An address by Lesetja Kganyago,
Governor of the South African Reserve Bank (SARB),
at the ninety-ninth annual Ordinary General Meeting
of the SARB shareholders
South African Reserve Bank, Pretoria
26 July 2019
Global economic conditions
The past year began with significant challenges for emerging markets, including South
Africa. In contrast to the synchronised pickup in economic growth of 2017, which had
surprised most observers by its magnitude, the major economies began to display
divergent growth patterns in 2018. While the United States (US) maintained a strong
pace of growth amid a sizable fiscal stimulus and a buoyant labour market, the
eurozone and Japan lost some momentum. Chinese demand felt the negative impact
of earlier monetary and regulatory tightening. Growth in world trade volumes also
began to slow, a move that was exacerbated by a flare-up in trade tensions as the US
slapped tariff increases on certain imports.
This confluence of factors, together with negative current account and price
developments in countries like Argentina and Turkey, resulted in downward pressure
on emerging market currencies and fixed-income assets. This move was compounded
by the appreciation of the US dollar, as investors anticipated a further normalisation of
US monetary policy and a widening of interest rate differentials with other major
economies. By early July 2018, the South African rand had depreciated by 12%
against the US dollar from its earlier peak of mid-February, a decline that extended to
25% when the rand reached its trough in September 2018.
So what has changed since then?
Some of the concerns about global growth that prevailed in mid-2018 have proved
accurate. Business confidence, trade flows and economic activity have continued to
lose momentum in most of the major economies. Now that the impact of the 2018
fiscal stimulus has started to fade, the US is not immune to those trends.
The trade tensions that sprang up more than a year ago remain unresolved, despite
the June 'truce' between China and the US that prevented an immediate tariff
escalation. Geopolitical tensions, especially in the Middle East, are adding to a climate
of uncertainty that weighs on business investment decisions globally. In this month's
update on the World Economic Outlook, the International Monetary Fund (IMF) is
projecting global economic growth of 3.2% this year, compared to a forecast of 3.9%
a year ago.
Support for the global economy and financial markets, however, has come in the form
by the world's major central
of a quick 'change of tack' banks, as they shifted from a
gradual removal of stimulus to indicating renewed easing, at least in the US and the
eurozone. The lack of inflation pressures provides room for such an approach. In fact,
core inflation in both the US and the eurozone is currently short of its 2% target, while
oil prices, amid slowing global demand, are off the highs reached in October 2018.
Meanwhile, in China, the authorities have loosened both fiscal and monetary policies
in an attempt to limit the pace of economic deceleration. Against such a background,
emerging market assets have rallied, and with inflation generally showing only a
limited response to last year's currency depreciation in several emerging countries,
the scope for their central banks to provide at least some accommodation has
increased.
Domestic economic conditions
This less favourable global growth and trade environment has added to South Africa's
economic concerns at a time when the domestic drivers of growth were already
stuttering. Addressing this audience a year ago, I highlighted how the rebound in
business optimism following changes in political leadership had already started to
erode in the second quarter of 2018.
This erosion has unfortunately continued over the past 12 months. Both the Rand
Merchant Bank (RMB) / Bureau for Economic Research (BER) survey of businesses
as well as other indicators, such as the Absa Purchasing Managers' Index (PMI) and
the Sacci Trade Conditions Indicator, are signalling low business confidence amid a
challenging environment in all sectors. Such low business confidence, coupled with
uncertainty about future economic growth, has weighed particularly heavily on private
sector fixed investment, which contracted by 2.5% year on year in the first quarter of
2019 and, overall, has stagnated over the past half-decade.
Weak private sector fixed investment has indeed been a key cause of the
disappointing performance of South African gross domestic product (GDP) growth.
Much has been said and written about the sharp contraction in first-quarter GDP
- -
growth 3.2% on an annualised basis and whether it was a true reflection of the
state of the economy. There is no denying that, from quarter to quarter, GDP has been
the SARB's
quite volatile of late. Indeed, internal econometric models estimate that
activity will recoup part of that first-quarter decline in the second quarter of the year.
That said, the less volatile year-on-year comparison shows that GDP growth slowed
to zero in the first quarter of the year, which was the weakest performance in exactly
three years and one that was indeed consistent with other indicators of activity. And
while our models envisage an improvement in the remaining quarters of the year, the
SARB projects GDP growth of only 0.6% in 2019 after 0.8% in 2018. This means that
in both years, as indeed in all but one of the past four years, real GDP would grow
slower than the population growth rate of 1.6%, thus contracting on a per capita basis.
Weak economic growth does not just hinder efforts to reduce poverty and inequality;
it also weakens public finances. For the current fiscal year, National Treasury projects
that the consolidated government deficit will rise to 4.5% of GDP and will only decline
to 4.3% next year. By contrast, in the 2018 Budget, projections were for a deficit of
only 3.6% of GDP for both fiscal years.
Inflation
In a constrained economic environment, it is not unexpected that some voices argue
that monetary policy could do more to support economic growth. But what exactly is
SARB's
the margin of manoeuvre, bearing in mind that any policy move must comply
with our mandate of price and financial stability?
Encouragingly, the past year has seen several favourable developments on the
inflation front. First, headline consumer price inflation averaged 4.6% between
July 2018 and June 2019, and stood at 4.5% over the past month. Overall, this is a
more benign pace of increase than the SARB had projected a year ago, even against
a background of higher oil prices, significant rand depreciation, and a 1 percentage
point increase in the rate of value-added tax (VAT) in 2018.
SARB's
Second, the Quarterly Projection Model (QPM) now forecasts average
inflation of 5.1% in 2020 and 4.6% in 2021, both well within the target range. In fact,
our projections for the less volatile core inflation rate are even closer to the midpoint
of that range.
Finally, several measures of inflation expectations, including the quarterly BER survey
of inflation expectations among analysts, businesses and unions as well as the bond
market-based metrics, have shown a steady decline over the past year, after many
years of remaining uncomfortably close to the top end of the target range.
Faced with rising longer-term upside risks to the inflation outlook, the SARB felt that it
was appropriate to act against such risks, especially in light of policy normalisation in
-
advanced economies which would most likely imply a higher neutral real interest
open economy like South Africa's. Hence, in November
rate for a small and 2018, the
Monetary Policy Committee (MPC) decided to raise the repurchase rate (repo rate) by
25 basis points, reversing the cut that had been implemented in March of the same
year. By early 2019 though, inflation performance was more benign than anticipated
and the risks to the inflation outlook had eased sufficiently enough for the SARB to
maintain an unchanged policy stance.
At the time of its latest meeting held on 18 July 2019, the MPC felt comfortable enough
with the recent downward trend in inflation outcomes, as well as the ongoing decline
in inflation expectations, to lower the repo rate by 25 basis points.
Overall, when looking back at the last few years, it is important to acknowledge the
progress that has been made in reducing inflation volatility in South Africa, including
in response to exchange rate shifts, and how this has allowed for a better anchoring
of inflation expectations and, in turn, how this has also limited the need for sharp
monetary adjustments. Since 2016, surveyed inflation expectations have declined by
100 basis points.
A more stable and predictable path of interest rates will enhance the environment for
sustained economic growth, as the experience of many advanced economies and,
increasingly, also the emerging economies has shown. The persistence of such gains
is, however, not certain, meaning that the MPC will continue to exercise vigilance in
the years ahead.
Financial stability
With the implementation of the Financial Sector Regulation Act 9 of 2017 (FSR Act) in
April last year, the SARB was provided with an explicit statutory mandate to protect
and enhance financial stability. The FSR Act further requires the SARB to monitor and
keep under review the strengths and weaknesses of the financial system, as well as
any risks to financial stability. To this end, the SARB has developed frameworks for
identifying, monitoring and mitigating systemic risks.
On the whole, the SARB currently assesses the financial sector to be strong and
stable. Nevertheless, potential vulnerabilities exist, as we have observed a few
emerging trends over the past year, particularly in the banking sector. While South
African banks remain adequately capitalised and profitable, the implementation of the
new expected credit loss accounting standard, namely the International Financial
Reporting Standard 9 (IFRS 9), has resulted in a deterioration in the quality of credit
on bank books. Furthermore, as persistently low domestic economic growth starts to
have an increasingly tangible impact on the balance sheets of both households and
corporates, credit quality may be expected to deteriorate further.
During the course of 2018, the SARB undertook stress tests on six major banks to
assess the resilience of the banking sector to hypothetical yet extreme
macroeconomic shocks. The outcome of the 2018 common scenario stress test
exercise suggests that, at an aggregate level, the South African banking sector would
be able to withstand the possible materialisation of a confluence of the main financial
stability risks. With respect to solvency, the banks were assessed to be capable of
maintaining their capital levels above the minimum capital adequacy requirements,
under the adverse macroeconomic scenarios considered. The SARB also discovered
that no material risks were emanating from the liquidity positions of the six major South
African banks.
The SARB regularly conducts an assessment of the prevailing financial stability risks.
These assessments are reported to the Financial Stability Committee (FSC) and
Financial Stability Review
published biannually in the (FSR). The risks identified since
the second quarter of 2018, which currently form part of the SARB's assessment,
include:

a deteriorating domestic fiscal position, exacerbated by, among other things,
weak domestic growth, a poor revenue outlook, and the fragile financial
positions of SOEs;

spillovers from weaker global economic growth;

the possibility of renewed and unexpected tightening in global financial
conditions and the subsequent potential rapid repricing of risk; and

rising cyber-dependency and security risks attributed to the ever-increasing
digital interconnection of people, systems and organisations.
The identification and monitoring of financial stability risks, while important, would be
rendered ineffective if we did not have the necessary tools at our disposal to mitigate
the occurrence and/or the impact of these risks. Over the past few years, the SARB
has been actively developing a macroprudential policy framework, complete with tools
and instruments. This past year, work continued to enhance the framework and the
financial stability toolkit.
There is a saying about the best-laid plans 'of mice and men'. Thus, while the SARB
ultimately aims to mitigate systemic risks, it also needs to plan for potential crises and
how to deal with them. In this regard, the SARB has taken a number of significant
steps towards strengthening South Africa's
resolution framework over the past year.
Two separate but related projects were initiated in this area, namely to implement a
resolution framework and a deposit insurance scheme.
The resolution framework, once promulgated into law, will bring South Africa's
framework in line with the Financial Stability Board's Key Attributes for
resolution
formalise the SARB's role as
Effective Resolution Regimes. This framework will also
the resolution authority, and will outline the responsibilities with respect to the orderly
resolution of designated financial institutions.
Meanwhile, the imminent establishment of the Corporation for Deposit Insurance
(CDI), as a subsidiary of the SARB, will provide explicit guarantees to protect
depositors should a bank ever fail. As a result, not only will depositor confidence in the
banking system be enhanced; the CDI will also assist government that, in the past,
may have compensated depositors with taxpayers' money.
Financial sector supervision and regulation
As you will recall, the FSR Act lays the foundation and the financial system regulatory
architecture of the Twin Peaks model. The Twin Peaks regulators, being the Financial
Sector Conduct Authority (FSCA) and the Prudential Authority (PA), work alongside
the SARB and other regulatory bodies to ensure the stability of our financial system
for the well-being of all South Africans. The PA was established on 1 April 2018 and
has been operating within the administration of the SARB, as prescribed by the FSR
Act.
While much of its first year was spent on refining and implementing the integrated
framework for supervision, including assuming responsibility for the insurance industry
and market infrastructures, the PA also had to complete the resolution of VBS Mutual
Bank. On 25 June 2019, the PA released its first Annual Report, which reflects all its
activities for the 2018/19 financial year.
The proposed nationalisation of the South African Reserve Bank
The debate about the proposed nationalisation of the SARB continues in the public
domain, fuelled by perceptions that private shareholders have control over the central
bank. The SARB has clarified, on a number of occasions and through various
communication channels, that its private shareholders participate as preference
shareholders and do not own or control the SARB, nor do they influence monetary
policy or any of the other regulatory functions.
Let me reiterate what I have repeatedly been saying in the public domain: the Board
of the SARB focuses on governance issues, while policy and regulatory decisions are
the preserve of the Governor and Deputy Governors. The South African Reserve Bank
Act 90 of 1989 (SARB Act) provides for 15 Board directors, eight of which are
appointed by the President, including the Governor and three Deputy Governors. The
remaining seven directors are elected by shareholders.
As shareholders of the SARB, you are fully aware that the SARB Act prescribes that
no shareholder or their associates are allowed to beneficially hold more than
10 000 shares. A fixed annual dividend of 10c per share is issued if profits are made,
resulting in the potential total annual dividend payout to shareholders by the SARB
being limited to R200 000. After setting aside contingencies, reserves, tax and the like,
90% of any remaining surplus accrues to government.
Celebrating 25 years of democracy
This year, we marked 25 years of democracy in South Africa through the launch of
under the theme
new commemorative circulation and collectable coins 'SA25'. This
series includes six new commemorative circulation coins: five themed R2 coins and a
themed R5 coin. Through these coins, we celebrate the Constitution, more specifically
the Bill of Rights, which is considered to be the cornerstone of our democracy.
We picked this theme because, aside from being the most iconic feature of our
democracy, the Constitution provides for independent institutions, including the SARB.
It defines our price stability mandate. The inflation-targeting framework aims to ensure
that inflation remains low to preserve the purchasing power of households and the
competitiveness of firms. We have endeavoured to ensure that the financial system
remains safe and that our policies aim to bolster the resilience of the economy.
Conclusion
As the public debate about the role of central banks continues, the SARB has ensured
that it continues to execute its mandate in the public interest. In this regard, we have
endeavoured to be transparent in the execution of our duties, including by providing
clear reasons for our decisions and clarifying the limitations in our ability to influence
long-term economic growth. In all our decisions, we must consider the trade-offs
between short-term and long-term gains. Anchoring inflation expectations, gaining
credibility, and building institutional capability are all important elements in enhancing
the resilience of the South African economy.
Thank you.
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