South Africa’s prime lending rate stands at 11.75%. Photo: Dean Hutton/Bloomberg/Getty Images
The Reserve Bank’s decision to increase the repo rate by 75 basis points to 5.5% on 21 July was monetary policy madness. It showed that the bank is only accountable to itself and does not care about the economic pain of millions of South Africans who are reeling from the shocks of a once-in-a-century pandemic and recession as well as the war in Ukraine.
The time has come to rethink the independence and mandate of the bank and the composition of its monetary policy committee.
For most of the past three decades, South Africa has had punitive, usurious interest rates, which impeded economic development. The bank’s actions have contributed to recessions and caused sharp economic downturns.
From March 1988 to October 1989, former governor Chris Stals increased what was then called the bank rate — the rate at which it used to lend to banks — by 850 basis points.
The prime lending rate soared to 21%. The country entered its worst recession since the Great Depression of the 1930s. GDP per capita declined for four consecutive years from 1990 to 1993. The public debt ratio increased.
In the wake of an emerging market crisis that had spread from east Asia to Russia, the Reserve Bank increased the repo rate to a high of 21.85% in August 1998 from 15% in May in a futile attempt to defend the rand. The prime lending rate soared to a high of 25.5%. GDP growth collapsed in 1999.
While almost every central bank in the world cut interest rates in the wake of the global financial crisis, the bank increased rates by 250 basis points after the start of the crisis in June 2007.
South Africa had an annual average prime lending rate of 13% from 1995 to 2019. It was 17.7% from 1995 to 2002, 12.7% from 2003 to 2008 and 9.8% from 2009 to 2019. In all phases the prime lending rate was way above inflation and the GDP growth rate. This impeded capital accumulation, depressed returns from investment and inflated payments for consumer loans for houses and cars.
There are many causes of inflation. It can be due to excess demand (or spending) which is above an economy’s productive capacity. In such cases, there is too much money chasing too few goods and services. Inflation can also be due to supply-side (or cost-push) factors such as Eskom price hikes.
The war in Ukraine has resulted in higher energy and food prices. While interest rate increases can reduce demand, they cannot end the war in Ukraine or reduce oil prices. Increasing interest rates due to a supply-side shock is the equivalent of prescribing a cough mixture for a broken leg.
In February, the under-utilisation of production capacity by large industrial companies was 22.2%, primarily due to insufficient demand for the products that companies could produce, according to Statistics South Africa. This means there was too little money chasing too many goods in the economy — the opposite of what happens when there is demand-pull inflation.
If one extends this spare capacity to the R6.1-trillion economy, there can be additional non-inflationary spending of more than R1-trillion.
A month of intense power blackouts has decimated demand and increased spare capacity. The government has still not paid millions of South Africans their outstanding social relief of distress grants. And the bank has forecast a 1.1% decline in GDP growth for the second quarter of the year.
If demand has already collapsed from its previously low levels, what is the point of piling on more misery and creating even more spare capacity in the economy?
Since November, the bank has increased the repo rate by 200 basis points — from 3.5% to 5.5%. Since banks have extended credit of about R4.5-trillion, the increases in the prime lending rate to 9% have sucked another R90-billion — 1.5% of GDP — from the economy.
For context, there have been no rate increases in China, Japan and Indonesia. Interest rates are much lower in the US (2.25% to 2.5%), the Eurozone (0%) and the UK (1.25%), which have much higher inflation rates than South Africa.
There was a modest increase in inflation to 7.4% last month. The bank’s forecast for this year is 6.5% from 4.5% last year. Core inflation, which excludes fuel and food prices, was only 4.4% last month. The bank has forecast core inflation of 4.3% for 2022, marginally higher than last year’s 3.1%.
While poor people experience a higher rate of inflation than the headline number, “a recession is worse than inflation”, as US economist Claudia Sahm says. The medicine should not kill the patient. Indian development economist Jayati Ghosh says: “Tighter monetary policy is a blunt tool which risks generating recession and unemployment — harming workers even more than price increases.”
The government must use fiscal policy tools to address the root causes of inflation and alleviate the pain.
It can increase the R350 a month social relief of distress grant to the food poverty line of R624 a month as a bridge towards introducing a basic income grant.
Suspending the fuel levy for the year and providing subsidies to taxi owners could provide a stimulus to the economy and contain rising transport costs.
The government can provide a subsidy to Eskom so there is no price increase next year.
After 28 years of failed economic policies, South Africa needs a mobilising vision and plan for the economy. This will require a new macro-economic policy framework that has a GDP growth target of 6% and the achievement of full employment that is binding on the treasury and the Reserve Bank. There must be a triple mandate for the bank to target growth, employment and inflation.
As Pali Lehohla, the former statistician general, has pointed out, monetary policy is too important to be left to the Reserve Bank governor and his employees alone. We must change the composition of the monetary policy committee to include members of civil society who understand the economic pain of South Africans and the need to align monetary policy with a new developmental vision.
Duma Gqubule is a financial journalist, analyst, researcher and adviser on issues of economic development and transformation.
The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian.
The Reserve Bank’s decision to increase the repo rate by 75 basis points to 5.5% on 21 July was monetary policy madness. It showed that the Bank is only accountable to itself and does not care about the economic pain of millions of South Africans who are reeling from the shocks of a once-in-a-century pandemic and recession and the war in Ukraine. The time has come to rethink the independence and mandate of the Bank and the composition of its monetary policy committee (MPC).
For most of the past three decades, South Africa has had punitive, usurious interest rates, which impeded economic development. The Bank’s actions have contributed towards recessions and caused sharp economic downturns. From March 1988 to October 1989, former governor Chris Stals increased what was then called the bank rate – the rate at which it used to lend to banks – by 850 basis points. The prime overdraft rate soared to 21%. The country entered its worst recession since the Great Depression of the 1930s. GDP per capita declined for four consecutive years from 1990 to 1993. The public debt ratio increased.
In the wake of an emerging market crisis that had spread from East Asia to Russia, the Reserve Bank increased the repo rate to a high of 21.85% in August 1998 from 15% in May in a futile attempt to defend the rand. The prime lending rate soared to a high of 25.5%. GDP growth collapsed in 1999. While almost every central bank in the world cut interest rates in the wake of the Global Financial Crisis, the Bank increased rates by 250 basis points after the start of the crisis in June 2007.
South Africa has had an annual average prime lending rate of 13% from 1995 to 2019. It was 17.7% from 1995 to 2002; 12.7% from 2003 to 2008; and 9.8% from 2009 to 2019. In all phases the prime lending rate was way above inflation and the GDP growth rate. This impeded capital accumulation, depressed returns from investment and inflated payments for consumer loans for houses and cars.
There are many causes of inflation. It can be due to excess demand (or spending) that is above an economy’s productive capacity. In such cases, there is too much money chasing too few goods and services. Inflation can also be due to supply-side (or cost-push) factors such as Eskom price hikes. The war in Ukraine has resulted in higher energy and food prices. While interest rate increases can reduce demand, they cannot end the war in Ukraine or reduce oil prices. Increasing interest rates due to a supply-side shock is the equivalent of prescribing a cough mixture for a broken leg.
In February 2022, the under-utilisation of production capacity by large industrial companies was 22.2%, primarily due to insufficient demand for the products that companies could produce, according to Stats SA. This means that there was too little money chasing too many goods in the economy – the opposite of what happens when there is demand-pull inflation. If one extends this spare capacity to the R6.1-trillion economy, there can be additional non-inflationary spending of more than R1-trillion.
A month of intense power blackouts has decimated demand and increased spare capacity. The government has still not paid millions of South Africans their outstanding social relief of distress grants. And the Bank has forecast a 1.1% decline in GDP growth for the second quarter of the year. If demand has already collapsed from its previously low levels, what is the point of piling on more misery and creating even more spare capacity in the economy?
Since November 2021, the Bank has increased the repo rate by 200 basis points – from 3.5% to 5.5%. Since Banks have extended credit of about R4.5-trillion, the increases in the prime lending rate to 9% have sucked another R90 billion – 1.5% of GDP – from the economy. For context, there have been no rate increases in China, Japan and Indonesia. Interest rates are much lower in the US (2.25% to 2.5%), the Eurozone (0%) and the UK (1.25%), which have much higher inflation rates than South Africa.
There has been a modest increase in inflation to 7.4% in June. The Bank’s forecast for 2022 is 6.5% from 4.5% last year. Core inflation, which excludes fuel and food prices, was only 4.4% in June. The bank has forecast core inflation of 4.3% for 2022, marginally higher than last year’s 3.1%. While poor people experience a higher rate of inflation than the headline number, “a recession is worse than inflation,” as US economist Claudia Sahm says. The medicine should not kill the patient. Indian development economist Jayati Ghosh says: “Tighter monetary policy is a blunt tool which risks generating recession and unemployment – harming workers even more than price increases.”
The government must use fiscal policy tools to address the root causes of inflation and alleviate the pain. It can increase the R350 a month social relief of distress grant to the food poverty line of R624 a month as a bridge towards introducing a Basic Income Grant. Suspending the fuel levy for the year and providing subsidies to taxi owners could provide a stimulus to the economy and contain rising transport costs. The government can provide a subsidy to Eskom so that there is no price increase next year.
After 28 years of failed economic policies, South Africa needs a mobilising vision and plan for the economy. This will require a new macroeconomic policy framework that has a GDP growth target of 6% and the achievement of full employment that is binding on the Treasury and the Reserve Bank. There must be a triple mandate for the Bank to target growth, employment and inflation.
As Pali Lehohla, the former statistician general, has pointed out, monetary policy is too important to be left to the Reserve Bank governor and his employees alone. We must change the composition of the MPC to include members of civil society who understand the economic pain of South Africans and the need to align monetary policy with a new developmental vision.
Duma Gqubule is a financial journalist, analyst, researcher and adviser on issues of economic development and transformation.
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The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian.