An address by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the SwissCham Southern Africa General Assembly
Zurich
8 May 2018
Recent developments in South Africa:
has the country turned for the better?
Introduction
Good evening, ladies and gentlemen, and thank you for the opportunity to address
you tonight.
Switzerland and South Africa have close economic ties, and there are numerous
opportunities to improve and expand on these.
The outlook for the South African economy has improved significantly over the past
few months. Recent political developments have generated renewed business and
consumer confidence, and investment prospects have been enhanced considerably.
However, a number of domestic challenges remain, and the global environment, while
favourable, is becoming more volatile and increasingly unpredictable. From the
perspective of the South African Reserve Bank (SARB), inflation appears to be under
control, but there are incipient risks.
In my remarks this evening, I will highlight some of these domestic and global
developments, and how we see them impacting on the South African growth and
inflation outlook.
The South African political and economic landscape
The political and economic landscape in South Africa has changed remarkably since
December 2017. At that time, both business and consumer confidence were at
alarmingly low levels, and the economic growth outlook was very weak. Standard &
Poor's had recently downgraded the country's local-currency debt rating to sub-
Moody's1
investment grade, while had placed the country on review for a downgrade
to sub-investment grade. The rand exchange rate was trading at around R14.20
against the US dollar in the face of increased portfolio capital outflows. Long-term
bond yields were at around 9.5% and risk premiums were elevated. The Medium Term
Budget Policy Statement
of October 2017 had signalled a departure from the fiscal
consolidation path, contributing to these unfavourable conditions. Overshadowing this
environment was the high degree of uncertainty regarding the outcome of the African
National Congress (ANC) leadership electoral conference in mid-December.
Let us fast-forward four months or so to 2018. The ANC leadership outcome was well
received, followed by a Cabinet reshuffle that contributed to restoring economic
confidence and growth. The national Budget tabled in February reaffirmed
government's commitment to the fiscal consolidation
path, a move which has gone
some way in restoring confidence in the country's
commitment to sustainable public
finances. There has also been a positive response to the new President's commitment
and actions to start rooting out corruption in various spheres of society, particularly in
government and state-owned enterprises.
with the business conditions'
Business confidence indicators improved, 'Expected
category in the Absa Purchasing Managers' Index surging in February
to its highest
level since 2001. Similarly, the FNB/BER2 Consumer Confidence Index reached an
Moody's affirmed the country's
all-time high in the first quarter of this year. investment
grade rating and changed the negative outlook to stable, preventing South Africa from
falling out of the Citibank World Government Bond Index, an event that could have
precipitated large-scale selling of South African government bonds by non-residents.
1
Moody's Investors Service
2
First National Bank / Bureau for Economic Research
The rand is currently trading at around R12.50 against the US dollar, after having
appreciated to a low of around R11.60 in late February. There has been a resurgence
of capital inflows against the emerging market trend, while credit default swap spreads
have narrowed by over 50 basis points.
Economic growth outcomes surprised on the upside in the fourth quarter of 2017, and
the growth outlook has improved. The key question is: is South Africa finally on the
road to a sustained recovery? Furthermore, are these developments 'real' rather than
just a reflection of ephemeral euphoria?
It has been a very positive start, and no doubt an important turning point for the
country. But it is too early to declare that we are on a new growth trajectory. Most of
the economic growth forecasts have been revised upwards, with the latest Reuters
consensus forecasts expecting growth of 1.6% and 1.9% for 2018 and 2019
respectively, up by almost 0.5 percentage points since November last year, and a
The SARB's growth
forecast of 2.3% for 2020. forecast for 2018 has been revised
upwards from 1.2% in November to 1.7% in March. Our model predicts a slight
moderation to 1.5% in 2019 due to tax effects, but reaching 2.0% in 2020. The
Monetary Policy Committee's (MPC) assessment is that the risks to these forecasts
are on the upside.
The improved outlook is based, together with upward revisions to past economic data,
on the strong improvement in confidence. Recent research conducted at the SARB3
suggests that the collapse in levels of confidence in the past few years had shaved off
around one percentage point from growth in both 2015 and 2016. In a similar vein, the
National Treasury estimates that the rebound in confidence could add 0.4 percentage
points to potential output. But a cyclical recovery based on a rebound in confidence,
however welcome, is not enough. Raising potential output significantly and in a
sustained way requires not just a commitment to structural reforms, but actual
implementation. This should go hand in hand with increased fixed capital formation.
3
-
Theo Janse van Rensburg and Erik Visser (2017). 'Decoupling from global growth is confidence
becoming a scarce commodity?' South African Reserve Bank Occasional Bulletin of Economic Notes,
October.
Underlying the subdued growth performance of the South African economy has been
the weak trend in gross fixed capital formation, particularly by the private sector.
Following two years of annual contractions, private-sector fixed capital formation grew
by 1.2% in 2017 and by 9.9% in the final quarter of the year, mainly due to expenditure
on transport equipment and machinery. It is still too early to tell whether this
unexpected increase is the beginning of a positive trend. However, we do need to
reverse the downward trend in the ratio of gross fixed capital formation to gross
domestic product (GDP), which had declined to 18.7% in 2017, down from a peak of
23.5% in 2008. This is some way off the 25% target set in the National Development
Plan.
The South African government has committed itself to a range of structural reforms,
many of which are contained in the National Development Plan, which remains a
'living' document. Some of the necessary interventions require longer time frames, for
example fixing the education system and ensuring broader skills development.
However, a number of selected reforms have been identified as the so-called 'low-
-
hanging fruit' these could be implemented relatively quickly and yield high returns.
According to the National Treasury, these reforms could increase potential output by
two to three percentage points from the current estimate of 1.5%. Telecommunications
reforms, which would entail the much-needed release of additional broadband
spectrum, could add an additional 0.6 percentage points to potential output. Other
reforms include lowering barriers to entry by addressing anti-competitive practices,
transport sector reforms, and prioritising labour-intensive sectors such as agriculture
and tourism.
In addition, there are reports of significant pent-up private-sector investment which has
been waiting for increased policy certainty. A notable sector is mining, which has not
seen any investment of significance for a number of years. Regulatory and policy
uncertainty, coupled with disagreement around the new Mining Charter, has
undermined one of the key sectors in the South African economy. According to the
Chamber of Mines, the resolution of these issues could unlock a significant amount of
investment capital.
Government has also expressed commitment to addressing the problems of poor
governance at some of the major state-owned enterprises. In turn, these issues have
resulted in costs borne by the broader economy and ultimately consumers.
Governance issues are also of great concern to foreign investors, particularly those
who already hold, or are considering buying, bonds of these corporations. The fragile
of Eskom's finances has
state potential fiscal consequences. All these issues need to
be sorted out and have been identified as priorities. A start was made when the boards
of some of these companies were changed and when audits of previous procurement
decisions were conducted. Much work still needs to be done at the operational level
to improve efficiencies and reduce costs. These corporations cannot simply rely on
unsustainable tariff increases, as in the case of Eskom, or on further government
bailouts, as in the case of South African Airways.
The role of the South African Reserve Bank
Achieving higher potential output growth is not within the power of the central bank.
The SARB can, however, contribute to an improved environment in a number of ways.
South Africa's institutional
For some time, ratings agencies and investors identified
strength as one of the stand-out features of its economy. The past few years have
seen a steady erosion of some of our key institutions. Fortunately, there is now
renewed focus on reversing this negative trend. In fact, this renewed focus is part of
the reason forwarded by Moody's for retaining the country's
investment grade rating.
The SARB, specifically its independence coupled with its mandate on price and
financial stability, is seen as an important part of the institutional strength of the
country. We have vigorously and successfully defended attempts to undermine our
independence and integrity, and we will continue to do so.
The SARB's
longer-term role, as set out in the South African Constitution, is to achieve
price stability in the interest of balanced and sustainable economic growth. As we have
emphasised on numerous occasions, interest rate policy is not the appropriate policy
lever to achieve higher potential output. However, lower inflation brings about lower
nominal interest rates, and because of lower risk premiums, real rates can decline as
well.
Low inflation also creates an environment that is more conducive for making
investment decisions, which is essential for growth. Furthermore, a low-inflation
environment protects the poor in particular; they are least able to protect themselves
against the ravages of high inflation.
the SARB's
Although key objective is price stability, we have explicitly adopted a
flexible inflation-targeting framework, which implies that we are sensitive to the impact
of any policy actions on cyclical growth. Our approach also recognises the importance
of distinguishing between demand and supply shocks. In the event of significant
exogenous supply-side shocks, we generally try to look through the first-round effects
of these shocks and focus instead on how these shocks feed through to higher inflation
expectations as well as higher wage and price setting.
At the same time, however, we recognise the importance of inflation expectations
declining to lower levels. Unless the wage and price setters in the economy adjust
their expectations lower, wage and price setting will be at higher levels, creating a self-
fulfilling outcome of higher inflation. We would prefer to see inflation expectations
anchored closer to the midpoint of the inflation target range of 3-6%.
Recent inflation developments have been generally favourable. Headline consumer
price index (CPI) inflation moderated to 3.8% in March, its lowest level since early
2011. However, this benign environment is not expected to continue as the
expectation is that the most recent reading was the low point in the current inflation
cycle due to a combination of base effects and tax increases (including the VAT4 and
fuel levy increases) is expected to confirm that the most recent reading was the low
SARB's
point of the current inflation cycle. The most recent forecast was for inflation
to average 4.9% this year, and 5.2% and 5.1% in the next two years respectively. So
while headline inflation is currently well below the midpoint of the target range, the
longer-term outlook is slightly above 5%.
4
value-added tax
There are admittedly a number of other positive developments. First, core inflation (i.e.
headline inflation excluding food, fuel and electricity) is more benign, indicative of
subdued underlying demand pressures in the economy. Core inflation measured 4.1%
in March and is forecast to average 4.6% this year and 4.9% in both 2019 and 2020.
Second, there has been a welcome decline in inflation expectations, as reflected in
the survey conducted by the BER. For some time, these expectations had been stuck
at around the upper end of the target range. In the most recent BER survey, however,
the average declined by half a percentage point to 5.2% and 5.3% for 2018 and 2019
respectively. Similarly, the five-year-ahead inflation expectations declined to
5.3%, their lowest since they were first surveyed in 2011.
The SARB recognises, however, that one reading does not constitute a trend, and we
would need to see further declines, or at least a stabilisation at these recent levels, to
feel confident that inflation expectations have fallen on a sustained basis.
Furthermore, to the extent that inflation expectations are backward-looking, it could
take some time for these expectations to move to lower levels, particularly if actual
inflation is expected to trend upwards from here on. In other words, it is too early to
declare victory in our quest to anchor inflation expectations closer to the midpoint of
the target range.
This improved inflation environment has contributed to a sounder macroeconomic
environment, one where earnings are not eroded at an excessively fast rate. It has
also afforded some room for monetary policy to remain accommodative for now and
help foster improved economic growth. At the most recent MPC meeting, the
repurchase rate (repo rate) was reduced by 25 basis points to 6.5%. With medium-
term inflation expectations at just over 5%, this implies a real repo rate of around 1.5%
model's estimate of the current neutral rate of
compared with the SARB around 2%.
MPC's
The assessment at that time was that the risks to the inflation outlook were
more or less balanced. In its deliberations, most of the upside risks emanated from
external sources. These risks are transmitted to the economy via the exchange rate
and, by extension, to the risks to inflation.
As an inflation-targeting central bank, the SARB does not target the exchange rate but
rather focuses on the second-round effects of exchange rate changes (in both
directions) on the inflation outlook.
This implies that our assessment of the risks to the rand is an important, although
certainly not the only, determinant of how we see the inflation trajectory going forward.
At the March 2018 MPC meeting, when the rand was trading at around R11.80 against
the US dollar, the exchange rate was assessed to be somewhat overvalued, and we
viewed further appreciation potential to be somewhat limited. Since then, this view has
been reinforced by a number of global developments that have clouded the outlook.
The global outlook and risks
For some time now, the global context has been relatively supportive and benign.
Global growth has been picking up in a steady but synchronised manner, and global
inflation has remained low, allowing monetary policies in the advanced economies to
remain broadly accommodative. This environment, together with unusually low
financial market volatility, has contributed to the continued strong capital flows to
emerging markets.
There are, however, a number of indications that this Goldilocks period is probably
over. Financial market volatility has re-emerged. Some investors appear concerned
about potential upside inflation surprises in the US, which could usher in a
considerably faster pace of normalisation than the one currently being signalled by the
US Federal Reserve (Fed). Furthermore, fiscal expansion in the US could place
additional upward pressure on both US short- and long-term interest rates, with
negative spill-over effects on most emerging market currencies and bonds.
Additional risks to many emerging-market assets stem from the recent rise in oil prices
underpinned by OPEC's5
and international trade tensions. The recent increases were
resolve to continue restraining supply in order to support prices. It is too early to tell
whether the US shale oil producers, as the new swing producers in the market, will
5
Organization of Petroleum Exporting Countries
respond in a meaningful way and either cap or moderate these increases. And while
the trade conflict seemingly developing between the US and China is perhaps best
described (for now) as a skirmish, it could easily develop into a larger-scale trade war.
Any broader retreat from a multilateral, rules based global trade system would not
leave emerging markets unscathed. Global value chains would be affected, while
reduced risk appetite could undermine cross-border capital flows.
I should note that while these recent developments are likely to create challenges for
South Africa and emerging markets in general, not all emerging market economies are
equally vulnerable to higher advanced economy interest rates. In fact, it is generally
accepted that most have become more resilient since the so-called 'taper tantrum' of
2013. Their macroeconomic fundamentals have generally improved, their real policy
rates are generally higher, and their current account and fiscal deficits have narrowed.
Inflation is within target in most of the inflation-targeting emerging markets.
In South Africa's case, our
current account deficit has narrowed from its widest level
of almost 6% of GDP in 2013 to 2.5% of GDP in 2017, while growth prospects have
improved and positive policy signals should reduce the risk premium investors require
in domestic assets. In that respect, we are encouraged that the recent weakening of
the rand (from relatively strong levels) seemed more a reflection of dollar strength
rather than idiosyncratic factors.
Conclusion
In the context of a supportive global environment, a strong financial sector and recent
developments that reinforce the strength of South African institutions, our assessment
South Africa's investment case remains compelling.
is that The South African outlook
is currently far better than has been the case for some time now. Enormous potential
can be unlocked by further reforms and improved policy coordination, which will open
up numerous investment opportunities for foreign investors in the country. In addition,
Government remains committed to improving the investment climate, as highlighted
in the Presidency announcement of our intention to host an investment conference
around September 2018. As the South African Reserve Bank we support this through
ensuring a prudent and transparent policy approach which is consistent with our
constitutional mandate.
I have no doubt that the trade and investment ties between Switzerland and South
Africa can improve even further. SwissCham Southern Africa has been playing an
important role in fostering these ties, and I wish you all the best in promoting trade and
investment in our country.
Thank you.