lesetja kganyago : south africa and the normalisation of world monetary policies address by mr lesetja kganyago, deputy governor of the south african reserve bank, at the merrill lynch 2nd annual fixed income investor conference, sandton, 27 november 2013. * * * introduction since the onset of the world economic crisis, monetary policy in the major advanced economies has been extremely loose. this has been helpful in supporting economic recovery in those economies, which has had positive spillover effects for developing countries, including south africa. in line with other emerging markets, we have also benefitted from capital inflows which have boosted growth, lowered our borrowing costs and reduced inflation, through a stronger currency. however, these trends have started to reverse following signals from the us federal reserve that it plans to reduce the pace of bond purchases and ultimately tightening monetary policy. today, i will discuss what this change means for south africa. the unmoved mover : us monetary policy the prospect of fed tapering moved to centre stage in world financial markets on the 22nd of may, when chairman ben bernanke told the us congress that he envisioned slowing or tapering the fed ’ s quantitative easing programme this year. the result was a worldwide increase in medium and longer term interest rates and outflows of capital from emerging markets, as investors responded to better rates of return in advanced economies. for emerging markets, the shock appeared most visibly through weakening exchange rates, especially in the countries with large current account and fiscal deficits. by september, this strong market reaction had achieved a de facto world monetary tightening which had only to be validated by an actual fed decision to taper. yet this, to the surprise of many, was not forthcoming. the reasons the fed declined to fulfill expectations were really quite persuasive. the federal open market committee had attempted to provide forward guidance on interest rates using unemployment as its main indicator, with 7 % unemployment as the guideline for ending qe and 6. 5 % the threshold for raising rates. by september, unemployment had fallen to 7. 3 %, suggesting that tapering would need to happen rather quickly if qe were to be finished when unemployment reached 7 %. however, unemployment was actually an unreliable indicator of the health of the us economy. this was because most of the improvement was being achieved not through people finding jobs but through people leaving the labour force. when unemployment hit 7. 3 % the labour force participation rate fell to 63. 2 %

stimulus during the crisis, but these conditions are now passing. as rates rise, interest costs will consume a greater portion of gdp. our attempts to estimate this effect point to an extra r11 to r30 billion in interest payments annually, averaged over the next four years and depending on the interest rate path. it is therefore important that fiscal policy adjust appropriately to more normal interest rates. national treasury ’ s most - recent mtbps shows that this exigency has been well - understood by the fiscal authorities, and we are confident that it charts a sustainable course for south africa. in addition to the fiscal and current account deficits, south african consumers are also likely vulnerable to higher interest rates. as the sarb ’ s september 2013 financial stability review shows, households have used low rates to increase their debts, driving the ratio of debt to disposable income to almost 76 %. the number of consumers with impaired credit records has climbed steadily since 2008, to nearly half the total. although south africa ’ s banks are well - capitalised and therefore capable of withstanding higher default rates, this raises concerns both for consumer demand, an important driver of gdp growth, and the wellbeing of these financially vulnerable households. will south africa experience a “ sudden stop ”? given south africa ’ s vulnerabilities, the question is not if world monetary normalization will affect us but rather how quickly and dramatically it will do so. the worst - case scenario is that we suffer a sudden stop, meaning inflows abruptly cease. one helpful definition of a sudden stop offered in the literature specifies a year - on - year fall in the financial account greater than two standard deviations from the mean. other scholars have expanded this to a fall greater than one standard deviation, with the added requirement that the decline in inflows must exceed 5 % of gdp, to exclude cases where low volatility bis central bankers ’ speeches produces small standard deviations. 1 by either definition, this has never happened in democratic south africa. indeed, some of these writers pick out south africa as a special case, a country which has experienced large currency swings but no sudden stops. by contrast, other emerging markets have a long history of “ sudden stops ”, and these have often been growth disasters ; indonesia, for instance, took about a decade to recover the gdp levels it had attained before the asian crisis of 1998. sudden stops have also affected advanced economies – although some of them stopped being advanced economies after suffering