CHRIS LOEWALD: Critique misses SA monetary policy complexity
Sifting through the invective thrown at the SA Reserve Bank monetary policy committee (MPC) in the econometric study by Gordon Institute of Business Science lecturer Dr Roelof Botha and University of Johannesburg College of Economics professor Ilse Botha isn’t easy, but it is necessary.
Judging from their comments, the two want to make monetary policy setting into a game: throw an interest-rate cut at anything that moves. Unfortunately for them, SA is no longer an immature, closed, self-financed economy, and has never been one in which weak demand leads automatically to lower inflation. In such an anachronistic and textbook economy, the output gap is the only factor to consider in making policy decisions. Reality is more complicated.
It is true that the repurchase rate rose from 5% in 2013 to 7% in 2016. That rise was in response to accelerating headline consumer price inflation, still at 6.4% in 2016, but also a current account deficit that had reached 5.8% of GDP in 2013 and was sitting at 4.6% in 2015. SA was squarely in the fragile five.
That level of foreign borrowing/import demand was unsustainable at that time, a recognition that the country cannot finance its own consumption and investment without borrowing from abroad. From the end of 2013, interest rates in the US rose more than 200 basis points, peaking at 2.5% by the end of 2018. So one interpretation of the domestic rise in rates that occurred from 2014 to 2016 is that almost all of it reflected the rising cost of capital in the rest of the world.
Ultimately, however, foreign lenders require a real, risk-adjusted return that compensates them for the risk they take when lending to a country with deteriorating credit ratings. Since the end of 2013 the rising SA risk premium added roughly an additional 100 basis points to domestic interest rates. Putting this together, rising foreign interest rates (two percentage points) and our deteriorating risk profile (one point) could have raised interest rates up to three percentage points.
In other words, the rate rise that did occur from 2014 to 2016 could have been much larger. How were we able to raise rates by less than this, despite our need for capital? The answer is that lower inflation improved real returns for savers and offset the rise in the risk premium. Keeping inflation near the middle of the target range has enabled the MPC to keep rates lower than they would otherwise have been. Lower inflation begets lower interest rates, not the other way around.
The authors further assert that had rates not gone up “GDP would have been more than R560bn higher in 2019”. It appears, however, that they simply project forward to today what GDP in real rand terms would have been with growth of 3% a year. This is the growth rate that obtained during the bounce-back from the global financial crisis, which they then assume is the trend growth rate. The subsequent deviation of real growth rates are then blamed on interest rates.
I agree that it would have been great had real growth reached 3% a year. But claiming that it didn’t because interest rates prevented more growth in private sector credit (the main driver of growth in their model) just isn’t plausible. In reality, growth is a complex of factors, and is mainly about productivity. Even a cursory review of the past 10 years begs one to wonder why the authors simply ignore the various obstacles to growth South Africans have been grappling with for years: electricity constraints, corruption, massive capital misallocation, uncertainty, faltering confidence, drought conditions, labour strikes, volatility in commodity prices, not to mention rising risk premia shown in long-term borrowing costs. Have these really played no role whatsoever in the economic trajectory? How quickly would SA have hit load-shedding with 3% growth per year?
We have noted in policy statements that the historically high levels of household debt racked up before the global financial crisis was one reason very low interest rates before 2016 failed to cause another housing boom. But a close look at import numbers show that South Africans continued to consume quite robustly despite the rate rise, and this has stayed high as a proportion of spending. It is possible that in very recent times, say since 2018, households reached a safer level of debt to begin demanding credit, but to claim that this should have happened years earlier is hard to take seriously.
Additional claims that fiscal deficits would be much lower also deserve a closer look. For instance, the authors of the study appear not to apply the same growth rates to public spending that they apply to revenue, and assume that all gains from higher growth would have been saved. The fantastic gain to the fiscal position the authors say the Bank has prevented is just that.
The focus of the authors’ report is worryingly short-term. Had they extended their data back a few years they would have found that SA recorded its strongest growth when inflation was at its lowest level (and interest rates much higher). The point here, worth making regularly, is that any growth benefit from higher inflation occurs only in the short term and at the expense of workers, poorer households and pensioners, who cannot protect their incomes or savings from inflation. Efforts to repeat such inflation surprises only drive inflation higher, with rapidly diminishing growth benefits and with the end product of either inflationary spirals or far higher interest rates. Neither of these can create the jobs SA society so badly needs and deserves.
Low and stable inflation outcomes support permanently lower interest rates, in turn supporting sustainable growth. And, as we are seeing in today’s very difficult conditions, having inflation under control gives us policy space to respond to crises (the repo is now at 5.25%), helping to ease an exceedingly difficult economic adjustment for the country.
• Loewald is head of the SA Reserve Bank's economic research department.