An address by Francois Groepe,
Deputy Governor of the South African Reserve Bank,
at the RMB Morgan Stanley Investor Conference
The Vineyard Hotel, Cape Town
25 September 2018
Distinguished guests, ladies and gentlemen.
It is a pleasure to be with you today and to share the stage with such an illustrious
group of speakers.
Today, I would like to discuss what has been a recurring theme in our economic
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discourse for the past decade the pursuit of structural reforms in the interest of
inclusive growth. It is top of mind for investors, businesses, labour unions, academics
and policymakers alike, including the Monetary Policy Committee (MPC). It has also
attracted a wide range of research and analysis, most prominently the National
Planning Commission's diagnostic
report, and has been central to the proposed
government policy interventions as captured within the National Development Plan
(NDP).
First, I will share my thoughts on this critical topic, and second, I will touch on the role
of the South African Reserve Bank (SARB) in relation to structural reforms.
Introduction
Structural reforms are policies mainly undertaken to improve the supply side of the
economy by reducing constraints on the production of goods and services. These may
include policies to reduce 'red tape', curtail monopoly power, raise the efficiency of key
public services, and even amend taxes and public spending programmes with the
intention of ensuring fiscal sustainability. Underlying these reforms is often an attempt
to strengthen the institutional fabric of the economy by ensuring that 'the rules of the
game' incentivise individual behaviour that contributes to the common good.
The need to lift productivity and growth through structural and institutional reforms has
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received a significant amount of attention not just domestically, but internationally.
Indeed, it is a challenge faced by economies of all income levels in many different
parts of the world. For example, in its latest Global Economic Prospects report, the
World Bank notes that both advanced and emerging market economies have
experienced a decline in their growth potential over the past decade. In a reference to
the global economy, the report emphasises 'an urgent need to press ahead with
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growth-enhancing policy adjustments including reforming product and labor markets,
raising investment in human capital, and building the policy buffers needed to allow an
appropriate countercyclical response to shocks when they materialize'.1 This policy
recommendation for the global economy applies equally to South Africa. Our growth
challenges are thus not unique, but they are certainly a cause for concern.
Similarly, the pressure to enhance the inclusiveness of economic growth in South
Africa is also being felt in many other parts of the world. While income inequality
between countries has fallen over the past 20 years, amid a rising middle class in
many emerging market economies,2 within-country inequality has increased in many
countries.3
The recent rise in populist rhetoric internationally appears to be, at least in part, a
reflection of rising inequality and a sense that economic gains are neither equally nor
widely shared. This perception was exacerbated by the global financial crisis which,
like many large crises, affected the poorest in society the worst.
The power of inequality and perceived economic injustice as contributing factors
towards political outcomes is being demonstrated in advanced and emerging
economies alike. The consequences of these outcomes have been profound. In
particular, decades of global economic integration, so widely held to be beneficial, are
now at risk of being reversed. A key implication of this reaction is that the policies
targeted at increasing gross domestic product (GDP) growth must also aim to be
inclusive if they are to be sustainable in the long term.
Considering South Africa's challenges in moving to a more equitable economy,
it is
disconcerting to observe the notable moderation in the potential rate of growth over
the past decade. Part of this moderation can be attributed to the legacy of the global
in some of South Africa's
financial crisis and a lower level of growth export-partner
economies. However, a significant share is self-inflicted, reflecting slow gains in
productivity, policy uncertainty and a lack of investment in key sectors.
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At the current level of potential GDP growth which the SARB estimates to be
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between 1.0% and 1.4% over the next three years the economy is not able to
generate real per capita income gains on a sustained basis. This is because
population growth is currently at about 1.6% per year.4 Achieving a more equitable
distribution of income is particularly challenging if it is not possible to grow the
economy faster than the rate of population growth. In such an environment, difficult
conversations about redistribution are unavoidable. However, if we could meaningfully
lift the GDP growth rate, redistribution could take place more easily through the sharing
of the additional gains.
Reforming the economy has therefore become imperative, particularly if the standard
of living is to be improved for all South Africans.
Government has put substantial effort into the development of the NDP, which
provides a clear and holistic structural reform framework. This plan has received
support from across the political spectrum. However, implementation has been
disappointingly slow.
The recent change in political leadership gave rise to a renewed sense of optimism
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around the structural transformation agenda not least because the President was
the Deputy Chair when the National Planning Commission drafted the NDP.
Encouragingly, the new administration has started to implement a number of reforms
aimed at improving governance, tackling corruption and reducing pressure on the
fiscus.
Despite the improvements in business and consumer confidence earlier this year, the
short-term economic outlook has remained subdued. Some analysts have noted that
the reform progress has not been sufficiently rapid to ignite economic activity. With the
economy now in a technical recession, following two consecutive quarters of
contracting economic activity, concerns about the implications of low growth for
employment creation, government finances and poverty alleviation have intensified.
The governance and fiscal reforms currently being implemented are better thought of
as improving institutional strength and the resilience of the economy. While they may
not meaningfully lift short-term growth, they are important in reducing downside risks
over the medium term and providing a degree of confidence to the private sector.
Embedding a sound institutional environment is essential for creating the virtuous
cycle in which iterative structural improvements are self-perpetuating.
To raise the growth potential of the South African economy, additional reforms are
required, specifically aimed at lifting productivity and increasing the efficiency of
product and labour markets. Structural reforms, even when small, have in the past
brought tangible benefits to our economy. The licensing of mobile phone operators in
the 1990s brought down the costs of land lines and moved South Africans to near
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universal access to a telephone over 90% of adults have had access to a land line
or mobile phone since 2016.5 In addition, allowing for private sector participation in the
electricity sector since 2010 has enabled the connection of 3776MW6 to the electricity
grid and increased private sector investment, and minimised the negative impact of
power shortages in 2015/16. There is room for more reforms which, as articulated in
the NDP, can lower the cost of living and improve the competitiveness of our exports.
Indeed, National Treasury has recently estimated that the potential growth rate of the
economy could be doubled by, among other things, releasing broadband spectrum,
increasing the skill levels in the economy, and addressing anti-competitive practices.7
Other analyses show that there is a positive correlation between the employment of
skilled workers and unskilled workers. In this regard, measures to increase the number
of workers with critical skills, including higher university throughput, the training of
artisans and easing visa regulations for individuals with critical skills, could be
beneficial.
While some of these reforms will take time to show in the growth numbers,8 more
immediate gains can be achieved by addressing the policy uncertainty that has
constrained private investment for some time now. In fact, providing a clear and
consistent message about the reform agenda will be as important as the agenda itself.
Former United States (US) Treasury Secretary Larry Summers has often been quoted
as saying that 'confidence is the cheapest form of stimulus'.9 However, in an
environment of rising inflation and fiscal constraints, it is also likely to be the most
effective stimulus currently available. In this regard, further clarity on the modalities of
the recovery package recently announced by the President will be important.
Over the medium term, it is important to emphasise that while the rate of growth in the
economy is set to rise only gradually, with a faster uptick contingent upon further
South Africa's
reforms, macroeconomic framework and strong set of institutions
continue to display remarkable resilience under challenging conditions.
South Africa's
This is no accident. Constitution was carefully drafted to provide for an
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independent judiciary, free media and democratic accountability all of which are
underpinned by an active civil society. Meanwhile, the macroeconomic framework has
been designed to ensure, among other things, that the exchange rate can effectively
absorb shocks from abroad without transmitting instability, alongside other automatic
stabilisers.
I would now like to discuss the role of the SARB in South Africa's institutional
and what we are doing to contribute to the country's macroeconomic
landscape
resilience and growth.
Bank's role in South Africa's institutional landscape
The South African Reserve
The primary role and the independence of the SARB are clearly articulated in South
Africa's Constitution.
It calls for the central bank to 'protect the value of the currency
in the interest of balanced and sustainable economic growth', and states that the
SARB 'must perform its functions independently and without fear, favour or
prejudice'.10
Central bank independence in the context of the SARB refers, at the minimum, to
instrument
independence, that is, the SARB has the flexibility to use any and all of the
tools at its disposal to achieve the set inflation target range.
The SARB communicates regularly with the public, trade unions, civil society,
parliament and representatives of government to explain and discuss economic
developments, as well as what informs the monetary policy stance. Through this
The SARB's
process, the SARB remains accountable to the South African public.
independence, however, allows it to avoid the trap whereby monetary policy is being
constrained by short-term political motives.
I wish to emphasise that the current shareholding structure of the SARB has no
bearing on its policymaking. Furthermore, the independence that the central bank
enjoys is unrelated to its shareholding structure as policymaking is the responsibility
of the four governors that are appointed by the President. Thus, the recent discussions
about government potentially changing the shareholding structure of the SARB are
largely inconsequential to the way in which the central bank operates. Nevertheless,
should the independence of the SARB come under threat for any reason, we will make
full use of all the legal avenues available to protect the independence of the SARB as
it is a very important pillar for monetary policy credibility.
To illustrate this point, allow me to briefly outline a temptation which is described in the
literature as a key reason for central bank independence. The temptation is known as
'time inconsistency'. It simply means that there is always an incentive for a central
bank to surprise the market with a more lax policy than is implied by its historical
behaviour. The incentive exists because unexpected stimulus will initially give rise to
an uptick in the economy. This is because prices are fixed in the short run, so the
stimulus will translate directly into higher output.
However, the economy will soon run into a capacity constraint, meaning that the higher
demand caused by a lax monetary policy will result in businesses marking up their
prices and unions raising their wage demands. As this occurs, the growth boost will
give way to higher inflation and job losses. The unexpected monetary policy shock will
dent the credibility of the central bank, as economic agents will be forced to reassess
bank's reaction function. This, in turn, will result in
the central higher inflation
expectations, while the medium-term growth prospects will, at best, be no better than
they were before.
It is easy to see why this type of behaviour could be attractive to a government in
search of short-term growth. However, if repeated, it can lead to escalating inflation
and a loss of confidence in the currency. One only needs to glance at the recent news
headlines to observe that such calamities are not confined to the history books.
The adoption of the inflation targeting framework was a significant structural shift for
South Africa following periods of persistently high inflation. Since the introduction of
inflation targeting in 2000, the SARB has worked hard to anchor inflation expectations
and to embed the inflation target range in the minds of South African citizens. We have
achieved hard-won credibility by avoiding the time inconsistency problem.
Nevertheless, we believe that it is possible to do better. In particular, we are aware
that inflation expectations have been anchored towards the upper end of the 3-6%
inflation target range rather than at the midpoint. This, in turn, has resulted in headline
inflation outcomes that have been uncomfortably close to 6% in recent years.
When inflation settles near the 6% mark, exogenous shocks, such as exchange rate
depreciation, can easily push inflation outside of the target range. The SARB operates
a flexible inflation-targeting regime. The MPC therefore looks through the initial impact
of supply-side shocks, with the aim of reacting to any second-round effects that these
shocks may cause. However, the flexibility of the SARB to do this is constrained when
such shocks quickly push inflation outside of the target range. Therefore, we are, as
part of an ongoing effort, attempting to steer inflation expectations towards the
midpoint of the inflation target range.
To increase transparency, the MPC has begun to publish a more detailed list of
forecasts as well as the endogenous repurchase rate path that is generated by our
macroeconomic model. Over time, the policy actions and communiqués of the SARB
are expected to anchor inflation expectations (and inflation itself) closer to the
4.5% level. The benefits of such an outcome include increased policy flexibility, a lower
inflation differential between South Africa and its major trading partners (implying less
pressure on the exchange rate), lower long-term interest rates and, of course, a
smaller annual erosion of purchasing power, which is particularly beneficial to the poor.
We are aware that, in the short term, there will be a trade-off between inflation and
growth, which implies that the transition to a lower inflation path will not be without
costs. To minimise these costs, the MPC will gradually guide expectations lower
through clear communication and appropriate policy-rate adjustments, as deemed
necessary. As with many important policy transitions, the long-term benefits will
significantly outweigh any short-term costs.
An expanded mandate
Over and above the primary mandate of price stability, the SARB has also recently
been given an explicit mandate to oversee financial stability. This mandate is provided
for in the Financial Sector Regulation Act 9 of 2017 (FSR Act), which was signed into
law last year. The FSR Act is the most fundamental reform of the South African
financial sector regulatory architecture in more than three decades.
The mandate for financial stability calls for the SARB to take steps to prevent systemic
events from occurring and to mitigate the adverse effects of a systemic event if and
when one does occur. The tools necessary for addressing system-wide risks are
commonly known as macroprudential tools.
Since the global financial crisis, it has become apparent that even if individual financial
institutions appear sound, there may still be a risk of broader financial instability due
to either excess leverage across the system or a high degree of common exposures
to a particular risk. Thus, the microprudential tools that have commonly been used to
safeguard individual banks, such as minimum capital and liquidity ratios, need to be
supplemented with a macroprudential approach to regulation. The SARB is currently
researching a variety of potential macroprudential tools and financial stability risk
indicators to improve the resilience of the broader financial system.
SARB's
The Financial Stability Committee has been set up to protect and enhance
financial stability. It is tasked with considering qualitative assessments of the
conjunctural assessments of risks to, and imbalances in, the broad financial system
and formulating policy action to mitigate identified threats, as well as considering the
appropriateness and adequacy of resolution policies and measures for crisis
The SARB's
management. toolkit is continually being refined and includes the ability
to deploy a countercyclical capital buffer for banks. This provides the SARB with the
means to raise aggregate bank capital buffers during upswings in the financial cycle,
and allows for the release of these buffers during downswings. Currently, given the
modest level of credit growth, the countercyclical capital buffer is set at zero.
The FSR Act has also established a Twin Peaks approach to financial regulation,
which means that prudential and market conduct regulation are now managed by two
separate entities. The SARB, as the prudential regulator, has received expanded
oversight responsibilities extending beyond banks, to include insurers and financial
market infrastructures. Meanwhile, a new entity, called the Financial Sector Conduct
Authority, has been established as the market conduct regulator.
meaningfully builds on South Africa's institutional strength within the
The FSR Act
financial sector by ensuring that the regulatory architecture is in line with best practices
globally. In particular, establishing a clear separation between prudential and conduct
regulation is an important reform because it ensures that there is adequate oversight
of both the soundness of financial institutions and the fair treatment of clients. Over
the longer term, we believe that centralising financial regulation within the SARB will
generate economies of scale and improve our ability to monitor risks across South
Africa's
highly interconnected financial sector.11
As I mentioned earlier, some important structural reforms do not show in the GDP
data. The financial sector reforms that I have been describing are an example.
Avoiding systemic crises does not necessarily result in a higher growth trajectory, and
hence its benefits are less apparent. One would need to consider counterfactuals to
determine the value of a stable financial sector. While this type of analysis is difficult,
we need only to observe the persistent effects of the global financial crisis to
appreciate the importance of a stable financial system. Certainly, the benefits extend
beyond the avoidance of economic losses and include a more stable social and
political environment. The fact that South Africa has not had a large-scale banking
crisis since attaining democracy serves to demonstrate the resilience of our financial
sector.12
South Africa's
Other structural reforms that have been critical for economic expansion
include the significant liberalisation of the capital account and the development of the
domestic bond market, which have deepened our financial markets. I provide these
examples to highlight that structural reforms can be varied but all have an important
role to play.
At the SARB, we believe that price and financial stability are complementary goals,
which together contribute towards creating an enabling environment for economic
growth. These goals reinforce each other because neither one is possible without the
other. And while we are working hard in both areas, we also recognise that our
contributions provide the necessary, but not sufficient, conditions for achieving
sustained, higher levels of growth.
A final point that I would like to touch upon is the work currently underway at the SARB
in the area of financial technology (fintech). Fintech is a key regulatory priority, but
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also a potential area of growth for the economy we do not have to look further than
Estonia and Singapore to realise the growth and transformational potential that the
use of technology may hold. As such, we have set up a unit focused solely on
understanding and utilising emergent fintech developments. Despite being in its
infancy, this unit reached a remarkable milestone recently by collaborating with various
banks to demonstrate that the domestic real-time gross settlement of interbank
payments can be decentralised and executed through distributed ledger technology.
We are anticipating many exciting developments in the fintech space over the coming
years, and will attempt to remain as close to the frontier in this domain as possible.
Concluding remarks
South Africa's economy is expected to stage a gradual recovery over the next two
years, as both domestic investment and export growth are forecast to rise. However,
a modest cyclical rebound of this nature is insufficient to address the high levels of
unemployment and inequality in our country. In order to reach more transformative
growth rates, as envisioned in the NDP, government will need to act decisively on the
recent reforms.
The SARB will remain focused on achieving its price stability and financial stability
mandates and, in concert with other regulators, it will continue to work towards further
improvements in the soundness and efficiency of the financial sector. Our efforts to
enhance what we do form part of a broader thrust towards an even stronger and even
more resilient institutional architecture in South Africa.
Thank you.