Mr. Stals looks at the effects of the changing financial environment on
monetary policy in South Africa Address by the Governor of the South African Reserve
Bank, Dr. C. Stals, at the Annual Dinner of the Pretoria branch of the Economic Society of
South Africa held in Pretoria on 15/5/97.
1. The objectives of monetary policy
The Gerhard de Kock Commission of Inquiry into the Monetary System and
Monetary Policy in South Africa laid the foundation for the monetary policy model applied in
South Africa over the past decade. Although the De Kock Commission's final report on
monetary policy was submitted in May 1985, it was only since 1986, when money supply targets
were first introduced, that the implementation of the model took its course. Indeed, full
implementation only came about after the untimely death of Gerhard de Kock in August 1989.
In line with monetary policies applied in most developed economies, the South
African monetary policy model is firmly directed towards the overall objective of creating and
maintaining a stable financial environment. For central bankers, the ultimate price of a stable
financial environment is a low rate of inflation -- a rate that, in the words of Alan Greenspan,
will have no material effects on the macroeconomic decisions of consumers, investors, traders,
producers and all other participants in total economic activity.
This monetarist approach to monetary policy does not imply that central bankers
have no interest in or sympathy for the national objectives of economic growth, job creation and
the improvement of the living conditions of the people. On the contrary, central bankers believe
that maximum economic development can only be achieved and sustained in an environment of
stable financial conditions. The efforts of monetary policy must therefore be directed towards
what central bankers can do best in support of the national objectives, and that is to manage the
money system of the country in the interest of overall economic development.
A stable financial environment is a precondition for sustainable economic
development, but provides no guarantee that the real economy will indeed perform at maximum
capacity. There are too many other macroeconomic (and non-economic) factors that will in the
end determine the actual economic growth performance. There is, however, convincing
theoretical logic and much empirical evidence to confirm that persistent unstable financial
conditions are detrimental for growth, particularly in a country with an economy based on the
principles of the market mechanism.
The De Kock Commission therefore in 1985 summarised its findings as follows:
"(The Commission) does not believe, for example, that anything can be gained in
the long run in terms of real growth or employment by accepting higher inflation rates. The
opposite is more likely to be true. Higher inflation will in the long run militate against growth
and job creation. The objectives of external balance, growth and employment will over time be
served best by creating and maintaining a climate of reasonable domestic price stability". (Par
47)
2. The changing financial environment
The deliberations of the De Kock Commission took place in an overall
sociopolitical and economic environment that was completely different from what we have to contend
with in South Africa today. With his wisdom and his foresight, Gerhard de Kock may have
envisaged, and surely wished for, an environment in which monetary policy could be applied
without the shackles of sanctions, boycotts, exchange controls, high inflation, social unrest and
political distortions that characterised the period of his domain.
Over the past decade, the situation has changed dramatically. The major
socio-political reforms of the early 1990's opened up the way for a normalisation of South
Africa's position in the world environment. Also in the field of economic and financial relations,
South Africa has been reintegrated in the international community from which it was excluded
over the preceding two decades. The international economic punitive actions against South
Africa were repealed in great haste after the Government of National Unity took power in April
1994, and South Africa took its rightful place again in international forums such as the United
Nations, the Bretton Woods Institutions (IMF and World Bank), the Organisation of African
Unity, and the British Commonwealth of Nations.
South Africa became reintegrated into a world financial system that was vastly
different from the one it had left in the late 1970's and early 1980's. The explosive
developments during its absence in electronics and in communications, and the revolutionary
trans-formation from mainly manufacturing/trading economies to a new service/information
based culture, led to a strong movement of globalisation in financial market activity. This
process forced the liberalisation of domestic and international financial markets in many
countries, led to the abolition of exchange controls and exposed countries more directly to the
disciplines of international markets.
Today in South Africa, there are more than 60 foreign banks that compete
through representative offices, branches and subsidiaries with the domestic banks to provide
financial services to the South African community. We are in the process of gradually removing
our exchange controls to join the other approximately 60 (out of 185) countries of the world,
that have already succeeded in removing all restrictions on current and capital account
international transactions. Non-residents participate very actively in the South African market
for foreign exchange and in the domestic money and capital markets. Prices on the Johannesburg
Stock Exchange and the Bond Exchange of South Africa are affected almost instantaneously by
developments in the rest of the world. Volumes in these markets have exploded to a level that a
De Kock Commission of fifteen years ago could not anticipate, not even in the wildest flight of
the imagination.
Recent changes in the South African community led to the more active absorption
of many South Africans in the market economy. Latent demands were stimulated by the reforms
and many expectations were created by the new political dispensation. The emphasis in fiscal
policy has changed dramatically, with the retention, fortunately, of basic sound disciplines.
The South African banking sector had to be restructured to provide for thousands
of informal savings clubs (Stokvels) and for community banking. There is even pressure on the
Reserve Bank to legalise fraudulent pyramid schemes such as those that recently brought the
country of Albania to anarchy.
3. The implications for monetary policy
The question does arise whether all these changes did not make the findings of the
De Kock Commission irrelevant. Should monetary policy still hold onto the same objective, and
has the task and the functions of the central bank perhaps not also changed over the past few
years?
The Reserve Bank believes, however, that the main objective of monetary policy
as defined by the De Kock Commission is as important and warranted today as it was in the
mid-1980s. Indeed, in the environment of a greater involvement of international participants in
the South African financial markets, it is of even greater importance that South Africa shall
maintain overall financial stability, that our rate of inflation shall be brought more in line with
the average rate of inflation in the economies of our major trading partners, and that
internationally recognised sound monetary and fiscal policies shall be applied at all times. The
main objective of monetary policy in the new South Africa must remain to protect the value of
the currency.
Critics of this unbending attitude of the Reserve Bank often confuse the objective
of monetary policy with three other aspects of Reserve Bank operations, namely the strategy
followed by the Bank in pursuance of its objective, the operational procedures applied by the
Bank, and the instruments used to achieve its objective. There may be a need at this juncture, in
light of the major changes of the past few years, to reconsider some of these aspects of monetary
policy that have more to do with the implementation of the policy, and not with the objective.
The strategy of a central bank can be described as the model it uses to pursue the
non-negotiable objective of protecting the value of the currency. On recommendation of the De
Kock Commission, the South African monetary policy model was based on monetary targeting
which anchors monetary policy decisions to changes in the money supply. This model worked
extremely well, particularly in the times of South Africa's economic isolation from the outside
world. It is doubtful, however, if this model is still the most effective strategy to maintain in the
new environment. It has, for example, become much more difficult for the Reserve Bank to
control the money supply in a situation where so many foreign banks operate in South Africa,
and where South African banks have so much easier access to financial resources from
correspondent banks in the rest of the world.
It is also a debatable issue whether the demand for credit in South Africa is not in
the new environment less sensitive to interest rate changes than before. And, furthermore, the
relationship between changes in the money supply and eventual price changes may have become
much weaker now that the volumes of transactions in the financial markets have increased so
much relative to turnovers in the markets for goods and services.
There is no doubt that the money supply has lost some of its usefulness as an
anchor for monetary policy. With South Africa not yet being ready for direct inflation targeting,
and with our inability to fix the exchange rate of the rand because of a lack of foreign reserves,
the Reserve Bank is gradually moving to a more ecclesiastic approach where a wider range of
monetary indicators are being used as a basis for monetary policy decisions. This wider range of
indicators includes changes in bank credit extension, the overall liquidity in the banking system,
the level and the yield curve of interest rates, changes in the official foreign reserves and in the
exchange rate of the rand and, of course, actual and expected movements in the rate of inflation.
The operational procedures of the central bank include the methods used for
providing accommodation to banking institutions, open market operations, intervention in the
foreign exchange market, the manipulation of interest rates, and the signalling to markets of
policy intentions. The South African Reserve Bank's main operational procedures over recent
years have been what the De Kock Commission described as the "classical cash reserve system
as a means of controlling bank credit creation, rather than the socalled American cash reserve
system". (Par. 76)
Without going into the details, in the South African system the Reserve Bank uses
its open market operations and other instruments of monetary policy to force banking institutions
to borrow more from the discount window whenever it is regarded as necessary to apply a more
restrictive policy. At some stage, the Reserve Bank will then also raise the Bank rate which, in a
situation of great dependence on the central bank, will force the private banks to follow with
increases in their lending and deposit rates.
Many other central banks operating in sophisticated financial markets are now
influencing short-term interest rates more directly with their operations in the markets. Instead of
overnight loans provided at the discount window, they enter into repurchase transactions with
banking institutions, with the added advantage that it can be coupled with a tender system for
central bank money, and a variable Bank rate.
The South African Reserve Bank will also have to introduce greater flexibility in
the operating procedures for the implementation of monetary policy if we want to cope with the
volatile international capital flows, exchange rate changes, and financial assets price movements.
It is of some concern to the Reserve Bank that over the past year interest rates in the South
African money market seem to have become more rigid. In the present system, the Bank no
longer gets reliable signals from market interest rates on changes in the underlying financial
conditions. If necessary, the operational procedures of the Bank will have to change to bring
more interest rate flexibility into the money market.
Finally, the instruments used for monetary policy may also have to be adapted to
the changing financial environment. In the past, the Reserve Bank, for example, often used the
Exchequer Account of the Government for the short-term withdrawal of surplus funds from the
money market. The recent introduction of an improved system for tax and loan accounts held by
Government with private banks, rules out the extensive use of this instrument for monetary
policy purposes. Similarly, arrangements now under negotiation with the Department of Finance
to relieve the Reserve Bank of the responsibilities for the primary issue of Government bonds,
and for the development of the secondary market in these bonds, will also change the Bank's
position in the capital market. It opens up the way for the Bank to have a more single-minded
open market policy approach.
The introduction of repurchase transactions in strictly defined acceptable
underlying financial assets will also provide an instrument of monetary policy that is more
malleable and can be adapted easier to the needs of the new financial environment of which
South Africa is now rapidly becoming an integral part.
4. Conclusion
There is much room for a continuing debate in South Africa on monetary policy,
but not so much on the issue of what the objectives of monetary policy should be, or whether
inflation is bad or good for the overriding objective of creating more jobs in the country. The
debate should rather concentrate on the effectiveness of the strategy, the operational procedures
and the instruments used in the pursuance of a monetary policy objective that has in any case
been casted in iron in the Constitution of the Republic of South Africa.