Daniel Mminele: Thoughts on South Africa's monetary policy
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
JP Morgan Investor Conference, Washington DC, 16 April 2011.
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1. Introduction
Good afternoon ladies and gentlemen.
Thank you to JP Morgan Emerging Markets Research Group for inviting me to share with
you some thoughts on South Africa's Monetary Policy.
In the years prior to the most recent global financial crisis, central banks in general appeared
to have almost perfected the conduct of monetary policy.1 Inflation targeting central banks
were given operational independence to vary the short-term interest rate in order to achieve
an inflation target. While this worked very well for some time, the global financial crisis
showed us that achieving price stability by no means equated to achieving financial stability.
This has resulted in somewhat of a paradigm shift for traditional monetary policy, and it
seems we may be on the cusp of a new era in central banking.
I would like to briefly discuss global economic developments and the changing role of central
banks, highlighting the challenges and lessons learnt from the global financial crisis. I will
then talk about South African monetary policy, as that is the reason for which I was invited to
speak to you today.
2. Global economic developments and monetary policy
The International Monetary Fund's (IMF) latest World Economic Outlook (WEO) reflects a
similar picture to that of a few months ago. The global economic recovery proceeds at an
uneven pace and although it is broadening, the divergence in economic activity remains
wide. The growth momentum in advanced economies is gaining traction, but is insufficient to
meaningfully impact on unemployment.
Emerging markets, on the other hand, are characterised by robust growth with signs of
overheating in certain economies. The IMF projects that global growth will moderate in 2011
to 4,5 per cent from 5 per cent in 2010. Advanced economies are forecast to expand by
2,5 per cent and emerging economies by 6,5 per cent.
The IMF has also identified a number of old and new risks, including the threat of spill overs
from the euro area periphery to core Europe, exacerbated by continuing weakness among
many European financial institutions, a lack of clarity on exposures and weak sovereign
balance sheets. This last point is not confined to Europe, but a risk to advanced economies
in general and the US and Japan more particularly. It is plausible that this state of affairs, if
not addressed, could result in an abrupt increase in interest rates, which could destabilise
global bond markets and emerging markets more particularly. In emerging economies, the
IMF highlights the risk of overheating and the threat of a hard landing. The IMF is of the view
that policy responses so far have been inadequate to address these pressures. Finally, oil
and food price risks are also on the upside.
The combination of these factors makes central banking a somewhat more complex
environment to operate in. The global economy has emerged from recession, but has not yet
returned to pre-crisis levels of output and employment. The very actions taken to mend the
global economy have contributed to a new set of challenges, in particular, ballooning
sovereign debt ratios. At the same time, inflation is picking up speed, owing to the spike in
food and oil prices, and the very tools central banks use to combat inflation run the risk of
attracting even more capital inflows into emerging economies. Monetary policy in the
developed world remains accommodative, policy rates are still close to zero and quantitative
easing remains a feature of some of the advanced economies.
As with any crisis, there are always lessons to be learned. One of these as I mentioned in the
introduction, is the limitations of monetary policy and the fact that the achievement of price
stability by itself does not lead to financial stability. We are already seeing greater emphasis
on financial stability compared to prior the crisis. Not only will central banks need to pay
greater attention to financial considerations in framing monetary policy, but will also most
likely play a greater role in macro prudential policy. In this respect, central banks are well
placed to deal with these challenges, having the relevant expertise in macro-economic
analysis, knowledge of financial markets, overseeing payments and settlements
infrastructure and (in many cases) explicit responsibility for the regulation and supervision of
financial institutions.2
Nonetheless, the financial stability objective of central banks remains clouded with
uncertainty. It is unclear to what extent it can be an additional objective of monetary policy,
and even if it is, how do central banks adjust the policy response, are there sufficient and
appropriate instruments available to central banks to fulfil this dual mandate and would
macro prudential policy at times not run the risk of undermining the effectiveness of the
monetary transmission mechanism. In addition, there are implications for legislative and
governance arrangements. There is much work underway in trying to understand exactly
what all this means.
So while central banks may have perfected the art of monetary policy in the last decade, they
have also undergone a tectonic shift in the last few years, which still has some way to go.
3. Emerging markets and capital flows
One of the consequences of the easy monetary policy employed over the past few years has
been the surge in capital flows to emerging market economies. The Institute of International
Finance (IIF) records that net private capital inflows to emerging markets increased from just
below US$200 billion in 2002 (1,5 per cent of GDP) to US$908 billion in 2010 (7 per cent of
GDP). The IIF estimates that inflows will rise to US$960 billion in 2011 and to over
US$1 trillion in 2012. These inflows reflect a combination of greater macroeconomic
fundamentals in emerging markets, significant fiscal deterioration and loose monetary policy
in advanced economies, and the increased integration of emerging economies into
international capital markets.
Many emerging market economies have taken various actions towards curbing capital
inflows in an attempt to limit currency appreciation. Measures considered and implemented
range from taxes on inflows, limits being placed on government bond investment by
foreigners, to pre-announced currency market intervention programmes, just to name a few.
South Africa too has experienced large capital inflows, with the resultant upward pressure on
the exchange rate of the rand. A favourable fiscal position, deep and liquid capital markets
and sound macroeconomic policy have made the country an attractive destination for
portfolio inflows. South Africa has studied the measures imposed by other emerging market
economies, but questions the efficacy of most of these measures. Furthermore, it is doubtful
that such measures would be appropriate for South Africa given our savings/investment
imbalance and dependence on portfolio flows to finance our current-account deficit. Like the
Philippines, where measures to encourage greater capital outflows were implemented, so too
has South Africa lifted some of the limits on outward investments for local pension funds,
insurers and individuals.
South Africa has also taken advantage of strong capital inflows to increase the level of
foreign-exchange reserves. Gross reserves have increased by approximately US$9,6 billion
since January 2010 to US$49,3 billion in March 2011. Of this amount, an increase of about
US$5,5 billion was recorded in the first quarter of 2011. During the 2010 calendar year, the
South African Reserve Bank purchased US$7,4 billion for foreign-exchange reserves
accumulation, while approximately US$3,8 billion was purchased during the first quarter of
2011. The Bank's policy continues to be that the exchange rate remains market-determined,
and therefore the policy is to accumulate reserves and not to defend or achieve a particular
level for the exchange rate.
4. Recent domestic economic developments
The improvement in global economic activity and in international commodity prices, along
with domestic monetary and fiscal stimulus, resulted in a cyclical improvement in the South
African economy. After emerging from recession in third quarter of 2009, growth accelerated
to 4,8 per cent in the first quarter of 2010, but moderated to 4,4 per cent in the fourth quarter
of 2010. On an annual basis, real GDP growth contracted by 1,7 per cent in 2009 but
improved by 2,8 per cent in 2010. There was a marked turnaround in manufacturing
production in 2010. After contracting by 10,4 per cent in 2009, the manufacturing sector grew
by 5,0 per cent in 2010. Despite the increase in activity, manufacturing production remains
well below the peak reached in 2008 and has been primarily driven by the motor vehicle
sector. In general, a lack of new private sector investment projects, relative strength of the
rand and unfavourable economic developments in some of the country's key export markets,
led to a subdued performance. High commodity prices and strong export demand also lifted
mining output in the fourth quarter. The economy, however, continues to be characterised by
a significant degree of underutilisation of productive capacity, measuring 80,7 per cent in the
fourth quarter of 2010, well below the pre-crisis average of around 85 per cent.
Among the expenditure components, real final consumption expenditure by the household
sector contracted for five successive quarters before resuming an upward trend from the final
quarter of 2009. In the fourth quarter of 2010, real final consumption expenditure by
households increased by just over 5,0 per cent, reflecting positive consumer sentiment and
disposable income growth. Credit extension figures show a better take-up of credit by
businesses, implying that the recovery in investment spending will pick up and that subdued
growth in gross fixed capital formation will improve. However, while the Bank is of the opinion
that consumption expenditure may remain relatively robust, it is unlikely to accelerate to
excessive levels in the short-term, owing to continued high levels of household indebtedness
(77,6 per cent of disposable income). The ratio of impaired advances to gross loans and
advances has remained at elevated levels of around 5,8 per cent for some time, but has
stabilised. Bank credit extension to the private sector is also relatively subdued, with total
loans and advances growing by 4 per cent since September 2010, house prices are either
declining or growing at low nominal rates, while equity prices will most likely also have a
moderating impact on wealth effects and consumption.
The Bank forecasts that growth will average 3,7 per cent in 2011 and 3,9 per cent in 2012.
Various high frequency indicators suggest a positive growth momentum going forward. The
composite leading business cycle indicator has remained in positive territory, both business
and consumer confidence levels are relatively high, and the Purchasing Managers Index for
the manufacturing sector maintained a level above the key 50 threshold. Notwithstanding
these developments, unemployment remains very high. Even the improved growth rates are
insufficient and well below what is required to significantly impact on the unemployment rate,
which measured 24,0 per cent in the fourth quarter of 2010.
As with any forecast, there are many risks. Notably, global developments present some
challenges. Peripheral Europe and the unfolding sovereign debt crisis remains a wildcard,
the US economy is still fragile despite substantial stimuli, events in North Africa and the
Middle East and their impact on oil prices, and the recent disasters in Japan could all derail
the nascent global recovery and hence, South Africa's economic outlook.
5. Recent monetary policy developments
The global inflation outlook has deteriorated somewhat over the past few months, driven by
higher prices for food and oil. Inflationary pressures in emerging market economies are more
pronounced, resulting in a few emerging economies already embarking on monetary
tightening. For South Africa, cost-push pressures have increased the upside risks to the
inflation outlook, while demand driven pressures remain subdued. The year-on-year inflation
rate for consumer prices increased by 3,7 per cent in February. Despite rising global food
prices, food price inflation in South Africa is still relatively low, helped by recent bumper
maize crops and exchange rate developments. But recent data releases clearly show an
accelerating trend at both producer and consumer levels.
The Bank's CPI forecast has been adjusted higher, but still reflects that inflation should
remain within the target range over the forecast period to the end of 2012. CPI inflation is
forecast to average 4,7 per cent in 2011 and 5,7 per cent in 2012, peaking at 5,8 per cent in
the first quarter of 2012. Much of the increase in inflation is based on higher assumptions for
international oil prices. The most recent survey shows that inflation expectations of financial
analysts have deteriorated slightly, but expectations of business and trade unions have
shown some improvements. The Bureau for Economic Research Inflation Expectations
Survey shows that inflation is expected to average 5,3 per cent in 2011 and 5,7 per cent in
2012, compared to 5,5 per cent and 6,2 per cent in the previous survey.
One of the key upside risks to the inflation outlook has been high real wage settlements.
There are, nonetheless, indications of a moderation in wage settlements, with the overall
wage settlement rate amounting to 8,2 per cent in 2010, compared to 9,3 per cent in 2009.
Nominal unit labour cost growth has similarly moderated, from 9,3 per cent in the third
quarter of 2010 to 7,7 per cent in the fourth quarter. Food and administered prices remain
significant upside risks to the inflation outlook, most particularly, oil prices. It seems likely that
oil prices will remain at elevated levels, even if current geo-political challenges can be
resolved.
The Monetary Policy Committee has kept the repo rate steady at 5,5 per cent since
November 2010. While the risks to the inflation outlook are tilted to the upside, they are
predominantly of a cost-push nature, but need to be monitored very closely for any second
round effects.
6. Conclusion
In summary, the past year has brought some recovery in global economic activity, although
the momentum has slowed somewhat. There are still many risks on the horizon, and South
Africa is subject to the same risks facing the global economy.
The economic recovery in South Africa is on track and short term economic indicators
suggest that we will continue to see further improvements. However, growth continues to be
at levels that are insufficient to meaningfully address unemployment.
Inflation has picked up, but is expected to remain within the target range over the forecast
period. At the conclusion of its last meeting, the Monetary Policy Committee deemed the
policy rate to be at an appropriate level. However, inflationary pressures will be monitored,
especially insofar as second round inflationary pressures may negatively impact the inflation
outlook, so as determine when policy adjustments may be required.
Thank you. Enjoy the rest of the conference.