Address by Daniel Mminele,
Deputy Governor of the South African Reserve Bank
at The Economist Corporate Network event
Johannesburg
30 October 2017
The performance of and outlook for the South African economy
Introduction
Ladies and gentlemen, good morning.
Thank you to The Economist for inviting me to come and address you on the topic
This is a
'The performance of and outlook for the South African economy'. very
pertinent topic, which could not be more relevant at this stage.
Last week, when presenting the Medium Term Budget Policy Statement, Finance
Minister Gigaba announced that National Treasury had revised its forecasts for
domestic GDP1 growth to 0.7% in 2017 and 1.1% in 2018, an adjustment of 0.6 and
0.9 percentage points respectively, from the projections made in February. These
forecasts are in line with those released two weeks earlier by the IMF2 in its October
2017 World Economic Outlook, with the IMF similarly having scaled down its forecasts
for South African GDP growth, by 0.3 and 0.1 percentage points for 2017 and 2018
respectively.
government's view of the economy, the
Describing former US3 President Ronald
"If the economy
Reagan once put it this way: moves, tax it. If it keeps on moving,
In my
regulate it. And if it stops moving, subsidise it." view, almost every economy has
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been through all these phases and South Africa is currently moving, albeit at a
relatively much slower pace than we would all like, and would be required to address
the challenges of unemployment and inclusive economic development.
The slack in growth is perhaps the most crucial economic issue in South Africa at
when it downgraded South Africa's sovereign
present. Indeed, credit rating in June,
Moody's
ratings agency listed 'reduced growth prospects' as one of the three key
drivers of the downgrade. Yet at the same time, most observers of the global economy
concur that the world's
economic and financial situation is more favourable than it has
been for years.
So why is South Africa missing out on the global recovery? What has driven the poor
performance of the past few years? Will this trend continue? If so, what role can the
South African Reserve Bank (or SARB) can play in making a contribution to address
the issue? These are the questions that I will attempt to answer in my address today.
When activity is volatile but broadly underperforming
The ability to analyse trends in the South African economy has been complicated of
late by the high volatility in quarterly GDP data. The standard deviation of the quarter-
on-quarter seasonally adjusted change in GDP has been close to 2.0 percentage
points, on average, over the past five years. To some extent, this volatility makes it
difficult to use the latest data point as an indication of a trend or to determine 'in real
time' inflections in the pace of activity. For example, data for the fourth quarter of 2016
and the first quarter of 2017 showed that the South African economy was in 'a technical
recession', with two consecutive contractions, however marginal they may have been.
This was followed by a rebound of 2.5% in the second quarter.
Surprisingly enough, this short-term volatility was not limited to those demand
components which, like public-sector investment or inventory changes, regularly
experience large deviations from the trend. Rather, it extended to generally more
stable aggregates, for example the household consumption of services. At this stage,
it is difficult to say to what extent this volatility reflects changes in household-sector
behaviour or data measurement challenges. What we can assume, however, is that
the underlying trend of the economy is somewhere 'in-between' the latest
observations. We may not be in a recession, but it is quite doubtful that the 2.5%
momentum of the second quarter can be sustained.
It seems pretty certain that South Africa is presently mired in very low growth.
Following an increase of only 0.3% in GDP last year, our models project a meagre
expansion of just 0.6% in 2017. These numbers continue to fall short of the domestic
population growth of around 1.5%. This means that, in per-capita terms, GDP is
declining and is likely to drop back this year to levels last seen in 2011. Effectively,
real GDP per capita will only have grown by 4% overall over the past 10 years,
compared with a growth of 20% over the previous 10 years.
Furthermore, as mentioned earlier, South Africa seems to be 'missing out' on the
global recovery. Because we are an open and relatively small economy, with
commodity-dependent exports and hence terms of trade that are highly sensitive to
global industrial demand, our domestic cycle generally moves 'in sync' with its global
counterparts. South Africa entered and exited the 2008-09 global recession with a
at the same time as most of the world's largest
slight delay, but more or less
economies. Such cyclical patterns are largely unavoidable, and the best that
macroeconomic policy can do is to limit their magnitude and hence their potential
distortionary effects.
What is worrying, however, is that while the gap between South African and world
growth hovered at around zero just before and during the global recession, this growth
gap has gradually widened ever since. It has averaged 1.8 percentage points in the
- based on the IMF's and the SARB's
last five years, stood at 2.9 in 2016, and
-
forecasts could increase to 3.0 in the current year. A similar observation arises when
comparing South Africa to its upper-middle-income peers4: in 2002-07, domestic
below this group's median; last year,
growth was, on average, 0.4 percentage points
the gap had widened to 2.5 percentage points.
Not 'a traditional recession' but 'a slow grind to a halt'
How can we explain this lacklustre performance of the South African economy? And
how can we explain its underperformance versus its peers?
In many ways, the downturn of the past few years does not display the traditional
characteristics of a recession. For example, there was no build-up of inflationary
pressures that necessitated the shift to a restrictive, demand-constraining monetary
policy. Inflation has displayed a rising trend since 2011, resulting in the Monetary
Policy Committee of the SARB raising the repurchase rate by 200 basis points
between January 2014 and March 2016. But by our own, admittedly imprecise,
calculations, the real interest rate remained below its neutral level for most of that
period. This would suggest that while monetary policy provided less stimulus, it did not
turn outright restrictive.
Equally, we did not see the kind of asset-price bubbles or the build-up of other financial
vulnerabilities which typically precede a recession, as the unwinding of such
imbalances generally results in lower private-sector appetite for borrowing, tighter
lending standards by banks, and a rise in precautionary savings by households. In
recent years, in part thanks to the generally accommodative stance of monetary policy,
banks'
non-performing loans have declined, the number of home repossessions has
equally fallen to low levels, and while equity prices have performed strongly, home
prices have broadly stagnated in real terms.
Admittedly, growth in loans and advances to the private sector slowed in 2016, from
almost 9% year on year in late 2015 to a low of 4.5% in November last year. Yet this
deceleration proved milder than in previous downward phases of the business cycle.
Confidence in the retail banking sector, as measured by the EY Financial Services
Index, remains above par, in contrast to the other major sectors of the domestic
economy. Civil cases for debt and insolvencies are below the average of the past
decade, even though surveys show that consumers are feeling increasingly
vulnerable.5 As for the savings ratio of households, while it rose from -2% of disposable
income in 2013 to around 0% thus far in 2017, it is only back to the levels last seen
after the global recession in 2008 and remains very low by historical standards.
was
Rather than 'a traditional recession', then, what South Africa experienced 'a slow
grind to a halt' that was driven more by long-term supply factors than by long-term
demand factors. Admittedly, several external factors, besides short-term domestic
disruptions, contributed to the weakness in GDP growth.
The recovery in world demand since the global financial crisis has been sluggish and
has displayed low trade intensity by historical standards. For example, the average
annual real import growth in South Africa's export markets -
as measured by the
-
OECD6 amounted to only 3.0% in the last five years and 2.1% in 2016, compared to
the 8.6% in the five years leading up to the global recession.7 And this was not just a
volume story: the prices of domestic commodity exports also fell, resulting in a decline
in South Africa's terms of trade by
7% between 2011 and 2014.
On the domestic front, the drought that affected South Africa over the 2015/16 summer
season resulted in an 8% contraction in agricultural output last year, which shaved off
0.2% from the 2016 GDP growth. Safety-related stoppages also affected mining
production in 2016.
Yet both these external and domestic factors do not explain the full extent of the
economic slowdown. Nor do they explain why our domestic economy, in contrast to
many of its peers, has failed to get much traction in the first half of 2017. After all, the
end of the drought, together with the improving global environment and the recovery
Africa's terms of trade from the second quarter of 2016 onwards,
in South was
-
expected to engineer at least some economic rebound but so far it is missing.
Most likely, the key to this lack of growth resides in a self-reinforcing 'negative
feedback loop' of policy uncertainties, low private-sector confidence, subdued
investment in productive capacities, and poor competitive performance. Causality
implications between growth and confidence go both ways. Attempts by our in-house
research to identify the possible causes of the ever-widening gap between South
African and world growth have found that the negative impact of low confidence has
increased in recent years, explaining as much as 1.15 percentage points of that gap
in 2016.
In turn, weak business confidence amid disappointing demand performance has
depressed private-sector fixed investment. Last year, it contracted by 6.8%. As of the
second quarter of 2017, it was down by 2.7% year on year and stood at 11.8% of GDP
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compared to a high of more than 15% at the start of the global recession its lowest
level since 2004. In an environment of low consumer confidence and a lack of property
price growth in real terms, the housing sector does not remain immune to such
subdued performance. Because of such softness in capital formation, as well as
subdued productivity growth, the potential pace of GDP growth has slowed to an
estimated 1.1% in both 2016 and 2017 from more than 3% at the start of the decade.
Weak private-sector investment, currently focusing mostly on replacing obsolete
capital rather than creating new capacities, coupled with a shortage of skilled labour
and, possibly, product market rigidities, appears to be weighing on external
competitiveness and export performance. South African firms may be slow to adjust
to changes in global demand patterns; they may lack the innovative edge to keep pace
with foreign competitors. While the causes may be uncertain, the fact remains that,
over the past decade or two, South African export volumes have consistently fallen
short of the demand in its trading partners, implying a loss of market share.8 A trend
towards real exchange-rate depreciation has not helped. In fact, market share often
stagnated in the aftermath of rand-depreciation phases but it declined when the local
currency recovered.
Most likely scenario: a modest recovery
The question remains: will economic stagnation persist in South Africa? There are
presently some grounds for very prudent optimism for the next year or two.
The external economic environment has improved. Last month, the IMF again revised
upwards its forecast for world growth in both 2017 and 2018, by 0.1 percentage points
in each case, to 3.6% and 3.7% respectively, up from 3.2% last year. Such upward
revisions mark a welcome break from the pattern of earlier years, when forecasters
regularly pushed back the timing and the scale of the global recovery. Furthermore,
this recovery is relatively broad-based, both geographically and across sectors, and it
is not generating the kind of price pressures that would prompt the major central banks
to aggressively tighten monetary policy and, as such, curtail that recovery.
Closer to home, the decline in inflation over the past year has provided some breathing
space to the consumer, allowing some gains in real disposable income despite net job
losses. Equally, the decline in the current account deficit, to 2.2% of GDP on average
in the first half of the year from as high as 5.9% of GDP in 2013, is helping (together
with an elevated global-investor appetite for higher-yielding government debt) to
shelter domestic financial markets from external or local shocks. This explains, in part,
why the rand and domestic bonds have not shown a strong or durable reaction, this
year, to adverse political or policy news.
In recent months, some domestic high-frequency data have shown signs of
improvement. Following a downward trend lasting more than three years, new vehicle
sales, expressed in seasonally adjusted terms, rose by 10% in September from an
April low. Manufacturing production, which had stagnated for the past five years,
increased in both July and August to its highest levels in more than a year. The
rebound in the mining sector has been even more pronounced. It would therefore
appear that both sectors will contribute positively to GDP growth in the third quarter of
this year. The RMB/BER9 business confidence index, while still well below the neutral
50 mark, rose off eight-year lows in the previous quarter.
However, all this is no cause for premature celebration. Many factors still limit the room
for a meaningful improvement in South African economic growth. Confidence remains
highly vulnerable to upcoming political events given their potential implications for
important government policies; it also remains vulnerable to the risk of further
sovereign credit rating downgrades. A further rise in the oil price could boost inflation
and undermine the terms of trade. And the extent of the impact that the normalization
of monetary policies in the advanced economies could have on emerging-market
assets, including the rand and domestic securities, is still unclear.
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Even in a relatively favourable scenario where confidence gradually improves,
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inflation remains moderate, and the output gap gradually closes structural factors
are likely to limit the scope for a meaningful growth pickup. Productivity performance
remains weak, with an average annual gain of only 1.2% in the past five years. The
shortages of skilled labour are likely to remain acute for an extended period of time
even if educational outcomes improve. Job-searching costs are high, making it that
much more difficult for low-skilled people to find employment. And the relatively high
concentration in many sectors, together with elevated regulation, results in barriers to
entry for new firms.10
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Consequently, even with the gradual removal of infrastructure bottlenecks for
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example, as more power supply comes on stream it is difficult to envisage much of
a pickup in potential growth in the next two years or so. For these reasons, the SARB
projects only a moderate acceleration in actual real GDP growth, from 0.6% this year
to 1.2% in 2018 and 1.5% in 2019.
How can monetary policy help?
How should monetary policy respond to such a situation? Conventional wisdom may
argue that, in the wake of a slowdown, interest rates should be reduced so as to
rekindle domestic demand. The SARB is cognisant of the fragile economic situation,
and to the extent that its decisions remain consistent with its mandate of ensuring price
stability, it takes appropriate actions to support economic activity. The 25 basis points
cut in the repurchase rate in July, which had been made possible by an improvement
in the inflation outlook, illustrates this approach. However, an aggressive easing of
- -
monetary policy for the sole purpose of kick-starting the economy could yield
disappointing returns for an unacceptable degree of risk, for the following reasons.
First, as I have mentioned earlier, monetary policy was not tight at the start of the
downturn, nor was that downturn the consequence of restrictive financial conditions.
South Africa's monetary stance merely
In recent years, moved from loose to roughly
neutral. Surveys and economic data support this assessment: fewer businesses than
-
usual report the level of interest rates as an obstacle to expansion in contrast to
political uncertainty, which has grown as a constraint in recent years. Equally, at 9.4%,
the ratio of household debt-servicing costs to income is in line with long-run historical
norms.
Second, because the downturn reflects non-monetary factors, it is doubtful how much
rate reductions, at present, would stimulate demand. The experience of the advanced
economies since the most recent global recession shows that if conditions are not met
for a rise in private-sector willingness to borrow, rate cuts are likely to have limited
influence on credit and demand growth. For example, if the main concern of many
businesses is a lack of policy and regulatory clarity, it is doubtful whether lowering the
cost of capital will entice them to invest. Equally, risk-averse households may use
lower interest rates to ensure a faster repayment of their debt rather than increasing
their expenditure or investing in new residential property.
the economy's
Third, even if demand were to respond to meaningful interest-rate cuts,
supply constraints might soon limit its ability to meet the increase in demand, resulting
in higher prices either directly or indirectly via a rise in imports that would widen the
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trade balance and depreciate the exchange rate. Domestic demand in South Africa
-
and this includes household consumption as well as fixed investment has always
been import-intensive, even in periods of prevailing economic slack. And while our
estimates of the output gap point to some degree of slack in the economy, others (such
as capacity utilization in manufacturing) paint a more ambiguous picture.
Fourth, the risks to the inflation outlook appear presently too skewed to the upside to
allow the SARB to embark on a sizable monetary stimulus without fears of a sustained
overshoot in the inflation target range. Ongoing careful assessment of evolving data
and vigilance continue to be imperative. Our own models suggest that, because of the
rigidities in the domestic wage and price formation process, the output gap does not
have a large impact on inflation trends. By contrast, the sensitivity to changes in the
rand, which could easily depreciate in the event of sizable rate cuts, is generally higher,
even if it appeared to decline in recent years.
Conclusion: the merits of a stability-oriented framework
Nevertheless, monetary policy does have a role to play in attaining stronger, more
SARB's
sustainable economic growth in South Africa. However, it remains the view
that the best way it can assist in reaching this goal is by fostering medium-term price
stability so as to minimise the distortionary effects of a volatile inflation. In particular,
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historical evidence both in South Africa and abroad suggests that when price
expectations are better anchored, any shock to inflation is more transient and hence
allows the central bank greater latitude to quickly respond to a slowdown in real
economic activity.
South Africa's
inflation-targeting regime is bearing fruit in that respect. Inflation
expectations (as measured by the BER11 survey of analysts, businesses, and trade
unions) are currently better anchored than in the early years of the inflation target
range. This, in turn, has resulted in more moderate fluctuations, both in the short-term
and in the long-term interest rates, over the economic cycle. The SARB remains
concerned, however, that these expectations have become too closely anchored
around the upper end of the 3-6% target band. Not only does this raise the risk that
any shock to prices will result in a durable overshoot of the target range; it also leaves
South African inflation structurally higher than in most of its trading partners. This
means that external competitiveness can only be maintained through a regular
weakening of the rand, which perpetuates a cycle of inflation and exchange-rate
depreciation that probably adds to the risk premiums in financial assets and, in turn,
unnecessarily raises the cost of capital.
In fact, international experience suggests that, since they have adopted a similar
regime, most of the other emerging countries that have managed to keep a lower rate
of inflation than South Africa have also enjoyed a stronger rate of economic growth.
Looking at a dozen or so large and open emerging economies with an inflation-
targeting regime, we find that the sample's median GDP growth (since the adoption of
higher than South Africa's whereas
the regime) has been about 0.5 percentage points
its inflation rate has been about 2.0 percentage points lower. If anything, the growth
gap is even bigger in the years since the global financial crisis.
In conclusion, it would appear that the economic difficulties that South Africa is
currently facing are not an indictment on the monetary-policy framework that has been
followed for the past 15 years or so. Rather, they illustrate that even a well-calibrated
economy's structural challenges. Of
monetary policy cannot, on its own, address the
course, monetary policy is always perfectible; its framework can evolve as underlying
economic structures change. And the SARB remains committed to constantly looking
for ways of carrying out its mandate better.
But at the end of the day, a central bank has too few tools at its disposal to solve the
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large number of problems that we are currently facing both here and abroad. This
brings to mind the words of James Penney, businessman and entrepreneur: "Growth
is never by a mere chance, but it is a result of forces working together."
Thank you.