Lesetja Kganyago: Monetary policy amidst high inflation
Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the
American Chamber of Commerce, Pretoria, 5 April 2023.
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Introduction
Ladies and gentlemen, thank you for inviting me to address you today. As you know,
South Africa and the United States (US) have a long history of economic cooperation,
and American businesses have played an important role in the development of our
economy. South Africa is the US's largest African trading partner and has the most
diversified and industrialised economy on the continent. Last year alone, the US
accounted for close to 9% of total exports and 7% came from imports.
In 2021, US exports to South Africa totalled US$5.5 billion a 25.8% increase from
2020, while US imports from South Africa totalled US$15.7 billion a 38.5% increase.
There are approximately 600 US businesses operating in South Africa and many use
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South Africa as their regional headquarters, and a springboard for greater opportunity
on the African continent.
Today I want to talk about monetary policy in the context of high inflation and an
environment of low growth - conditions which are, unfortunately, normal for South Africa
but now also feature globally. The challenge currently being faced by all central banks
is how to steer monetary policy to get inflation down without plunging the economy into
a recession, and doing so in a context in which key determinants of inflation and growth
are outside our control.
Getting policy correct in turn depends on how well we handle the analytical challenge of
distinguishing between the supply and demand sources of our inflation and growth
problems.
Are the price pressures we see today related to specific shocks that will gradually fade,
or are they more permanent? How are global shocks impacting a country like South
Africa and how should policy respond to them?
These are the questions I will try to unpack today.
Where we stand now
Higher energy and other commodity prices, supply bottlenecks as well as insufficient
inventories are some of the factors that drove inflation sharply higher in 2021 and early
2022. In recent months, headline inflation has started to come down in most
jurisdictions, largely reflecting lower energy prices. By contrast, core inflation rates
remain sticky. The lagged effects of energy, food and other cost increases are still
feeding through to wages, services prices and many final prices.
Furthermore, in many countries, labour markets remain very tight, even as economic
momentum has slowed. This has forced businesses to offer higher wage increases to
attract or retain workers. Furthermore, indications of still-solid profit margins suggest
that firms continue to have significant latitude to pass through costs to their customers.
So, while inflation forecasts show a decline in inflation, both for headline and core
inflation, the uncertainty about the trajectory is very high. Forecasters are unsure about
the terminal level of inflation and how fast it will get there. For example, members of the
Federal Open Market Committee (FOMC) foresee, on average, personal consumption
expenditure inflation of 3.3% this year and 2.5% in 2024.
Consequently, the world may, for a relatively long period, have interest rates that are
high by the standards of the past 20 years.
Banking strains and policy
While it is clear that central banks prefer to address higher-than-desired inflation with
interest rates, there is a possibility for financial stability concerns to cloud policymaking.
Financial markets have adjusted their forecasts for rates in recent weeks as strains in
financial institutions emerged. However, it is important to remember that while pockets
of vulnerability exist in the global financial system and can be exposed by the recent
quick shift to more elevated funding costs, global banks are by and large much better
capitalised and more resilient to shocks than they were before the global financial crisis.
This explains why, at least so far, central banks have been able to 'ring-fence' problem
institutions and maintain confidence through targeted interventions, without
compromising on the necessary steps required to bring inflation back to target. This
separation of financial stability concerns and the policy steps needed to address
inflation is a critical benchmark for policy effectiveness. Central banks need to
emphasise how the determinants of the two problems differ, how policy in each domain
can and should respond, and to maintain the trust of the markets and the public so that
the correct steps are taken.
How the world affects South Africa
There are several channels through which the global developments I have just
described influence South Africa's economy and markets and, in turn, the policy
response of the South African Reserve Bank (SARB). First, higher global interest rates
weigh on world growth, and hence the demand for South Africa's exports. The impact
on our balance of payments and, in turn, the rand, can be compounded as slower
global growth reduces the prices of our commodity exports.
Second, global banking strains can also result in reduced lending to South Africa, as
such pressures often prompt major financial institutions to pull back loans from 'riskier'
destinations, especially emerging market countries. However, South African banks do
not have large external liabilities, while the corporate sector is not heavily dependent on
foreign bank financing. Hence, we are confident that this channel of contagion should
remain relatively limited.
Lasty, financial markets are probably a stronger channel through which global
conditions affect South Africa. Portfolio flows have historically been a key source of
funding for our current account, which is in a deficit most of the time, and these flows
are highly sensitive to global financial conditions. South Africa's current rating status as
well as the recent greylisting of the country by the Financial Action Task Force will
continue to exert downside risks to the rand, which has already underperformed most of
its emerging market peers in recent months.
Domestic inflationary pressures
As described earlier, the exchange rate remains under pressure due to idiosyncratic
domestic factors as well as the evolving global situation, thus exerting upward
inflationary pressures. This limits the benefits of slowing global inflation to domestic
inflation. In fact, the SARB has revised its inflation projections upwards - headline
inflation is now forecast to decelerate at a slower rate, averaging 6.0% in 2023 (5.4%
previously) from 6.9% in 2022. This is, in the main, due to higher fuel and food price
inflation - a direct consequence of a more depreciated exchange rate. Domestic food
price inflation continues to rise despite normalising global agricultural commodity prices.
Inflation pressures on food price inflation appear to be broad-based, with most
components still at double-digit inflation rates. While these pressures are expected to
ease over the forecast period, food price inflation usually spills over into wage costs and
other constraints, such as electricity and logistics, which will continue to put upward
pressure on prices and business input costs.
Fuel inflation continues to decline, benefitting from the correction in oil prices on the
back of slowing global demand. However, here again, the depreciation in the currency
is limiting the extent of this benefit, and it is thus likely to keep headline inflation
elevated.
In addition to this, while core inflation surprised on the downside recently, the exchange
rate-sensitive core goods continued to accelerate. Second-round effects are also
starting to show up in services inflation, with categories such as restaurants and hotels
as well as public transport rising significantly. Other key services components such as
insurance and housing inflation are starting to normalise from their recent lows, with
insurance inflation averaging 6.4% in the recent outcome (February) compared to 3.1%
at the same time in the previous year. Inflation expectations, which have increased and
remained above the target midpoint, are also key to the overall evolution of services
inflation. They largely characterise wage negotiations and ultimately inform price
formation in the economy.
Monetary policy going forward
In light of all this, the SARB has often been asked: What is your view on economic
growth and what is your forecast for inflation? These are important questions for any
central bank and we find ourselves faced with an important conundrum, that is, juggling
high inflation against low growth.
Like many of our global peers, we are cognisant of weak growth prospects. Our gross
domestic product (GDP) projection for 2023 is 0.2%, on the back of the electricity
supply deficit. By contrast, inflation remains elevated. Our primary goal as a central
bank is to anchor inflation expectations and to reduce the extent to which higher
inflation does spill over into pricing behaviour in the following year. Our role as central
banks is to keep inflation expectations anchored to prevent wage spirals from
generating permanently higher inflation.
As discussed at our Monetary Policy Committee (MPC) meeting held at the end of
March, the balance of risks to the inflation outlook are assessed to be on the upside. As
we have conveyed on several platforms, we believe that we have taken the right
decisions over the past few MPC cycles to ensure that we get inflation back to the
midpoint of the target range, but this cannot preclude further steps if inflation and
inflation expectations continue to surprise higher. At this stage, we do not know what
the terminal interest rate level will be, but we hope that the way in which we explain our
policy creates confidence that future inflation will come back to target. We continue to
monitor data and developments and we stand ready to act, as and when warranted.
Concluding remarks
In conclusion, I think many of us will agree that the emerging financial vulnerabilities are
introducing new headwinds for global financial markets. As such, global conditions are
likely to remain volatile in the near term, with tightening financial conditions in the US as
new weaknesses in financial institutions emerge and concerns of contagion intensify.
On the upside, the banking sector, globally, is much better capitalised than it was in
2008 and has become more resilient to shocks. However, central banks have to guard
against continued volatility in financial markets while ensuring that they keep to their
mandate of price stability.
Thank you.
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Details are available at https://www.state.gov/u-s-relations-with-south-africa/