Gill Marcus: The outlook for the South African economy in a challenging
global environment
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, to the
Distinguished Speakers Seminar, European Economics and Financial Centre, London, 8
April 2014.
* * *
Thank you for the opportunity to address you this afternoon. Today's discussion takes place
at a time when the UK is one of the advanced economies that is showing signs of sustained
recovery from the global financial crisis. This is good news not just for the UK, but also for
South Africa, which still has strong trade and investment links with your country. However,
after nearly seven grueling years, we need to recognise that the global financial crisis is not
yet over. Rather, we have entered a new phase, one which is moving in the right direction,
but one that is no less uncertain and risky than previous phases, and which poses new
challenges for emerging economies in particular. The unwinding of the extraordinary
monetary policy actions of the past by the US Fed is taking us all into unknown territory, and
there is no history or precedent to guide us. Emerging economies had to deal with the
spillover effects of monetary accommodation in the advanced economies, and the challenges
to be faced by their reversal will be no less daunting. However, while the adjustment will be
difficult, I believe that emerging economies in general, including South Africa, are more
resilient and better equipped to respond to such challenges than was the case in the past.
One of the consequences of the unconventional monetary policies adopted in a number of
the advanced economies in response to the global financial crisis was a significant change in
the pattern of global capital flows. As the search for yield became more intense, emerging
economies had to contend with large capital inflows. Although these flows presented
opportunities, they also brought challenges in the form of appreciating exchange rates and
lower interest rates, which had the potential to cause a buildup of macroeconomic
imbalances, including, in some instances, excessive credit extension, asset price bubbles
and widening fiscal and current account deficits. The appreciating currencies also made the
products of these economies less competitive, with significant consequences for domestic
manufacturing, for instance.
The announcement by the US Fed in May last year that a reduction of asset purchases was
likely to commence at some stage later in the year had a marked impact on these global
capital flows, amid initial uncertainty about the timing and quantum of the tapering. The
widely expected commencement of tapering in September did not occur, and markets
overscrutinised every bit of data coming out of the US for possible indications of the start of
the process. An extremely volatile period of "risk on" and "risk off" episodes ensued,
particularly for those countries that had been the previous beneficiaries of the capital inflows.
Indications of slowing employment growth in the US were seen as good news for emerging
markets, as it implied a delay of either tapering or normalisation. As a result, emerging
market exchange rates, including the rand, experienced a high degree of volatility in the face
of these changing flows. As shown in a recent paper by Eichengreen and Gupta, the
countries most affected were those with large current account deficits and those with
relatively large and liquid financial markets which allowed for investors to be better able to
rebalance their portfolios. The issue was further complicated by the fact that the markets
initially conflated tapering, which related to the slowdown of Fed asset purchases, with
monetary policy tightening or normalisation of short-term policy rates.
It appears now that the financial markets generally accept that tapering by the US Fed will
proceed at a steady pace. However, the next phase of normalisation, that of the timing and
extent of the US policy rate cycle, is now the subject of intense speculation. Already we have
seen the market reaction to the Fed statements following the most recent FOMC meeting,
when there were indications that the timing of the first policy rate adjustment may occur
sooner than previously believed.
There is little doubt that this process will not proceed in a linear fashion: the outlook for the
coming interest rate cycle is likely to keep changing and be affected by the ebbs and flows of
data coming out of the US. The outlook may also be complicated by the monetary policy exit
strategies of the UK, Japan and the ongoing challenges faced by the Eurozone. While
emerging markets, including South Africa, are likely to experience periods of relative stability,
as is the case at the moment, we do expect volatile periods ahead. Thus while a sustained
recovery in the US is critical to ending the global financial crisis, and is good news, in the
short run it introduces increased risks and volatility with consequences for growth, capital
outflows, commodity prices, exchange rate depreciation and inflation in many emerging
markets.
But this volatile global financial market environment is not the only challenge facing us. The
possibility of a slowdown in China poses further risks, not only to the growth recovery in the
advanced economies, but also to emerging markets in general. Trade and investment
linkages with China have increased markedly in recent years, and a slowdown could
adversely affect these trends. An important channel of transmission of a slowdown is already
being felt by commodity exporters through the impact on commodity prices, particularly
industrial commodities. The nature of the reaction function of the Chinese authorities and
possible stimulus packages is still uncertain. Complicating the outlook are the challenges
faced by the Chinese banking sector, in particular the shadow banking sector, which has the
potential to reinforce the slowdown.
More positively, the outlook for the advanced economies appears to be improving, but
already some doubts have arisen regarding the strength of the recovery following a generally
disappointing first quarter. From a South African perspective, although the recovery in the UK
appears to be sustained, we are particularly concerned about the slow pace of recovery in
the rest of Europe, which remains an important destination for our manufactured exports.
The outlook for emerging markets, by contrast, has deteriorated in recent months, and there
is a risk that a generalised slowdown in these economies could undermine the recovery in
the advanced economies.
How has South Africa fared against this challenging backdrop? Following the initial
announcement by the US Fed regarding possible tapering, the rand was one of the
currencies most negatively affected. The rand was at around R9,00 against the US dollar at
the beginning of May 2013, and depreciated to around R10,00 against the dollar following
the initial tapering announcement. It then followed a volatile depreciating trend, reaching its
weakest point of R11,39 against the dollar immediately after the January MPC meeting.
Since then it has followed an appreciating, but volatile trend, to reach a recent high of around
R10,50 in early April. We expect this pattern of volatility to continue, as the hesitant move
towards US monetary policy normalisation proceeds, with markets being overly sensitive to
any data coming out of the US. For example, last week's non-farm payrolls data came in
slightly lower than expected. This disappointing news for the US was seen as good news for
emerging markets, and the rand, along with the Brazilian real, appreciated by over one per
cent in response.
Underlying these volatile movements in the exchange rate was the changing pattern of
capital flows. During 2012, net purchases of South African government bonds by
nonresidents totaled R88,6 bn, influenced in part by South Africa's inclusion in the Citibank
World Government Bond Index during the year. These flows became more volatile during
2013, in line with the on-off nature of the move towards tapering. As the markets became
more certain that tapering would begin, portfolio outflows proceeded at a significant rate.
Between November 2013 and January 2014, net sales of bonds by non-residents amounted
to R46 bn while net equity sales amounted to R25 bn. Since then, however, the outflows
have abated, and in February and March net purchases of equities to the value of R13,3 bn
were recorded, alongside a small net inflow into the bond market of R250 m. While to date
the current account deficit has been adequately financed through other forms of capital
inflows and without recourse to selling reserves, it could create a challenge going forward.
However, the rand has also been affected by a number of other idiosyncratic and global
factors. These include a series of protracted strikes in the motor vehicle and mining sectors
in particular; a decline in the terms of trade of just over 4 per cent in 2012 and 2013, largely
in response to the slowdown in China; and a widening of the deficit on the current account of
the balance of payments, which, in conjunction with the fiscal deficit of around 4 per cent of
GDP is seen to have contributed to the vulnerability of the economy to the possibility of a
sudden stop in capital flows. The current account deficit widened from 2,3 per cent of GDP in
2011 to 5,8 in 2013, with the trade account accounting for about half of this number.
This deterioration has occurred despite the significant depreciation of the nominal effective
exchange rate of the rand of over 22 per cent since the beginning of 2012. Apart from the
usual adjustment lags and J-curve effects there are a number of factors that could explain
the slow response. First, to the extent that the depreciation is an adjustment to the declining
terms of trade, it is cushioning the mining sector, rather than being a stimulus to further
output and investment. Second, the pass-through to consumer prices has been relatively
constrained to date, and ironically this impedes the adjustment process as the required
relative price changes have not taken place. While this muted pass-through does help to
ensure that the depreciation is real, the competitive advantage of manufacturers has been
eroded by sharp increases in a number of key inputs in recent years, particularly electricity.
Third, our traditional trading partner countries, particularly in Europe, are still experiencing
slow growth. While Africa has now overtaken Europe as the main destination for our
manufacturing exports, the capacity of these countries to import could also be negatively
affected by the reversal of capital flows and declining commodity prices.
Fourth, protracted domestic labour disputes have impeded output and exports in the
manufacturing and mining sectors, while at the same time uncertainty regarding proposed
mining legislation had dampened new investment in this sector. In addition, structural
infrastructural constraints, particularly relating to electricity supplies as well as transport,
have negatively affected our ability to get goods to, and out of, the ports. Finally, there is the
relatively inelastic nature of import demand with respect to capital equipment for the ongoing
much-needed infrastructure expenditure, which we must not cut back on.
There are tentative signs that we may have reached the turning point with respect to the
adjustment process. The current account deficit narrowed to 5,1 per cent of GDP in the final
quarter of 2013, down from 6,4 per cent in the previous quarter, and although the trade
deficit widened further in January to R16,9 bn, February saw a surplus of R1,7 bn, following
a R6,1 bn increase in the value of exports, and a R12,5 bn decline in imports. Net exports
made positive contributions to GDP growth in both the third and fourth quarters of 2013,
contributing 1,6 and 7,8 percentage points in these two quarters respectively. The fourth
quarter outcome was the highest contribution to quarterly growth since the final quarter of
2007, and although net exports were still a drag on annual growth in 2013 at -0,5 percentage
points, this was significantly lower than the -1,7 percentage points recorded in 2012.
Furthermore, the Bureau for Economic Research's indicators for manufactured export sales
and orders rose to its highest level in 10 years in the first quarter of this year. At the same
time, declining new motor vehicle sales, amid weakening consumer demand, could
contribute to a reduction in imports. There has also been a response on the services account
where tourism receipts have increased markedly, and we expect this trend to continue. So
despite the ongoing challenges to platinum exports, we are cautiously optimistic that we may
be seeing a sustained improvement in the current account.
While the exchange rate has been an important shock absorber for the South African
economy, some concern has been expressed regarding its volatility. We have not attempted
to intervene directly in the foreign exchange market as we do not believe that such
intervention would be effective, given the size of South Africa's foreign exchange market, and
our relatively low level of foreign exchange reserves of around US$50 billion. Fortunately we
do not suffer some of the negative balance sheet effects that have led to a "fear of floating" in
a number of emerging economies: we do not have significant currency mismatches and our
corporates, banks, households and government have relatively small net foreign currency
exposures. However, volatility does make it difficult to plan and make long term investment
decisions. From a monetary policy perspective, our focus is not to try and influence the
exchange rate, but rather to focus on preventing the second round effects of the depreciation
from impacting on the overall inflation rate. As I will touch on later, the exchange rate has
had an impact on inflation, and remains a significant risk to the inflation outlook.
South Africa's growth performance in the post-crisis period has been disappointing, having
averaged 2,8 per cent since 2010. This can be attributed in part to the slow recovery in our
major trading partners. In 2013, growth averaged 1,9 per cent, well below potential growth
currently estimated to be between 3,0 and 3,5 per cent. The Bank's forecast for growth in
2014 and 2015 is 2,6 per cent and 3,1 per cent for these two years respectively. While this is
an improvement, it is still below potential, and likely to have a minimal positive impact on the
unemployment rate, which currently stands at 24,1 per cent. Employment growth has been
slow, and what growth there has been has mainly been in the public sector. For example, in
the year to the fourth quarter of 2013, non-agricultural formal sector employment grew by
0,5 per cent or about 41,000 jobs, of which 39,000 were in the public sector.
The constraints to growth are mainly structural in nature, but in the near term there are two
main risks to the growth outlook. The first is the uncertainty of electricity supply. South
Africa's electricity supply has been constrained for some time, and has no doubt impacted on
investment decisions in the economy. The current tight conditions on the grid are likely to be
stretched going into winter, imparting a near-term downside risk to our growth outlook.
However, this constraint should be relieved during 2015 due to a significant new power plant
build programme that has been in place over the past few years. New capacity is expected to
come on stream late in 2014, and as this gets added to the grid, the shortage should ease.
A further challenge arises from the protracted strike in the platinum sector, which is now in its
12th week, with no resolution in sight. To date exports have been temporarily cushioned by
the depletion of stockpiles, but it will affect the GDP growth outcome. Whether or not this
strike has longer term ramifications will depend on its persistence, the nature of the ultimate
settlement, and any knock-on effect on other sectors and wage settlements. However, the
dispute is indicative of an urgent need to address industrial relations not only in the mining
sector but in the broader economy, and requires a change in mindset from both workers and
employers. We are hopeful that an acceptable settlement can be achieved soon that satisfies
all parties. But in the meantime the cost to workers, financially and in terms of human
suffering, and to the mining companies is enormous.
There are also a number of positive developments, in addition to the significant infrastructure
build programme that is already well advanced, that will underpin growth in the longer term.
Last year parliament unanimously adopted the National Development Plan as the long term
vision for growth and employment creation. While this is not a rigid blueprint, it provides a
framework which, if largely implemented, should change the South African economy
fundamentally. The key points in the NDP are to promote faster and more inclusive economic
growth, to build a capable state, to promote good governance and an active citizenry and to
promote collaborative partnerships across society, including between government and
business.
The key economic policy recommendations are to promote exports, raise competitiveness,
lower the cost of living for the poor, improve skills development and improve the functioning
of the labour market. Critical actions required for faster economic growth include investing in
economic infrastructure to lift the potential growth of the economy and removing regulatory
barriers to newer firms to promote easier entry and greater competitiveness.
South Africa has already made significant strides in improving the lives of millions of people.
Without going into too much detail, a report released by Stats SA last week showed that
poverty levels in the country have dropped from 57,2 per cent in 2006 to 45,5 per cent in
2011. As of 2011, 32,3 per cent of the population were living below the National Planning
Commission's lower bound poverty line, compared with 42,2 per cent in 2006. The Gini
coefficient, which reflects income inequalities remains high but declined from 0,72 to 0,69.
The focus on economic infrastructure expenditure in the NDP is key. The recent government
budget provides for capital expenditure by the major state-owned companies of almost R400
billon to be spent on infrastructure during the coming three years, the bulk of this on
electricity and transport infrastructure. This should have a positive impact not only on current
growth during the build phases, but also on future growth as infrastructure bottlenecks are
eased. The investment outlook from the government and state-owned enterprises therefore
looks positive, and should help with the crowding in of private sector investment. We are also
seeing favourable signs in the construction sector, particularly in civil construction.
The outlook for private sector fixed investment is also more positive, despite relatively low
levels of business confidence. Having been relatively subdued during the past few years,
growth in gross fixed capital formation by the private sector increased from 3,9 per cent in
2012 to 5,5 per cent in 2013. Part of this increase was related to green energy investment.
This indicates that if the near-term constraints can be eased and business confidence
improves, there is scope for further growth in fixed investment, and this could allow for a
rotation away from consumption expenditure towards investment as the main driver of
growth. In 2013, the contribution of consumption expenditure to GDP growth had declined to
1,7 percentage point, compared with 2,3 in the 2012, while the contribution of gross fixed
capital formation was unchanged at 0,9 percentage points.
In contrast to the mining sector, the manufacturing sector also shows tentative signs of
having turned the corner following particular strike-related challenges during 2013,
particularly in the motor vehicle sector. The manufacturing PMI had been below the neutral
level of 50 index points for the second half of 2013 and early 2014, has now returned to
above 50. We are hopeful that these green shoots will lead to a sustained recovery in the
sector amid a recovery in motor vehicle exports in particular.
There are also significant opportunities for South Africa at the regional level. According to the
latest World Economic Outlook, economic growth in sub-Saharan Africa is expected to
average 6,1 per cent in 2014 and 5,8 per cent in 2015. As I noted earlier, there has been a
significant shift in South Africa's trade patterns in recent years. In 2007, 38 per cent of South
African manufactured exports went to Europe, with 25 per cent going to Africa. By 2012 the
picture had reversed, with 25 per cent going to Europe, and 38 per cent going to Africa. The
impact of the recession in Europe, for example, was felt particularly hard in the motor vehicle
export sector. However the decline in vehicle exports to Europe in 2012 was more than
compensated for by a 19 per cent increase in vehicle exports to Africa in that year.
The focus of South Africa's regional interactions has not only been on the trade side. Foreign
Direct Investment in the region grew from less than US$1 bn in 1990 to almost US$40 bn in
2012. South African companies have been very active in this respect and have increasingly
made their presence felt on the continent in mining, the retail sector, construction,
telecommunications, agri-business and banking in particular. There is enormous potential for
regional infrastructure development which will enhance the growth potential of South Africa
and its neighbours.
The current environment has created a difficult context for monetary policy. For some time
now the Monetary Policy Committee has had to face the dilemma of a relatively subdued
growth environment and a rising trend in inflation. Apart from a temporary breach of the
target in July and August 2013, inflation has remained within the target range since early
2012, and the repurchase rate had been unchanged at 5,0 per cent since July 2012.
Notwithstanding the unusually low level of pass-through to inflation, the exchange rate has
posed the biggest upside risk to the inflation outlook. Adverse exchange rate and food price
developments resulted in a deterioration of the inflation outlook in January 2014 when the
forecast suggested that inflation was likely to breach the upper end of the band during the
second quarter of 2014, and to peak at an average of 6,6 per cent in the final quarter of the
year. Inflation was expected to average 6,0 per cent in the second quarter of 2015 and
remain close to the top of the band for the remainder of the year.
With the risks to the inflation outlook seen to be on the upside, this trajectory suggested the
need for some monetary policy tightening. However, the difficulty facing the MPC was the
slow pace of economic growth, the lack of clear demand pressures as seen in the tepid
growth in consumption expenditure by households, amid subdued growth in credit extension.
In the event, the MPC decided that it would be appropriate to embark on a moderate
tightening cycle, starting with a 50 basis point increase of the repurchase rate in January. It
was indicated that the speed and intensity of the cycle would be dependent on unfolding
data, and would be consistent with our flexible inflation targeting framework. At the most
recent meeting in March, the inflation forecast had improved slightly, particularly for 2015,
and the MPC kept the repurchase rate unchanged. Nevertheless we re-emphasised that we
are in a moderate tightening cycle, but that it does not necessarily mean that rates will be
changed at every meeting or by the same amount. An important consideration for the MPC
was that failure to react could have an adverse impact on inflation expectations which until
now have been relatively stable and anchored, albeit at the upper end of the target range.
Despite the increase in the repo rate in January, the real policy rate is still slightly negative,
and well below what could be considered the neutral rate. While such an accommodative
stance has been considered appropriate given the developments in the real economy,
pressures from the exchange rate and capital flows, and the possible normalisation of
monetary policy in the US imply that this stance cannot be maintained indefinitely. At this
stage we do not have a clear view of what the longer term post-crisis "new normal" neutral
interest rate will be, either in South Africa or at a global level. This is a subject of debate in
most countries. We do know that some adjustment will be required, but the nature of the
adjustment needs to be sensitive to the context that we find ourselves in. And the context will
determine how pre-emptive or reactive we will be.
This does not mean that we blindly follow US monetary policy. The impact of Fed tapering
and associated capital outflows has been felt on the long term bond yields, which at one
stage had increased by about 200 basis points, but have since moderated somewhat. This is
not surprising, as tapering has more to do with the long end of the yield curve than the short
end. Central banks can indirectly influence long term rates, but do not have the same direct
control over them as they do with short term rates.
As noted in a recent article in the FT by Charles Goodhart, long-term interest rates are more
correlated across countries than short-term rates, and countries with flexible exchange rates
are more able to set policy rates independently of the Fed funds rate. However, this
independence is not complete. Exchange rate pressures may lead to inflation pressure that
may require a monetary policy response. But this partial independence does mean that short
term rates can be more related to domestic cyclical considerations.
In conclusion, South Africa, along with many of its emerging market peers, is facing a
challenging period ahead. We are facing a difficult global context, which will have significant
and uncertain spillover effects on us. While the advanced economies will pay lip-service to
mitigating these effects, the reality is that they are likely to conduct their policies with
domestic consideration in mind. South Africa also faces a number of domestic challenges.
The solutions are there, but we need the community of purpose to implement these
initiatives. Education and infrastructure are key elements in the much needed structural
reform agenda, but this investment takes time and there is no quick fix. It is going to be a
difficult road ahead, but it needs to be done and can be done. Monetary policy will play its
role, but it cannot solve the underlying structural problems. We will continue to ensure a
stable macroeconomic environment and a well-regulated financial sector, within a flexible
inflation targeting environment.
Thank you.