An address by Fundi Tshazibana,
Deputy Governor of the South African Reserve Bank (SARB),
Nedgroup Investments 11th Annual Treasurers' Conference
at the
Central banking in an era of stagflation risk: a view from the MPC
25 August 2022
Introduction
Good afternoon and thank you for the invitation to address you today. Nowadays it
feels very strange to be in front of a live audience, instead of a screen. Three years
ago, when I spoke at this conference, the world was a different place. When the
COVID-19 crisis started, we all said that everything was different. Two years later,
everything is different again. Trying to figure out these 'new
differents' certainly feels
I'm lost in the multiverse or my daughter's version of the world'.
like 'upside-down
In October 2021, Wordle took the world by storm as people tried to guess the letters
that made up the 5-letter word of the day. The most popular game back in 2020 was
letters... specifically which letter shape would describe the
also about economic
recovery.
o Would it be a V-shape, with a quick downturn and equally quick rebound?
o An L-shape, with a collapse to a persistently lower level of output?
o Or a K-shape, with a recovery for the rich and an ongoing recession for the
poor?
Everyone had their favourite letter. Despite all the imagination that went into crafting
these scenarios, I don't recall anyone warning of global stagflation.
But nowadays,
I'm not
everyone is worried about that toxic mix of high inflation and weak growth.
sure what letter could have denoted this outcome.
The journey since 2020
So how did we get here? And where are we going? Advanced economies went into
the COVID-19 crisis on the back of a decade of subdued growth and below-target
inflation.
Central bankers invested heavily in strategies to deal with the zero lower bound on
'lowflation'.
interest rates to avoid getting stuck in Japan-style Worries about high
inflation were often considered as dated and alarmist. This was particularly the case
in the United States. New fiscal thinking also emphasised taking advantage of
interest rates that were low relative to growth rates. All of this suggested that
macroeconomic stability was secure and there was ample scope for aggressive
policy action to manage the COVID-19 crisis.
In emerging markets, the situation looked very different.
Few of us had to worry about too low inflation. We read the new fiscal literature with
interest. For emerging market countries, including South Africa, interest rates were
clearly above our growth rates. But none of us were complacent about
macroeconomic stability.
Many emerging markets also confronted low-trend growth rates, well below those
achieved a decade before. As a result, we had started diverging from advanced-
economy-living standards, after a prolonged period of convergence. These
circumstances called for stability-oriented macroeconomic policies, coupled with
growth-boosting structural reforms.
The South African perspective
Let's move
closer to home. At first sight, the COVID shock changed everything. It
was often said it would be better to do too much rather than too little. Indeed, South
Africa joined in the global response with aggressive fiscal and monetary policy
action.
Given strong monetary policy credibility, our policy rate cuts were particularly large
relative to peer countries. Despite our large monetary response, the SARB fielded
many questions about the possibility of much lower inflation, or even deflation.
We also heard various calls for more extreme SARB action, extending beyond rate
cuts to policies such as Quantitative Easing. As policymakers, we agreed that there
was high uncertainty, but as the SARB, we also explained that much lower inflation
was unlikely. We further communicated that South Africa probably would not need
unconventional tools such as QE, given both minimal deflation risk and the fact that
we still had ample firepower with our regular repo rate tool, which was nowhere near
the zero lower bound. While we agreed on the need for strong policy support to
manage the impact of COVID-19, we saw the distinction between boldness and
recklessness.
Well, were we on the right track? Inflation for 2020 ended up averaging 3.3%,
vindicating the SARB's assessment about a prolonged target undershoot or even
deflation. The actual outcome was close to our April 2020 emergency MPC meeting
forecast, where we projected 3.4% inflation for the year. From that point, inflation
largely played out as expected. Inflation also normalised at a fast pace in the next
year, averaging 4.5% for 2021 as a whole, precisely in the middle of our target
range.
As for growth, South Africa's recovery was slow relative to our peers', with progress
repeatedly interrupted by shocks such as flooding, riots and load-shedding. That
said, growth outcomes in 2021 and early 2022 generally surpassed expectations.
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Revisions to our MPC growth forecasts were therefore consistently to the upside in
contrast with the pre-COVID period, where we were generally revising growth
downward. For instance, at that unscheduled April 2020 MPC meeting, we
envisioned growth of 2.2% in 2021, a number we eventually marked up to 4.9%. Our
estimates of slack in the economy also narrowed over time, mainly because of
better-than-expected growth.
In these circumstances, the view of the MPC was that we had provided about the
right amount of policy support. Our assessment was also that it would be appropriate
to start moving away from emergency-level interest rates during the course of 2021.
By the fourth quarter of 2021, we had a whole new different. Fortunately, unlike
some of the advanced economy central banks, we had not committed to forward
guidance on interest rates. Nor had we changed our framework in ways that made it
more backward looking, for instance through average inflation targeting. We also did
not have to worry about the sequencing of balance sheet policies, a factor which
appears to have complicated timely policy adjustments elsewhere.
The path to policy normalisation
We started the normalisation cycle with a relatively modest 25 basis point increase at
the November 2021 MPC. This was, incidentally, only a few days before Fed Chair
Powell said he was retiring the term 'transitory' for inflation.
The SARB's
gradual pace of normalisation continued with interest rate increases in
January and March of this year. From May, we started seeing evidence of inflation
persistence. Thus, we accelerated the pace of tightening, to 50 basis points, and
then stepped it up further in July, hiking by 75 basis points. Those decisions were
shaped by a deteriorating inflation forecast, with a strong likelihood of a sustained
target breach, starting with the unexpectedly high May print, at 6.5%, as well as the
June outcome of 7.4%. The rand had also begun weakening after a period of
resilience. Furthermore, inflation expectations were clearly rising, both in survey
results and as implied in financial market variables.
Now that we have got rates back up from 2020's record lows,
the question we face is
how quickly we need to get to positive real rates, and ultimately a more neutral
In turn, this depends on just how persistent higher inflation will be. Here's
stance.
how I assess the main factors. Upside risk from higher price passthroughs, higher
wage settlements, currency corrections driven by interest rate differentials. But also
moderating such as lower oil prices, moderating food prices and the large gap
We don't see much demand pressure in
between headline and core inflation. this
economy. At the same time, it seems firms can put through price increases and have
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them accepted. This is consistent with a small or zero output gap an economy that
does not have a lot of slack but also isn't overheating. We appear to have moved
past the phase when we were getting disinflationary pressure from spare capacity in
the economy, to a space where this factor is broadly neutral.
On the labour market, South Africa's high unemployment rate is clearly not an
important determinant of inflation. If it was, we would've been in deflation by now,
given the massive downward pressure on wages from labour market slack. Instead,
what we have seen between the first quarter of 2021 and the first quarter of 2022 is
average compensation growth in the region of 5%. This is reasonable given the
underlying inflation rate and productivity growth. The risk, however, is that this
number could accelerate.
The structure of our labour market is such that some parts of the workforce are
privileged. They are protected either by labour laws that favour insiders, or by skills
shortages that confer market power. These segments of the workforce tend to
demand full cost-of-living adjustments, over and above any productivity growth they
achieve. This tends to drive up inflation for everyone else. We are alert to this threat.
On the exchange rate, the rand had been resilient through much of the first half of
this year, despite the stronger dollar. We saw a range of advanced economy
currencies depreciate, including the Japanese yen and the euro, but a group of
emerging market currencies, including the South African rand, seemed to be immune
to the strong dollar. However, this trend suffered a breakdown in June. We are no
longer in the space where we can have low policy rates without currency weakness.
There are too many other countries offering higher policy rates, and we are getting
less support from export commodity prices than we did previously. Although
exchange rate dynamics are always unpredictable, the SARB's baseline
forecast is
that we are seeing some exchange rate pressure to inflation, but timely rate
increases keep this from being a major source of pressure.
Set against these considerations, the good news is that oil prices seem to be easing
again, and there is also some tentative progress on the food price front. We have a
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large gap currently between our headline and core inflation measures 3
percentage points, with core at 4.4% and headline at 7.4%. If headline starts to move
back towards core, we won't have low
inflation, but we will at least be closer to the
midpoint of our target. Even taking into account these moderating factors, we would
still want to get back to 'normal' interest rates, but there would be less urgency to get
there fast.
On the whole, our policy stance remains accommodative. The 75 basis-point hike in
July might have been the largest hike since 2002, but our starting point was very low,
and the repo is still below the inflation rate. Indeed, if you apply a simple Taylor rule
to the data, where the policy rate is a function of normal or neutral rates adjusted for
deviations from the inflation target and full output, you will certainly get an outcome
above 5.5%. This applies even when you are looking at next year's inflation, past the
12-month impact of the Ukraine war price shock.
picture. I'd like to offer two
Let me conclude, by stepping back a bit to see the bigger
comparisons.
The first has to do with South Africa's performance relative to other countries. It is
still early days, and I don't want to signal complacency, but given the size of the
global shock underway, it is fortunate that South Africa has a good chance of getting
through this without particularly high inflation or high interest rates.
Our July QPM projection, which is a reasonable baseline, shows inflation peaking
during the current quarter and then moving back towards our midpoint target during
Meanwhile, the QPM's endogenous policy rate moves
the rest of the forecast period.
moderately higher, but the stance is never tight. For instance, the average repo rate
is about the same as it was in the pre-COVID period, when it was between 6% and
7%; the QPM has repo averaging 6.5% next year and 6.75% in 2024. This compares
well with what has happened in many other countries.
I hope you have all taken time to appreciate the fact that South Africa's inflation has
been below the inflation rates of the United States, the United Kingdom and even
Germany, in recent months. Perhaps more relevant, we have not seen target misses
of the scale experienced by many of our peers, and unlike those countries, we have
not had to raise rates well into restrictive territory. The SARB is not happy about our
target breach, but given what is happening to the world, neither our inflation rate nor
our interest rates look especially onerous. It's actually a reasonable outlook, given
the worst global inflation shock in a generation.
My second observation is an historical comparison. A decade ago, during the global
taper tantrum, South Africa was one of the most-affected countries. For instance, we
were included in the grouping known as the 'Fragile Five'. In 2020, during the onset
of the COVID-19 shock, South Africa was once again identified as a vulnerable
country. For example, Adam Tooze published a widely read essay in Foreign Policy
describing the coronavirus as the 'biggest emerging market crisis ever', which
included the claim that, and I quote, "At the head of the list of vulnerable countries is
South This year's financial market storm has hurt a wide range of countries.
Africa".
The experiences of the worst hit, like Sri Lanka, have reminded us once again that
It's striking, however, that of the
macroeconomic stability is precious. Fragile Five
from 2013, only one country, Turkey, is in danger of an acute macroeconomic
dislocation today.
Yes, South Africa remains vulnerable to external shocks, and this keeps us awake at
Africa's resilience during this stress episode is very welcome.
night. But South We
have benefitted from some good luck, mainly from higher commodity prices. In large
part, the macroeconomic choices of the past few years have also reduced fragility.
This reflects necessary fiscal policy decisions, especially around the public sector
wage bill, as well as a prudent monetary policy.
There are many accounts being written now of what central banks got wrong, that
made the ongoing inflation surge possible. Reading them, I realise that despite the
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criticisms we at the SARB are sometimes attacked for not being adventurous it is
clear that when central banks do become adventurous the consequences can be
even more unpopular.
Conclusion
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To conclude, looking back over the past very exciting three years, the SARB
probably did about the right amount of stimulus in 2020, and we probably started
withdrawing stimulus at about the right time, in late 2021. Obviously, the war in
Ukraine was an unexpected shock. But South
Africa's inflation profile was not too
problematic prior to that shock.
Looking ahead, and all else being equal, we have a reasonable chance of getting
through this current 'different' without high interest rates. But life is never
straightforward in central banking. Conditions remain highly uncertain, so we cannot
be precise about where interest rates are going. Before this crisis, there was a strong
preference, globally, for forward guidance, but recent events are really testing central
bank communication. We've all been reminded that forecasts are flawed and that
circumstances change fast. Plans that looked measured and reasonable at one point
can look wholly inappropriate at another.
As the MPC, we've not made any promises about
future policy rates. Our approach
remains risk-based and data-dependent. Our objective is to get inflation back to
target over the medium term, and we will continue to do what it takes to achieve that,
adjusting our plans as we get new information.
We have been urging structural reforms for many years, but this year it feels like we
may finally be nearing a tipping point. We need to lift our potential growth.
Fortunately, we have the base of macroeconomic resilience and the private-sector
balance sheet strength, and with the right reforms, we really could have balanced
and sustainable growth again.
Thank you.