The watchword on interest rates: Caution Reply

When SARB’s Monetary Policy Committee (MPC) meets again at its usual two-monthly gathering next week, will the hawks or doves prevail? For some time the SARB has been impaled on the horns of a familiar but painful dilemma: how to reconcile its concerns about rising inflation with the reality of a steadily weakening economy? The latest GDP figures show that SA’s growth rate in 4Q2015 was only 0.6%, with growth of 1.3% in 2015 and 2.2% in 2014 as a whole. Credible forecasts of GDP growth in 2016 are now well below 1%, with only slightly better growth expectations for 2017. The overall economic outlook remains both uncertain and vulnerable.

Raymond Parsons

Prof Raymond Parsons

There are a number of global and domestic factors that explain why the SA economy is currently in a bad space and which cannot be laid at the door of monetary policy. SA is again in one of those phases which is becoming chronic, namely, a serious drop in confidence. And a flexible exchange rate regime is supposed to largely act as a ‘shock absorber’, as it did with the startling replacement of Finance Minister Nene last December, to facilitate adjustment to developments.

Yet the recent decline in growth has also coincided with a two-year period of a so-called ‘rising interest rate cycle’ and steadily higher borrowing costs in the economy. Correlation or causation? And how does a pro-cyclical dearer money approach fit in when public policy is now rightly directed to re-expanding the economy and reviving the momentum of growth? It is also common cause that SA is facing a serious risk of an investment rating downgrade to ‘junk status’ this year.

Hence the strong message of both the recent state-of-the nation address and the Budget speech emphasizing the need to avoid a further downgrading. The urgent and successful implementation of fiscal discipline, together with sensible growth policies, therefore remain overriding imperatives, Political decision-makers must be held accountable for addressing the crucial growth constraints that lie beyond monetary policy. We cannot look to interest rate policy to promote growth prospects. But we can ask that, given the fragile state of SA’s business cycle, neither should it needlessly weaken them.

It would indeed be paradoxical for Finance Minister Gordhan to be presently leading a top level roadshow overseas to boost investor confidence, while simultaneously the SARB back home again raises interest rates which limit growth prospects. The credit rating agencies themselves constantly emphasize the need for positive growth prospects and on this score they will clearly not be giving SA any ‘get-out-of-gaol-free’ cards this year.  Will the SARB then be doing the Finance Minister a favor by further rate increases next week?

The fact that inflation has breeched the upper end of the SARB’s inflation target range of 6% must, of course, be a matter of serious concern for the MPC, given its mandate. It fears that, through wage and price inflation, inflationary expectations will take hold and the inflation anchor will drag. The SARB nonetheless agrees that the cost-induced inflation SA has experienced so far is mainly driven by factors such as Eskom tariffs, the weak rand and the drought.

For a while now cost inflation has been cutting deeply into disposable income and spending. The pace of spending in the economy decelerated to 2009 levels last year and the outlook for 2016 is no better. High unemployment, slower wage growth and high debt levels are weighing on consumer spending. Is this an economic situation which is amenable to further substantial interest rate hikes? Can we credibly tell hard-pressed consumers and farmers that the only remedy for drought and higher food prices is much higher interest rates?

In any case, although the SARB does not specifically target the exchange rate, the experience of the recent past does not suggest higher interest rates have had much impact on the rand. To attract foreign capital SA needs a much better growth outlook, not just juggling with interest rate differentials in ways that may harm growth. And the more the level of business activity declines, the weaker are likely to be the forces of ‘pass through’ of higher import costs to the economy. There are whirlpools on both sides, not on one only.

The balance of risks to be assessed is thus more acute than it was at the January MPC meeting, at which there was divided opinion about how far to go. SARB must now create a monetary policy setting appropriate to the overall economic circumstances in which SA presently finds itself. The unpleasant reality remains that the SA economy is at a tipping point, where the margin for error is small. This is not the time for an aggressive monetary policy but rather a need for caution.

Parsons is a Professor at the NWU School of Business and Governance

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