Simon Segal
Encouraged by declines in the inflation rate and money supply growth, economists are increasingly changing their forecasts and talking about the next movement in the Reserve Bank’s (RB) interest rates being down rather than up. This will herald a decline in the prime and bond rates for the first time since November 1993. Any action, however, is only likely well into next year.
Until recently the consensus among economists was that the RB’s rates had further to rise. Some were expecting that prime rate, now 18,5 percent would exceed 20 percent by year-end.
The bond market too is indicating a rate fall — rates on the long-end (maturing in 10 years’ time) dropped to around 15 percent this week, their lowest level in over a year.
Such optimism is fuelled by August money supply figures and September’s inflation rate. Government is also ahead in its funding targets for this fiscal year which means government supply of paper is short of institutional demand, hence pressure on bond prices to rise and rates to fall.
The rate of increase in M3 money supply slowed to 14,84 percent compared to 15,82 percent the previous month. The inflation rate dropped to 7,5 percent compared to July’s nine percent. An inflation rate falling to five percent, mentioned by RB Governor Chris Stals, now does not appear such a starry-eyed idea. Most economists are still, however, looking at inflation averaging nine to10 percent this year.
An inflation rate of 7,5 percent and a prime rate of 18,5 percent leaves the real (inflation adjusted) prime rate at 11 percent. Many economists are critical that this is too high compared to most economies and especially punitive when South Africa’s development and growth needs are taken into account.
Real short-term money market rates are 6,95 percent in South Africa, compared to 2,6 percent in Malaysia, 22 percent in Brazil, and a negative 4,55 percent in Mexico.
>From this sample of developing economies’ real interest rates, one can take a pick to suit an argument. The RB, however, will remain cautious about relaxing its monetary policy too soon.
Firstly, the deficit on the current account of the balance of payments is running at some R1-billion a month. So far this is being more than offset by net capital inflows, hence the improvement in the RB’s reserves from R7,8-billion in August 1994 to R11,9-billion in August 1995. But short-term capital inflows are volatile and unpredictable. At R11,9-billion, South Africa’s reserves are still only worth 1,3 months’ worth of imports.
Secondly, with growing social and political pressures to deliver more on reconstruction and development there are still doubts about government’s commitment to fiscal restraint. The deficit before borrowing is still five to six percent of the gross domestic product (GDP).
Most economists agree that monetary policy still has to be tighter than it would otherwise need to be were fiscal policy tighter — whether rates have to be as high is disputed.
Thirdly, there is a danger that the declining inflation and money supply figures are statistically deceptive as they are off high bases. When they come off lower bases, as they will be next year after the present declines, further drops become increasingly difficult.