Gill Marcus: Overview of the South African economy
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the
93rd ordinary general meeting of shareholders, Pretoria, 26 July 2013.
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Dear Shareholders,
Members of the Board,
Deputy Governors,
Ladies and Gentlemen,
The past financial year has been as difficult as any since the global financial crisis began.
The crisis has continued to mutate and the impact on South Africa has been compounded by
domestic challenges that have at times overshadowed the global risks. The latest mutation
comes in the form of a slowdown in the emerging market economies, which until recently had
been the main engine of global growth.
In its recent World Economic Outlook update in July, the IMF revised down its April forecasts
for global growth in 2013 by 0,2 percentage points, mainly as a result of a sudden
deterioration in the outlook for the emerging markets. The Brics countries featured very
strongly in this downgrade: growth in China was lowered from 7,8 per cent to 7,5 per cent;
Russia from 3,4 per cent to 2,5 per cent; India from 5,8 per cent to 5,6 per cent; Brazil from
3,0 per cent to 2,5 per cent and South Africa from 2,8 per cent to 2,0 per cent. The speed of
this downturn is cause for concern, and illustrates that the idea that the emerging markets
can decouple from the advanced economies and become an independent engine of global
growth is overly simplistic.
This slowdown is compounded by financial market uncertainties and turbulence that followed
the announcement by the US Federal Reserve that it may begin to slow the pace of asset
purchases. Long-term yields spiked in both advanced and emerging bond markets, as capital
flowed out of emerging markets in particular. While the markets have calmed down
somewhat following their original overreaction, this episode illustrates not only the difficulties
that advanced economies will have in reversing their highly accommodative monetary policy
stances in the future, but also the likely spillover effects on emerging and developing
countries. Our challenge as a country will be to anticipate and reduce our vulnerability to
these risks.
In the meantime, however, loose monetary policy is expected to persist in most of the
advanced economies as downside risks to growth continue and inflation remains largely
benign with a concern about deflation rather than inflation, particularly in Japan and the
United States. The Eurozone remains mired in a deepening recession, the Japanese
recovery is uncertain, and the US economy, while showing signs of improving, is facing
headwinds from a sharp fiscal contraction.
The South African economic growth prospects have also weakened in the face of global and
domestic constraints. The Bank's most recent forecast is for growth of 2,0 per cent in 2013,
rising to 3,3 per cent next year. However, there are downside risks to this forecast,
particularly given electricity supply constraints. At the same time, driven mainly by a
depreciating currency and rising wage and salary costs, the forecast inflation path has
moved up, and a temporary breach of the target range is expected in the third quarter of this
year, despite an absence of strong demand pressures. Although our forecast suggests that
inflation will remain within the target range thereafter, it is uncomfortably close to the top of
the target range and the risks to this forecast are seen to be on the upside.
The Bank's primary mandate remains price stability within a flexible inflation targeting
framework. This means that we need to be cognizant of the state of the economy, and the
policy dilemma has become more marked with rising inflation and slowing growth. Against
the backdrop of a volatile currency responding to domestic and global developments, we can
expect a challenging year ahead for monetary policy.
As was elaborated in the Annual Report, the Bank has the responsibility to act on its
expanded mandate of financial stability. This is part of a global phenomenon which has seen
responsibility for financial stability and macroprudential oversight becoming increasingly the
responsibility of central banks. This has raised expectations about what central banks can
and should do, with the danger that expectations can become unrealistic. The move to the
Twin Peaks regulatory architecture is well under way. In terms of this framework, the Bank
has been given responsibility for prudential regulation of the financial sector, which will entail
a move of a number of personnel from the Financial Services Board (FSB) to the Bank. In
addition, the Bank has been given responsibility for macroprudential oversight. The coming
year will therefore not only see logistical and personnel challenges, but also challenges of
integrating our expanded mandate of financial stability with our primary mandate of price
stability.
An important function of the Bank is the management of the country's official gold and foreign
exchange reserves. For some time there has been a need to build up the country's holdings
of foreign exchange reserves, which were - and still are - low in comparison to IMF
estimates of reserve adequacy and our emerging market economy peers. The need to
accumulate these reserves was driven by the imperative to reduce the country's vulnerability
to sudden large outflows of capital, something to which our economy is prone. We have
made good progress in this regard in the past 10 years, with gross gold and foreign
exchange reserves increasing from US$8 bn in June 2003, to current levels of US$47 bn.
Net reserves increased from US$1 bn to US$45 bn over the same period. During the past
financial year, most of the moves in the level of reserves were a result of valuation changes
relating to fluctuations in the gold price and exchange rate movements. Direct accumulation
was limited given the weakening of the rand over the period. However, our responsibility for
managing these reserves has impacted significantly on the profitability of the Bank.
The financial statements presented to you today show that the Bank has recorded a loss for
the third consecutive year. For the 2012/13 financial year, a loss of R1,5 billion was
recorded, compared with R491 million in the previous financial year. It is important to
elaborate on the nature of these losses, as they arise due to the unique nature of a central
bank. The structure of the Bank's balance sheet is intrinsically linked to the diverse
responsibilities of a central bank. As has been elaborated in a recent paper published by the
Bank for International Settlements, central banks pursue national welfare and not profits. It
follows therefore that profitability is not necessarily a good guide for measuring success, and
a focus on profitability can lead to sub-optimal policies for the country as a whole. The Bank's
activities and financial results should therefore be seen in a broader context and not within
the artificial narrow confines of its balance sheet.
The major source of our losses emanate from our accumulation and holding of foreign
exchange reserves. When the Bank purchases foreign exchange, it injects rand liquidity into
the market. Unless we neutralise this liquidity increase, it could have inflationary
consequences. There are a variety of ways that we can do this through our open market
operations, for example through foreign exchange swap transactions, conducting reverse
repurchase transactions, or the issuing of Reserve Bank debentures. This process is known
as sterilisation. However, while we are paying around 5 per cent (linked to the current repo
rate) on these transactions, we earn very little on our holding of foreign exchange reserves.
This is because the ongoing global financial crisis has resulted in abnormally low interest
rates in the advanced economies. And it is the currencies of these countries that are held as
our reserves.
The cost of sterilisation and the low returns on foreign currency holdings continue to impact
the financial results of the Bank. The income of the Bank is mainly derived from foreign
investments and, due to the low-yielding environment this was insufficient to cover the
operational costs of the Bank. In addition, the total income of the Bank decreased by
R282 million compared with the previous year, mainly due to a reduction in commission on
banking services.
Clearly we could improve our balance sheet by not accumulating reserves or by reducing our
reserve holdings. However this would not be in the interest of the country as a whole. To the
contrary, our reserves are still considered to be on the low side, and over time we will need
to build up these reserves further. But it is also important to point out that reserve
accumulation has in fact been highly profitable for the country. As the rand has depreciated
over time, the rand value of these reserves has increased quite substantially. However, in
terms of the SARB Act, these revaluation gains (or possible losses) accrue to the
government through the Gold and Foreign Exchange Contingency Reserve Account
(GFECRA), while the current low return and cost of sterilisation accrue to the Bank. As
shown in the Annual Report, the GFECRA stood at R67,6 bn at the end of the 2011/2012
financial year, growing to R125,5 bn at the end of March 2013. In this sense the artificial
separation of these two components of reserve accumulation give a distorted picture, and we
need to bear in mind this context of accounting conventions. We have to take policy
decisions that are in the best interests of the country.
A further contributory factor to the increased losses reported this past financial year relates to
the Bank's role as the sole issuer of currency in the economy. The previous banknote series
had been in existence since 1992. A decision was taken to introduce a new series, and at the
same time upgrade the security features of the banknotes in order to minimise counterfeiting
risks. The introduction of a new currency series involves high initial fixed costs for a number
of years as the stocks are built up, including buffer stocks. It is important to bear in mind that
the notes and coin in circulation peaked at a level above R110 bn during the financial year,
and increases at about 10 per cent per annum (compared to the peak in the previous year).
In November 2012, the new Mandela banknote series was launched resulting in a
R819 million increase in the cost of currency in comparison to the prior year, recognising that
as we knew we were introducing the new note series, production of the old notes was
deliberately kept to the minimum required so that we could draw down on the buffer stocks.
In summary, the losses experienced by the Bank since 2010 are not a reflection of bad
management or poor budget controls, but are the result of the exceptionally low foreign
yields and the cost of issuing the new currency series. We are not driven by a profit motive
and the losses arise from us performing our functions in the interest of the economy. But at
the same time we cannot be complacent and use this as an excuse for uncontrolled
expenditure. We therefore remain committed to containing our costs and maximising
operational efficiency.
At this time we would normally have expanded on some of the questions raised during the
shareholder road shows held in Pretoria, Durban and Cape Town on 10, 11 and 12 July
2013, respectively. However, the questions posed this year were either specific to the
persons attending the meetings or have been addressed in my earlier remarks.
Unfortunately, this year's shareholder road shows were not well attended and the Bank has
decided that it will no longer hold the road shows in Durban and Cape Town unless
circumstances dictate otherwise. However, the road show in Pretoria will still take place prior
to the AGM each year. The general information letters that are distributed to shareholders at
least twice each year, will continue.