging 4.8%, but with very low or sometimes negative rates
in the second half of the year. (Both July and August outcomes
were -0.5%.) Core inflation has been persistently close to the
midpoint, with core goods below it (averaging 2.6% since the
beginning of 2018) and services generally slightly higher (at 5%
over the same period); the latest data show some acceleration
in core goods, but offsetting deceleration in services.
Inflation expectations have moderated further, although most
measures are still above 4.5%. The highest inflation category
has been administered prices, with water, rates and taxes, and
electricity all outside the inflation target range. (Their year-todate averages are 11.8%, 12.7% and 8.3% respectively).
Between the three MPC meetings covered in this MPR,
there have been relatively limited inflation forecast changes.
The core themes of each forecast have remained the same:
inflation close to 4.5% in 2019; a temporary acceleration past
5% in 2020, based on a fuel price base effect; and a reversion
to 4.5% over the course of 2021. Over the past six months,
the near-term inflation outlook has moderated, given downside
surprises in the data. The projections for late 2020 and early
2021, by contrast, have risen marginally, due to a more
depreciated exchange rate. The end-point for the inflation
forecast has remained 4.5%, with the repo rate path required
to achieve this goal lower than it was as of the previous MPR.
Oil prices and fuel inflation
Over the course of 2019, the SARB’s near-term oil price
assumptions
have
fluctuated
between
US$58
and
US$73 per barrel, on a quarterly basis. The assumptions for
2020 and 2021 have been much more stable, between US$65
and US$68 per barrel. The main factors generating volatility
have been geopolitical problems (Venezuela’s collapse, ship
Percentage change over four quarters

Headline inflation forecast*
Sources: Stats SA and SARB

Actual

Mar 2019

Sep 2019

3–6% inflation target range
Midpoint
* Dotted lines indicate forecasts
US$ per barrel

Evolution of crude oil price forecasts*
Source: SARB

Actual

Jan 2019

Mar 2019

May 2019

Jul 2019

Sep 2019

* Dotted lines indicate forecasts

Monetary Policy Review October 2019
seizures in the Gulf of Hormuz, attacks on Saudi oil facilities),
which have pushed prices up, as high as US$74 per barrel in
May, and weakening global demand, which has pushed them
down again, to a low of US$56 per barrel in August.
Fuel price inflation was unusually low in the first quarter of
2019, due to a dip in world oil prices in late 2018. This means
fuel prices are likely to appear higher in 2020, especially in the
first quarter of 2020, with a year-on-year inflation rate close to
12%. This is the main reason headline inflation is also projected
to be higher next year. This statistical anomaly aside, the fuel
price inflation outlook is quite benign, with average fuel inflation
of around 4% from mid-2020 to the end of 2021.
Food inflation
Throughout 2018 and the first half of 2019, the MPC forecasts
showed inflation for food and non-alcoholic beverages (NAB)
reaching a turning point. Food and NAB inflation outcomes
nonetheless kept surprising on the downside, dipping to lows
of 2.9% in both February and April (well below a longer-run
average of 6.5%). In May and June, food inflation finally trended
higher – only for it to dip again unexpectedly in July. (It moved
up again in August, although the data appeared only after the
forecast had been finalised.) Relative to six months ago, the
food forecast trajectory has been lowered somewhat, although
it still has an upward slope. Food inflation is now projected to
peak at 6% in the third quarter of 2020, before moderating
towards the middle of the target by the end of 2021.
This pick-up in food inflation is consistent with meat prices
normalising, after an extraordinary two-year period in which
meat price inflation first rose to double digits (in the context
of herd-rebuilding, following the drought) and then fell into
deflation (aided by an outbreak of foot-and-mouth disease,
which blocked exports) – a 17 percentage point swing, from
peak to trough. The recovery in meat price inflation is now
well entrenched, and is expected to persist at least into 2020.
There is also an upside risk to this forecast, given a mooted
82% tariff on chicken imports from suppliers outside the
Southern African Development Community or the European
Union, which would raise local prices.
Maize prices rose by about a third between July 2018 and July
2019. Over the next 18 months futures prices are fairly flat,
however, suggesting bread and cereals inflation will moderate
from a peak of 8.5% in the fourth quarter of 2019 – up from
a trough of -5.0% in the first quarter of 2018. This outlook is
supported by favourable crop estimates for 2019, at 11.0 million
tons for the season, compared to 10.5 million tons projected
in April 2019.

Dried meat (1.0)

Poultry (2.1)

Lamb (0.7)

Pork (0.2)

Beef (1.4)

Mar 2019**

Jul 2019**

Sep 2019**

Total**
Percentage points
Meat inflation contributions and forecasts*

** Percentage change over 12 months
Numbers in brackets indicate weight in headline CPI basket.
Total excludes other meat.
Sources: Stats SA and SARB
* Dotted lines indicate forecasts
-2

Percentage change over 12 months

Evolution of bread and cereals inflation forecasts*
Sources: Stats SA and SARB
-6
-3

Actual

Mar 2019

May 2019

Sep 2019
* Dotted lines indicate forecasts
Percentage change over four quarters

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

Actual

Sep 2018

Mar 2019

Sep 2019
* Dotted lines indicate forecasts
Monetary Policy Review October 2019

Administered price inflation
Electricity inflation, at the consumer level, recorded 10.6% in
July 2019, 2.4 percentage points below the 13% assumed six
months ago, which was based on National Energy Regulator
of South Africa (NERSA) allowances. The gap was due to two
factors. First, electricity is sold to consumers via municipalities,
at different price tiers for different usage volumes. The NERSA
rulings put an upper cap on price increases, but Statistics
South Africa (Stats SA) surveys all the usage price bands
across municipalities, leaving the average price increase
facing consumers somewhat lower than the maximum
permissible increase determined by NERSA. Second, more
idiosyncratically, not all municipalities implemented their annual
increases in July, with the City of Tshwane delaying its increase
by a month in the context of a court challenge. (Electricity
inflation therefore moved higher in August.)
Despite the July downside surprise in electricity inflation,
electricity inflation remains high, well outside the SARB’s target
range. This situation is expected to persist over the forecast
period, with the annual averages for electricity inflation at 9.0%,
9.7% and 7.4% for the years 2019, 2020 and 2021 respectively.
These projections include both NERSA’s tariff rulings and the
regulatory clawback account increases.
Administered prices have also exerted sustained upward
pressure on headline inflation via two other categories, rates
and taxes, and water. Like electricity, rates and taxes inflation
has also been in double digits, at 14.8% from July 2018 through
June 2019, up from 5.8% the year before, with the jump due to
a property re-valuation exercise by the City of Johannesburg.
Inflation for this category has fallen back now that this price
shock has passed, although it remains outside the upper end
of the target range, at 6.7%. Water tariff inflation has also been
Consumer food price inflation (September 2019 forecasts)
Percentage change over four quarters, March 2019 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–18*
2018*
2019*
2019Q1
2019Q2
2019Q3
2019Q4
2020Q1
2020Q2
Food and non-alcoholic beverages


* Annual average percentage change
Sources: Stats SA and SARB
Percentage change over four quarters

Evolution of electricity price forecast*
Sources: Stats SA and SARB

Actual

Sep 2018

Mar 2019

Sep 2019
* Dotted lines indicate forecasts


Monetary Policy Review October 2019
high, although in this case double-digit inflation has been
more sustained, with price gains averaging 11% since 2012,
and remaining high this year (at 12.8% in the first quarter, and
11.8% in the second).
Core inflation
Over the past two years, core inflation has been slightly below
4.5%, with core goods well below the midpoint and services
somewhat above it.25 Core goods inflation has ticked up,
averaging 3.1% so far this year, compared with an average of
2.3% in 2018. Services inflation has slowed further, however,
reaching 4.6% in April and May, an eight-year low. (Subsequent
readings have been slightly higher: 4.8% for June, and 4.7% for
both July and August.) These offsetting trends have permitted
core inflation to remain slightly below the inflation target
midpoint.
25 Services represent about two-thirds of the core basket, with core goods
filling the remaining third. This explains why small changes in services can
shift core as much as larger movements in core goods.
Headline inflation (September 2019 forecasts)
Percentage change over four quarters; March 2019 forecasts in brackets
Actual
Forecast
Actual
Forecast
Weight
2009–18*
2018*
2019*
2019Q1
2019Q2
2019Q3
2019Q4
2020Q1
2020Q2

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

Core inflation and its components
Sources: Stats SA and SARB

3–6% inflation target range
Midpoint
Forecast

Core inflation

Core goods

Services

Monetary Policy Review October 2019

Lower inflation in the services category reflects much weaker
price pressures in the housing sub-component. Excluding
housing, services inflation would still be around 1 percentage
point above the 4.5% midpoint. This gap with headline reflects
sustained real increases in some service components, such
as medical insurance and education, a relative price shift also
observable in many other economies. Interestingly, the size
of the gap has remained fairly steady during the disinflation
period, at about 1 percentage point over headline, which
indicates relative prices are still rising but at a lower nominal
inflation rate.
Housing accounts for nearly a third of services (32.8%) and
16.8% of the entire CPI basket, with a split of 13.3% for owners’
equivalent rent (OER) and 3.5% for actual rentals, making it the
single biggest expenditure item for South African households.
Its second-quarter inflation reading of 3% was the lowest on
record (with OER having been added to the CPI a decade ago).
The third quarter outcome is projected at 3.3%, slightly higher
than the second quarter, but not high: average inflation for this
category has been 4.6% since January 2009.
As discussed in previous MPRs, one important driver of
housing disinflation has been the end of the Western Cape
property boom. As dynamics in the Western Cape market
came to more closely resemble those elsewhere in the country,
from 2017, the underlying weakness of the broader property
market became clearer in the inflation data.
That weakness also appears to have intensified over the
past two years, with lower income growth, greater political
uncertainty and new housing supply combining to suppress
prices. In particular, survey evidence shows clear upticks
in ‘downscaling for financial reasons’ and ‘emigrating’ as
reasons for selling homes. Vacancy rates for rental properties
have edged higher, most clearly in the high-price (R12 000+)
category. Data on new residential projects also shows a strong

Services

Services excluding housing


Percentage change over 12 months

Services inflation
Sources: Stats SA and SARB
Inflation target midpoint

Headline inflation

OER

Rental


Percentage change over four quarters

Housing inflation
Sources: Stats SA and SARB
Inflation target midpoint
Reasons for selling residential properties*
Per cent of total sales


Moving to be closer to work or amenities..

In the FNB property market survey, owners are requested to pick the reasons for selling their houses.
** Year to date
Source: FNB

Monetary Policy Review October 2019
increase in completion rates, with a marked acceleration in
2019, illustrating how robust price increases in previous years
generated a supply response.
In the core goods category, the single biggest source of
higher prices remains alcoholic beverages and tobacco,
where inflation is primarily a consequence of higher sin taxes.
Inflation pressures elsewhere in this category are subdued,
a pattern closely related to the exchange rate. Much of the
core goods category is traded items (such as cars, clothes
and appliances), and import penetration is generally high. With
the exchange rate trend quite stable over the past four years,
averaging R14.28 per US dollar so far this year, compared
with R14.68 per US dollar in 2016, firms have had leeway to
minimise price increases. This benign situation contrasts with
the 2011–2016 period of sustained rand depreciation, during
which core goods accelerated, ultimately peaking above 6%.

Other reasons* (right-hand scale)

Downscaling for financial pressure

Upgrading

Emigrating


Per cent of total sales (both scales)

Reasons for selling houses
* Includes life stage, relocating within South Africa, safety and
change in family structure
Sources: FNB and SARB


R billions (Real*)

Residential buildings completed
* 12-month moving average
Sources: Stats SA and SARB
Percentage change over 12 months (both scales)
-30
-15

New vehicle inflation and the exchange rate

Nominal effective exchange rate

lagged six months (right-hand scale)

New vehicle CPI
Sources: Stats SA and SARB
-10
-5

2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Percentage points
-2

Contributions to core goods inflation

Alcoholic beverages and tobacco

Other core goods

Clothing

Vehicles


Sources: Stats SA and SARB
2015 2016 2017 2018 2019

2010 2011 2012 2013
Forecast

Core goods

(percentage change over 12 months)

Percentage change over four quarters

Services inflation and inflation expectations*

Five-year-ahead inflation expectations

Two-year-ahead inflation expectations

Services inflation**
Sources: BER, Stats SA and SARB

Midpoint of inflation target range
* Total, combining expectations of labour, business and analysts
** Dotted line indicates forecasts
Monetary Policy Review October 2019

Medium term inflation drivers
Over the medium term, the model interprets inflation as a
function of an exchange rate gap, a unit labour cost gap, an
output gap (discussed in the real economy chapter), inflation
expectations, and ultimately the repo rate, which adjusts to
deliver on the inflation target.
Exchange rate
The forecast challenge in interpreting rand movements is
two-fold: seeing through volatility, and gauging the extent of
pass-through from the exchange rate to consumer prices. In
forecasting the exchange rate, the QPM uses an estimated
equilibrium exchange rate based on fundamentals, with the
expectation that deviations from the equilibrium rate will close
over time, aided by the interest rate. The exchange rate affects
inflation through two channels. It is captured directly for prices
of imported, finished products like petrol. In other respects, the
exchange rate affects input costs, with the degree of inflation
pressure proxied by the size of the real exchange rate gap (that
is, the distance from equilibrium). Pass-through to inflation
is around 0.13 percentage points26 for a 1 percentage point
shock to the real exchange rate, with that number reflecting the
peak addition to inflation, which occurs four quarters after the
shock. (It is not the cumulative pass-through to the price level.)
The estimated real exchange rate gap was -2.6% for the
second quarter of 2019, implying a rand exchange rate fair
value of R14.39. It widened to -5.7% in the third quarter (with
an estimated fair value of R14.88 per dollar in that quarter) as
the rand depreciated. The gap would have widened further
but for some simultaneous depreciation in the estimated real
equilibrium, based on a higher country risk level. This gap is
projected to narrow over the forecast period, to -1.3% in 2020
and -0.6% in 2021, meaning that the rand settles at a nominal
fair value of R15.12. The persistence of a negative gap entails
additional inflation pressure over the forecast period, which
helps to explain why the September MPC inflation forecast
was somewhat higher than that for July.
Employee compensation
The QPM incorporates price pressures from the labour market
through a real unit labour cost (ULC) gap, which measures
compensation relative to productivity. The simple intuition is
that with a positive gap, pay is increasing faster than output,
which raises firms’ costs and generates inflation. Where pay
matches productivity, there is no inflationary impulse.
Over the past six months, nominal compensation growth
has trended lower, by more than had been expected six
months ago. However, volatility in the data has complicated
26 This number is lower than the 0.2 percentage points pass-through in the
Core Model, which was the number historically cited as the pass-through
coefficient. The Core Model pass-through estimate is actually around
0.15 percentage points, which rounds to 0.2 percentage points, but is
actually very close to the QPM estimate.
Per cent

Real effective exchange rate gap forecast
Source: SARB


Mar 2019

May 2019

Jul 2019

Sep 2019
Values <0 imply undervaluations
Implied rand-US$ exchange rate

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


Sep 2019

Mar 2019

Actual

Forecast
Percentage points

Contribution to unit labour cost gap

Real wage gap

Productivity

Unit labour cost gap (per cent)

Source: SARB

Monetary Policy Review October 2019
efforts to understand the trend. In July in particular, the
forecast used a smoothed wage series to adjust for an abrupt
shift in first-quarter compensation. To address this issue
more permanently, the September forecast switched over
to using only QES data, having previously relied on national
accounts data for employee compensation, and QES data for
headcounts. Both the QES and national accounts versions of
employee compensation provide a broadly similar account of
wage trends, with average wage growth roughly halving from
where it was in the 2010–2017 period. The QES data are less
volatile, however.
On its own, slower wage growth would reduce inflation.
However, GDP growth has also been marked down over
this period, which raises ULC growth because productivity is
lower. As a result, the overall real ULC gap has not changed
significantly over the past few forecasts. It continues to reach
zero by the end of 2021, implying inflationary pressure from
the labour market will finally cease, for the first time in over
a decade.
Inflation expectations
Inflation expectations play an important role in policy
transmission, especially in the stylised world of the QPM.
Different theories of expectations make different claims about
how flexible and forward-looking expectations can be. For
the purposes of the SARB forecasts, inflation expectations
are treated as a blend of backward- and forward-looking
elements, with the forward-looking component based on the
model’s own inflation forecasts (i.e. the best guess of future
inflation) and the backward-looking portion derived from the
BER survey (or more precisely, how the BER survey is likely to
evolve in future). This treatment ensures expectations do not
rapidly converge on 4.5%, but also permits them to converge
on the SARB’s preferred inflation outcome over time, as agents
come to notice and believe the MPC’s 4.5% messaging.
Since the previous MPR, inflation expectations have
moderated, if slightly less than expected six months ago.
Specifically, two-year ahead expectations have fallen to 5.1%,
as of the third quarter, relative to a level of 5.0% anticipated
in March 2019. The forecast still projects that expectations
will reach the target midpoint by the end of 2021, which will
require expectations to fall another 0.6 percentage points in
just over two years. This compares with the 0.8 percentage
point adjustment realised since 2017, a comparable period.
The challenge, however, will be lowering inflation expectations
in the context of actual inflation somewhat above 4.5% – over
5% on average in 2020 – even if this inflationary pressure
is temporary. Historically, inflation expectations have ‘looked
through’ single-year events, following longer-term average
outcomes than the latest year’s inflation rate. If this persists,
expectations will end the forecast period at or very close to
the 4.5% midpoint, as projected.
Percentage change over four quarters

Sources: Stats SA and SARB
Average nominal wage growth

Compensation of employees

(national accounts)/employment (QES)

Total salaries and wages (QES)/employment (QES)
Per cent
2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: BER
Surveyed inflation expectations*

Total

Financial analysts

Businesses

Trade unions
* Two years ahead
Midpoint of inflation target range

Forecast
Per cent

Sources: BER, Stats SA and SARB
Inflation and inflation expectations

Headline inflation

Inflation expectations*

Headline inflation (five-year moving average)

* Two years ahead
Monetary Policy Review October 2019

Conclusion
The MPC has had tangible success in shifting inflation close to the
centre of the 3–6% inflation target. This has been achieved through
a mix of communication, fortuitous supply-side shocks and weak
demand. Inflation expectations remain above 4.5%, suggesting
inflation has not yet been securely anchored in the centre of the
target range. Nonetheless, inflation expectations have clearly come
down, and the risk of target breaches is low. The SARB’s baseline
expectation is that inflation will stabilise at 4.5% at the end of 2021,
completing the transition to a lower-inflation economy.
Box 6 What did the VAT increase do to inflation?

A base effect occurs when the rate of change between two time periods
moves because of a difference in the earlier number. For instance, the year-onyear inflation rate between March 2018 and March 2019 involved comparing a
data point with a 14% VAT rate with another with a 15% VAT. In the April 2018/
April 2019 comparison, however, both data points featured a 15% VAT rate.
This would have produced a lower year-on-year inflation rate, everything else
being equal.
On 1 April 2018, South Africa’s value-added tax (VAT) increased from 14% to
15%. Typically, in international experience, VAT increases have straightforward
effects: inflation is higher for a 12-month period, then slows again when
the base effect kicks in.1 The local experience, however, was less clear-cut.
Inflation did shift higher in April 2018, from 3.8% to 4.5%, but much of the
increase came through petrol prices, which were unaffected by VAT. Twelve
months later, headline inflation moderated by just 0.1 percentage points, from
4.5% to 4.4%. This suggests the higher VAT rate was a non-event for inflation.
A close look at the data, however, shows a clearer, substantial VAT impact.
To identify VAT effects, this box draws on disaggregated consumer price index
(CPI) data, broken down to 99 discrete components, of which 57 are subject to
VAT. At this level of disaggregation, it is possible to distinguish individual items
that are VAT exempt (like potatoes) from those that are subject to VAT (such as
potato chips) – distinctions that are not visible using broad categories like ‘food’.
The 57 items in the VAT basket cover VAT-affected goods comprehensively.
For this VAT basket only, inflation was 0.58 percentage points higher in
April 2018, and 0.64 percentage points lower in April 2019. During this period,
meat inflation was collapsing, which masked some of the VAT effect (as discussed
in Box 4 of the October 2018 Monetary Policy Review, p. 29). Excluding meat,
the inflation rate for the VAT series was higher, up 0.75 percentage points in
April 2018, with a fall of 0.71 percentage points in April 2019.
These changes are relatively substantial. The fact that headline barely moved
when the VAT dropped out of the base therefore requires some explanation.
In fact, the 2019 base effect was concealed by a simultaneous uptick in
fuel prices. Had fuel inflation not accelerated, the VAT base effect would
have lowered headline inflation to 4.2% in April 2019, rather than the 4.4%
actual outcome.
The changes observed in the data are roughly proportional to a 1 percentage
point VAT increase. Controlling for the previous trends in the series, it appears
roughly three-quarters of the higher VAT rate was passed on to consumers.
(By contrast, the South African Reserve Bank’s initial forecasts anticipated
100% pass-through.) It is plausible that firms absorbed some of the increase
given weak consumer demand, but this absorption effect is not very large.
Ultimately, the verdict on South Africa’s VAT increase is in line with international
experience: the VAT increase raised costs for consumers, but did not shift
inflation persistently higher.

Percentage change over 12 months
Dec

Mar
Jun
Sep
Dec
Mar
Headline, VAT and non-VAT inflation
Sources: Stats SA and SARB

Headline inflation

VAT-affected items

Items unaffected by VAT
Percentage change over 12 months
Dec

Mar
Jun
Sep
Dec
Mar
Trends in VAT-affected CPI items
Sources: Stats SA and SARB

VAT-affected items

VAT-affected items (excluding meat)

Monetary Policy Review October 2019
Box 7
Forecast accuracy in a disinflation period
1 These inflation projections are matched to actual outcomes. The errors that are made are assessed based on both accuracy (RMSE) and bias (average
errors). Bias reveals persistent mistakes in a particular direction and accuracy ensures errors in opposite directions do not cancel each other out.
This box reviews the Monetary Policy Committee (MPC) inflation forecasts for the period 2017–2019. During this time, inflation decelerated
from over 6% to around 4.5%, falling further and faster than anticipated. One surprise was food price inflation, which slowed to unusually
low levels in the aftermath of the 2016 drought. However, the core inflation forecasts were also too high, owing to a mix of factors, including
the exchange rate, wages and housing prices. A major additional challenge was gauging how fast the MPC intended to achieve 4.5%, and
therefore how rapidly inflation expectations would moderate. This was a particularly difficult problem in the context of the Quarterly Projection
Model (QPM), introduced in November 2017, given how that framework pins medium-term inflation to the model target through an inflation
expectations channel.
Context
Final consumer price index (CPI) data are available for 2017 and 2018, and sufficient data are available for 2019 to estimate the annual
outcome with confidence. The earliest 2017 forecast was published in January 2016, projecting inflation at 7%; the outcome was 5.3%. For
2018, the initial forecast was 5.5%, and the outcome was 4.6%. For 2019, the earliest projection had inflation at 5.5%; subsequent forecasts
first rose to 5.7%, then moderated steadily, to 4.2%. Core inflation projections for these three years were similarly overstated.
Compared to earlier forecasts, for the period 2010–2016, the accuracy of the South African Reserve Bank’s (SARB) forecasts for 2017 and
2018 has been materially unchanged, with an absolute error of 0.4 percentage points for 1–3 quarters ahead, and 0.9 percentage points for
4–6 quarters ahead (based on root mean square errors (RMSE)). However, the average forecast errors have been higher, meaning that the
mistakes skewed more clearly in one direction during 2017–2018 than they had previously.1
Compared with private sector analysts, as represented by the median projection of the Reuter’s survey, the SARB was not alone in a larger
upward bias for the 2017–2018 period, compared with 2010–2016. The upward skew is marginally larger for the SARB, but it is also
substantial for the Reuters median. As for accuracy, the analyst forecasts have also been largely consistent over the two periods, with the
same RMSE score at 4–6 quarters ahead, and some improvement in the shorter-term. As with the bias measures, accuracy differences
between the SARB and analysts are relatively small.
CPI: average forecast error

SARB

Reuters

Percentage points
4–6
Period 1: 2010 to 2016


Average quarters ahead
Sources: Reuters and SARB
1–3

SARB

Reuters
Percentage points
4–6
Period 2: 2017 to 2018


Average quarters ahead
Sources: Reuters and SARB

Monetary Policy Review October 2019

CPI: root mean square error

SARB

Reuters
Percentage points
4–6
Period 1: 2010 to 2016


Average quarters ahead
Sources: Reuters and SARB


SARB

Reuters
Percentage points
4–6
Period 2: 2017 to 2018


Average quarters ahead
Sources: Reuters and SARB

Surprises
The similarity of errors between the SARB and analysts’ forecasts points to surprises in data outcomes, rather than some problem unique
to the SARB. Four such surprises stand out. First, the exchange rate did not depreciate as first expected. The initial rand/dollar projections
were set at R17.10 and R17.59, for 2017 and 2018 respectively, compared with actual outcomes were R13.31 and R13.23. Much of this
error reflects the old Core Model convention of taking the last actual data point and keeping it constant in real terms over the forecast period,
thereby assuming away any exchange rate rebounds. Since the adoption of the QPM, which treats the exchange rate differently, these
projections have typically been revised by smaller amounts. The rand has also been less unstable recently.
Second, food price inflation was also overstated, a problem discussed in a previous Monetary Policy Review (MPR) box.2 As food price
inflation slowed in the wake of the 2016 drought, the forecasts consistently projected a near-term turning point, which did not actually
materialise until mid-2019. (Indeed, even this turning point has been less steep than anticipated.) Ultimately, food inflation has been unusually
low for an extended period of time, averaging 3.4% between January 2018 and August 2019, compared with an average of 6.8% for the
preceding nine years.
Compensation growth has also slowed markedly, from 8.4% during 2016 to 4.2% in 2018. Although wage gains have remained above
productivity improvements throughout this period, and have therefore been an ongoing source of inflation pressure, the degree of pressure
has faded faster than anticipated.
Finally, housing inflation fell to record lows, in the context of buoyant supply and weak demand (as discussed in the prices chapter). This
created weakness in services prices, for reasons not well captured by the usual services drivers, especially inflation expectations. Services
inflation was therefore revised lower for 2018 and 2019. (It was not forecast separately before the introduction of the QPM.)
In contrast to these four factors, neither oil nor the output gap played clear roles in driving the upside forecast errors. The oil price assumptions
were generally revised higher over the 2017–2019 period, which would have pushed inflation above previous projections, so this factor cannot
explain persistently high forecasts. Similarly, the output gap estimates have not become more negative over time, with the exception of 2019,
meaning that weak demand was not providing an additional disinflationary impulse missed in earlier forecasts, for the years 2016, 2017 or 2018.
Disinflation and the QPM
The QPM is premised on a 4.5% inflation target. However, when the QPM was introduced, the timeline for getting to 4.5% was not clear. This
posed a problem for the QPM framework, in which the inflation target is immediately credible – with the implication that inflation expectations
converge on the target rapidly. However, when the QPM was adopted, surveyed inflation expectations were around 6%, and had been sticky
there for several years – suggesting forceful monetary policy would be required to lower them. With the shift to 4.5% not an immediate priority,
the first year of QPM forecasts did not show inflation expectations stepping down to 4.5%, and did not have inflation hitting the 4.5% target
within the published forecast horizon. The objective of projecting the most probable inflation outcome trumped the model objective of getting
to the target within two or three years.
2 See Box 3 ‘Unpacking food inflation’ in the October 2018 MPR, p. 15.

Monetary Policy Review October 2019
Ironically, interventions in the QPM to make it more ‘realistic’ probably made the headline forecasts worse. Actual inflation ended up close to
4.5% throughout 2018 and 2019, which is where the QPM wanted it. In part, it was a coincidence that inflation outcomes matched the model
target, given unanticipated shocks like lower food price inflation. However, intervening to keep inflation expectations elevated meant projecting
a relatively high path for core inflation, and especially its services component. This overstatement of services inflation had to be unwound later,
with the 2019 services forecasts moderating from an annual rate of 6% inflation down to 4.8%.
To address these challenges, the QPM has been modified so its treatment of inflation expectations includes a backward-looking factor, allowing
expectations to evolve more realistically.3 Furthermore, from January 2018 the forecasts have been tethered to 4.5% at the end of the forecast
horizon, meaning the model proposes whatever is needed to hit the target over the medium term. This shift was facilitated by actual outcomes
close to the midpoint, and greater clarity from the MPC that the 4.5% objective is live, not just a future aspiration, which helped close the gap
between the most-likely inflation outcome and the inflation outcome determined by the model’s structure. Strikingly, as a result of this shift, the
SARB inflation forecasts are now lower for 2021 than those of most private analysts. This suggests the upside bias of recent SARB forecasts
will not be a feature of future inflation forecast assessments.
The SARB’s inflation forecasts have been revised lower from meeting to meeting, for headline inflation as well as core:
Downside inflation surprises have come from food, the exchange rate, unit labor costs and housing. Adjustments to projected inflation
expectations also helped lower services inflation for 2019:
3 As discussed in the prices chapter, as well as in Box 6 of the October 2018 MPR, p. 37.
Percentage change
Targeted inflation


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Source: SARB
MPC meeting dates
4.6
4.2
Percentage change
Core inflation
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Percentage change
Food and NAB inflation
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Per cent
Unit labour cost*
* As the QPM used a non-comparable wage measure for Nov 2017
to May 2018, those data are not shown.
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Monetary Policy Review October 2019

Neither oil prices nor the output gap explain downside inflation surprises, except for 2019:
Implied rand per US$
Exchange rate
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Percentage change
Services inflation
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
US$ per barrel
Brent crude oil
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Percentage of potential GDP
Output gap
Source: SARB
MPC meeting dates


Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan
Nov
Sep
Jul
May
Mar
Jan

Monetary Policy Review October 2019
Conclusion
Global macroeconomic conditions are highly unusual. Around
40% of government bonds worldwide are trading at negative
interest rates. A number of sovereign yield curves have
inverted, including those for Germany, Switzerland, the US,
and the UK, meaning these governments can borrow more
cheaply for the long term than the short term. Advanced
economy inflation rates have been stubbornly low, generally
below inflation targets, despite large declines in unemployment
and exceptionally loose monetary policies.
These circumstances pose acute challenges for conventional
macroeconomic theory.27 If advanced economy Phillips Curves
have flattened out, so that even tight labour markets do not
generate much price pressure, central banks are deprived of
their main tool for raising inflation.28 With interest rates near
the zero lower bound most of the time, central banks will also
struggle to manage business cycle fluctuations, because they
will have limited space to cut during downturns. As for fiscal
policy, if interest rates remain persistently below GDP growth
rates (r<g, in the jargon), then budget deficits can be sustained
indefinitely – undoing the usual truism that deficits now will
have to be repaid with surpluses later.29
South
Africa
also
faces
challenging
macroeconomic
circumstances, but the character of those challenges is far less
novel. Inflation has remained within the 3–6% target range, and
generally in the top half of the range. Interest rates are positive,
with the repo at 6.5% currently, leaving the zero lower bound
constraint irrelevant for practical purposes. Furthermore, the
yield curve, far from being inverted, is unusually steep. In turn,
high long-term yields reflect sovereign risk, a product of rapid
debt growth. With interest rates higher than GDP growth rates,
the r<g debate is moot: deficits cannot be sustained indefinitely.
Through history, overspending and excess debt are common
phenomena. The problem, for economists, is how to
restore debt sustainability. This is difficult because budget
consolidation efforts can hurt growth, so attempts to narrow
fiscal deficits may not improve the debt-to-GDP ratio. However,
where sustainability is in question, it may also become very
expensive to borrow, which is similarly growth damaging.
27 For a broad review, see O Blanchard and L H Summers (eds), Evolution
or revolution? Rethinking macroeconomic policy after the great recession,
2019.
28 As discussed by J Powell, ‘Monetary policy and risk management at
a time of low inflation and low unemployment’. Speech by Jerome
Powell, Chairman of the US Fed, at the 60th Annual Meeting of the
National Association for Business Economics, Boston, Massachusetts,
2 October 2018.
powell20181002a.htm (accessed 14 September 2019).
29 O Blanchard, ‘Public debt and low interest rates’, PIIE Working Paper Series
No. 19-4, Washington: Peterson Institute for International Economics,
February 2019. publicdebt-and-low-interest-rates (accessed 16 September 2019).
Percentage points
Gap between 5-year bond yields and 2020–2024
nominal GDP growth forecasts
Sources: Bloomberg, IMF and SARB
Turkey
Nigeria
Mexico
Russia
Brazil
South Africa
Italy
Greece
Colombia
Indonesia
Japan
US
Chile
Poland
UK
Portugal
Thailand
New Zealand
Switzerland
Australia
France
Spain
Malaysia
Austria
Netherlands
Germany
Denmark
Philippines
Sweden
India
China
-6
-4
-2

Emerging economies

Advanced economies

Monetary Policy Review October 2019

Moderating fiscal deficits may therefore be necessary to
contain risk and prevent worse growth outcomes in future.30
Turning to monetary policy, there is little in the policy stance
that is difficult to explain using standard theory. The repo
rate is being calibrated to close the output gap and stabilise
inflation, in the middle of the target, in line with a conventional
Taylor-type rule. By focusing expectations around a clearly
defined objective – the 4.5% midpoint of the 3–6% range –
policymakers have contributed to bringing inflation down. But
even with lower inflation, the risks of falling into deflation or
hitting the zero lower bound appear very remote. Indeed, if
there is a puzzle to be solved, it is why inflation has not fallen
further given weak growth rates: South Africa continues to
have higher inflation than most other countries.
This MPR sets outs a case for inflation remaining within the
target range for the foreseeable future, and ending the forecast
period at 4.5%. There will be a temporary spike in inflation in
early 2020, to over 5%, which is mainly due to a fuel price base
effect. Beyond that, inflation will stabilise in the middle of the
target range, the same place it has been for the past two and
a half years.
The projected repo rate remains below the estimated neutral
level throughout this period, in recognition of weak growth. Were
inflation lower, the repo outlook could be more accommodative
still. Similarly, if the sovereign risk premium were to come
down, the neutral rate would moderate and monetary policy
would enjoy more space. However, even a significantly more
expansionary repo stance would very likely not deliver growth
rates adequate to South Africa’s challenges, given acute
constraints elsewhere in the economy. With potential growth
rates of little more than 1%, and business confidence subdued,
demand stimulus would likely raise imports and inflation more
than investment and growth.
Given the scale of South Africa’s economic challenges, as well
as global risks, monetary policy will do well to maintain the
current mix of a benign inflation outlook and below-neutral
interest rates. There are risks a change in the environment
could force an outright-tight policy stance. To control these
risks, South Africa needs reforms. These are likely to entail
some short-term pain. The cost of postponing reforms further,
however, is rising at an accelerating rate.
30 A Alesina, C Favero and F Giavazzi, Austerity: when it works and when it
doesn’t, 2019; J Bianchi, P Ottonello and I Presno, ‘Fiscal stimulus under
sovereign risk’, Federal Reserve Bank of Minneapolis Working Paper Series
No. 762, Minneapolis: Federal Reserve Bank of Minneapolis, September
2019.

stimulus-under-sovereign-risk (accessed 15 September 2019).
Proportion of countries (per cent)

>10.1
Distribution of inflation (annual, 2019)
Sources: IMF and SARB
-10

Emerging economies

Advanced economies
South Africa

Monetary Policy Review October 2019
Statement of the Monetary Policy Committee
23 May 2019
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Over the past few months, global growth has rebounded
somewhat,
but
significant
downside
risks
remain,
in particular from threats to the global trade regime.
Domestically, electricity supply constraints and a protracted
strike in a major gold mine contributed to a weak firstquarter performance. Business and consumer confidence
continues to weigh on the near-term growth forecast.
Recent monthly inflation outcomes have remained around
the midpoint of the inflation target range, in part due to weak
demand and positive inflation data surprises. The mediumterm inflation outlook has moderated slightly.
The year-on-year inflation rate, as measured by the consumer
price index (CPI) for all urban areas, was 4.4% in April (down
from 4.5% in March). Goods price inflation was 4.2% (up
from 4.1% in March), while services price inflation was 4.6%
(down from 4.9% in March). The South African Reserve
Bank’s (SARB) measure of core inflation (which excludes
food, fuel and electricity) was 4.1% in April (down from 4.4%
in March). Producer price inflation for final manufactured
goods increased to 6.2% in March (from 4.7% in February).
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) has improved since the previous
meeting of the Monetary Policy Committee (MPC). Headline
inflation is now expected to average 4.5% in 2019 (down
from 4.8%), increasing to 5.1% in 2020 (down from 5.3%)
and moderating to 4.6% in 2021 (down from 4.7%). Headline
CPI inflation is now expected to peak at 5.5% in the first
quarter of 2020 and settle at 4.5% in the last two quarters
of 2021.
The main drivers of the forecast are a lower starting point
for food and services inflation and the revised oil price
assumptions. Food price inflation is now expected to
average 3.7% in 2019 (down from 4.1%). The assumptions
for Brent crude oil in the QPM were revised up from US$64
to US$69.50 for 2019. The assumptions for 2020 and 2021
were also revised up from US$65 to US$68.
Moderation in rental prices, unit labour costs and inflation
expectations also contribute to lower core inflation over the
medium term. The forecast for core inflation is lower at 4.5%
in 2019 (down from 4.8%), 4.8% in 2020 (down from 4.9%)
and 4.5% in 2021.
Average inflation expectations have been declining slowly
since the end of 2017. The inflation expectations of market
analysts in the May 2019 Reuters Econometer survey were
unchanged at 4.7% for 2019, while expectations edged
down to 5.2% for 2020 (from 5.3%) and 5.0% for 2021
(from 5.1%). Market-based expectations implicit in the
break-even inflation rates (i.e. the yield differential between
conventional and inflation-linked government bonds)
remain sensitive to exchange rate movements. Since our
last meeting, five-year break-even rates increased to 5.1%
and ten-year break-even rates were unchanged at 5.8%.
The next Bureau for Economic Research (BER) inflation
expectations survey will be published in July.
Global gross domestic product (GDP) is expected to
average 3.3% in 2019 and then stabilise around 3.5% from
2020. While global economic activity remains moderate
overall, growth momentum has slowed somewhat, and
there are many risks. Trade tensions have escalated
between the United States (US) and China, weighing on
market confidence. Further tariff increases could disrupt
global value chains and further reduce global trade. The
International Monetary Fund’s (IMF) April 2019 World
Economic Outlook estimates that tariff increases could
subtract as much as 0.8 percentage points from global
growth. Much uncertainty remains around Brexit, alongside
other geopolitical developments. In some countries, there
also remain significant financial vulnerabilities associated
with elevated private and public debt.
Inflation in most advanced economies remains below
targeted levels, allowing major central banks space to put
monetary policy normalisation on hold. However, the risk of
a renewed tightening of financial conditions should not be
underestimated.
The performance of emerging market currencies was
mixed, reflecting a combination of changes in investor
sentiment, easier monetary conditions in major economies,
and country-specific factors. Currencies of countries with
stronger macroeconomic fundamentals remain better
placed to benefit from these developments. The rand has
benefited from improved sentiment towards riskier assets
but will continue to be affected by idiosyncratic factors such
as domestic growth prospects and policy settings.
Since the March MPC meeting, the rand has appreciated by
1.5% against the US dollar, by 2.5% against the euro, and by
3.1% on a trade-weighted basis. The implied starting point
for the rand is R14.40 against the US dollar, compared with
R14.00 at the time of the previous meeting. At these levels,
the QPM assesses the rand to be slightly undervalued.
Based on recent short-term indicators and negative growth
in mining and manufacturing, GDP is expected to contract in
the first quarter of 2019. The disappointing data outcomes
Monetary Policy Review October 2019

partly reflect supply-side constraints due to load-shedding
and a strike at a major gold mine. Fixed capital formation
and household consumption expenditure also remain weak.
The Absa Purchasing Managers’ Index (PMI) has recovered
to 47.2 index points, remaining below the neutral level. The
SARB’s composite leading business cycle indicator has
trended lower since March 2018 and decreased further, by
0.4%, in March 2019.
The SARB now expects GDP growth for 2019 to average
1.0% (down from 1.3% in March). The forecast for 2020 and
2021 is unchanged at 1.8% and 2.0% respectively. The nearterm growth outlook is limited by the larger-than-expected
slowdown in the first quarter, weak business and consumer
confidence, as well as growing pressure on households’
disposable income. Real fixed investment is now forecast
to contract by 0.3% in 2019, while household consumption
expenditure will rise by a modest 1.0%.
The MPC assesses the risks to the growth forecast to be
on the downside. Weak business confidence, possible
electricity supply constraints and high debt levels in certain
state-owned enterprises will continue to limit investment
prospects. An escalation of trade tensions could significantly
impact global trade with likely negative impacts for South
Africa as a small open economy. The MPC remains of
the view that current challenges facing the economy are
primarily structural in nature and cannot be resolved by
monetary policy alone. It is now even more urgent to have
a combination of prudent macroeconomic policies and
structural reforms that raise potential growth and lower the
cost structure of the economy.
The MPC welcomes the continued downward trend in
recent inflation outcomes and the moderation in inflation
expectations. These are positive developments, as the MPC
would like to see inflation remain close to the midpoint of the
inflation target range on a more sustained basis.
The overall risks to the inflation outlook are assessed to
be more or less evenly balanced. While there is scope for
further moderation in meat and services prices, oil prices
are expected to remain elevated and global food prices
appear to have bottomed out. Electricity and water prices,
among other administered prices, present additional
upside risks.
Against this backdrop, the MPC has decided to keep
the repurchase rate unchanged at 6.75% per year. Three
members preferred to keep the rate on hold and two
members preferred a cut of 25 basis points. The MPC
assesses the stance of monetary policy to be broadly
accommodative over the forecast period. Any future policy
adjustments will continue to be data-dependent.
The implied path of policy rates generated by the QPM is
for one cut of 25 basis points to the repurchase rate by the
end of the first quarter of 2020. The endogenous interest
rate path is built into the growth and inflation forecast. As
emphasised previously, the implied path remains a broad
policy guide which could change in either direction from
meeting to meeting in response to new developments and
changing risks.
Per cent

2015 2016 2017 2018 2019 2020 2021
Repurchase rate forecast (May 2019)

90%

60%

30%

Repo rate

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

Monetary Policy Review October 2019
Summary of assumptions: Monetary Policy Committee
meeting on 23 May 2019*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 55 and 56.
Monetary Policy Review October 2019

Summary of selected forecast results: Monetary Policy Committee meeting
on 23 May 2019*
Selected forecast results (annual)
Actual
Forecast


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


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


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

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

Monetary Policy Review October 2019
Statement of the Monetary Policy Committee
18 July 2019
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the May meeting of the Monetary Policy Committee
(MPC), near-term indicators have been pointing to weakerthan-anticipated global economic activity. Global financial
conditions have eased, as central banks in advanced
economies have signalled a move towards monetary
accommodation. However, downside risks remain, and are
dominated by escalating trade and geopolitical tensions.
In the domestic economy, gross domestic product (GDP)
contracted in the first quarter due to a combination of
supply-side and demand-side factors. Monthly inflation
outcomes have stayed around the midpoint of the inflation
target range, as food and services price inflation remained
subdued. The medium-term inflation outlook is unchanged.
The year-on-year inflation rate, as measured by the
consumer price index (CPI) for all urban areas, was 4.5% in
May (up from 4.4% in April). Goods price inflation was 4.2%,
while services price inflation was 4.6%. The South African
Reserve Bank’s (SARB) measure of core inflation (which
excludes food, fuel and electricity) was 4.1%. Producer price
inflation for final manufactured goods decreased to 6.4% in
May (compared to 6.5% in April).
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) is for headline inflation to average
4.4% in 2019 (down from 4.5%). The projections for 2020
and 2021 remain unchanged at 5.1% and 4.6% respectively.
Headline CPI inflation is expected to peak at 5.4% in the first
quarter of 2020 and settle at 4.5% in the last two quarters of
2021. The forecast for core inflation is lower at 4.4% in 2019
(down from 4.5%) and 4.7% in 2020 (down from 4.8%), but
is unchanged at 4.5% in 2021.
Electricity, food and fuel price inflation has shaped the trend
in headline inflation. The assumptions for Brent crude oil in
the QPM have been revised down from US$69.50 to US$67
for 2019. The assumptions for 2020 and 2021 remain
unchanged at US$68. Fuel price inflation is expected
to average 3.2% in 2019 and to peak at 13.1% in the first
quarter of 2020. Although food price inflation has continued
to surprise on the downside, it is expected to start rising
from the end of 2019 and to peak at 5.6% in the second and
third quarters of 2020.
Inflation expectations have continued to moderate.
According to the Bureau for Economic Research (BER)
second-quarter survey, expectations for headline inflation
are for 4.8% in 2019. Inflation expectations for 2020 and
2021 eased to 5.0% and 5.2% respectively. Five-year-ahead
inflation expectations remain unchanged at a historical low
of 5.1%.
The inflation expectations of market analysts in the July
2019 Reuters Econometer survey have been revised lower
to 4.5% (from 4.7%) in 2019 and to 5.0% (from 5.2%) in
2020, and remain unchanged at 5.0% in 2021.
Market-based expectations implicit in the break-even
inflation rates (i.e. the yield differential between conventional
and inflation-linked government bonds) have declined
significantly since our last meeting, reflecting a firmer
exchange rate and subdued domestic and global inflation
pressures. Five-year break-even rates decreased to 4.5%
and ten-year break-even rates decreased to 5.3%, the
lowest level since January 2015.
Global GDP is expected to average 3.3% in 2019 and then
stabilise at around 3.5% from 2020. While global growth
remains relatively healthy overall, recent indicators on trade
and manufacturing have deteriorated sharply, and a range
of downside risks to growth remains. Growth in world
trade volumes contracted for the fifth consecutive month,
declining by 2.1% in April 2019. Trade tensions remain
heightened, weighing on market confidence and lowering
investment. Other downside risks include geopolitical
developments and high levels of corporate and sovereign
debt. Across most countries, there is limited policy space to
respond to shocks.
Inflation outcomes and inflation expectations in most
advanced economies remain below targeted levels.
Recent communication by the Federal Reserve Bank
and the European Central Bank indicates that, in the
absence of significant shocks, monetary policy will remain
accommodative over the medium term. However, market
expectations of the extent of future central bank actions
appear high, creating the risk of significant market volatility
should these not materialise.
Emerging market currencies are firmer, reflecting a
combination of United States (US) dollar weakness and
shifting market sentiment. However, country-specific factors
remain important, with currencies of countries with stronger
macroeconomic fundamentals having fared better.
Since the May MPC, the rand has appreciated by 3.3%
against the US dollar, by 2.4% against the euro, and by 2.3%
on a trade-weighted basis. The implied starting point for the
rand is R14.30 against the US dollar, compared with R14.40
at the time of the previous meeting. At these levels, the QPM
assesses the rand to remain slightly undervalued. While the
rand has benefited from improved sentiment towards riskier
assets, it underperformed its emerging market peers due to
idiosyncratic factors. Domestic growth prospects and fiscal
risks rate high among investor concerns.
Monetary Policy Review October 2019

South Africa’s GDP contracted by 3.2% in the first quarter,
reflecting weakness in most sectors of the economy. The
sharp quarterly decline was primarily caused by electricity
shortages and strikes that fed into broader weakness in
investment, household consumption and employment
growth. Based on the recent short-term indicators for the
mining and manufacturing sectors, a rebound in GDP is
expected in the second quarter of 2019.
Continued low business confidence remains a concern
for the MPC. The Absa Purchasing Managers’ Index (PMI)
averaged 46.3 points in the second quarter, remaining
below the neutral level. The Rand Merchant Bank (RMB)/
BER Business Confidence Index remains unchanged at
28 points. The SARB’s composite leading business cycle
indicator continued to trend lower.
The SARB now expects GDP growth for 2019 to average
0.6% (down from 1.0% in May). The forecast for 2020 and
2021 remains unchanged at 1.8% and 2.0% respectively.
The MPC assesses the risks to the growth forecast to be
balanced in the near term but remains concerned about the
longer-term risks. Investment prospects will continue to be
limited in the absence of structural reforms. An escalation of
trade tensions could have further negative impacts.
While some cyclical factors constrained recent GDP
growth outcomes, the MPC remains of the view that the
current challenges facing the economy are primarily
structural in nature and cannot be resolved by monetary
policy alone. Implementation of prudent macroeconomic
policies, together with structural reforms that raise potential
growth and lower the cost structure of the economy,
remains urgent.
The MPC welcomes the continued downward trend in
recent inflation outcomes and the moderation in inflation
expectations of about 1 percentage point since 2016. The
MPC would like to see inflation remain close to the midpoint
of the inflation target range on a more sustained basis, with
inflation expectations also anchored around these levels.
The overall risks to the inflation outlook are assessed to be
largely balanced. Demand-side pressures are subdued,
wages and rental prices are expected to increase at
moderate rates, and global inflation should remain low. In
the absence of shocks, relative exchange rate stability is
expected to continue.
However, the impact of upside risks on the inflation outlook
could be significant. Global financial conditions can tighten
abruptly due to small shifts in inflation outlooks in advanced
economies and changing market sentiment. Domestically,
the financing needs of state-owned enterprises (SOEs)
could place further upward pressure on the currency and
long-term market interest rates for all borrowers. Food,
electricity and water prices also remain important risks to
the inflation outlook.
Against this backdrop, the MPC has unanimously decided
to reduce the repurchase rate by 25 basis points to 6.5%
per annum with effect from 19 July 2019.
Monetary policy actions will continue to focus on anchoring
inflation expectations near the midpoint of the inflation
target range in the interest of balanced and sustainable
growth. In this persistently uncertain environment, future
policy decisions will continue to be highly data-dependent,
sensitive to the assessment of the balance of risks to the
outlook, and will seek to look through temporary price
shocks.
The implied path of policy rates generated by the QPM is for
one cut of 25 basis points to the repurchase rate by the end
of the fourth quarter of 2019. The endogenous interest rate
path is built into the growth and inflation forecast. The implied
path remains a broad policy guide which could change in
either direction from meeting to meeting in response to new
developments and changing risks.
Per cent

Repurchase rate forecast (July 2019)

90%

60%

30%

Repo rate

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

Monetary Policy Review October 2019
Summary of assumptions: Monetary Policy Committee
meeting on 18 July 2019*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 55 and 56.
Monetary Policy Review October 2019

Summary of selected forecast results: Monetary Policy Committee meeting
on 18 July 2019*
Selected forecast results (annual)
Actual
Forecast


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


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


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

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

Monetary Policy Review October 2019
Statement of the Monetary Policy Committee
19 September 2019
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the July meeting of the Monetary Policy Committee
(MPC), economic indicators confirm weaker global economic
conditions and low inflation. Central banks in advanced
economies have provided more monetary accommodation,
helping to ease global financial conditions. Downside risks
from escalating trade and geopolitical tensions remain
pronounced.
In the second quarter of this year, South Africa’s gross
domestic product (GDP) rebounded from the contraction
experienced in the first quarter, but economic activity levels
still remain weak. Monthly inflation has been around the
midpoint of the inflation target range, as food and services
inflation remains subdued.
The year-on-year inflation rate, as measured by the consumer
price index (CPI) for all urban areas, was 4.3% in August
(up from 4.0% in July). Goods price inflation in August was
3.9% (up from 3.4% in July), while services price inflation
remained at 4.7%. Food price inflation rose to 3.9% (up
from 3.4%), due to rising cereal and bread prices. The South
African Reserve Bank’s (SARB) measure of core inflation,
which excludes food, fuel and electricity, rose slightly to
4.3%. Producer price inflation for final manufactured goods
decreased to 4.9% in July (compared to 5.8% in June).
The medium-term inflation outlook is largely unchanged.
The inflation forecast generated by the SARB’s Quarterly
Projection Model (QPM) is for headline inflation to average
4.2% in 2019 (down from 4.4%). The projection for 2020 is
unchanged at 5.1%, and for 2021 slightly up to 4.7% (from
4.6%). Headline CPI inflation is expected to peak at 5.3% in
the first quarter of 2020 and settle at 4.5% in the last quarter
of 2021. The forecast for core inflation is lower at 4.3% in
2019 (down from 4.4%), is unchanged at 4.7% in 2020 and
is slightly higher at 4.6% in 2021 (up from 4.5%).
Electricity, food and fuel price inflation continue to shape
the near- and medium-term trajectory of headline inflation.
Fuel price inflation is expected to average 2.4% in 2019 and
to peak at 11.8% in the first quarter of 2020. While food
price inflation has generally surprised on the downside, it is
expected to peak at about 6.0% in the third quarter of 2020.
Electricity prices came out higher than expected in August,
at 11.8%, but remain in line with the forecast.
Inflation expectations have continued to moderate gradually.
According to the Bureau for Economic Research (BER) third
quarter survey, expectations for headline inflation were
down slightly for 2019 to 4.6% (from 4.8%). Expectations for
2020 remain unchanged at 5.0% and eased from 5.2% to
5.1% for 2021, reaching the lowest levels since 2007. Fiveyear-ahead inflation expectations also declined to 5.0%
(from 5.1%).
The inflation expectations of market analysts in the
September 2019 Reuters Econometer survey have been
revised lower to 4.3% (from 4.4%) for 2019 and remain
unchanged at 4.9% and 4.8% in 2020 and 2021 respectively.
Market-based expectations implicit in the break-even
inflation rate (the yield differential between conventional
and inflation-linked bonds) have remained stable since the
previous MPC. Five-year break-even rates are currently at
about 4.6% and ten-year break-even rates at 5.4%.
Global GDP is expected to slow to 3.2% in 2019 and rise
to around 3.5% in 2020. While global growth remains
resilient, recent indicators on trade and manufacturing
have deteriorated and a range of downside risks to growth
remain. Growth in world trade volumes has continued to
decline, with trade tensions weighing on market confidence
and lowering investment. Other downside risks include
geopolitical developments, further oil price shocks, and
high levels of corporate and sovereign debt. Across most
countries, there is limited policy space to respond to shocks.
Inflation outcomes and inflation expectations in most
advanced economies remain below targeted levels.
Barring significant shocks, monetary policy in major
advanced economies will remain accommodative over the
medium term. However, market expectations of further
accommodation appear high, creating ongoing risk of
market volatility should these not materialise.
Since the July MPC, the rand has depreciated by 4.6%
against the US dollar, and by 3.0% against the euro. The
implied starting point for the rand is R14.88 against the US
dollar, compared with R14.40 at the time of the previous
meeting. At these levels, the QPM assesses the rand to
remain slightly undervalued. While the rand has benefited
from improvements in global sentiment, investors remain
concerned about domestic growth prospects and fiscal
risks.
GDP rebounded to 3.1% in the second quarter, following
a decline of 3.1% in the first quarter. The sharp quarterly
rebound was caused by stronger output in nearly all
sectors, including investment and government consumption
spending. However, longer-term weakness in most sectors
Monetary Policy Review October 2019

remains a serious concern. Based on recent short-term
economic indicators for the mining and manufacturing
sectors, the third-quarter GDP outcome is expected to
be muted.
Business confidence has declined further. The Absa
Purchasing Managers’ Index came out at 45.7 points in
August (from 46.3), and the Rand Merchant Bank (RMB)/
BER Business Confidence Index fell to 21 points (from 28).
The SARB’s composite leading business cycle indicator also
continued to trend lower, although the coincident indicator
remains positive.
The forecast of GDP growth for 2019 remains unchanged at
0.6%. The forecasts for 2020 and 2021 have decreased to
1.5% (from 1.8%) and 1.8% (from 2.0%), respectively due to
revisions to global growth and domestic potential growth.
The MPC assesses the risks to the growth forecast to be
balanced in the near term, but remains concerned about
medium-term growth and weak employment prospects.
Escalation in global trade tensions, further domestic supply
constraints and sustained higher oil prices could generate
headwinds to growth. Public sector financing needs remain
high, exerting pressure on the currency and pushing local
bond yields higher relative to country peers. Implementation
of prudent macroeconomic policies and structural reforms
that lower costs, and raise investment and potential growth,
remains urgent.
The overall risks to the inflation outlook are assessed to be
largely balanced. Demand-side pressures remain subdued
and food, wages and rental prices are expected to increase
at moderate rates. Global inflation should remain low.
In the absence of shocks, relative exchange rate stability
is expected to continue. Some upside risks to the inflation
outlook remain, in particular from fuel, electricity and
water prices.
The MPC welcomes the sustained moderation in inflation
outcomes and the fall in inflation expectations of about
1% since 2016. The Committee would like to see inflation
expectations also anchored closer to the midpoint of the
inflation target range on a sustained basis.
Against this backdrop, the MPC unanimously decided to
keep the repurchase rate unchanged at 6.5% per annum.
Monetary policy actions will continue to focus on anchoring
inflation expectations near the midpoint of the inflation
target range in the interest of balanced and sustainable
growth. In this persistently uncertain environment, future
policy decisions will continue to be highly data-dependent,
sensitive to the assessment of the balance of risks to
the outlook, and will seek to look through temporary
price shocks.
The implied path of policy rates over the forecast period
generated by the QPM indicated no changes to the
repurchase rate. This remains a broad policy guide, which
could change in either direction from meeting to meeting
in response to new developments and changing data
and risks.
Per cent

Repurchase rate forecast (September 2019)

90%

60%

30%

Repo rate


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

Monetary Policy Review October 2019
Summary of assumptions: Monetary Policy Committee
meeting on 19 September 2019*
1. Foreign sector assumptions
Actual
Forecast

1. Real GDP growth in South Africa’s

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


3. Change in international commodity prices in US$

2. Domestic sector assumptions
Actual
Forecast


Notes
1.
Shaded areas indicate forecast assumptions.
2.
The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 55 and 56.
Monetary Policy Review October 2019

Summary of selected forecast results: Monetary Policy Committee meeting
on 19 September 2019*
Selected forecast results (annual)
Forecast


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


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


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

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

Monetary Policy Review October 2019
Foreign sector assumptions
1. Trading-partner gross domestic product (GDP) growth
is broadly determined using the Global Projection Model
(GPM), which is adjusted to aggregate the GDP growth
rates of South Africa’s major trading partners on a tradeweighted basis. Individual projections are done for the
six largest trading partners (the euro area, United States
(US), United Kingdom, Japan, China and India. Other
countries considered, although with small weights,
are Brazil, Mexico and Russia. The remaining trading
partners are grouped into the ‘Rest of Countries’ bloc.
Since sub-Saharan Africa is also a major trading region
for South Africa (but does not have a bloc in the GPM,
it is modelled separately and then combined with the
aggregate of all countries in the GPM to make up total
trading partner growth.
2. As with GDP growth, the output gap is determined using
the GPM and is adjusted in a similar way. The output gap
is driven by a combination of country-specific domestic
factors, external factors, and financial-real linkages
(beyond interest rate and exchange rate effects).
Domestic factors include expectations of future demand
and medium-term interest rates. External factors include
exchange rate impacts on demand, direct spillovers
through trade with trading-partner countries, and
foreign demand.
3. The commodity price index is a weighted aggregate
price index of the major South African export
commodities.
4. The Brent crude oil price is expressed in US dollars
per barrel. The assumption incorporates supply and
demand dynamics as well as oil inventories (of all grades).
The assumption is also informed by projections from the
US Energy Information Administration, the Organization
of the Petroleum Exporting Countries and Reuters.
5. World food prices is the composite food price index of
the United Nations Food and Agriculture Organization in
US dollars. It is weighted using average export shares
and represents the monthly change in the international
prices of a basket of five food commodity price indices
(cereals, vegetable oil, dairy, meat and sugar). World food
price prospects incorporate selected global institution
forecasts for food prices and imbalances from the
anticipated trend in international food supplies relative to
expected food demand pressures.
6. International consumer prices are also broadly
determined using the GPM. The index is an aggregate
of the consumer price indices of the euro area, the
US and Japan, weighted by their relative trade shares.
Consumer prices are determined for each of these
economies by accounting for inflation expectations,
demand pressures, and pass-through from changes in
the relevant exchange rate. Other institutional forecasts
for international consumer prices are also considered.
7. International policy interest rates are again broadly
determined using the GPM. Interest rates are a weighted
average of the policy rates of the euro area, the US and
Japan. They are individually determined by a ‘Taylortype’ monetary policy rule. The communications of the
relevant central banks and other institutional forecasts
are also considered.
Monetary Policy Review October 2019

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

Monetary Policy Review October 2019
Glossary
Advanced economies: Advanced economies are countries
with high gross domestic product (GDP) per capita,
diversified exports, and close integration into the global
financial system.
Balance of payments: This is a record of transactions
between the home country and the rest of the world over a
specific period of time. It includes the current and financial
accounts. See also ‘Current account’ below.
Brent crude: Brent crude is a light and sweet blend of oil
from five different fields in the North Sea. The price of Brent
crude is one of the benchmark oil prices in international
markets.
Budget deficit: A budget deficit indicates the extent to which
government expenditure exceeds government revenue.
Business and consumer confidence: These are economic
indicators that measure the level of optimism about the
economy and its prospects among business managers and
consumers.
Commodities: Commodities can refer to energy, agriculture,
metals and minerals. Major South African-produced
commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication
of aggregate price changes in the domestic economy. The
index is calculated using a number of categories forming
a representative set of goods and services bought by
consumers.
Core inflation: Core generally refers to underlying inflation
excluding the volatile elements (e.g. food and energy prices).
The South African Reserve Bank’s (SARB) forecasts and
discussions refer to headline CPI excluding food, nonalcoholic beverages, fuel and electricity prices.
Crude oil price: This is the United States (US) dollar price
per barrel of unrefined oil. See also ‘Brent crude’ above.
Current account: The current account of the balance of
payments consists of net exports (exports less imports)
in the trade account as well as the services, income and
current transfers.
Emerging markets: Emerging markets are countries with
low to middle income per capita. They are advancing rapidly
and are integrating with global (product and capital) markets.
Exchange rate depreciation (appreciation): Exchange rate
depreciation (appreciation) refers to a decrease (increase) in
the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange
rate changes on domestic inflation (i.e. the percentage
change in domestic CPI due to a change in the exchange
rate). Changes in the exchange rate affect import prices,
which in turn affect domestic consumer prices and inflation.
Forecast horizon: This is the future period over which the
SARB generates its forecasts, typically between two and
three years.
Gross domestic product (GDP): GDP is the total market
value of all the goods and services produced in a country.
It includes total consumption expenditure, capital formation,
government consumption expenditure, and the value of
exports less the value of imports.
Gross fixed capital formation (investment): The value of
acquisitions of capital goods (e.g. machinery, equipment
and buildings) by firms, adjusted for disposals, constitutes
gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers to
CPI for all urban areas that is released monthly by Statistics
South Africa (Stats SA). Headline CPI is a measure of price
levels in all urban areas. The 12-month percentage change
in headline CPI is referred to as ‘headline CPI inflation’ and
reflects changes in the cost of living. This is the official
inflation measure for South Africa.
Household consumption: This is the amount of money
spent by households on consumer goods and services.
Inflation (growth) outlook: This outlook refers to the evolution
of future inflation (growth) over the forecast horizon.
Inflation targeting: This is a monetary policy framework
used by central banks to steer actual inflation towards an
inflation-target level or range.
Monetary policy normalisation: This refers to the unwinding
of an unusually accommodative monetary policy. It could
also mean adjusting the economy’s policy rate towards its
real neutral policy rate.
Neutral real interest rate (NRIR): The NRIR is the level at
which the real interest rate will settle once the output gap is
closed and inflation is stable.
Nominal effective exchange rate (NEER): The NEER
is an index that expresses the value of a country’s
currency relative to a basket of other (trading-partner)
currencies. An increase (decrease) in the NEER indicates
a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted
average exchange rate of the rand is calculated against
20 currencies. The weights of the five major currencies are
as follows: the euro (29.26%), the Chinese yuan (20.54%),
the US dollar (13.72%), the Japanese yen (6.03%), and the
British pound (5.82%). Index: 2010 = 100. See also ‘Real
effective exchange rate’ on the next page.
Output gap/potential growth: Potential growth is the rate
of GDP growth that could theoretically be achieved if all
the productive assets in the economy were employed
in a stable inflation environment. The output gap is the
Monetary Policy Review October 2019

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

Monetary Policy Review October 2019
Abbreviations
BER

Bureau for Economic Research
CDS

credit default swap
CPI

consumer price index
ECB

European Central Bank
EMBI+

JPMorgan Emerging Market
Bond Index Plus
FAO

Food and Agriculture Organization
Fed

Federal Reserve
FRA

forward rate agreements
GDP

gross domestic product
GPM

Global Projection Model
Haver

Haver Analytics
IIF

Institute of International Finance
IMF

International Monetary Fund
JSE

JSE Limited
MPC

Monetary Policy Committee
MPR

Monetary Policy Review
MTBPS

Medium Term Budget Policy Statement
NAB

non-alcoholic beverages
NEER

nominal effective exchange rate
NERSA

National Energy Regulator of South Africa
NRIR

neutral real interest rate
OER

owners’ equivalent rent
PMI

Purchasing Managers’ Index
QES

Quarterly Employment Statistics
QLFS

Quarterly Labour Force Survey
QPM

Quarterly Projection Model
RAF

Road Accident Fund
REER

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

Rand Merchant Bank
RMSE

root mean square errors
SARB

South African Reserve Bank
SIT

services, income and current transfers
SOEs

state-owned enterprises
SSA

sub-Saharan Africa
Stats SA

Statistics South Africa
UIP

uncovered interest parity
UK

United Kingdom
ULC

unit labour cost
US

United States
VAT

value-added tax
VIX

Chicago Board Options
Exchange Volatility Index