Reserve Bank should adopt a wait-and-see style Reply

Borrowing costs are important to most consumers and businesspeople in SA. Whether the Monetary Policy Committee (MPC) of the SA Reserve Bank (SARB) raises rates again at its meeting this week is therefore of significance to the economy. Decisions by business and consumers will be influenced by what will be decided soon about interest rates here and abroad, even if the rise is small, and given other economic pressures.  What is the outlook?

Prof Raymond Parsons

Prof Raymond Parsons

Following the latest robust jobs data there, a strong consensus is emerging that US interest rates may now eventually be poised to rise by 25 basis points at the next Federal Reserve meeting on December 16. The risk is that even a tiny rise in US interest rates can suck capital from emerging markets like SA, knocking currencies and share prices.  Indeed, just the prospect of US interest rates rising next month has already strengthened the dollar and weakened the rand, but there has been some currency ‘overshooting’.

Yet the task of the SARB is to assess the balance of risks between inflation and growth and to make a judgement call on interest rates at each MPC meeting. The MPC faces this policy dilemma constantly as it navigates in an uncertain and volatile world economy. While at its September meeting the MPC saw the risks as more or less evenly balanced and thus left interest rates unchanged, this is no longer appears the case. The risks now look more asymmetrical, with output in several sectors struggling to remain in positive territory.

For example, for the year to date manufacturing output has only grown marginally, new vehicle sales are sharply down, mining output has contracted, and unemployment has risen. In short, if the SARB takes the wrong decision on rates, it might tip the economy into recession. Despite the uncertain economic outlook, the expected 2015 growth rate of less than 1.5% and the benign inflation outcomes of recent months, the SARB may nevertheless resume its promised upward adjustment of rates.

On the other hand, some economists think that the SARB may again leave rates unchanged. The Bank itself describes the domestic economic outlook as ‘fragile’ and is aware of the chronically low levels of consumer and business confidence. So why should monetary policy now be counter-cycle? The ‘doves’ may also argue that, although the chances of a rise in US interest rates soon have increased, it is not yet a foregone conclusion. Economic analysts have regularly been wrong about US interest rates.  It would therefore be better for the SARB not to again seek to pre-empt the Fed outcome and rather reassess the situation at the next MPC meeting in January 2016.

But there are other perceived concerns which may sway the arguments towards a rate increase this week. The ‘hawks’ argue that the SARB should be more worried about inflationary expectations, the danger of ‘second round’ wage effects, and the negative impact of the unfolding drought on food prices. To head all this potential off and to send the right signal about the SARB’s commitment to its inflation target, it is thought the Bank must continue to raise interest rates. Most of these are conventional worries for a central bank but are misplaced in present economic circumstances.

For one thing, SA’s inflation is cost-induced and not amenable to discipline from higher interest rates, except at an unnecessary cost in growth and employment. Inflation has been driven by administered prices such as Eskom and municipal tariffs, not by boom conditions which would indeed eventually require monetary restraint. Furthermore, evidence of a wage-price ‘spiral’ is weak and inflationary expectations seem stable. And while steps must be taken to ameliorate the effects of the drought, raising interest rates is not one of them. If the drought persists it could become a worse economic threat to SA growth next year than higher interest rates.

SA should in any event concentrate on addressing the structural obstacles to a better economic performance, and not seek solutions to its growth challenges in monetary policy. The way to build confidence is for SA to be seen to be successfully implementing sensible long term policies and projects. Global setbacks have exposed the structural weaknesses in the economy. ‘When the tide goes out’, says Warren Buffet,’ you see who has been swimming naked’. Given the present complex global and domestic economic cross-currents the  modest advice to therefore offer the SARB for now is: ‘wait and see’.

Raymond Parsons is a Professor at the North West University Business School

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