What's this repo rate anyway?
Dazed and confused by the realisation of what another 2% on the bond rate means in actual money, the average South African could be forgiven for feeling that a new nightmare has arisen from the arcane murk of the economy.
First life was tough because of the gold price, then inflation became prime evil. Now the repo rate seems to have taken control of our financial lives, as the banks cite it as the reason for putting up their interest rates.
At first sight the repo rate is an innocuous animal, a familiarly shortened name for the repurchase rate, or the cost to banks of borrowing money from the Reserve Bank.
It is variable, and determined by daily tenders for repurchase agreements. At the beginning of this week it was 17%.
The Reserve Bank decides how much money it is willing to make available to commercial banks. If they want more, they have to use the punitive marginal lending facility with its interest rates of more than 30%.
The repo rate system was adopted in March as a more flexible replacement for the old situation where the Reserve Bank set its lending rate. The repo system is supposed to create more competition among the banks by encouraging them to manage their liquidity more efficiently.
To an extent this has worked, as shown by the different time scales the big banks have adopted in raising their interest rates.
The repo system has also made interest rates potentially more volatile. Although there has been a hike in rates, they could fairly quickly come down again if the repo rate is cut. A pessimist would point out that, equally, the interest levels could also rise again.
South Africans reportedly spend more than two-thirds of their income on repaying debt, which makes higher interest rates very unpleasant. But the flip side is the gains for savers, since higher interest will give better returns.
Banks’ profit margins are affected by the difference between their cost of borrowing from the Reserve Bank and the amount they can get for lending money. High repo rates mean pressure on profits, which the banks counter by putting up their interest rates to consumers. The pain at banks’ margins is particularly intense if they have had to use the marginal lending facility.
The economic and financial powers that be have been blaming each other for the latest turn of the interest-rate screw. Banks plead mitigating circumstances, citing the pressures of international competition, the need for strong financial services companies and the demands of their shareholders. They argue that the Reserve Bank is not providing enough liquidity, while the central bank argues that banks should become more efficient at using and finding cash.
How much money, or liquidity in jargon, the Reserve Bank supplies is determined by its assessment of South Africa’s economy and its relationship with the rest of the world. So the repo rate is tied to all other aspects of the economy.
The Reserve Bank is on a mission to protect the value of the rand, while trying to pursue balanced economic growth in a free market system with private initiative and effective competition.
An abruptly plummeting currency is something countries try to avoid since it sends shock waves through the economy. The Reserve Bank has been trying to slow down overly dramatic drops in South Africa’s currency by using its foreign exchange reserves to buy rands.
South Africa is considered to be an emerging market, which puts it in the same broad category as Russia and the troubled Asian economies. No matter how much pundits argue that we are different, to international investors South Africa is still tarred with the same risky brush as other emerging markets.
A lot of the foreign money put into the country has been “hot money” - it has been put into the financial markets rather than physical investments. This hot money can swiftly move out of South Africa’s economy and into somewhere perceived as safer. Keeping the interest rates high makes South Africa more alluring to investors, who balance the higher risk against the higher returns.