X P Guma: Low domestic inflation in an environment of high oil prices,
vigorous household spending and credit demand and a widening current
account deficit; and the outlook for interest rates in South Africa
Luncheon address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at Investec,
Pretoria, 4 July 2006.
* * *
Inflation in the world economy has declined significantly in recent years and has remained relatively
subdued over the past few years despite a significant rise in commodity prices and strong economic
growth. Chart 1, based on World Bank data illustrates the trend in world inflation, clearly showing the
peak that occurred at a rate in excess of 35 percent per annum in the early 1990s and the rapid
deceleration to rates around 5 per cent per annum thereafter.
South Africa's inflation performance began to improve during the 1990s, as the next chart indicates;
and subsequent to the adoption of the inflation targeting framework, inflation as measured by CPIX
entered and has remained within the target range since September 2003.
Oil prices have risen sharply since 2003 (as the next chart indicates), on account of various
determinants. During this year, the spot price of Brent crude oil has increased dramatically from
approximately US$59.9 per barrel in February to levels around US$70.5 per barrel towards the end of
April and an average of US$68.15 per barrel in June.
Continued brisk expansion in final consumption expenditure by households has been underpinned by
a steady increase in household disposable income, continued buoyancy in the real estate and
securities markets and what some describe as an accommodative interest rate environment. Overall
household debt as a percentage of annualised disposable income increased to a record level of 68
percent in the first quarter of 2006.
Robust growth in gross domestic expenditure and a concomitant strong increase in the value of
merchandise imports resulted in a sizeable deficit on the trade account of the balance of payments in
the first quarter of 2006. Given the larger shortfall on the services and income account with the rest of
the world and the somewhat subdued performance of South Africa's exports - notwithstanding the
buoyancy of international commodity prices, the current account of the balance of payments registered
a deficit equivalent to 6.4 percent in the first quarter of 2006.
Interestingly, as others have observed, despite the sell-off in emerging markets since May,
nonresidents have remained net buyers of South African financial assets and there have been significant
investment flows into South Africa over the past year. Non-resident investors bought a net R13 billion
worth of South African equities during May 2006 and R460 million the first half of June 2006. Despite
generally negative sentiment towards emerging market-market assets, they continued to buy R768
million worth of bonds in May and R4.5 billion in June.
About this there can be little argument, for all that I have done is to summarise the facts. It is also not
in dispute that the repo rate, the rate at which the South African Reserve Bank will lend to the banks,
was increased recently, primarily on account of deteriorating risks to the outlook for inflation.
What we can debate, and what I look forward to hearing your views about, is the nature of the conflict
regarding the outlook for interest rates in South Africa. The South African Reserve Bank Monetary
Policy Review (May 2006) states it as follows: "On the one hand the inflation outlook, as reflected in
the recent inflation forecasts of the Bank, has improved significantly... "on the other hand, there a
number of developments that have led the MPC to remain vigilant". This was before the last meeting
of the MPC. Does a dilemma remain and how would you characterise it?
Let me have your views.