EDITORIAL: Deep rate cut only one side of the equation
The economy needs structural reform to stimulate a supply-side response
Something that seems to be very odd happened in the currency markets on Tuesday. SA’s currency emerged among the best performers against the dollar, jumping almost 2% just after 5.30pm local time.
On the face of it, this might not be the type of action one would expect in an environment where the Reserve Bank is widely expected to slash rates. Lower rates should, all things being equal, reduce the appeal of holding local assets, especially in an environment where investors are driven more by fear than greed in the wake of the coronavirus outbreak.
This is the time when investors look for safety in US treasuries and their record-low yields or bonds in Germany that guarantee a capital loss if held to maturity with their negative yields. In times such as these, it is better to take bets that result in you losing some of your money and not all of it.
So what do we make of the reprieve in the rand?
One way to read it is that analysts who are betting on the Bank to throw caution to the wind might be disappointed and some traders are positioning themselves accordingly, despite markets pricing in a near 100% chance of a cut in the repo rate by 50 basis points to 5.75%, a level not seen since 2015.
Some of the Bank’s critics, including Roelof Botha and Ilse Botha from the Gordon Institute of Business Science and the University of Johannesburg, argue that even this would not be enough and blame the Bank for much of the malaise that has beset the economy in recent years. Their full report will not make happy reading for governor Lesetja Kganyago, who is compared unfavourably to his predecessor, Gill Marcus.
Market moves over one day are not enough to determine how the Bank will act on a decision that will be driven by fast-moving events that can quickly spiral out of control. For one thing, a look at some of the worst movers in currency markets on Tuesday would signal that the partial recovery in the rand had very little to do with domestic matters. At the time of writing, the Japanese yen was at the bottom of the scale, indicating a tentative recovery for riskier assets more broadly in the face of the stimulus from developed-economy central banks.
There is still much confusion in the market, and trends over the past couple of weeks have shown bouts of strength to be short-lived while sell-offs have been violent. In that context, it is understandable that there is much uncertainty within and outside the Bank about the rates outlook.
While it is easy to compare, unfavourably, the monetary stance with what prevailed during the Marcus era, things in SA started to change radically after Kganyago took the baton in 2014. The state capture that characterised the Zuma era accelerated. With all the controversies about the nuclear build, and the firing and reinstatement of finance ministers came a rapid increase in the country’s risk premium, reflected in higher bond yields.
By the middle of 2017, SA’s credit ratings from Standard & Poor’s and Fitch had slipped to junk, with only Moody’s keeping the country in investment grade, a status it may lose as early as this month. Kganyago has consistently argued that SA’s risk premium, rather than the central bank’s policy, has been responsible for saddling the country with interest rates that may have otherwise been lower.
“A deep cut of 200 basis points is required as a matter of urgency,” argue Botha and Botha. That would be a big call for a central bank to make in a week in which the country’s 10-year yields have jumped towards 11%. Some may even call it reckless, risking a damaging run on the rand at a time of national crisis.
Lullu Krugel, an economist at PwC, has a suggestion that looks more realistic given the conditions, suggesting a 50-basis point cut that may well be spread over two meetings to show the Bank “is not in panic mode”.
Debating the direction of monetary policy can only be a good thing. The danger is that we may obsess too much over rates and lose sight of the things that hold us back — a lack of structural reform to boost the economy’s competitiveness.