Lesetja Kganyago: How the new global environment is influencing
the state of South Africa's economy
Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the
Lebanese Chamber of Commerce, Pretoria, 7 March 2023.
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Introduction
Ladies and gentlemen, it is my pleasure to address you today at this event hosted by
the Southern African Lebanese Chamber of Commerce. I commend the efforts of the
Chamber to deepen economic ties between Lebanon and Southern Africa, especially
the long-established and thriving Lebanese community in South Africa. Last year, trade
between South Africa and Lebanon amounted to over R170 million. As we look into the
future, I believe there is room to strengthen ties even more.
The topic chosen for my address - how the global environment is influencing the state
of South Africa's economy - could not be more topical. Since the spread of the
COVID19 pandemic across the globe three years ago, the world economy has faced numerous
shocks, which have compounded the domestic challenges faced by South Africa and
complicated the task of central bankers, both here and in the rest of the world.
COVID-19 and other macroeconomic shocks
The major disruptions since the onset of the pandemic in early 2020 challenged the
belief of many that the world had entered a long phase of low and stable inflation. We
now know that the 'closing and reopening' of economies due to the pandemic would not
occur without major supply and demand mismatches in most markets. Supply chains,
stretched by the staggered reopening of economies, only proved as resilient as their
weakest link, resulting in major delivery lags and higher costs in key industries. Labour
supply did not adjust automatically when firms began to hire again, resulting in tight
labour markets and, in some jurisdictions such as the United States or the United
Kingdom, an unusually high level of unfilled vacancies relative to unemployment.
There was no precedent in recent history that we could learn from relating to the policy
responses required to manage the pandemic shock. Even after economies had
reopened, fears of long-term scarring, including bankruptcies and permanent job
losses, prompted coordinated responses from governments and central banks to
uphold highly stimulative policies. In retrospect, we now know that such stimulus
provided excess support to demand at a time when supply was struggling to adjust,
which compounded inflation.
The war in Ukraine, which exacerbated the shock to prices of oil, gas and some inputs
into food production, such as fertilisers, added to the global inflation problem. Even a
country like South Africa, where supply constraints did not originate, faced price
pressures from more expensive imports, shortages of key inputs, elevated shipping
costs and the depreciation of the rand as financial markets repriced the outlook for
global interest rates. Worldwide inflation pressures have forced broad-based and, in
many cases, unusually fast monetary policy normalisation.
Where do we stand now?
Thankfully, some of the shocks that caused the global inflation surge have begun to
abate, albeit at a slow pace. Energy and agricultural commodity prices have fallen.
Shipping costs have largely normalised; other input prices have slowed significantly too.
Yet, in many countries, inflation remains far above target and is showing signs of
persistence in several sectors. This is particularly the case in non-housing services,
where prices are highly dependent on wage growth, but also in some consumer goods.
In South Africa, headline inflation also remains above the upper end of the target band,
though it has been gradually moderating since the latter part of 2022 - primarily driven
by a decline in fuel prices from the peaks observed mid-2022. However, we are not
completely out of the woods yet. Domestic fuel prices have been rising, albeit
moderately, and there is a risk that we could see further increases in the coming
months, largely as a result of exchange rate volatility. This shows that the domestic
inflation outlook is still susceptible to global factors, exacerbated by domestic
conditions, of course.
In South Africa, food price inflation has yet to peak, despite the decelerating trend
observed in global agricultural commodities. Domestic meat prices are still accelerating,
reflective of lingering supply constraints in the beef market following last year's outbreak
of foot and mouth disease. While these constraints are expected to gradually unwind
over the near term, persisting electricity supply issues - and the need for costly energy
alternatives - will keep raising input costs for food producers in industries such as
poultry and dairy farming. These may be passed through to consumers.
Although core inflation has come in lower than our expectations over the past two
months, we still caution that it remains above the midpoint of the South African Reserve
Bank's (SARB) target of 3-6%. In fact, our baseline view is that core inflation -
particularly core goods - is likely to remain sticky over the next few months, before
starting to ease over the medium term. For now though, prices of exchange
ratesensitive goods continue to accelerate. In the services sector, while some components
have surprised on the downside over recent months, we may start to see the margins in
some of these sectors, such as insurance and housing, also starting to pick up pace
and, as such, exert upside pressure on overall inflation.
As we have communicated before, the SARB will continue to monitor price
developments and act to guide inflation back to the midpoint of the target band over the
medium term. Elsewhere in the world, major central banks have repeatedly indicated
that they have not yet completed their policy normalisation. They may need to keep
policy in restrictive territory for an extended period until clear signs emerge that inflation
is returning sustainably to target.
Implications for growth
The number and pace of rate hikes needed to fight global inflation suggests we are
likely to see weaker world growth in 2023, even ashousehold cash buffers and
corporate profitability have limited the downside risk, so far. The International Monetary
Fund (IMF) forecasts global growth of 2.9% this year, after growth of 3.4% in 2022, and
this means weaker demand for the exports of small, open economies such as South
Africa.
Implications for the domestic economy are twofold: first, directly through weaker growth,
and second, through a possible deterioration in our external accounts. Amid weaker
exports volumes, combined with South Africa's persistent and more intensive
loadshedding as well as a deterioration of its ports and railway infrastructure, the SARB's
gross domestic product (GDP) growth forecast for this year currently sits at 0.3%. Stats
SA published the Q4 GDP report this morning and the outcome was much weaker than
what we thought it would be. It seems like the adverse impact of these factors has
already started materialising, placing further downside risk to our current forecast.
2022Q4 GDP came in at -1.3%, bringing growth for the year 2022 to 2.0% - below our
estimate of 2.5% at the January MPC meeting. A deep dive into these numbers shows
that the decline was broad-based over the quarter, with 7 out of the 10 sectors
detracting from GDP growth.
From the expenditure side, we note the pressures faced by households, where elevated
inflation has necessitated higher interest rates. While the domestic labour market also
continues to recover gradually, an environment of weak growth implies that we may
start seeing renewed job losses. Furthermore, while nominal wages have shown a
recovery, real incomes, however, remain constrained. Nonetheless, we do expect
household spending to remain supportive of the little growth that is projected for the
year. This view is also corroborated by today's GDP report, which continued to show
positive growth in household consumption. Furthermore, although having moderated
over recent quarters, growth in fixed investment showed some recovery in Q4 and is
also expected to contribute positively going into 2023.
From this it is clear that the outlook for even the relatively low growth rates we project
over the medium term, remains highly uncertain - in light of our own domestic
constraints. The outlook also hinges on how quickly South Africa's structural constraints
can be addressed over the medium term.
From an external accounts' perspective, South Africa has benefitted from the generally
high commodity prices that have prevailed over the past two years. These, however,
have been moderating since the second half of 2022, in line with the slowdown in global
growth, with further declines in South Africa's commodity export prices expected in
2023. While the reopening of the Chinese economy led to renewed strength for key
commodities such as iron ore, platinum, copper and steel at the beginning of the year,
this may not be sustained. The recovery in China's economy should mostly be led by
services, while the commodity-intensive construction sector is unlikely to rebound at a
fast pace.
At the same time, the persistence of domestic electricity supply constraints implies that
more businesses and households may be investing in alternative energy solutions,
thereby driving up imports. This, balanced against projections of lower export volumes,
equates to a deteriorated current account balance over the short to medium term.
The role of the financial channel
Financial markets are another channel through which global conditions affect South
Africa. Global growth, inflation and the pace of policy normalisation in advanced
economies affect investor risk appetite, cross-border capital flows and, hence, the
availability and cost of external funding. So far, considering the pace of policy
normalisation in major economies and the extent to which 'safe assets' have re-priced,
the shock has not been strong by historical standards. Capital outflows from emerging
markets were moderate for most of 2022 and recovered in the fourth quarter as global
conditions improved. Throughout 2022, the rand weakened by a mere 6.5% against the
US dollar, initially helped by supportive terms of trade and South Africa's current
account surplus.
But 2023 may still hold challenges on the financial front. If, as developments in
February suggest, investors become more worried about global rates having to stay
higher for longer, they may again shun riskier assets, and that includes South African
bonds and equities. A similar outcome may occur if the consequence of policy
normalisation is a deeper economic contraction than what markets currently discount. In
both cases, South Africa may face renewed capital outflows, and the deterioration in the
current account over the past year means this could trigger new volatility in our asset
prices.
Furthermore, if global investors become more selective in their choice of assets, South
Africa may suffer from its own idiosyncratic issues and various fiscal risks such as rising
public sector wage costs and an increasing need for fiscal support for some of our
stateowned companies. Following the outbreak of COVID-19, unprecedented fiscal support
in many economies has once again put sovereign debt sustainability at the forefront of
investors' concerns. Many emerging countries face a mix of elevated public debt from
the pandemic as well as low growth. This, combined with the higher borrowing costs
that currently prevail, means that attracting foreign capital can become more
challenging.
Concluding remarks
It has been quite a journey since the outbreak of the pandemic. Lockdowns were
instituted almost universally to stem the spread of the virus, while fiscal and monetary
authorities around the world implemented unprecedented policy support for their
economies. And as we navigated through those risk shocks and their inflationary
impacts, the start of the war in Ukraine in early 2022 presented a new set of challenges
for economic policy around the globe.
The impacts of both these shocks continue to linger and present a conundrum, for
monetary policy especially. The global economy appears to be experiencing
stagflationary conditions - with high inflation and low growth. These conditions create
some tension between anti-inflation policies and pro-growth policies. That
notwithstanding, global central banks have communicated their resolve to bring inflation
back to target, as low and stable inflation is a prerequisite for high and sustainable
growth.
Similarly, in South Africa, we are also faced with high inflation and weak growth, and
face similar policy challenges. However, weak growth in our domestic context is
aggravated by structural constraints such as inadequate electricity supply, making this
an even more challenging task. The encouraging news is that we have started to see a
disinflationary trend. Inflation remains quite elevated, and like our peers around the
world, as the SARB, we remain committed to seeing inflation sustainably returning to
target.
Thank you.