Daniel Mminele: Monetary policy in volatile and uncertain times
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
breakfast of the Association of Corporate Treasurers of Southern Africa, Johannesburg,
27 May 2011.
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1. Introduction
Good morning ladies and gentlemen.
Thank you to the Association of Corporate Treasurers of Southern Africa (ACTSA) for
extending this invitation to share some thoughts with you this morning on monetary policy.
However, before I delve into issues related to monetary policy, I would like to provide a brief
overview of the global policy agenda, how it has been shaped by the crisis and efforts
underway to restore macroeconomic and financial stability and a more balanced global
economy.
As the title of my speech suggests, the global economic and financial environment is one
fraught with volatility. While we may have emerged from the crisis, the recovery has been
difficult and risks remain large. Sovereign debt difficulties in peripheral Europe as well as in
some other advanced economies, banking systems still in need of repair, and geopolitical
risks, all compounded by natural disasters, are issues we need to grapple with. It is within
this highly uncertain environment that central banks need to manoeuvre and find ways to
best deal with rising inflationary risks without jeopardising the recovery and creating threats
to financial stability.
2. An uncertain and volatile global landscape
The sovereign debt crisis in peripheral Europe shows little signs of abating. Speculation
around a possible Greek debt restructuring or, in some quarters even around an eventual
exit from the euro zone is gathering momentum and threatens the outlook for Ireland and
Portugal, and could possibly cause disruptions in Spain and core Europe. We have recently
seen further rating downgrades and revisions to rating outlooks by rating agencies. Martin
Wolf,1 in an article in the Financial Times, relates the euro zone's approach to the fiscal
crises to the story of a man sentenced to death by his king. The king tells him that he can
keep his life if he teaches the monarch's horse to talk within a year. Surprisingly, the
condemned man agrees. Asked why he did so, he answers that anything might happen: the
king might die; he might die; and the horse might learn to talk. In essence, Martin Wolf
argues that policymakers have decided to play for time in the hope that the countries in
difficulty will restore their creditworthiness. The significant rise in the cost of borrowing for
peripheral European countries shows that, if this indeed was a deliberate strategy, it is not
succeeding. It is unclear how a debt restructuring would affect markets and the real
economy. Some argue that this would be the most practical solution for Europe, while others
say that, given the interconnectedness of sovereign debt markets and the banking systems
in Europe, this has the potential to trigger developments similar to what was witnessed
around the Lehman Brothers collapse.
The International Monetary Funds' (IMF) latest World Economic Outlook and Global
Financial Stability Report (April 2011) reflects a recovery that appears to have solidified.
However, growth on average remains below pre-crisis levels, unemployment is high, and
inflationary risks have picked up. The story of the two-speed economic recovery is well
known - modest growth and still high unemployment in advanced economies, contrasted
with robust growth in emerging market economies, but marred by high rates of youth
unemployment and rising inflation. In many emerging economies output gaps have become
positive, inflation is rising and capital flows from developed to emerging economies continue
unabated. The combination of weak sovereign balance sheets, weak real estate markets,
high funding requirements for sovereigns and banks in advanced economies, together with
overheating and booming asset markets in emerging market economies, tilts the balance of
risks to growth to the downside. Political and social unrest in the Middle East and North
Africa as a result of rising food and commodity prices also threatens to add to already heady
inflationary pressures.
Thus, while the global recovery may be on a firmer footing than a year ago, it is questionable
whether growth is more balanced than before the crisis. Improved growth prospects in
developed countries have largely been driven by fiscal spending and loose monetary policy,
although more recently, certain advanced economies have begun to reduce the fiscal
stimulus and started raising policy rates. On the other hand, emerging markets reflect robust
consumer spending and private sector investment. Such an uneven recovery could fuel
further imbalances and delay the current recovery while also sowing the seeds of future
crises.
3. The global policy agenda and South Africa
Global imbalances were one of the foremost causes of the crises and therefore, have
become a significant agenda item for the G20, which effectively replaced the G8 as the
leading forum for international economic co-operation and coordination. Since 2008, the
status of the G20 has been elevated, recognising that co-operation on a global scale is
required to successfully and sustainably deal with the crisis. To this end, the vital role of
emerging market economies was recognised, and rightly so. Over the past five decades, the
global balance of power has shifted towards emerging-market economies, whose share of
global GDP has increased alongside the decline in that of advanced economies. Between
1960 and 1985, advanced economies on average accounted for about 75 per cent of global
GDP (based on purchasing power parity weights), this share declined gradually to
57 per cent in 2009. In contrast, over the same period, the share of emerging market and
developing economies increased steadily from 17 per cent to almost 40 per cent.2
At the
height of the financial crisis during 2008 and 2009, emerging markets were the sole engine of
world growth.
In 2009, G20 countries committed to a new framework for strong, sustainable and balanced
growth (referred to as the Framework), as well as a Mutual Assessment Process (MAP). The
Framework is intended to ensure that the individual country actions contribute to a coherent
path forward, while the MAP is intended to gauge the degree of collective consistency of G20
macroeconomic policy actions. To this end, a number of indicators have been agreed upon
to enable the identification of globally systemic imbalances and to ensure that preventative
and corrective action is taken timeously. The co-operation to a large extent proved to be
highly effective in the immediate aftermath of the financial crisis, but is now facing some
challenges given the increasingly divergent developments across countries and regions.
There is wide recognition that there is a need for an adjustment in exchange rates in order
for global rebalancing to occur. This process is also referred to as demand rotation and
requires deficit economies to save more and consume less, while surplus economies are
required to spend more and save less. Surplus countries are therefore expected to shift
focus from external demand to domestic demand in order to sustain growth. In contrast,
deficit economies will need to rely more on external demand. This implies that exchange
rates will adjust, with the exchange rates of deficit economies depreciating, while the surplus
economies will need to let their currencies appreciate. As you can well imagine, this is a
contentious issue amongst G20 countries, given that developed and developing economies
have differing policy priorities. However, what is important is that co-ordination does exist on
various economic aspects, including sustainable, balanced growth, financial sector reforms,
and reform of international financial institutions.
Excess global liquidity on account of easy monetary policies in advanced economies,
coupled with the combination of promising growth prospects, improved governance and
capital account liberalisation, made emerging market economies very attractive investment
destinations. Consequently, currency tensions came to the fore early last year as volatile
capital flows returned to emerging market economies, resulting in currency appreciation and
thereby eroding export competitiveness and disrupting macroeconomic stability. Apart from
currency appreciation, these inflows have also increased the possibility of bubbles in asset
prices in emerging economies. There have been a range of responses to the surge in capital
inflows, from outright intervention to the imposition of capital controls. The thinking behind
the management of capital flows has shifted somewhat in the process. In essence, where
previously much criticism was directed at measures to deal with capital inflows, it is now
widely accepted that under certain conditions this can be a legitimate component of policy
responses to deal with the surge in capital inflows. To this end country-specific
circumstances are an important consideration when deciding what measures may be
appropriate or not.
Accordingly, although an old topic in economic literature, the G20 under the French
Presidency has added a new agenda item, namely, the "Reform of the International
Monetary System". A working group was established to discuss the future global monetary
system, with a view to achieving a more stable and representative system. A key focus area
of this working group centres on developing a better understanding of the consequences and
causes of capital flows, with a view to developing a framework of non-prescriptive guidelines
to govern currency interventions in the face of volatile flows. This agenda item is very much
aligned with the Framework.
Movements in currency markets over the past few years are indicative of global
developments, where the US dollar's role as the sole global reserve currency is increasingly
being questioned. Other currencies, including those of major emerging market economies
(when they satisfy relevant criteria) are likely to play a larger role in future. But, it will be a
long journey before there is any significant change to the US dollar's status as the world's
reserve currency.
South Africa, being the only African country represented on the G20, supports efforts
towards strong, balanced and sustainable growth and the reform of the international
monetary system, and officials from the National Treasury and the South African Reserve
Bank actively participate in G20 working groups. There is certainly a need for global
co-operation, as we have clearly seen, economic and financial disruptions in one place can
cause not just ripple effects elsewhere, but crises of significant proportions. Co-operation at
the global level is essential to ensure that the seeds of the next crisis are not inadvertently
sown in the measures currently being developed and implemented, and to ensure that we
will be adequately prepared to tackle future challenges.
In April this year, South Africa was also accepted officially as a fully-fledged member into the
BRIC (Brazil, Russia, India and China) bloc, bolstering its position on the global economic
arena, and strengthening political and trade ties within the bloc. South Africa accounts for
about a third of gross domestic product in sub-Saharan Africa. This membership is mutually
beneficial, opening up vast opportunities for Africa, while at the same time offering BRIC
members improved access to mineral resources and approximately one billion consumers on
the continent. It is important for South Africa to harness the opportunities that come with its
membership of BRICS and to leverage its position to support growth, development and
employment creation initiatives in the country.
4. South Africa's growth outlook
Although the South African financial system has to date emerged relatively unscathed from
the financial crisis, largely owing to sound financial regulation and supervision, the real
economy did suffer. The economy contracted by 1,7 per cent in 2009, following growth of
5,6 per cent in 2006 and 2007 and 3,6 per cent in 2008. Growth in real gross domestic
product has improved since the recession experienced in 2009, but is insufficient to address
the burgeoning joblessness rate, which measured 25 per cent in the first quarter of 2011.
The output gap remains negative, as growth remains below trend and output below levels
achieved prior the crisis.
The accommodative monetary policy stance of the Bank over the past few years has
certainly helped to prop up household consumption expenditure. Household consumption
expenditure has been the main driver of growth, making the largest contribution of
2,8 percentage points to growth in GDP during 2010. Even so, growth has not been
excessive and there are tentative signs that this positive momentum may be levelling off, as
suggested by recent economic data in the form of retail sales, motor vehicle sales and credit
growth. Consumers remain relatively highly indebted, while impaired advances as a
percentage of total loans and advances have remained somewhat sticky since the end of
2009 at levels close to 6 per cent. High levels of household indebtedness together with the
elevated level of the number of consumers with impaired credit records, is likely to constrain
consumers to some extent going forward.
Positive trends in the composite leading business cycle indicator and the Kagiso/BER
Purchasing Managers Index suggest that the recent trends and outlook for the manufacturing
sector has improved. The details in the various business confidence surveys confirm this
view. The year-on-year increase in the physical volume of manufacturing output measured
4,6 per cent in March, following the 5,7 per cent increase registered in February. On a
three-month on three-month basis, the increase was 4,0 per cent. These developments are
encouraging especially when viewed against the backdrop of the appreciation in the
currency. However, there is still a substantial degree of slack in the manufacturing sector.
The Bank's forecast reflects GDP growth averaging 3,6 per cent and 3,9 per cent in 2011
and 2012, respectively. These forecasts are somewhat lower than those of some other
emerging market and developing countries.
5. South Africa's monetary policy response
Inflation in a number of emerging market countries has been rising steadily over the past
year, driven by the rise in global food and commodity prices. The large share of food and
energy in the CPI baskets of many emerging market countries is a major factor behind rising
inflation. In addition, in many cases output gaps have closed, resulting in a tightening of
monetary policy in many emerging market economies.
In contrast, South Africa has maintained a repo rate of 5,5 per cent since November 2010,
following the reduction in the policy rate by 650 basis points since March 2008. South
Africa's inflation picture has been somewhat benign compared to other emerging markets.
Domestic CPI reached a low point of 3,2 per cent in September 2010, at a time when other
emerging market countries inflation rates had already started rising owing to rising
commodity prices. South Africa's inflation rate has risen steadily since then, with CPI
measuring 4,2 per cent in April 2011.
At this stage there are no discernible inflationary pressures coming from the demand side of
the economy, the output gap remains negative and there are tentative signs that the
momentum in consumer demand may be levelling off. Furthermore, core inflation readings,
when measured by adjusting overall CPI for food, non-alcoholic beverages and energy
prices, were relatively subdued at 3,4 per cent in March.
However, the inflation outlook has deteriorated over the past couple of months, largely due to
external cost-push factors. The main factors behind the upward trend in inflation have been
food, and transport prices. Food price inflation increased from 3,5 per cent in February 2011
to 4,8 per cent in April, while petrol prices increased at a rate of 16,3 per cent. Other
administered prices also placed upward pressure on prices, with electricity increasing by
19,0 per cent in April. Administered price inflation increased by 10,7 per cent in April, driven
by a 12,1 per cent increase in the regulated component. If one excludes administered prices
from CPI, the CPI would have measured 3,1 per cent in April. So far, these developments
have not filtered through to broader price pressures and the appreciation bias in the rand
exchange rate for most of this year, has helped to contain price pressures. That said, April
inflation data does suggest that core measures may be beginning to rise.
The Bank has revised higher its inflation forecasts over the past few MPC meetings. The
main risks to the inflation outlook continue to emanate from cost push pressures, including
administered prices. While annual inflation rates are expected to average 5.1 per cent and
6.0 per cent in 2011 and 2012, respectively, our latest forecast shows that inflation is
expected to breach 6 per cent in the first quarter of 2012 and to peak at 6,3 per cent. Inflation
is expected to return to within the target range thereafter, but remain close to the upper end
of 6 per cent. The breach is likely to be temporary, but is also dependent on further
developments in food and oil prices and the potential second round effects, and the risk that
these price pressures feed through to more generalised inflation. The recent decline in oil
prices and moderation in international food prices to some extent alleviates some of the
inflationary pressures that have confronted the South African economy. Another risk factor
on the domestic front is the developments in wage inflation. Despite high unemployment,
wage increases remained in excess of inflation and in the first quarter of 2011, measuring
8,2 per cent according to Andrew Levy Employment Publications. At the same time, labour
productivity has declined, resulting in an increase in unit labour costs.
Despite the upward revision to the inflation forecasts, the repurchase rate was maintained at
5,5 per cent at the most recent MPC meeting in May. This is essentially due to the large
influence of exogenous factors on current and projected inflation trends. The MPC is
however cognisant of the current cost-push pressures and the potential of these to filter
through to more generalised price pressures. These pressures will be closely monitored, and
the MPC will take timeous action to ensure that second round effects do not take hold and
that inflation pressures are kept in check.
6. Conclusion
To conclude, uncertainty in the global environment has not abated, as reflected by increased
volatility in financial markets. While the global recovery has proceeded at a moderate pace, it
remains unbalanced and uneven. To this end, the G20 is addressing issues of global
imbalances and also reflecting on the future global monetary system. Such developments will
have an impact on South Africa and policy developments going forward, as we are part of the
global economy and one of the more liquid amongst emerging market financial markets.
South Africa's growth outlook has improved, although it remains below pre-crisis levels and
below that of other emerging and developing countries. Inflation has recently trended higher,
and while the Bank's forecast shows that CPI will breach the upper end of the target range,
based on current information the MPC expects that this will be a temporary breach. However,
developments will be closely monitored for any second round effects which could result in
broader based price pressures.
Thank you.