Daniel Mminele: Recent economic and monetary policy developments in
South Africa
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at a
Breakfast Meeting hosted by Ethical Foundation for Leadership Excellence, Polokwane,
Limpopo, 27 July 2016.
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1. Introduction
Good morning, ladies and gentlemen.
Thank you to the Ethical Foundation for Leadership Excellence for creating an opportunity for
us to interact over this business breakfast today. Allow me to start by commending the
Foundation on the important initiatives it has been undertaking since its official launch last
year, to contribute to improved governance standards through ethical leadership excellence.
I have been asked to give you an update on recent economic and monetary policy
developments. Many studies have highlighted the economic and social costs of bad
leadership in various spheres of society, and thus one should not under-estimate the
important role that ethical leadership can play in addressing the economic challenges that
the world, including South Africa, currently faces.
We strongly believe that the credibility and reputation of the South African Reserve Bank
(SARB), which is very critical to our work, depends on excellent leadership. Thus the Bank
pays particular attention to its own leadership. Having engaged for two years in a bank-wide
authentic leadership training programme, to access and use reflective and coaching skills,
the Bank is now embarking on leadership development customised for each management
level.
We concluded the most recent of our Monetary Policy Committee (MPC) meetings less than
a week ago, and my remarks today will be largely informed by our assessment from that
meeting. After some points on the global backdrop, I will talk about recent economic and
financial market developments in South Africa, and provide an update on monetary policy in
this challenging economic environment. Before I conclude I will briefly touch on economic
developments in the Limpopo province, relative to national trends.
2. Global economic developments
A week ago the International Monetary Fund (IMF) released the World Economic Outlook
(WEO) update, which confirmed that the global economy continues to struggle to find
momentum. The IMF noted lackluster growth in most advanced economies, low potential
growth and a gradual closing of output gaps, while prospects remained diverse across
emerging market and developing economies. Similarly, the G20 Finance Ministers and
Central Bank Governors indicated over the weekend that the global economic recovery
continues, but is facing challenges and downside risks, amid fluctuating commodity prices,
high financial market volatility, geo-political conflicts, terrorism and refugee flows. While
some of these factors have been with us for a number of years now, more recently, the
downside risks facing the global economy have been compounded by the outcome of the
British referendum vote, or Brexit, as it is more commonly referred to. As a result of Brexit,
the global outlook for 2016-17 has worsened, as the vote added significant uncertainty to an
already fragile global economic environment, and is likely to affect confidence and weigh
negatively on consumption and investment. I should add that Brexit has also highlighted the
importance of inclusive growth, an issue which was highlighted in the latest G20
communique.
The IMF noted that prior to Brexit, economic data and financial market developments pointed
to an improvement in the outlook for a few large emerging markets and a modest upward
revision to global growth for 2017 (0.1 percentage point). In the aftermath of Brexit, however,
the IMF downgraded global growth projections by 0,1 percentage points for both 2016 and
2017 to 3,1 and 3,4 per cent respectively. Advanced economies were primarily responsible
for the more pessimistic outlook, with the IMF revising the United Kingdom's 2017 outlook
downwards by almost a full percentage point, while the euro area's outlook was downgraded
by a lesser 0,2 percentage points.
With the exception of sub-Saharan Africa, where the IMF downgraded its outlook by over
1 percentage point for 2016, mainly on account of adverse developments in Nigeria and
South Africa (the two largest economies), the outlook for emerging markets has generally
remained steady, with stronger than expected recoveries in Russia and Brazil in the
forecasts. Although the contribution of emerging markets to global growth has dwindled in
recent years, they continue to account for around 58 per cent of global gross domestic
product (GDP) and therefore remain significant.
Given that the Brexit outcome was generally unanticipated, the outcome was initially followed
by heightened financial market volatility and renewed risk aversion. Emerging market
economies were subjected to a strong negative impact from Brexit, however, the emerging
markets most strongly affected have been those that are highly dependent on the EU as an
export market, like South Africa. Notwithstanding the short term financial market volatility,
financial markets have since recovered and asset prices have rallied. This development was
supported by a good level of preparedness by major central banks and quick responses after
the referendum, demonstrating readiness to act decisively in dealing with any fallout in the
financial markets.
While there has been some reprieve in financial markets, it is to be expected that until Brexit
negotiations have been completed or the likely outcome becomes clearer, there could be
significant bouts of volatility and heightened uncertainty. This means that forecasts will be
subject to further revisions as the impact of Brexit unfolds, and the respective positions of the
negotiating partners are revealed. Heightened uncertainty is likely to spill over into financial
markets, which usually means capital outflows from emerging market economies which are
perceived to be more risky, as investors look for so-called safe haven assets. At the same
time, however, Brexit appears to have swung the monetary policy pendulum more towards
an even easier stance in advanced economies, and as such, in the short term we could still
witness inflows into emerging markets as investors search for higher yields. The US Fed,
which had embarked on a normalisation path for its monetary policy, may now slow down its
pace, again adding to uncertainty and volatility. The results of their most recent deliberations
will be announced tonight, and the markets are waiting to glean from their statements what
the likely future trajectory of interest rates might be.
It has been argued that in sub-Saharan Africa, Brexit could potentially have severe
repercussions given that the European Union is one of the region's biggest trade and foreign
investment partners. South Africa's trade links are relatively small, but could suffer the most,
given its strong investment and financial links with the UK and the relatively high integration
of domestic markets with global financial markets. According to Moody's South Africa has
been the largest recipient of UK foreign direct investment (FDI) in Africa, accounting for
about 30 per cent of total UK investment in Africa in 2014.1 Moody's further assert that given
South Africa's lowest FDI levels in 10 years in 2015, Brexit-related uncertainty might delay
investment decisions and introduce a downside risk to FDI inflows into South Africa.2
Market expectations of even easier monetary policy in advanced economies are reflected by
the decline in long term government bond yields, across all maturities. Since the date of the
referendum the yield on 10-year US Treasury bonds has declined by 19 bps, while the
10-year German bond yields and the UK bond yields are down by 12 and 57 bps
respectively. The universe of negative yielding fixed income instruments is now around
US$13 trillion, an unusual state of affairs that may harbour many risks for financial stability.
Therefore there is a need for increased vigilance to guard against distortive allocations of
capital and asset price bubbles.
Other risks facing the global economy include unresolved legacy issues in the European
banking system; continued reliance on credit as a growth driver in China which heightens the
risk of an eventual disruptive adjustment; and non-economic risks already mentioned earlier
such as geopolitical threats and terrorism, amongst others.
3. Recent domestic economic and financial market developments
As noted in the recent MPC statement, the domestic economic growth outlook remains
extremely challenging. Real economic activity in South Africa has contracted in the first
quarter of 2016, declining at an annualised rate of 1,2 per cent, whilst also contracting on a
year-on-year basis for the first time since 2009 when economic conditions were dominated
by the effects of the global financial crisis. The poor performance in the first quarter reflected
a further decline in the real output of the primary sector coupled with slower growth in the
value added by the tertiary sector. Two key factors need to be mentioned in this regard,
namely the unfavourable climatic conditions which had a considerable impact on the
agricultural sector, and the challenging trading environment encountered by the mining
sector. Together these two factors caused the primary sector to contract at a rate of 15,5 per
cent in the first quarter of 2016.
Similarly concerning are trends in real gross domestic expenditure which declined at an
annualised rate of 1,3 per cent in the first quarter. Contractions were recorded in real final
consumption expenditure by households and real gross fixed capital formation, while growth
in real final consumption expenditure by general government also slowed in the first quarter
of 2016. Gross fixed capital formation contracted sharply in the first quarter of this year, the
second consecutive contraction, and accounted for by both the private sector and general
government. Confidence levels have deteriorated, as measured by the FNB/BER consumer
confidence index, while the BER retail confidence index declined sharply in the second
quarter. The deterioration in consumer confidence means that household consumption
expenditure is likely to remain subdued, further exacerbated by high debt levels, rising costs
of debt servicing, and slow employment growth. Consumption expenditure has been further
constrained by the absence of significant wealth effects owing to the weak performance of
asset markets, particularly the housing market. These factors have contributed to persistence
of high rates of unemployment. In the first quarter of 2016 the official unemployment rate
increased to 26,7 per cent. Annual losses in employment have been recorded in the
manufacturing, private households, electricity, agriculture and transport sectors. Youth
unemployment remains a serious challenge, having increased markedly to 54,5 per cent in
the first quarter of 2016.3 The unemployment challenge was emphasized by Mr David Lipton,
First Deputy Managing Director of the IMF, in Johannesburg last week. In his speech he
pointed to the limited progress on reforms to remedy the unemployment situation and
recommended a fresh and energetic review of South Africa's policies, followed by action.4
Although the negative growth in the first quarter of this year is anticipated to have been the
low point of the cycle, the recovery is expected to be weak. At the July meeting of the MPC,
the SARB revised downward the growth projection for this year to zero per cent, from the
previous projection of 0,6 per cent. In order to achieve a growth rate of zero per cent, the
economy will need to grow by between 0.8 and 1.0 per cent in each of the three remaining
quarters. For growth to be at 0.5 per cent for 2016, we would require growth of above 2 per
cent for the remainder of the year. Furthermore, the SARB does not believe that a
contraction in the second quarter is likely - a result that would tip the economy into a
technical recession. The reasons for this are reasonably positive economic data thus far for
the second quarter, in particular, the mining and manufacturing sectors are expected to add
positively to growth, consistent with the Barclays PMI which has been above the neutral
50 level since March. In addition, the BER manufacturing confidence index also improved,
while the real value of building plans passed is indicative of some improvement in the sector,
particularly with respect to residential construction.
Looking further out, growth rates of 1,1 per cent and 1,5 per cent are forecast for the next
two years, down from 1,3 per cent and 1,7 per cent previously. The Bank's estimate of
potential output has been revised down marginally to 1,4 per cent in 2016, rising to 1,7 per
cent in 2018.
Turning to the external sector, although the prices of some of South Africa's major exports
such as iron ore and coal have recovered, the slowdown in the Chinese economy is
generally expected to keep commodity prices depressed in the immediate future.
Fortunately, whilst growth in merchandise exports remain subdued, the value of imports has
edged only slightly higher, with increases in the value of imported capital and intermediate
goods largely offset by lower imports of consumer goods. As a result, the country's trade
deficit narrowed to R38 billion in the first quarter of 2016 from R41 billion in the fourth quarter
of 2015.
South Africa's current account balance nonetheless deteriorated in the first quarter from
4,6 per cent of GDP in the fourth quarter of 2015 to 5,0 per cent of GDP. This outcome was
largely as a result of the widening deficit on the services, income and current transfer
accounts. South Africa's current account deficit leaves it vulnerable to short-term capital
outflows if investors' risk perceptions and appetite were to be adversely influenced. South
Africa relies on short-term private-sector capital inflows to finance its current account deficit
and a decline in capital inflows will put pressure on the country's balance of payments.
4. Monetary policy
The SARB's primary mandate is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth.
In this respect, the SARB follows a flexible inflation targeting (IT) policy framework, where
temporary breaches of the target can be tolerated in the interest of smoothing out
fluctuations in the growth trajectory. However, the disappointing growth outcomes and
outlook highlighted earlier have been accompanied by rising inflationary pressures. This has
presented a challenging policy environment for the MPC.
The inflation rate, as measured by the increases in the consumer price index (CPI), was
recorded at 6,3 per cent year-on-year in June 2016 compared to a 6,1 per cent in May 2016.
The inflation rate has exceeded the upper band of the target since the beginning of the year
averaging 6,3 per cent for the first 6 months of 2016. The main drivers were increases in the
prices of food and non-alcoholic beverages which increased by 11,0 per cent in June, only
slightly below the recent peak of 11,3 per cent in April. Goods price inflation measured
6,7 per cent, up from 6,6 per cent in May, while services inflation increased to 5,8 per cent
from 5,7 per cent in May. The Reserve Bank's measure of core inflation, which excludes
food, fuel and electricity increased marginally to 5,6 per cent compared with the 5,5 per cent
annual increase in the previous month.
On the other hand, producer price inflation for final manufactured goods has been on a
downward trend, declining from 7,0 per cent in April to 6,5 per cent in May mainly due to a
moderation in price inflation of food, beverages and tobacco products. This was below the
consensus forecast of 6,9 per cent but the impact of the drought is still evident in the
increase in prices of agricultural products, particularly cereals and other crops as well as live
animals and animal products.
Inflation expectations, as reflected in the survey conducted by the Bureau for Economic
Research, have remained anchored near or just above the upper end of the inflation target
range. In the second quarter, average expectations for 2016 were 6,3 per cent, marginally up
from 6,2 per cent. Average expectations for 2017 were unchanged at 6,2 per cent and were
marginally down to 5,9 per cent for 2018. Average 5-year inflation expectations declined from
6,1 per cent to 5,9 per cent in the second quarter, with downward revisions by all groups.
The yield differential between inflation linked bonds and conventional government bonds
(break-even inflation expectations) declined across all maturities but remain elevated.
The latest inflation forecast of the Bank shows a marginal improvement compared with the
previous forecast, although an acceleration in inflation is still projected for the second half of
this year. Inflation is only expected to return to within the 3 - 6 per cent target range during
the third quarter of 2017, averaging 5.5 per cent in 2018. According to SARB forecasts,
inflation is expected to average 6,6 per cent in 2016 and 6,0 per cent in 2017, compared with
forecasts of 6,7 per cent and 6,2 per cent at the MPC meeting in May. The expected peak, at
7,1 per cent in the fourth quarter of 2016, has been revised slightly down from 7,3 per cent
due in part to lower administered price inflation (mainly petrol prices). An encouraging
development is the moderation in the forecast for core inflation, from an average of 5,8 per
cent in 2016 to 5,3 per cent by 2018. Whereas previously core inflation was expected to
breach the upper end of the target range in the third quarter of 2016 for four consecutive
quarters, a one-quarter breach, at 6,1 per cent, is now expected in the fourth quarter of this
year.
A discussion on the inflation outlook would be incomplete without referring to developments
in the exchange rate of the rand, one of the biggest risks to the inflation outlook. The recent
volatility experienced by the rand exchange rate has been driven mainly by external factors
and changes in global risk perceptions. Although the rand depreciated sharply in the
immediate aftermath of the British referendum, it has reversed these losses. At the time of
the most recent MPC meeting, the rand had appreciated against the major currencies, and
on a trade-weighted basis, the rand had appreciated by 12,2 per cent. The rand has been
supported by the global search for yield, the improvement in commodity prices, and also
reacted to the unexpectedly large trade surplus recorded in May. Despite this recent
strength, the rand remains vulnerable to possible changes in investor sentiment; changes in
US monetary policy expectations; and domestic concerns including the possibility of ratings
downgrades later in the year.
Other risk factors for inflation include increases in average wage growth in excess of inflation
and productivity gains; elevated food price inflation; and potentially higher oil prices should
global demand recover. On the other hand, a weaker global growth scenario could also imply
that there may be a degree of downside risk to the international oil price assumption; a sharp
decline in agricultural prices next year should favourable weather patterns transpire as
forecast and the absence of demand pressures and weak consumption expenditure growth
may also contribute to downside pressures.
As you will know, the MPC felt that local and international developments since our last
meeting in May in relation to inflation and growth overall justified a pause in the hiking cycle
at the July meeting. The situation will continue to be monitored closely as the risks to the
inflation forecast are assessed to continue to be tilted to the upside, even if they have
moderated somewhat recently. It remains to be seen if some of the favourable factors that
contributed to the decision to keep interest rates unchanged will be sustained. This will
require ongoing vigilance and careful analysis of incoming data and information, and the
MPC will not hesitate to act when deemed appropriate.
As I move towards the end of my speech, please allow me to briefly touch on some
economic developments in the Limpopo Province.
5. Limpopo Province
The growth performance of the province - like that of the South African economy - has been
disappointing. The average growth rate for the period 2009-14 averaged 1,3 per cent as
compared to the national average of 1.8 per cent.5 Unfortunately, statistics are not available
to assess the most recent economic growth performance of Limpopo in relation to the
national growth rate. However, an assumption can be made that, given the dominant role of
mining and agriculture in the province, developments will likely have mirrored national trends.
As for inflation developments, while the inflation rate in Limpopo has declined from 8,2 per
cent in May 2016 to 7,4 per cent in June 2016, it is nevertheless still over 1 percentage point
higher than the national average and significantly above the top end of the inflation targeting
rate. This has both adverse welfare and competitiveness effects and is something that
warrants attention at the provincial level particularly in terms of addressing the bottlenecks
that are adversely affecting the price formation process in the province.
With an estimated share of national GDP of just over 7 per cent, Limpopo makes an
important contribution to the economy of South Africa. The primary sector has always played
a key role in the province, with its contribution growing from 17 per cent in 1996 to just over
27 per cent in 2014. This has in large part been due to the mining sector, with its contribution
increasing from around 15 per cent in 1996 to around 25 per cent currently. Approximately,
41 per cent of South Africa's platinum group metals (PGMs), 90 per cent of red-granite
resources and approximately 50 per cent of the country's coal reserves being located in the
province. In addition, it has been found that antimony, a highly strategic mineral found in
large quantities in China, is another of Limpopo's major assets6. In addition to mining,
agriculture and tourism are the other pillars of the Limpopo economy, with the province
having identified infrastructure development, industrialisation and manufacturing as potential
new game changers that will enable it to achieve higher growth rates in the future.
The potential of this province is beyond question. The province is well-endowed with
minerals. While the fortunes of the mining industry are subject to international commodity
price movements, the policy challenge is to ensure that the potential benefits that could be
derived from the natural resource endowment are optimized.
6. Conclusion
In conclusion, it is clear that the global and domestic economies face challenging times
ahead, riddled with uncertainty which could exacerbate volatility and dampen confidence,
and thus undermine consumption and investment required to support sustainable and
balanced growth. What the impact of the added complication of Brexit will bring, will only
become clear over time. While we may have little control over many of the external factors,
we need to decisively tackle some of the local impediments that are well within our control
through collaborative leadership from Government, business and labour. The SARB remains
fully committed to making a constructive contribution in line with its mandate of achieving and
maintaining price stability in the interest of sustainable and balanced economic growth.
Thank you.