T T Mboweni: Overview of the South African economy
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 88th
ordinary general meeting of shareholders, Pretoria, 18 September 2008.
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Introduction
The past year has been a difficult one for both the global and domestic economies. At the
time of the previous annual general meeting of the South African Reserve Bank (the Bank),
the sub-prime mortgage crisis in the United States (US) was in an early phase, and at that
stage the full implications were yet to be seen. A year later we are witnessing the
repercussions in terms of pressure on the international financial markets and a slowing
global economy. Compounding these developments were sustained increases in the prices
of a number of commodities, particularly food and oil, which have fuelled domestic and global
inflation. The South African banking sector has been relatively insulated from these financial
market uncertainties. Nevertheless, greater vigilance has been required in supervising and
regulating the domestic banking sector and payment system, which contributed to an orderly
financial market environment.
At the same time, monetary policy has faced particular challenges as relative price
movements and strong domestic demand caused inflation to exceed the inflation target
range. In carrying out its mandate of achieving and maintaining price stability, the Bank has
tightened the stance of monetary policy over the past year. However, the Bank has retained
its focus on maintaining the efficient internal workings of the Bank. It is in this context that I
report to you today.
This year a comprehensive economic report is included as part of the Annual Report. In
Annual Economic
previous years this economic report was published as a separate Report.
The economic report provides an analysis of developments in the domestic and international
economy during the year under review, with particular emphasis on developments that have
had implications for the operations and policy implementation of the Bank. The focus of this
address is on the main operational areas of the Bank.
Monetary policy
The challenges facing monetary policy intensified during the year. Inflation was impacted
initially by strong domestic demand pressures, and sustained and significantinternational oil
and food price increases. Since April 2007, CPIX inflation has exceeded the upper end of the
target range of 3 to 6 per cent and it has risen persistently since then. In July 2008 CPIX
inflation had reached a level of 13,0 per cent.
The Monetary Policy Committee (MPC) has consistently recognised that there is little that
monetary policy can do to avoid the impact or first-round effects of exogenous relative price
changes on domestic inflation. Monetary policy needs to focus on preventing these
firstround effects from feeding through to a generalised or broad-based increase in inflation.
Central to this is the management of inflation expectations. If monetary policy fails to act
appropriately, inflation expectations will become less anchored, with implications for price
and wage setting. Whereas initially much of the pressure on inflation came from exogenous
sources, more recently it has become evident that second-round effects have become more
prominent. During the year under review underlying inflation has increased consistently: in
July 2007 CPIX inflation excluding food and petrol measured 5,0 per cent, whereas by July
2008 it had increased to 7,4 per cent.
There was also some deterioration in inflation expectations. During the second half of 2007
expectations, as reflected in the inflation expectations survey conducted on behalf of the
Bank by the Bureau for Economic Research at Stellenbosch University, remained within the
target range, although there was a moderate upward drift. This was despite the unfavourable
inflation outcomes. However, the picture changed in 2008 when expectations increased
significantly above the upper end of the inflation target range for all years in the forecast
period. This deterioration is consistent with other market-based measures of inflation
expectations.
During the past year there have been a number of factors that impacted on inflation and that
influenced monetary policy decisions. These included endogenous and exogenous factors.
The international oil price continued to put pressure on domestic inflation. Oil prices were
affected by strong global demand, particularly from fast-growing emerging-market
economies, most notably in Asia. Numerous oil-supply disruptions, mainly a result of
geopolitical developments and adverse weather conditions, also affected the oil market. As a
result, the price of North Sea Brent crude oil increased from just over US$50 per barrel in
January 2007 to reach a high of over US$145 per barrel in July 2008, before moderating in
recent weeks. The combined effects of the international oil price and rand exchange rate
developments have resulted in a cumulative increase in domestic petrol prices of about
R2,75 per litre since September 2007.
Despite an improved domestic maize harvest and relatively benign weather conditions, food
prices also continued to place upward pressure on inflation. Factors sustaining pressure on
international food prices include drought conditions in some regions, export restrictions in a
number of countries, the diversion of food crops to biofuels production, and increased global
demand fuelled by strong growth and higher incomes in emerging markets in particular.
Domestically, between August 2007 and July 2008, food prices contributed on average 4,1
percentage points to average CPIX inflation of 9,3 per cent.
Pressures from food and oil prices have also impacted on global inflation. Despite a general
downturn in most of the advanced economies, monetary policy in numerous countries has
been tightened in recent months in response to heightened inflation pressures.
Since early 2008, the exchange rate has also begun to pose a threat to the inflation outlook.
The exchange rate reacted to a number of developments including the widening deficit on
the current account of the balance of payments, electricity supply constraints, bouts of global
risk aversion and movements in the US dollar against other currencies. More recently, the
rand exchange rate has appreciated somewhat from its earlier lows. The trend of wage
settlements has also become an increasing risk to the inflation outlook. Nominal wage
settlements have been increasing over the past year, although they are still on average
below the inflation rate, particularly once productivity changes are adjusted for.
Most other domestic determinants of inflation remained well contained and have either been
neutral or helpful to inflation developments. After a long lag, household consumption
expenditure showed a definite response to the tightened monetary policy stance, despite
only a moderate slowdown in bank credit extension to households.
Demand for durable goods has been particularly responsive to higher nominal interest rates.
Asset price developments, in the form of lower equity prices and a subdued housing market,
reduced the pressure on inflation emanating from wealth effects. Output growth, which has
measured around 5 per cent per annum during the past four years, showed signs of
moderating and the economy appears to be growing somewhat below potential output
growth. Fiscal policy also remained supportive of monetary policy.
In response to the impact of these developments on the inflation outlook, the monetary policy
stance has been tightened progressively over the past year. The repurchase rate was
increased by 50 basis points after each of four of the six MPC meetings held since the
previous annual general meeting. Since the tightening cycle began in June 2006, the
repurchase rate has been increased by a cumulative 500 basis points. In January 2008
interest rates were kept on hold despite a mildly deteriorated inflation forecast. At that time,
the risks to the outlook were more or less the same, but the MPC assessed that the extent of
these risks had moderated somewhat. However, by the next meeting this assessment had
changed in the light of new developments, including the risk posed to the outlook by Eskom's
application for a significant further increase in the price of electricity.
At its most recent meeting in August 2008 the MPC decided to keep the monetary policy
stance unchanged. The committee decided that although upside risks to the inflation outlook
remained, the degree of risk had subsided somewhat, particularly in the light of the continued
slowdown in household consumption expenditure, the widening output gap and the lower
international oil prices. The inflation forecast of the Bank showed that inflation was expected
to peak in the third quarter of 2008 and then begin to decline, and to return to within the
target range by the second quarter of 2010.
The fact that inflation has been outside the target range for some time has been regarded by
some as an indication of the failure of the inflation-targeting framework. It is generally
accepted that a flexible inflation-targeting regime should allow for a deviation from the target
in the event of exogenous shocks, which are beyond the control of the monetary authorities.
Our framework also allows for deviations from the target in such instances, to avoid an
excessive impact on output variability. However, to prevent second-round effects, it is
important that expectations remain well anchored. Failure to respond will inevitably cause
expectations to become dislodged and result in a further acceleration of inflation. The Bank
remains committed to bringing inflation back to within the target in a reasonable time frame.
Money-market operations
The Bank manages the daily liquidity requirement in the money market so as to ensure that
the implementation of monetary policy is consistent with the stance determined by the MPC.
During the past year the daily liquidity requirement has been kept within a range of between
R6,6 billion and R14,7 billion. The purchases of foreign exchange from the local
foreignexchange market create rand liquidity that has to be drained in order to maintain a liquidity
shortage in the money market. Liquidity was drained in a number of ways, including the
issuing of SARB debentures, conducting longer-term reverse repurchase transactions and
increasing deposits in the sterilisation account that the National Treasury holds with the
Bank. In addition, increases in notes and coin in circulation, and in the statutory cash
reserves of commercial banks also drained liquidity.
Accumulation and management of reserves
The Bank continued to increase the level of official gross gold and foreign-exchange
reserves, from US$29,8 billion at the end of August 2007 to US$34,3 billion at the end of
August 2008. Over the same period, the international liquidity position increased from
US$27,4 billion to US$33,5 billion. In addition to accumulating foreign-exchange reserves,
the Bank reduced the level of its borrowed reserves from around US$3,2 billion at the end of
August 2007 to US$896 million at the end of August 2008. Borrowed reserves were reduced
with the repayment of the outstanding portion of the syndicated loan entered into in 2005.
South Africa is one of a number of emerging-market countries that have a relatively high
current-account deficit, which underlines the need for a healthy level of reserves. The current
level of reserves puts South Africa more or less in line with many of its peers in the
emerging-market community and it meets the generally accepted reserve-adequacy
measures. However, the Bank does not regard the current level as excessive and is likely to
continue accumulating reserves at a moderate pace when market conditions permit.
Enhancing the reserves management processes of the Bank has been a strategic focus area
for a number of years, commensurate with the growing responsibility associated with higher
levels of reserves. This improvement continued during the past year. The primary focus
during the period under review was the formulation and partial implementation of a strategic
asset allocation, which involved the quantification of risk tolerance in the form of a target
duration per currency and a risk budget to facilitate the active management of reserves. In
line with these developments, the roll-out of the internally managed portfolios was initiated to
move closer to the approved strategic asset allocation.
Currency distribution
In celebration of former President Nelson Mandela's 90th birthday on 18 July 2008, the Bank
issued five million pieces of the bi-metal commemorative R5 coin depicting the former
president. Arrangements were made to distribute this special commemorative coin to all
provinces prior to 18 July 2008, thereby ensuring that they were available nationally on Mr
Mandela's birthday.
The national payment system
In March 2008 the Bank celebrated the 10th anniversary of the implementation of the South
African Multiple Option Settlement (SAMOS) system. During 2008 an upgrade of the SAMOS
system was initiated to facilitate the implementation of delivery-versuspayment in the
settlement of money-market securities. Another project was initiated to review the South
African settlement system infrastructure and applications, and to benchmark them against
those of other central banks. Business continuity management also received special
attention during 2008. Interbank clearing and settlement are of systemic importance and the
Bank co-operated with stakeholders to minimise potential disruptions in this domain.
The Bank continued to develop the oversight of the national payment system (NPS). This
included the issuing of directives relating to the conduct of system operators and third-party
service providers in the payment system, which became effective in December 2007. The
measures contained in these directives are aimed at ensuring the safety and efficiency of the
NPS. The Bank also participated in the Continuous Linked Settlement system oversight and
served on the foreign-exchange settlement subgroup of the Bank for International
Settlements.
The Bank, in its role as overseer of the NPS, established the National Payment System
Advisory Body (NPSAB), which is representative of all the regulated stakeholders within the
NPS. This body allows for regulated bank and non-bank participants to establish
associations that can represent the interests of their members at the NPSAB.
Financial stability
The resilience of financial markets globally has been severely tested during the past year
following the widespread impact of negative developments in the US housing and subprime
mortgage markets. As a result of the securitisation of sub-prime loans, the effect turned out
to be more widespread than anticipated originally. Emerging-market economies, in general,
and South Africa, in particular, have proven to be remarkably resilient in the midst of this
financial market turmoil. The impact on South Africa has been indirect, mainly through
financial market volatility and the resultant economic slowdown in the US and other major
industrialised countries.
The Bank, in recognising the importance of a stable financial system to support its primary
objective, seeks to identify inherent weaknesses in the financial system and monitor risks
that may result in financial system disturbances. The domestic financial system was
assessed as sound, based on a quantitative analysis of a standard set of financial
soundness indicators. The Bank's qualitative assessment of the inherent robustness of the
financial system environment against the 12 key financial soundness standards of the
Financial Stability Forum shows a high level of general compliance with international
standards and best practice.
Bank regulation and supervision
As part of its bank supervision function, the Bank focused on the impact of international
financial market developments on the banking sector. In mid-2007 the Bank requested a
selection of South African banks to provide detailed reports on their exposure to the
prevailing risks. It was found that local banks had no direct exposure to the sub-prime
mortgage market, while certain of the banks' international franchises had only limited
exposure. However, indirect effects, such as increased funding costs, were observable. In
view of the developments in financial markets and specific events in some international
banking institutions, the Bank deemed it important to embark on a process to evaluate the
appropriateness of South African banks' incentive schemes during 2008.
A major change to the South African banking regulatory and supervisory framework occurred
as a result of the implementation of Basel II on 1 January 2008. The process followed in
implementing Basel II was characterised by its broad consultative approach; several
quantitative impact studies and field tests; amendments to the regulatory and supervisory
frameworks; and regular interaction with all South African banking institutions. The amended
Banks Act, 1990 and Regulations relating to Banks, as well as the revised supervisory
process were implemented at the same time.
The Bank, in close co-operation with the Financial Intelligence Centre, continued to monitor
the compliance of banking institutions with legislation relating to anti-money laundering and
combating the financing of terrorism. Furthermore, in August 2008 the Bank participated in
the Financial Action Task Force's mutual evaluation of South Africa's anti-money laundering
and counter-terrorism financing system.
International co-operation
The African continent and the Southern African Development Community (SADC) region
remain the focal points of the Bank's international relations efforts as programmes to achieve
regional integration gain momentum. The Bank currently hosts the Secretariat of the
Committee of Central Bank Governors (CCBG) in SADC and continues to support the
implementation of CCBG projects. Significant progress has been made in the committees
dealing with payment systems, information technology, macroeconomics, banking
supervision and legal issues. This progress has been shared with the finance committees in
Parliament where the ratification of the Finance and Investment Protocol, a key instrument to
advance regional economic integration in SADC, has been sought.
In our relations with multilateral institutions our efforts have been concentrated on increased
participation in key forums such as the G-20. The chair of the G-20 passed on to Brazil from
South Africa at the beginning of this year. South Africa remains an active participant in this
forum of systemically important advanced and emerging-market economies. The focus of the
forum this year includes competition in the financial sector, fiscal space for social inclusion
and clean energy. In addition, with the active involvement of the forum, progress was made
this year with the reform of the Bretton Woods institutions, particularly in relation to quota
reform and the finances of the International Monetary Fund (IMF).
The Bank, through the SARB College (the College) continued to contribute to training in
Africa by co-operating with international training institutions and central banks. The College
hosted the residential segment of the IMF Financial Programming and Policies course, and a
course for African countries on external vulnerabilities. The College also co-hosted a
highlevel seminar on capital flight in sub-Saharan Africa with the World Bank Institute.
Internal administration
The Annual Report of the Bank was distributed to shareholders before this meeting. The total
assets of the Bank show an increase from R220 billion at the end of March 2007 to R300
billion at the end of March 2008. The increase was mainly the result of the accumulation of
official gold and foreign-exchange reserves; and was financed, in the main, by an increase in
government deposits, the issuing of SARB debentures, an increase in currency in circulation,
and the effect of valuation adjustments to the net reserves as a result of exchange rate and
gold price movements. These adjustments are reflected in the increase in the Gold and
Foreign Exchange Contingency Reserve Account.
The Bank's profit before taxation increased from R2 907 million for the previous financial
year to R3 475 million for the financial year ended 31 March 2008. Budgeted expenditure of
the Bank for the current financial year amounts to R1,9 billion.
The four subsidiary companies of the Bank, namely the South African Mint Company, the
South African Bank Note Company, the South African Reserve Bank Captive Insurance
Company and the Corporation for Public Deposits achieved their objectives during the
financial year. After a review of reports by their Boards of Directors and internal and external
auditors, the Bank is satisfied that the subsidiaries are managed in accordance with their
objectives and best corporate governance practice. The results of the subsidiaries are
reported on a consolidated basis with those of the Bank in the financial statements in the
Annual Report.
The shares of the Bank continued to trade through the over-the-counter trading facility,
implemented on 1 October 2005. During the period 1 April 2007 to 31 March 2008, 42
transactions were successfully concluded, representing 69 516 shares.
Human resources remain an important focus of the Bank. As at the end of March 2008 the
Bank employed 1 896 permanent and 48 contract staff members. The staff turnover rate was
about 7 per cent, which is significantly lower than the banking-sector average of about 11 per
cent. In terms of overall racial employment equity, the Bank progressed from 43 per cent
black employees in 2000 to 58 per cent in 2008. Accordingly, the Bank's overall target of 50
per cent black employees has been realised and surpassed. At managerial level, 44 per cent
of the positions are filled by black employees compared with 18 per cent in 2000. Overall
gender equity improved from 42 per cent female employees in 2000 to 47 per cent in 2008.
The Bank aims to have 50 per cent female employees at all levels of employment by 2011.
Performance management received special attention during the past year. This issue was
identified in the Bank's Seventh Annual Report on the Employment Equity Plan to the
Department of Labour as the only remaining barrier to employment equity. A special task
team was commissioned to research, investigate and benchmark best practice relating to
performance management. The report was finalised and approved by the Remuneration
Committee of the Bank.
At the Bank we consider the wellness of employees as one of our primary human capital
objectives. In this regard, we have updated and modernised clinic facilities that will cater for
the well-being of employees. In the area of HIV/AIDS management we have completed
prevalence testing, conducted industrial theatres to sensitise staff, and are implementing
Bank-wide peer counsellor and educator training.
The Bank has always considered training and development to be of paramount importance.
In the past financial year the Bank spent an amount of about R33 million on training,
development, study aid, bursaries, skills development levies and educational grants. The
Cadet Graduate Programme of the Bank increased its intake from 10 in the previous year to
17 in 2008. The College formed a strategic alliance with the University of South Africa and
the Institute of Bankers in South Africa to offer a nationally recognised qualification, namely
the Advanced Diploma in Central Banking, which is also prescribed for the Cadet Graduate
Programme.
A number of high-level workshops and seminars were organised by the College for specific
niche markets. The second biennial conference on Challenges for Monetary Policy-makers in
Emerging Markets is being organised and is scheduled to take place in October 2008.
Business continuity plans have been developed and successfully tested for all critical
business processes. The Bank further continues to contribute towards the establishment and
maintenance of a resilient business continuity capability within the broader financial sector,
including the cash management industry.
The upgrading of the back-up uninterrupted power supply for Head Office is in progress. This
is being done to prevent interruptions in Bank operations as a result of unplanned power
disruptions. The Bank has also embarked on a project to investigate the energy efficiency
and environmental friendliness of its buildings. This project should result in a reduction in the
consumption of electricity and fuel.
Planning is in progress for several projects at the various branches around the country to
ensure the efficient distribution of currency. The design for the proposed new Bloemfontein
Branch has commenced, and tenders are awaited for extensive additions and alterations to
the East London Branch. The new cafeteria at the Pretoria North Branch has been
completed. Furthermore, the Cape Town Tower Block will be upgraded and the
Johannesburg Branch will undergo major repairs. At Head Office large projects aimed at
enhancing the existing infrastructure have been completed. These include the replacement
of carpets, modernisation of lifts and maintenance of the air-conditioning system. The
upgrading of the fire protection and evacuation systems, and the project to improve
accessibility for people with disabilities are under way.
Conclusion
Global and domestic developments are expected to continue to pose a challenge to
monetary policy in the coming year. In the international markets heightened volatility is
expected to persist and growth in industrialised countries is expected to moderate further.
The outlook for commodity prices is therefore uncertain and this makes for a difficult
monetary policy environment. The Bank will continue to focus on bringing inflation down to
within the inflation target range. The objective of the Bank remains to achieve and maintain
low inflation in the interest of sustainable economic growth.
During times of global financial market instability it is even more important to maintain
vigilance over the payment system, domestic financial markets and the banking system in
particular. After the successful implementation of Basel II, the Bank will continue to monitor
closely the domestic banks not only with respect to the possible impact of global
developments, but also to the impact of tighter credit conditions on indebted households and
firms.
Staff development will remain one of our strategic objectives. There will be a continued focus
on training and development within the context of our Employment Equity Plan. Appropriate
training is a benefit not only to the individual, but more generally to the Bank and the wider
economy.
Acknowledgements
I wish to thank the Presidency, the Government and Parliament for their continued support.
The Bank maintained a good working relationship with the National Treasury through the
system of bilateral committees. Furthermore, I wish to thank the Minister and Deputy Minister
of Finance, and the Director-General of the National Treasury and his staff for their ongoing
support and co-operation.
Sincere thanks are also due to the members of the Board of the Bank for their tireless efforts
in ensuring appropriate corporate governance in the Bank. I welcome Mr Elias Masilela who
has been appointed to the Board as a government representative. He takes the place of Prof.
Vishnu Padayachee whose term of office expired last year. I wish to take this opportunity to
thank Prof. Padayachee for his valuable contributions to the Bank over the past years. The
successes achieved in dealing with the challenges of the past year are due to the continued
dedication and commitment of the deputy governors, management and staff of the Bank. I
wish to thank them all for their contributions and I am confident that these efforts will ensure
that the coming year is even more successful.