François Groepe: African central banks and monetary policy challenges
Address by Mr François Groepe, Deputy Governor of the South African Reserve Bank, at the
Credit Suisse Africa Conference, Cape Town, 6 November 2015.
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Introduction
Good morning, ladies and gentlemen.
Allow me to express my pleasure at being invited to deliver the opening address at this
year's Credit Suisse Africa Conference.
The theme chosen for this address - "African central banks and monetary policy challenges"
- is particularly relevant today, seeing as financial market participants grapple with volatile
markets informed by a fluid economic and monetary policy environment. The context is a
highly interconnected world where spillover and spill-back risks are evident, and which brings
about new challenges.
In my speech, I will look at some of these global challenges and how they have shifted over
the past few years, then focusing on their particular relevance for African nations and, in turn,
looking at the ways in which African central banks can deal with their policy implications. I will
briefly highlight the experience of the South African Reserve Bank in that respect, and
discuss how increased cooperation between regional central banks can help to strengthen
the way in which we navigate these challenging times.
A more challenging world environment
Despite the elapse of nearly seven years since the height of the global financial crisis, a
fullyfledged global economic recovery remains elusive, and new challenges continue to appear.
The recovery process that began in some segments of the world economy has started to
tentatively bear fruit. Banks in the United States and, increasingly, in the eurozone have seen
sufficient improvements in their balance sheets to allow for the resumption of positive credit
growth. At the same time, financial conditions have improved sufficiently for corporate
entities in these regions to resume hiring, a necessary condition for a consumer recovery.
Furthermore, in Europe, a mix of central bank initiatives and political will to hold the
European construct together has handed most peripheral countries markedly lower
borrowing costs and has created room for them to escape from their double-dip recession.
The global growth outlook, however, continues to vacillate and has once again deteriorated
somewhat recently. In its October 2015 World Economic Outlook, the International Monetary
Fund downgraded its global GDP growth forecasts by 0,2 per cent to 3,1 per cent and
3,6 per cent in 2015 and 2016 respectively. The 3,1 per cent global growth forecasted for
2015 is materially lower than the 3,8 per cent forecasted a year ago. This downward revision
is mainly as a result of the downscaling of the growth projections for the emerging
economies.
The downwardly revised growth outlook for emerging-market economies is mainly
attributable to the relative slowdown in China which faces overcapacity in its traditional
industries, a property oversupply, an erosion of its competitive advantages, and elevated
levels of debt. Other large emerging-market economies are, however, also feeling the strain,
in particular those which have a high degree of dependence on commodity exports.
Furthermore, investor risk aversion towards emerging-market assets has been rising against
a backdrop of market uncertainties about the timing and impact of US policy rate
normalisation coupled with concerns about the economic slowdown in Asia and the impact of
lower commodity prices. This has contributed to significant capital flow reversals from
emerging-market economies, and the Institute of International Finance has recently projected
that emerging markets will see net capital outflows this year for the first time since 1988.1
Why these developments matter to Africa
These international developments are highly relevant for sub-Saharan Africa. At the time of
the global financial crisis, regional growth was relatively sheltered from adverse
developments in the major economies. Regional GDP, for instance, continued to grow by
4,1 per cent in 2009, whereas most of the advanced economies and some emerging-market
economies were in recession. The lack of depth in most African financial markets as well as
the limited linkages between their banking systems and those of the advanced economies
had in part explained Africa's relative resilience. However, Africa appears to have become
more vulnerable to global developments since then.
The exposure of sub-Saharan economies, particularly to China - which is now a key
contributor to the global slowdown - has continued to increase over recent years.2 The
region's exports to China have grown, on average, by around 25 per cent per year between
2000 and 2014, far outpacing the growth rates of less than 10 per cent for exports to the US
and the EU. According to the IMF, China in 2014 accounted for more than 20 per cent of
exports in about 15 sub-Saharan countries, including Angola, the DRC, South Africa and
Zambia. Interestingly, exports to the other BRICS economies also increased over the past
decade, by close to 20 per cent on an annual basis.
But China's relevance for African economies is not limited to trade links. According to the
United Nations Conference on Trade and Development (UNCTAD), China is now the largest
developing foreign investor in Africa, and official Chinese data indicate a doubling in the
stock of foreign direct investment to Africa between 2009 and 2012, to US$21 billion.
The sharply lower commodity prices equally hold significant implications for Africa. Despite
some diversification of their economies over the past decade or so - in particular into the
services sectors such as retail, finance and mobile telephony - the export base of countries
in sub-Saharan Africa remains highly dependent on commodities. The IMF has identified
15 countries in the region, beyond its eight oil-exporting countries, where non-renewable
resources represent more than 25 per cent of exports. In nine of those, the share exceeds
50 per cent - and these calculations exclude agricultural commodities, on which many poorer
African nations remain heavily dependent.3 The negative impact of the lower commodity
prices is not limited to lower domestic income, tax revenues and employment in the mining
sector, but is equally likely to result in the curtailment of drilling and extraction investment
projects.
The region, however, is likely to continue growing above trend in the near future. The IMF
forecasts sub-Saharan GDP growth of 4,3 per cent in 2016, up from the estimated 3,8 per
cent in the current year but still below the 5,25 per cent average growth rate of the past five
years. The most recent projections of the World Bank similarly show a moderate recovery in
2016 and 2017. There are, however, some downside risks to these forecasts, such as the
impact of adverse weather conditions on the agricultural sector and the possibility that
ongoing public spending on infrastructure may be curtailed due to deteriorating public finance
metrics in several countries.
Indeed, the more challenging external environment for African countries occurs at a time
when these countries' external and budget balances have been deteriorating. The IMF
forecasts that, in 2016, 30 of the 45 sub-Saharan countries will have a current-account deficit
in excess of 5,0 per cent of GDP. The region's external shortfall is expected to be as high as
5,5 per cent of GDP, compared with the low of 0,7 per cent in 2011 and net surpluses in the
years before the global financial crisis. Equally, the average budget deficit for the region is
estimated to have risen to 4,2 per cent of GDP this year, up from 1,8 per cent three years
ago; as a result, the public-debt-to-GDP ratio is likely to have reached its highest level since
2005. The re-emergence of the 'twin deficit' phenomenon in many African countries may
prove of particular concern at a time when global financing conditions have deteriorated and
the credit spreads of most emerging sovereigns widen this year, in particular among
subSaharan issuers.
Many African countries have taken advantage of the low yields in developed countries to
increase their issuance of foreign currency-denominated Eurobonds in recent years. Such
issuance has helped these sovereigns to tap into international investor demand for yield and
reap the rewards of earlier efforts to improve their creditworthiness. However, it has also
increased their external debt burden as most of the region's currencies have come under
pressure. The trend towards currency depreciation that was witnessed throughout most of
the emerging world has not spared sub-Saharan Africa. Since the start of the year, for
example, the currencies of countries such as Angola, Ghana, Kenya and South Africa
depreciated by between 10 and 25 per cent against the US dollar. In the case of others, like
Zambia, the currency-value loss has been close to 50 per cent.
These currency developments have complicated the servicing and refinancing of external
debt, and have also contributed to a rise in inflationary pressures in some countries,
offsetting the positive effect of lower oil prices in this context. For the sub-Saharan Africa
region as a whole, the IMF now forecasts average inflation to accelerate to 6,9 per cent this
year and to 7,3 per cent in 2016 compared to 6,4 per cent in 2014.
How central banks can respond to the challenges
A situation where real economic growth slows but inflation accelerates is not one that central
banks particularly relish in having to contend with. Central banks' mandate of inflation
targeting, be it direct or indirect, requires them to be responsive to any build-up of price
pressures, especially if it could result in the un-anchoring of inflation expectations. This is
particularly relevant where inflation remains sticky at the upper end of the inflation target
range. Yet at the same time, a slowdown in economic growth - at least in the event that it is
demand-driven and results in a negative output gap - means that the central bank has to be
mindful not to exacerbate the cyclical moderation by unduly tightening monetary policy.
Procyclical monetary tightening can negatively impact on economic growth and employment,
and over time could contribute to financial instability.
It is worth noting that the nature of the inflation pressures faced by African central banks may
itself be changing. A recent IMF study showed that while, in the past, inflation cycles tended
to be heavily influenced by domestic supply shocks, the role of foreign exchange, money
supply and domestic demand shifts has gradually increased over time.4 It is therefore likely
that demand shocks (global, regional and local) matter increasingly more for inflation rather
than supply-related ones. Ever-increasing trade and financial integration has been beneficial
to growth and development in sub-Saharan Africa over the past decade or two; it has also
brought greater dependency on and responsiveness to international economic and financial
trends, and with it also the need for greater cooperation and exchange of information among
African countries, including their central banks.
So how should central banks in Africa respond to these new challenges? First of all, there is
no "one size fits all" policy response. Because of the structural differences between African
countries - such as their oil exporter/importer status, the diversification of their production,
the degree of development of their respective financial sectors, and the health of their public
finances - they are not equally vulnerable to the current global challenges. As mentioned
earlier, the outlook for both growth and inflation in the region's member states shows
significant divergences. The IMF, for example, forecasts that inflation in several countries -
mostly members of the CFA zones but also some oil importers, like Kenya - is expected to
remain muted, or even to decline, in 2016. Several other countries, however, including many
of the largest economies of the continent, are likely to see inflation drifting higher or
remaining around uncomfortably elevated levels.
Nonetheless, common themes may be emerging. In an environment of weakening growth in
key trading partners such as China, of lower commodity prices and of potentially challenging
global liquidity conditions, exchange rates are likely to remain under some kind of pressure.
But this need not be a negative development. In many ways, provided that a country's
external debt remains moderate, depreciated exchange rates act as an automatic stabiliser
against an external demand and/or terms-of-trade shock.
It is nevertheless the responsibility of central banks to ensure that such depreciation does not
result in a lasting price spike or in an un-anchoring of inflation expectations. This can be a
particular risk in Africa, where a large share of consumer goods is imported, and at a time
when food prices - a large portion of the CPI basket in many regional economies - are
increasingly sensitive to global, rather than domestic, developments. According to the IMF's
latest Regional Economic Outlook for sub-Saharan Africa, a key factor behind the improved
growth performance of sub-Saharan Africa in recent years has been an improved policy
environment. Gains in the quality of policymaking and sounder macroeconomic management
can ill-afford to be reversed.
In some countries, the challenge for policymakers has been compounded by the relaxation in
public spending policy - in particular civil service wage settlements - in recent years. This is
certainly not an unusual or a surprising development as it is reasonable to affect some
degree of redistribution when economic growth and improved fiscal revenue allows for it
given the skewness of income and wealth distribution in many of these countries. It is,
however, of great importance that such efforts be undertaken in a sustainable manner and
not at the cost of discarding fiscal discipline, as a lack thereof could exacerbate inflation
pressures and weigh on investor sentiment, thus complicating the task of monetary
policymakers.
Admittedly, this possibly points to the limitations of the role that central banks can play in
dealing with the current global and regional challenges. Other economic agents, in particular
fiscal policymakers, have a key role to fulfil alongside monetary authorities in ensuring that
the path to sustained growth and development in Africa is not derailed. Appropriate
countercyclical fiscal policies, which prioritise investment in infrastructure and human capital
over current spending, would go some way in assisting central banks in executing their
mandates.
It is worth noting that many central banks' mandates have been expanded to now explicitly
include financial stability. This may not have been a major focus area in the past for most
African central banks due to the region's relatively low credit depth and its lack of large,
sophisticated financial markets. But the rapid development of the financial sector, the
growing interconnectedness of the countries' banking systems, and the gradual opening of
their capital markets has necessitated an increased focus on financial stability. The IMF
recently found evidence of linkages - in particular in the case of sub-Saharan Africa
countries - between lower commodity prices and financial stability metrics, such as non-
performing bank loans, returns on equity, and ratios of liquid assets to deposits. Despite
these linkages, it is evident that a growing financial system which is well regulated and
supervised is likely to result in better allocation of capital to different economic sectors, the
facilitation of entrepreneurship, stronger job creation and, overall, the promotion of
sustainable economic development.
Dealing with challenges - the experience of the South African Reserve Bank
The global challenges described above, and the questions of how to deal with them, have
not spared the South African Reserve Bank. South African growth has slowed due to various
external factors, not least due to the worsening terms of trade on the back of softer
commodity prices. It is worth noting that commodity exports continue to represent about
60 per cent of South Africa's external trade but trade is increasingly shifting to other
emerging-market economies, for example export shipments to China and the other BRICS
countries have risen from 2,6 and 3,0 per cent in 2005 to 9,6 and 5,2 per cent in 2014
respectively.
These external factors have been compounded by domestic supply issues, prominent among
which were electricity constraints, prolonged strikes in the mining and manufacturing sectors
as well as skills shortages and uncertainties in certain fields of policy, such as the mining and
agricultural sectors. The South African Reserve Bank forecasts GDP growth of 1,5 per cent
this year and 1,6 per cent next year, which is substantially lower than the post-recession high
of 3,2 per cent in 2011. The Bank further estimates that a part of this deterioration may be
structural and that potential economic growth has slowed from around 3 to 3,5 per cent in
20105 to about 1,8 per cent this year.
Inflation continues to remain of some concern, even as growth slowed and the persistence of
a negative output gap seemingly dampened the pass-through effects of currency
depreciation to headline CPI inflation. Core consumer price increases have remained
relatively elevated against a background of prolonged currency depreciation, above-inflation
wage settlements and administrative price increases. Furthermore, the Bank projects that
headline inflation will exceed its target range for two quarters in 2016 before declining to 5,7
by the fourth quarter of 2017.
The South African Reserve Bank has also been closely monitoring the broad-based
measures of inflation expectations, in particular the Bureau for Economic Research's surveys
of analysts, businesspeople and trade unions, which have shown greater stability over the
past three to four years yet have remained anchored around the upper limit of the Bank's
inflation target range. With inflation expected to overshoot its target range for two quarters in
2016, the Bank has been wary of any possible un-anchoring and/or an upward drift in these
expectations. As a result, it stands ready to tighten policy further should such adverse
developments occur. The Bank's Monetary Policy Committee has repeatedly indicated that it
sees itself in a gradual tightening cycle. So far, interest rates have increased by 100 basis
points, to 6,0 per cent, since January 2014. The sluggishness of economic growth and the
persistence of a negative output gap inform our view of the gradualism of the current
normalisation cycle. Nevertheless, the core mandate of the Bank is price stability, which
means that the Bank remains vigilant and stands ready to act against any build-up of inflation
pressures which may result in a persistent deviation from the inflation target range.
Cooperation and the role of the Association of African Central Banks
Before concluding, let me return to the importance of cooperation between the respective
central banks on the continent, and in particular allude to the work undertaken through the
Association of African Central Banks, the AACB.
As the economic, banking and financial inter-linkages between African countries multiply, the
mutual understanding of our financial systems and the exchange of information on risks
associated with, among others, cross-border bank lending can be of paramount importance
to limit the risks of contagion through the continent of any future shock. In this respect, the
role of the AACB, which has provided African central banks with a mechanism for
cooperation and a forum for discussion since 1965, is likely to continue to grow in the coming
years.
I would like to highlight the role which the South African Reserve Bank in particular is playing
in leading the recently established working group on cross-border banking supervision. Our
initial interaction with colleagues from other African central banks makes us confident that
the working group will be able to formulate sufficient methods to improve cross-border
supervision. Indeed, we anticipate that, over time, this working group will become the
preferred platform where experiences are shared, ideas are discussed, and, ultimately, the
effective supervision of cross-border banking operations is strengthened. The sharing of
knowledge and the more effective use of skills and resources will no doubt be key, in the
longer run, to improving the supervision of continental banking groups.
Conclusion
In conclusion, I would like to emphasise that sub-Saharan Africa has shown promising gains
in economic growth and diversification, human development and policy governance over the
past decade. It will be the task of all stakeholders, central banks included, to ensure that
these gains are built upon in coming years, even as the global environment becomes more
challenging. Allowing for the necessary adjustments of financial variables, like exchange
rates, without endangering financial stability; keeping inflation stable without putting undue
strain on fragile economic growth; and ensuring cooperation between the continent's
regulatory institutions to allow for the development of cross-border financing while keeping
risks in check are among the major challenges of the coming years. I have no doubt that,
despite these challenges, the African Renaissance will continue to gain traction and that the
next decade or two will see significant overall improvements in all developmental and
economic metrics.
Thank you.