An address by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the CEEF Africa Annual Banquet
in celebration of 21 years of leadership investment
Johannesburg,
19 June 2017
South Africa's crisis of confidence and the policy response
Good evening, ladies and gentlemen.
Thank you for inviting me to address you today.
The global economy has been as favourable recently as it has been for some time.
We are experiencing a synchronised cyclical upturn across major economies. South
Africa's
terms of trade are near all-time highs. Meanwhile, global financial markets
have resumed a search for yield, causing stronger capital inflows to emerging markets,
including South Africa.
By contrast, the domestic economy has fallen into recession, with output contracting
in both the last quarter of 2016 and the first quarter of 2017. Although this is the first
technical recession since 2009, it continues a trend of exceptionally poor economic
performance. We have warned about poor economic performance for several years,
and although we did not expect the first-quarter GDP1 figure to be quite so weak in
quarter-on-quarter terms, our assessment in the May MPC2 meeting was that the risks
to the growth forecast were on the downside.
Meanwhile, inflation has returned to within the target range, as expected. Some recent
numbers have come in a bit lower than anticipated, but our forecast still indicates
inflation in the upper half of the target range across the forecast horizon, which
stretches to the end of 2019.
The combination of lower inflation and lower growth suggests, at least to some, that
the time has come for rate cuts. The MPC will meet in late July to consider how the
outlook has changed, and we will make the appropriate decision at that time. We are
not here for me to give interesting hints about the next repo rate decision. The best
source on MPC decisions is the MPC statement, not speeches a month prior.
Instead, this speech is about our broader policy constraints and the medium-term
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outlook for the South African economy. We confront major challenges challenges
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which cannot be resolved in any meaningful sense by fine-tuning the repo rate and
we need to grapple with those problems. Monetary policy does have a role to play, but
it is crucial to acknowledge the limits to monetary policy and to focus on its optimal
contribution over a medium-term horizon.
South Africa's macroeconomic strategy
Today, I will start by discussing since 2009
before turning to the outlook.
The world economy and South Africa's macroeconomic strategy
The most recent Global Financial Crisis was a huge economic earthquake, one which
threw South Africa and most other countries into recession. Like many big
earthquakes, it was followed by a series of aftershocks. One was the euro area crisis
of 2011-12, which produced two years of negative growth in one of our most important
trading partners. More recently, the global economy has suffered a second aftershock
in the form of an emerging market slowdown, linked to weaker commodity prices,
overstretched policy frameworks, and risk-off sentiment in global financial markets.
Because of these shocks, world economic growth has repeatedly fallen short of
forecasts.
as 'support
The South African policy response to these conditions can be summarised
and wait'.
Macroeconomic policy provided support in the form of low interest rates and
large budget deficits. At the same time, we waited for the global economy to recover.
But this strategy has yielded disappointing results. In part, this is because we ended
up waiting much longer than expected. Furthermore, as the waiting went on and
domestic growth kept slowing, loose policy settings became not simply a response to
slow growth but also one of its causes.
As the post-Crisis period dragged on without a robust global recovery, persistently
large fiscal deficits caused our debt-to-GDP ratio to almost double.3 By importing large
quantities of savings from the rest of the world and then exporting revenue to pay the
interest, our current account widened to become very large, exceeding 6% of GDP in
some quarters. Investor doubt about the strength of our macroeconomic framework
contributed to higher borrowing costs as well as exchange rate weakness, with the
rand becoming one of the world's
worst-performing currencies. The depreciated
currency was, of course, a major reason why inflation forecasts began indicating
prolonged breaches of the top end of our inflation target range. By 2014, it was clear
that this broad macroeconomic trajectory was unsustainable; something had to
change. Accordingly, monetary policy embarked on a gradual tightening cycle, with
the repo rate rising from 5% to 7% over the course of two years. Similarly, fiscal
policymakers set out a consolidation agenda to stabilise debt and contain spending
growth.
It would be wrong to say that policymakers slammed on the brakes. Rather, we eased
off the accelerator. The monetary policy adjustment was the most limited and gradual
in recent history, with the repo rate rising by just 2 percentage points over 27 months.
At 7%, which is where we are now, the policy rate remains quite low from a historical
perspective.
Meanwhile, although fiscal policy has become less expansionary, deficits have
remained larger than 3.5% of GDP over the past three years. These deficits have been
more than simply the unfortunate consequence of low tax revenues caused by slowing
- - South Africa's
growth. In structural terms that is, correcting for the economic cycle
fiscal deficit has still averaged about 3% over the past three years, according to IMF4
estimates.5 As an illustration, 3% is greater than the output of the entire agriculture,
forestry and fishing sector; it is a large amount to borrow every year and it injects
substantial spending into the economy.
Africa's
South macroeconomic settings also look accommodative in comparison with
those of other countries. In fiscal terms, most of our peer countries have borrowed less
commodity exporters, South Africa's average
heavily. Amongst the major non-oil post-
deficit is larger than any
Crisis country's except Brazil's.6 Indeed, not only have many
of our peers achieved smaller deficits than we have; sometimes they have even
managed budget surpluses. For example, Chile, Colombia and Peru all exploited the
post-Crisis rebound in commodity prices to balance their budgets.7 If anything, South
Africa stands out for running consistently large budget deficits despite historically high
commodity prices. The result has been higher debt service costs and reduced fiscal
space.
In monetary policy terms, South Africa more closely resembles its emerging market
peers. Most of these countries began tightening policy around 2013 or 2014. Some of
these countries faced inflation well above their targets and therefore raised rates
sharply. The most prominent cases were Brazil and Russia, where policy rates went
up by 700 and 1 150 basis points respectively. Where the inflation challenge was less
extreme, smaller adjustments were possible. Colombia, for instance, tightened by 450
basis points, Indonesia by 200 basis points, and Chile by just 50 basis points.
More recently, some emerging markets have had space to cut rates. The prevailing
pattern has been that the countries that are closer to their inflation targets, and which
previously increased rates more, now have greater scope to cut. For instance, inflation
in Chile has fallen from 5.7% at its peak to just 2.6%, below the 3% inflation target,
permitting the central bank to reduce rates by 100 basis points. In Brazil, inflation has
declined from a high of 10.6% at the start of 2016 to 4.1% in May, and the policy rate
has come down from 14.25% to 10.25%. Brazil's inflation target, for your information,
is a point of 4.5% within a range of 3-6%.
In sum, we have run accommodative macroeconomic policies throughout the post-
Crisis period. Since 2014, the degree of stimulus provided by policy has been reduced
to contain inflation and slow the pace of debt accumulation. Policy nonetheless
remains broadly supportive of economic activity. Despite this fact, growth has slowed
steadily throughout the post-Crisis period. To some extent, we have been able to
blame this on an unfavourable global economic environment. Yet, now the global
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economy looks as healthy as it has in years but the South African economy is still
struggling. So why are we doing so badly? And what can be done about it?
South
Africa's crisis of confidence
At the present juncture, our fundamental problem is confidence. In economic
discussions, 'confidence' is
sometimes an opaque and disreputable concept. Paul
coined the term 'confidence fairy' for when
Krugman in 2010 pundits rely on magical
But I'm
thinking to explain how their favourite policies can have only good effects.8
we can't
afraid that, in South Africa at the moment, comfort ourselves that confidence
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is a mythical creature. It would be more accurate to say that it is very real but badly
endangered.
The BER's9
We have reliable measures of business and consumer confidence.
surveys show that the confidence levels of both these sectors are at their lowest since
the Global Financial Crisis. These two indicators slipped below their long-term
averages in late 2015 and have stayed there ever since. Just last week, for example,
new data for business confidence in the second quarter came out at a fresh post-Crisis
low, with 70% of the respondents pessimistic about local business conditions.
Weak confidence has profound economic consequences. When people are this
they don't make large purchases.
worried about the economy, theory tells us,
Businesses defer investments. All of this weakens economic growth. These theoretical
predictions are completely consistent with what we see in the data.
Why is confidence so subdued? The answer is simple. Everyone in South Africa is
worried about their country. Twice a year, South African Reserve Bank (SARB) hosts
monetary policy forums in 10 major and secondary cities. During these forums we find
that people want to talk about governance, about the exchange rate, about credit rating
downgrades. They're worried about policy; they're worried about living in a junk status
country. It is a depressing discussion, but in a way it is impressive: economic issues
often seem obscure, yet people quickly become informed and passionate when the
situation is serious.
The message we get from regular South African citizens is fundamentally very similar
to the one we hear from the ratings agencies. We have deep-rooted problems of
unemployment, poverty and inequality. Our economy is not growing as fast as it needs
to, and this problem has been getting worse.
Nonetheless, South Africa still has strengths. In particular, we have functioning
institutions that deliver on their mandates. We also have sophisticated firms and
markets, even if there is always room for improvement. Nonetheless, these general
maintain South Africa's status as an
positives help to upper-middle-income country, a
member of the G2010, and a member of the BRICS11 grouping. Many other countries
do worse. But if South Africa doesn't start doing better, it won't be able to meet its
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challenges and it will be overtaken by other countries. So what do we do about our
growth trap, our downgrade challenges, and our crisis of confidence?
There are roughly two narratives forming around the subject. One of them holds that
if the ratings agencies don't like us, that's their problem -
and their judgement is
unreliable and biased anyhow. Policy settings are much too tight; fiscal and monetary
discipline really means asphyxiation. If private confidence is so elusive, it might as well
be ignored. This view is wrong-headed and dangerous. In my view, it amounts to
shooting yourself in the foot, finding it hurts, then shooting yourself in the other foot to
get even.
The alternative view is that South Africa needs to re-establish its strengths and recover
from there. Back before the Global Financial Crisis, some observers used to look at
they weren't high enough, that we
growth rates of 3% or even 4% and complain that
had implemented such excellent macroeconomic policies and worked so hard to make
the country attractive to investors, yet the rewards were meagre. We are now seeing
We don't grow at 3% anymore; we don't
what it looks like when we are not so virtuous.
even grow fast enough to keep up with the growth rate of the population. There was a
lot to be said for an economy with rock-solid finances, confident investors and 3%
growth. I think we can do even better than 3% growth, but we certainly need not do
worse.
The contribution of the South African Reserve Bank
So what is the contribution from the SARB? Our fundamental, constitutional mandate
is to protect the value of the currency in the interests of balanced and sustainable
growth. Balanced growth is about seeing to it that the value of the currency allows both
exporters and importers to engage productively in the economy. It also means that the
economy's growth is sustainable, that imbalances are neither generated that cause
crises through over-heating nor throw the economy into severe downturns. All of this
is clearly in the interest of all South Africans.
We implement this mandate through a flexible inflation targeting framework. We
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sometimes hear the objection that targeting inflation is bad for growth that is, one
part of our constitutional mandate conflicts with the other, and protecting the buying
power of the rand is anti-development. However, low inflation is actually the ally of
development. There are several reasons for this. Low inflation helps maintain the value
of the money in your pocket. This is good for all South Africans, but especially the
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marginalised and poor those without the information or power to protect themselves
from inflation. Low inflation also helps maintain the competitiveness of South African
goods and services in foreign and domestic markets, by moderating real exchange
rate appreciation. Furthermore, low inflation produces lower interest rates. In
summary, there is no long-term trade-off between growth or inflation. Keeping inflation
low, protecting the value of the currency, is supportive of growth.
Through history, some countries have tried to deny these truths, pretending that high
inflation somehow begets sustainable growth. This kind of macroeconomic populism
is usually a precursor to misery, not least because it impoverishes nearly everyone in
society. The few who benefit are those that somehow are able to capture a dwindling
supply of the necessities of life or gain privileged access to foreign currency (for a
short time). Neither the middle classes nor the poor of high inflation countries are
likely today to be partisans of such an approach to policy.
The impact of inflation on interest rates is often misunderstood. This is probably
because the interest rate is our main tool for controlling inflation, so when interest rates
rise the reason for this is typically higher inflation. Sometimes people suggest that if
we would just ignore the inflation, then interest rates wouldn't have to move and we
could have more growth. But as I explained in my speech at the University of Kwazulu-
Natal earlier in the year, interest rates incorporate compensation for expected inflation.
For this reason, as the Fisher equation states, the rate of interest is equal to expected
inflation plus a real premium. If you have two identical countries, and one has a three
percent inflation target and the other has a six percent target, then interest rates will
be exactly three per cent higher in the country with the higher target. If that country
raises its target to nine per cent, then interest rates will end up rising another three
percent. And if that country simply stops trying to control inflation at all, then it will
become harder to borrow in its currency, with lenders switching to some other currency
with more predictable inflation. In the short run, you can get lower interest rates by
- and investors aren't
surprising people with higher inflation. But once they wake up
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slow to see higher inflation interest rates have to rise.
For this reason, one of the most effective ways for lowering interest rates is to keep
inflation low and predictable. Looking around the world, the evidence is very clear that
low inflation countries have low interest rates and high inflation countries have high
interest rates. In the extreme cases, such as Sweden, inflation is so low they even
have negative interest rates. Sweden's repo rate, for example, is currently at
-0.5 per
cent. By contrast, in countries with much higher inflation, like Argentina or Nigeria,
policy rates are much higher. Nigeria's is currently 14 per cent.
Argentina's is 26.25
per cent.12 So although it is the case that interest rates typically rise in response to
lower
higher inflation, on average interest rates are because of lower inflation. This is
why inflation targeting is a way to get lower rates over time.
This sets the context for our current policy settings. Inflation in South Africa has
moderated in recent months. We now have a good chance of getting inflation down
well within the middle part of the target. Inflation is likely to move in this direction
because of declining food inflation, our policy communications, the stronger exchange
rate, and the sensitivity of price and wage setters to weak economic conditions. If we
can keep inflation lower, anchoring inflation expectations, that should in turn generate
a lower rate of interest to support the economy.
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Unfortunately, we also have to worry about higher inflation if things go wrong that is,
if the exchange rate begins depreciating again, if wage settlements are excessive, or
heard, loud and
if our monetary policy communication isn't clear. These factors limit
our policy space.13
The ratings agencies have been clear that the effectiveness of the central bank is one
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of the strongest pillars supporting this economy a claim that speaks to both our price
and financial stability mandates. We will continue to honour our constitutional mandate
and the trust placed in us by the South African society.
Thank you.