Daniel Mminele: South African monetary policy in the context of central
banking developments abroad
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
Tradition dinner, Johannesburg, 28 November 2012.
* * *
1. Introduction
Good evening and thank you to Tradition South Africa for the kind invitation to speak to you
this evening. I have been asked to talk about South African monetary policy in the context of
the influences from monetary policy globally.
Monetary policy has evolved in leaps and bounds over the past few years and
unconventional measures, in particular, quantitative easing (QE), has become a fundamental
part of monetary policy around the world. Japan, known as the pioneer of QE, unfortunately
has not had much success with this policy, failing to boost either growth or inflation despite
very accommodative monetary policy. There are many views about Japan's so-called lost
decades and why it is different for the US and others, and how the speed, vigour and manner
in which QE applied can make a difference. Japan's experience is translated into what is
happening in the US and elsewhere, and doubts are raised about the appropriateness and
success of such unconventional measures. It is too early to draw any definitive conclusions,
but no doubt in time economic textbooks will be full of evidence of the success or otherwise
of QE.
I will start my remarks off by firstly looking at countercyclical monetary policy, in particular as
it pertains to emerging market economies, and the spill-over effects of monetary policies
abroad. I will end my remarks by talking about the more recent developments pertaining to
South Africa, with reference to the Monetary Policy Committee meeting held last week.
2. Counter-cyclical monetary policy and spillovers
Monetary policy in advanced economies has undergone a drastic makeover since the
2008-2009 crisis, from the implementation of unconventional policies, to forward guidance
being provided, and increasingly talk of moving towards specific numerical measures to
which monetary policy tightening should be tied. The so called "7/3 threshold rule"1 has often
been bandied about as an alternative to the explicit forward guidance provided thus far by
the Federal Reserve Bank. Under such a rule, the Federal Open Market Committee (FOMC)
may indicate that it will maintain the fed funds rate at current levels until such time as
unemployment moves below 7 per cent or inflation above 3 per cent, at which point, the
federal funds rate may be raised.
Alongside such unconventional policies in advanced economies, emerging market
economies have witnessed a break from past behaviour, where central banks have
graduated from conducting pro-cyclical monetary policy to counter-cyclical monetary policy.
This is significant because counter-cyclical policy was seen to be largely the domain of
advanced economies, and in crisis situations, emerging markets instead opted to tighten
monetary policy as they sought to defend the value of their currencies, contain capital flight
and reinforce policy credibility.
In February 2012, the Board of Governors of the Federal Reserve System published a
discussion paper entitled "Monetary policy in Emerging Market Economies: What Lessons
from the Global Financial Crisis?"2 The paper looked specifically at the counter-cyclicality of
emerging market central banks' monetary policies during the 2008-2009 crisis, and found
that at the height of the crisis, over 80 per cent of emerging market economies loosened
monetary policy. Similarly, a study3 conducted in 2012 found that between 1960-1999,
51 per cent of developing countries were pro-cyclical with an average correlation between
GDP and interest rates of -0.02 per cent. This compared to 0.38 per cent for industrial
countries. In contrast, for the period 2000-2009, around 77 per cent of developing countries
showed counter-cyclical monetary policy. In both periods, South Africa was found to be
counter-cyclical, with the correlation increasing from around 0.25 to 0.75 per cent.
The Bank for International Settlements (BIS) in its June 2012 Quarterly Review made
reference to this shift among emerging market central banks, and pointed out the benefits of
counter-cyclical policy, in particular, the associated reduction in output volatility, which also
helped to stabilise the global economy. It is important to realise, however, that not all
countries can benefit from counter-cyclical monetary policy. In particular, a country with large
short-term foreign currency borrowings could suffer massive exchange rate depreciation, the
costs of which could offset any potential costs of a pro-cyclical policy.
The discussion paper I referred to earlier investigates the factors that allowed for this shift to
happen, and poses the question whether this marks the beginning of a new era in which
emerging markets can now conduct counter-cyclical policy in a sustainable manner. The
study finds that robust institutions, stronger macroeconomic fundamentals, reduced
vulnerabilities, greater openness to trade and international capital flows and more
importantly, financial reforms and adoption of inflation targeting, helped to facilitate this shift.
By adopting inflation targeting and implementing financial reforms, greater policy credibility
was achieved. Not only does the development of local financial markets enable a more
efficient transmission of monetary policy, but the promotion of local financial markets has
also encouraged greater borrowing in local currencies in domestic markets, which has
helped to reduce the risk of capital flight, as well as currency and maturity mismatches. As
such, the development of domestic financial markets has helped to facilitate the conduct of
counter-cyclical monetary policy. Central banks that have adopted inflation targeting and
moved to a low inflation environment were also seen to be more independent and credible,
which also helped to facilitate the loosening of monetary policy.
The BIS notes a few caveats:
•
Firstly, that low interest rates in advanced economies may have allowed emerging
market central banks to cut policy rates more sharply than they could have done
otherwise, which would then overstate the degree of counter-cyclicality.
•
Secondly, that the prolongation of low interest rates in advanced economies could
complicate counter-cyclical monetary tightening in the future.
•
Finally, the BIS also provides the example of some euro area countries which
despite following counter-cyclical policies are facing a crisis today - underlining the
importance of continuously monitoring financial imbalances and sustainability of
policies.
These caveats brings me to the subject of spill-overs, an issue the G20 spends much of its
time discussing, and requested of the IMF to produce spill-over reports for the five most
systemically important economies.4 These reports quantify, inform and educate about the
spill-over effects of the policies of these five economies.
The arrival of QE brought much scepticism and unease, with talk of currency wars gaining
momentum owing to the spill-over effects of such easy monetary policy on emerging
markets. In particular, QE led to increased liquidity globally; amplified carry trade activity
owing to favourable spreads; the financialisation and resultant boom in commodity prices;
volatility in financial markets, in particular exchange rates; and robust capital inflows into
bond and equity markets.
The IMF 2011 Spill-over report for the US5 provides an analysis of QE spill-overs and finds
that from both conventional and unconventional US monetary stimulus, there were in fact
substantial output gains, occurring predominantly via significant reductions in nominal bond
yields and increases in equity prices, with exchange rates also appreciating both in advanced
and emerging market economies. Under conventional policy, for example, the IMF estimates
peak output gains of 0.3 per cent in the US; 0.1 - 0.3 per cent for other advanced
economies; and 0.0 - 0.2 per cent for emerging markets. Under QE1, the IMF estimates
peak output gains of 0.4 per cent in the US; 0.1 - 0.3 per cent for other advanced
economies; and 0.0 - 0.4 per cent for emerging markets. The study also finds, however, that
the effect of QE2 was somewhat smaller than QE1. In September 2012, the Fed announced
a third round of QE, the impact of which is yet to be seen. Nonetheless, the results of
these studies are not surprising, given that the US is the benchmark for pricing of other
global assets, and was long hailed as the engine of global growth.
Unconventional monetary policies may very well complicate policymaking for emerging
market central banks and create significant challenges going forward, not least of which
relate to the unwinding of loose monetary policy in the advanced economies and the
implications for capital flows. This could have significant repercussions for emerging markets,
and the rest of the world, given the increased weight of emerging market economies in global
output. Strong capital inflows to emerging markets over the past few years also means that
emerging market assets have taken up an increasing share of investor portfolios. In its 82nd
Annual Report published in June 2012, the BIS notes a number of longer-term risks for
central banks related to prolonged monetary accommodation. These include a threat to
advanced economies central bank credibility should they feel pressured to do more and
therefore complicate even further the eventual exit from monetary accommodation; a gradual
dislodging of inflation expectations in emerging markets should there be doubts about the
determination to pursue price stability and exit large scale foreign exchange interventions;
and undermining of operational autonomy and financial independence.
Having said this, and understanding the significant risks introduced to emerging markets as a
result of QE, there is no denying that in the earlier phases of the crisis, QE policies did help
to stabilise markets, support trade and help to prevent a breakdown in demand and
economic activity.
3. Recent monetary policy developments in South Africa
We are often asked how much influence global monetary policy has on domestic rate setting.
Of course, the Monetary Policy Committee does take into consideration in its deliberations,
the decisions of policymakers elsewhere. These are important inputs into the
decision-making process, given the large spill-overs associated with global policymaking on
economic and financial market variables.
Like other emerging market countries, South Africa has witnessed significant portfolio
inflows. In 2008, net outflows of R78 billion were recorded, and since 2009 until
26 November 2012, non-residents have bought a cumulative R280 billion worth of bonds and
equities. The nature of these flows has changed, from being primarily equity inflows (turning
from net inflows of R75 billion in 2009 to net outflows of R17 billion in 2011 and outflows of
R8.3 billion year-to-date) to being predominantly bond inflows (from net inflows of
R15.5 billion in 2009, to R85 billion year-to-date). Factors such as South Africa's inclusion
into the World Government Bond Index have supported this trend, as well as the appreciation
of the rand for much of the past three years, and are a clear reflection of the interest rate
sensitivity of capital flows. Having twin deficits (fiscal and current account) and a low
domestic savings rate, these inflows were not unwelcome, also to the extent that they helped
to lower long-term borrowing costs. One can also argue that rather than inflows being
diverted to South Africa because of expectations of rand appreciation, it was the inflows that
in fact caused to the rand to appreciate. Whichever view is taken, the exchange rate of the
rand did nonetheless appreciate from almost R12 against the USD in 2008 to under R6.60 in
2011.
Other emerging markets lowered policy rates to support growth; they also intervened in the
exchange rate markets to try and stem appreciation pressure, or imposed capital controls.
South Africa's policy rate was also lowered, although we were less aggressive than other
emerging markets in dealing with these inflows as we did not at any time feel it necessary to
intervene in the exchange rate market nor were any capital controls imposed. We did,
however, with a surplus position on our Balance of Payments, mop up extra liquidity from
both portfolio and direct investment flows, and consequently managed to grow the official
foreign exchange reserves. We have been consistent in our approach, and have maintained
an easy stance throughout the crisis, given that inflation largely remained under control and
growth was moderate.
Exchange rate appreciation has been both a positive and a negative, on the one hand
lowering South Africa's trade competitiveness, but also helping to dampen inflationary
pressures given the influence of the exchange rate on consumer prices. CPI receded from
13.7 per cent in August 2008 to 3.2 per cent in September 2010, at the same time growth
slowed somewhat, never quite recovering from the recession, while unemployment increased
to over 25 per cent. It is the combination of these factors, a large output gap, the absence of
any significant underlying price pressures and a still dismal outlook for the global economy,
that has given the Bank room to manoeuvre and reduce the repo rate from 12.0 per cent in
2008 to 5.0 per cent in July 2012.
However, since July domestic developments in the form of labour unrest, credit rating
downgrades, and a widening in the current account deficit, have taken centre stage and been
the prime determinant of exchange rate movements, which previously was primarily
determined by movements in the USD/EUR exchange rate and other global developments.
The exchange rate of the rand has weakened considerably from just above R8.00 against
the USD at the beginning of August to levels close to R9.00 against the USD in November.
Such developments, together with the lagged effect of higher food prices and higher wage
settlements as seen in certain sectors of the economy, do not bode well for inflation going
forward. A wide range of estimates have been released from various analysts trying to
ascertain the potential impact of the rebasing and reweighting of the CPI basket in 2013. Our
own estimates indicate some upward pressure on both headline and core prices, as noted in
the MPC statement, to the magnitude of around 0.2 per cent on headline CPI. However, I
should caution that these estimates are subject to the final set of price-updated weights
which will only be published in January 2013, and as such, are subject to change.
Alongside a less favourable outlook for inflation, the domestic growth outlook has
deteriorated, not only due to developments in the euro zone and US, but intensified further
by labour market instability. Such actions as we have seen in the mining and agricultural
sectors in particular, not only amplify wage pressures, but hurt output growth and export
volumes, raise the prospects for even higher unemployment and aggravate the widening in
the current account deficit. The third quarter GDP figures provided the first glimpse of the
negative impact from the strike action, as growth slowed from 3.4 per cent in the second
quarter to 1.2 per cent quarter-on-quarter. Mining reflected a contraction of 12.7 per cent,
while manufacturing grew a paltry 1.2 per cent. The negative impacts of the strike action on
growth have not fully fed through and we are likely to see further weakness in the quarter
ahead. Both business and consumer confidence are far from robust and it is unlikely that the
demand side of the economy will provide much support. The Bank has lowered its growth
forecast to 2.5 per cent for 2012, improving to 3.6 per cent in 2014 - with risks tilted to the
downside. Inflation forecasts on the other hand, have been adjusted higher and the risks are
tilted to the upside. The forecast do not take into consideration the new CPI weights or the
rebasing that will take place in January 2013, nonetheless, the CPI forecast was revised
higher to 5.5 per cent for 2013 (previously 5.2 per cent), and the forecast for 2014 kept
unchanged at 5.0 per cent. The outlook for core inflation remains relatively benign, with a
peak of 5.0 per cent in the first quarter of next year and an average of 4.8 per cent in 2013,
dropping to an average of 4.5 per cent in 2014.
The combination of low global growth, domestic challenges further hampering the growth
outlook, rising wage settlements, a weaker rand and higher current account deficit - makes
for a very difficult combination of factors to consider when making policy decisions.
Olivier Blanchard in 2006 presented a paper entitled "Monetary Policy; Science or Art". He
said that monetary policy can pretend to be close to science if it can be conducted using
simple and robust rules, however, monetary policy must be closer to art if it is frequently
confronted to new, poorly anticipated and poorly understood, contingencies. In that case,
each of these contingencies requires fast thinking and having to make decisions, not fully
based on existing research but rather on well trained intuition. There is little doubt that
monetary policy has gravitated towards being more of an art than a science.
Thank you