Daniel Mminele: South Africa's monetary policy, developments,
challenges and the road ahead
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
South Africa Tomorrow Investor Conference, New York City, 8 October 2014.
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Introduction
Good morning Honourable Minister Nene, Ambassador Rasool, the SA Consul-General in
New York, Mr Monyemangene, ladies and gentlemen. Thank you to the Johannesburg Stock
Exchange, UBS and Standard Bank, and the South African National Treasury for organising
this second South Africa Tomorrow Investor Conference and creating an opportunity for us to
interact as policy makers, business leaders and investors. We meet at a time when global
financial markets are increasingly focusing on the consequences of eventual monetary policy
normalisation in the world's major economies, and emerging countries with large and liquid
financial markets, like South Africa, come under the spotlight once again.
At the inaugural South Africa Tomorrow Conference last year, I was able to take stock of the
major economic and financial market developments that had occurred in South Africa in the
twenty years since the advent of democracy. In particular, I focused on the recovery in
economic growth in the decade leading up to the 2008 financial crisis, the structural changes
the economy has undergone, and the growth and deepening sophistication of our financial
markets. Despite the challenges which the country is currently facing, these achievements,
among which was the early establishment of macro-economic policy credibility, are still being
built upon, and the National Development Plan (NDP) which Minister Nene has just talked
about in detail, provides a framework for ensuring further progress towards a more
successful and fair economy. Yet at present, a lot of questions are being asked of policy in
general and monetary policy in particular, and it is mostly on this latter point that I will focus
my remarks today.
SA's monetary policy framework and post-crisis developments
Last year I pointed out that the flexible inflation-targeting framework which the country
adopted back in 2000 had delivered clear benefits, contributing to a decline in the level and
volatility of both inflation and nominal interest rates. These benefits remain visible today. In
particular, measures of inflation expectations - for example, as computed every quarter by
the Bureau of Economic Research from the views of businesses, labour unions and financial
analysts - appear more strongly anchored than they did in the past. Whereas these
expectations used to be adaptive, responding with a lag to the actual inflation cycle, they now
display a greater degree of stability, albeit currently (and of some concern to the central
bank) around the upper end of the 3,0 to 6,0 per cent inflation target range.
On balance, it is probably fair to say that the greater stability in inflation and inflation
expectations generated over time by our policy framework has allowed the Reserve Bank to
respond more flexibly to the shocks which South Africa has faced since the global financial
crisis. These shocks did not require the use of "unconventional tools" of the type that several
central banks in the developed world, but also in some parts of the emerging world, used at
the time. The solidity of South Africa's banking system enabled it to withstand the crisis
without meaningful disruptions, and as a result, the central bank did not have to intervene in
either the interbank or the FX markets to ensure their proper functioning and an adequate
supply of liquidity. Nonetheless, South African growth experienced significant headwinds
post crisis, with GDP contracting by as much as 1.5 per cent, in real terms, in 2009. Thanks
to a subsequent period of decelerating inflation, the South African Reserve Bank was able to
respond with a cumulative reduction of 650 basis points in the repo rate between December
2008 and November 2010. A further 50 basis-point cut followed in July 2012, which brought
the repo rate to a thirty year low of 5.0 per cent per annum, a level that prevailed until
January of this year.
As the nominal policy rate was being lowered, the real interest rate eventually moved into
negative territory, when compared with either actual inflation or broad-based inflation
expectations as measured by the Bureau of Economic Research's surveys.
These negative real rates helped cushion the impact of the recession on both the corporate
and the household sectors, limiting the impact of weaker growth on business liquidations and
enabling households to gradually reduce their leverage ratio without dramatic cutbacks in
consumption. Thus, the household debt-to-income ratio fell from a peak of 83.0 per cent in
the first quarter of 2009 to 73.5 per cent in the second quarter of 2014, while real household
consumption expenditure still grew by an annual average of 3.2 per cent over that period.
Admittedly, more recently, household consumption expenditure has come under pressure,
with growth rates exhibiting a declining trend since the second quarter of 2013.
Recent challenges and developments
The current environment in which South Africa's monetary policy operates, however, has
become increasingly more complex over the past year and a half, owing to a mix of both
domestic and external factors, which have impacted growth and inflation. The country
currently faces a mix of subdued economic growth and relatively high inflation, with risks
skewed to the upside. In part, but not exclusively, because of supply constraints, including a
lengthy strike in the platinum mining sector and delays in the completion of new
powergenerating capacity, real GDP has stagnated in the first half of the current year. Real GDP
contracted 0.6 per cent in seasonally-adjusted, annualized terms in the first quarter, and this
was barely reversed in the second quarter. On a year-on-year basis, growth has slowed to
1.0 per cent in the second quarter, the lowest reading since South Africa exited the recession
at the end of 2009.
At the same time, though, inflation has drifted gradually higher and breached the top end of
the 3.0 - 6.0 per cent target range in April of this year. Part of this overshoot reflected
aboveaverage inflation for petrol and foodstuffs, some of which fortunately is already moderating or
likely to moderate in light of lower international agricultural prices or improved domestic crops
since the beginning of the year. Nonetheless, underlying prices have also been picking up,
and the Bank's preferred measure of core inflation (excluding food, non-alcoholic beverages
and petrol) has climbed to 5.8 per cent as of August 2014, following a sustained uptrend from
a low of 3.0 per cent in early 2011. While demand-driven price pressures remain largely
absent, amid slowing final domestic demand growth and moderate expansion in credit to
households, the marked and sustained depreciation in the rand's exchange rate since early
2011 has clearly contributed to the upward trend in core consumer prices, which is of
concern to the Monetary Policy Committee.
Beyond the challenges posed by divergent trends in growth and inflation, the persistence of
negative short-term real interest rates is not desirable from a longer-term perspective, as
they could exacerbate existing, or generate new imbalances in the economy. Beyond the
well-known impact that negative interest rates can have on the allocation of financial
resources to different sectors of the economy, or on the price of financial assets, it also
important to point out their impact on the attractiveness of savings, especially in a country
like South Africa, where the low level of domestic savings remains a factor behind the
elevated structural current account deficit.
All in all, these factors have led the Reserve Bank to embark on a gradual policy
normalisation process, though one that remains data-dependent, as it acknowledges the
complex factors behind the price outlook. The Bank first raised the repo rate by 50 basis
points in January 2014, a decision informed by a significant deterioration in the inflation
forecast (indicating the possibility of inflation being outside the target range for an extended
period), amid concerns that a sustained depreciation in the exchange rate of the rand would
significantly raise the risks to the inflation outlook. Although we had generally observed a
lower level of pass-through when compared to previous episodes of currency depreciation,
the extent and duration of the depreciating trend meant that the risk profile was worsening.
Allow me to reiterate that while the Reserve Bank does not target a particular level or range
of the exchange rate, we are nonetheless mindful of the potential negative consequences of
accelerated rand depreciation on the outlook for inflation, as well as broad measures of
inflation expectations. The January rate hike was followed by a second increase, in July
2014, of 25 basis points, bringing the policy rate to its current level of 5.75 per cent per
annum.
Before I leave this part of my speech which looked at recent challenges and developments, I
thought, given the audience of today, I should briefly touch on the decision during August
2014, to place African Bank Limited (African Bank) under curatorship, even if I am digressing
from the main focus of my speech (being monetary policy), to which I shall return in a few
moments.
After an extended period of more intensive regulatory monitoring of and interaction with
African Bank, and following a loss of confidence by its shareholders and funders, the
Registrar of Banks placed African Bank under curatorship on 10 August 2014, as announced
by the Governor. Curatorship was the most suitable legal structure while the enabling
legislation for a new regulatory framework, which will include provisions dealing with
resolution, is still in the process of being finalised. Some of the support measures recently
announced as part of the resolution package for African Bank were informed by the
principles contained in the Financial Stability Board's Key Attributes for Effective Resolution
Regimes, which are expected to feature in the new legislation. The decisive intervention led
by the South African Reserve Bank helped to limit the risk of contagion to the rest of the
financial system.
The support measures announced, which are currently being implemented by the curator
under the oversight of the Registrar of Banks, are intended to facilitate an orderly, structured,
and fair approach to addressing the challenges at African Bank in an effort to secure a viable
future on the basis of a transformed business model, while ensuring minimum disruption to
our financial and credit markets. At the time of curatorship, African bank's total asset size
amounted to R58 billion, or 1.44 per cent of total banking sector assets. However, lessons
from the financial crisis indicate that systemic risk should not only be defined with reference
to the size of an institution, but also in relation to its "interconnectedness", i.e. links to other
banks, financial market participants and financial products.
The proposed solutions were developed in a collaborative process between the public and
private sector. The leadership and commitment shown by South African commercial banks
and the Public Investment Corporation in underwriting the capital raising for the envisaged
"good bank" bears testimony to the strong underpinnings of our banking and financial
system, the resilience of which will be enhanced by these measures. The issues around
African Bank were unique to the business model of that bank, and it would be incorrect to
deduce any fundamental concerns around either the South African banking system or the
business of unsecured lending. The South African Reserve Bank wishes to reaffirm that it
has no concerns about the quality of South Africa's banking system, which continues to be
robust and healthy, based on good levels of capitalisation, liquidity and profitability.
What the road ahead could entail
Where do we go from here? Based on the Bank's projections for growth and inflation over
the coming years, and of the uncertainties that surround these projections, it would be
reasonable to infer that a gradual, data-dependent, normalisation path remains appropriate.
The Bank's most recent inflation forecast indicates that CPI inflation may have peaked at
6.5 per cent in the second quarter, and is expected to average 6.2 per cent for 2014 and
5.7 per cent in 2015, before a (marginal) re-acceleration to an average of 5.8 per cent in
2016, mainly reflecting the assumption of a faster increase in electricity prices. As indicated
before, the MPC sees the risks to the headline inflation forecast skewed to the upside, with
possible renewed pressure emanating from the exchange rate. Core inflation is expected to
remain within the target range for its headline counterpart, reaching a peak of 5.8 per cent in
the first quarter of 2015 before moderating to an average of 5.5 per cent in 2016.
At the same time, real GDP growth, which the Bank projects to recover to 2.8 and 3.1 per
cent, respectively, in 2015 and 2016 from a subdued 1.5 per cent in the current year,
probably will not be strong enough to engineer a quick disappearance of the output gap,
notwithstanding uncertainties as to the actual pace of potential growth in the economy. Thus,
the persistence of slack would appear to reduce the likelihood that demand-driven price
pressures could emerge in South Africa within the near future. The key challenge remains
implementing structural reforms that will help lift the potential growth of the economy. Many
of these have been identified in the National Development Plan and form part of
Government's infrastructure investment plans and other measures, such as those directed at
enhancing education and skills, and supporting small and medium enterprises.
Let me touch on some of the risks we see to the inflation outlook. On the domestic front,
wage settlements in several key sectors have been well above current and expected inflation
rates, and there have been some worrying signs of an apparent de-linking of wage demands
(as well as some actual settlements) from underlying inflation and productivity growth trends.
On the external front, the Bank is extremely mindful of the potential vulnerability of the
domestic capital markets, and the exchange rate, to shifts in international portfolio flows as
monetary policy in some major economies, especially the US and the UK, eventually moves
towards a more conventional stance. In an environment where South Africa's current account
deficit remains elevated and is only expected to narrow gradually over the next two years,
the risk of abrupt swings in portfolio flows into South Africa's capital markets cannot be
under-estimated.
Implications for South Africa of global financial developments
The experience of the "taper tantrum", as the episode which followed the first clear mention
by the US Federal Reserve in May 2013, of the need to eventually wind down its open-ended
asset purchases became to be known, illustrated the sensitivity of domestic financial markets
to the global backdrop. Between the beginning of May 2013 and its lowest level at the end of
January 2014, the rand's nominal effective exchange rate depreciated by as much as 26 per
cent, while over the same period, the yield on the benchmark R186 government bond
increased by more than 230 basis points. Expectations of future policy action embedded in
derivatives like the forward rate agreements, or FRAs, moved in sympathy, with the FRA
curve quickly pricing in not just an earlier but also a speedier pace of interest rate hikes by
the Reserve Bank.
Part of this selloff probably represented more a re-pricing of risk at longer maturities - i.e. a
higher "term premium" - rather than changes in actual expectations of future policy rates. It
was indeed striking to see how strong the correlation had become, during the taper tantrum
episode, between the longer ends of government yield curves in South Africa and the United
States, and this, despite the meaningful differences in economic and policy fundamentals
between the two countries. The depth of domestic capital markets, which were able to
absorb significant net sales of SA bonds by non-residents (R68 billion from the beginning of
May 2013 up to the end of last week, according to JSE data) also played a part. The
renewed reduction in that "term premium" in major fixed-income markets in 2014, as policy
guidance by the Federal Reserve seemed to reduce investors' uncertainties as to the future
path of US rates, probably was a key factor towards the renewed decline in South African
yields and the relative stabilisation in the rand since the end of January up until August1.
Certainly, in terms of communication, central banks have progressed somewhat over the
past couple of years, and particularly since the taper tantrum, the associated volatility in
financial markets related to monetary policy communication, has also declined.
The big question remains, however, how sustainable is the recovery that we are currently
experiencing? Or are we at risk, when US policy rates finally rise in 2015, assuming the
median projections of both FOMC members and market participants prove to be correct, of a
repeat of the market snapback that we witnessed in 2013? It is not possible to answer this
question with a great degree of confidence, for even if we assume that US policy tightening is
largely "priced" into markets, the potential for a renewed rise in risk premiums exists,
especially in light of the current low levels of implied volatility in a broad range of markets.
Nevertheless, several factors could usher in a different scenario from that of the "taper
tantrum".
Admittedly, the more the US economy continues on its "healing" path following the shock of
the 2008-09 global financial crisis, the more eventual policy normalisation becomes
unavoidable, and the less likely it is that the Federal Reserve would delay policy action
because of, say, more elevated volatility in the US Treasury market. Nevertheless, the
Federal Reserve has equally made it clear that considerable uncertainty surrounds its
baseline economic outlook, and that it remained watchful of potential developments that may
hinder the US economic recovery. In testimony to the Joint Economic Committee of the US
Congress on 7 May 2014, Federal Reserve Chair Janet Yellen referred to some specific
risks, indicating in particular that "one prominent risk is that adverse developments abroad,
such as heightened geopolitical tensions or an intensification of financial stresses in
emerging market economies, could undermine confidence in the global economic recovery."
Therefore, the pessimists among market participants may err in fearing that US policy
normalization will proceed irrespective of global developments, and in particular, of its effect
on financial conditions in both the major developed and emerging economies.
At the same time, the global economic recovery remains highly uneven, and this has
translated into a growing policy divergence between the major central banks. In particular,
the Eurozone has in recent quarters experienced a renewed loss of economic momentum
and a drift in inflation rates towards very low levels, which have prompted the European
Central Bank to provide additional accommodation, first in the form of targeted long-term
repo operations, and then via the announcement of a programme to acquire asset-backed
securities and covered bonds on the central bank's balance-sheet. The mix of lower
Eurozone inflation and expectations of additional central bank liquidity appear to have been
key in driving Eurozone government bond yields lower this year; and in turn, this may be
another reason why yields on major emerging bond markets, like South Africa, have also
trended lower. Provided, as the market consensus expects, that there is no quick reversal of
current inflation and policy trends in the Eurozone, developments in that region may continue
to dampen, in the future, the impact of US policy normalisation on flows into, and prices of,
SA financial assets.
Whatever the outcome and wherever we may find ourselves next year this time, I believe a
lot of progress has been made by policy makers around the world, and particularly within the
G20, where there is greater cooperation and greater awareness and efforts made towards
understanding the impacts of policy actions across countries, in particular the spill overs and
feedback loops and therefore how this might influence not only individual countries but also
the global growth trajectory. Our level of crisis preparedness has also been enhanced
through various global financial safety nets which have been strengthened since the crisis,
not just in terms of the IMF toolkit, but also regional financial safety nets, and more recently,
the BRICS Treaty on the Contingent Reserve Arrangement, which was signed by the BRICS
countries at the Fortaleza Summit in July this year.
We can also be optimistic about the efforts of the G20 to lift global growth and ensure that
this growth is more balanced and sustainable. As you may know, the G20 is committed to
developing new measures that aim to lift our collective GDP by more than 2 per cent by 2018
above the trajectory implied by policies in place at the time of the St Petersburg Summit in
2013. We have been working hard towards this goal during 2014, and have made some
headway in developing growth strategies that talk to this ambition. As indicated in the most
recent communique in Cairns, preliminary analysis by international organisations such as the
International Monetary Fund and the OECD indicates that measures committed to thus far by
G20 countries will lift our collective GDP by an additional 1.8 per cent through to 2018,
including from important positive spill overs. We also continue to focus on the need for global
rebalancing and appropriate macroeconomic policies as a means to achieve strong,
sustainable and balanced growth. We trust that by the time of the Leaders' Summit in
November, additional commitments made will lift this number to 2 per cent. Structural
reforms will be important in lifting growth, reducing unemployment and enhancing trade.
These commitments will not just end there, as there will be a process for monitoring and
ensuring implementation.
Conclusion
To summarise, it would seem that South African monetary policy will continue to face
conflicting challenges, with respect to both the economic growth and the inflation outlook, in
the times ahead. A global economic recovery would normally improve the domestic
economic outlook and create a more stable backdrop for domestic policy normalization,
however, it is at risk from the present lack of sustained economic upswing in regions like the
Eurozone or Japan. Rising US policy rates risk complicating the financing of South Africa's
current account and placing pressure on the rand, however, this upside risk to inflation could
be mitigated by the very consequences of slow growth in some of the world's major regions,
mainly the pursuit of stimulative monetary policies.
These conflicting challenges, and the uncertainties that surround them, call for particular
vigilance on behalf of monetary policy-makers, and for a readiness to adapt one's monetary
stance to a changing macroeconomic environment. At present, the Monetary Policy
Committee remains of the view that interest rates will have to normalise over time. While the
balance is delicately poised with regard to the timing of any policy adjustments, and requires
careful judgement to avoid pre-mature action in the wake of an already weak economic
growth environment, it is similarly important that the Bank, in following a forward-looking
approach to monetary management, does not allow any doubting of its preparedness to act
when necessary and in keeping with the commitment to its primary objective.
Thank you.