ROELOF BOTHA: Reserve Bank’s monetary policy is bent on curbing economic growth

The Reserve Bank’s monetary policy committee (MPC) is doing more harm than good in the way it is dealing with the recent spike in the consumer price index (CPI).

In the process of trying to curb inflation by raising interest rates, the MPC has once again demonstrated its obsession with inflation targeting, as well as its ignorance over the causes of higher inflation during 2022.

Ever since global inflation started heading north at an alarming rate, much of the conventional wisdom surrounding the causes of this unfortunate trend has revolved around energy prices, especially gas, oil and petroleum.

When analysing the composition of the basket of goods and services that form the basis for the calculation of the CPI, these prices have stood out in SA and its key trading partners. However, when comparing the current upward phase of the commodity price cycle during 2022 with the previous surge in energy prices recorded between 2011 and 2013, it becomes clear that oil is not the culprit.

Rather, it is the cost of shipping oil, petroleum and all other traded goods from one port to another. Oil from Saudi Arabia has to travel almost 10,000km before it reaches the port of Cape Town.

Sea freight

The persistent supply chain disruptions caused by the Covid-19 pandemic and now worsened by the Russian invasion of Ukraine have provided a stark reminder of the strategic economic importance of maritime container trade. Logistics data tracked by the UN Conference on Trade & Development shows that the sea carries more than 80% of the world’s traded goods by volume and 70% by value.

The lockdown restrictions induced by the pandemic not only blocked supply chains in ports around the globe, but also did so in an errant manner. When one port reopened some of its destination ports closed, and this pattern kept on repeating for the better part of two years.

Ultimately, too few ships and a recovery of demand conspired to send freight costs into orbit, with the Statista Freight Rate index increasing from $1,262 per container in September 2019 to $10,361 in September 2021 — an unprecedented jump of 721%.

The good news is that global shipping freight rates have since tumbled around 80% — a highly predictable recovery from an extraordinary trend induced by the Covid-19 pandemic. Lower shipping freight rates and a further easing of supply chain constraints are the main reasons for the welcome decline in global inflation since the end of 2022.

However, restrictive monetary policy has nothing to do with the imminent return, to a larger measure, of price stability. Most other central banks have made the same mistake as SA’s, some even openly acknowledging the damage their policies would cause, mainly in the form of lower economic growth or possibly recession.

As pointed out in a recent Roosevelt Institute report co-authored by Nobel laureate Joseph Stiglitz, inflation was bound to drop as global supply chain bottlenecks started easing, with or without any central bank policy intervention.

Monetary policy is a blunt instrument that is not designed to target specific drivers of inflation such as supply chain disruptions, skills shortages or temporary increases in energy prices. All of these call for better-targeted policies, which are by their nature in the domains of fiscal and industrial policy.

It is interesting to note that the recently adopted Inflation Reduction Act in the US provides subsidies for investments in green energy that will increase spending in the short run but play an important role in mitigating the pervasive negative externalities of climate change, including the vagaries of fossil fuel prices, some of which were recently caused by war-mongering dictators.

Other flaws

In SA, the case against restrictive monetary policy has a number of additional dimensions, all of which demonstrate an uninformed approach to dealing with higher inflation.

Unlike the US and most other key trading partners, SA’s manufacturing sector continues to suffer from a large degree of unutilised production capacity, which stood at 21.7% in the third quarter of 2022 — almost 6% lower than four years earlier. The main reason remains a lack of sufficient demand — further confirmation of the absence of any sign of demand inflation.

SA’s real bank rate is currently just below zero, in sharp contrast to negative real interest rates of 2% in the US, 4.1% in Japan, 6.7% in the eurozone and 7% in the UK. Since the end of 2021 the MPC has raised the cost of capital (based on the prime overdraft rate), no less than 50%.

Over the past 14 years capital formation, which is desperately needed to expand the country’s infrastructure and productive capacity in the private sector, has been in freefall, from 21.5% of GDP in 2008 to 14% in 2022. High interest rates are not conducive to dealing with this key growth objective.

Based on the current level of private sector credit extension the inexplicable return to restrictive monetary policy is costing SA households and businesses about R13bn a month in additional debt servicing costs. Over 12 months this will equate to more than the country’s total annual agriculture production.

A third indictment of the Bank’s interest rate policy is that total household credit extension has not remotely recovered from the effects of the extremely high real interest rates from before the Covid-19 pandemic, and it remains well below the level of a decade ago (in real terms).

The SA economy has never been able to grow at sustainably high rates in the absence of meaningful growth in private sector credit extension. To the extent that unjustified hawkish monetary policy reduces output growth, fiscal stability will also be threatened.

Lastly, the country’s millions of unemployed and marginalised people are the ones that suffer most when an unwarranted obsession with rigid inflation targeting is allowed to override the critically important policy objectives of growth and employment creation.

It is clear that a need exists for a more broad-based debate on the manner in which monetary policy is conducted in SA. Ideally, the MPC should be expanded to include senior economists from the National Treasury, the department of trade, industry & competition and the private sector. The latter could consist of a rotating panel of suitably qualified economists with substantial experience in macro-economics.

• Dr Botha is economic adviser to the Optimum Group.