Lowering interest rates in line with First World countries could create a consumer spending surge that would outstrip South Africa’s capacity to meet supply, an Absa bank economist said on Monday.
Senior economist John Loos said in a statement: ”Due to the key structural difference between the South African household’s financial make-up and that of developed countries such as the United States, United Kingdom, Germany or Japan, in the form of a far lower debt-to-disposable income ratio, moving interest rates into line with those countries would probably create a consumer spending surge that domestic output capacity may not be able to accommodate.”
The drop in interest rates by 550 basis points in six months last year had ”stimulated consumer demand growth that is strong by current developed world standards. This, coupled to a possible drought-induced surge in food price inflation, makes current interest rate levels more appropriate than some may think,” Loos said.
Loos was commenting in light of the South Africa Reserve Bank (SARB) Monetary Policy Committee meeting on Wednesday.
He said: ”The Reserve Bank appears to pick up some criticism from time to time due to the fact that by global standards South Africa has extremely high real interest rates at a time when global inflationary pressures are low and the major economies have maintained rock bottom rates for some time already.
”South Africa also has high real interest rates in spite of the fact that the important CPIX measure of inflation (four percent in December 2003) is well within the target range of three to six percent.”
Loos said South Africa’s interest rates should not be compared to other countries as SARB ”has an inflation target that it has yet to achieve on a sustainable basis”.
”It also ignores the fact that structurally the South African economy possesses its own unique set of characteristics. To shift from a high to a low interest rate economy over the long term, South Africa would need to make key structural changes — in the area of household spending and household debt, for example — which would take time.”
Loos said: ”South African households … by their actions reflect a scenario of comfortable interest rate levels and not of unduly high ones. Why is it that such high interest rates can succeed in stimulating consumer demand growth in South Africa to such an extent, while in other countries a rise to such high levels of interest rates would send the consumer into an eternal state of despair?
”The reason is that South African households have adapted to a high interest rate scenario compared to say the United States consumer.”
He said: ”With South Africa having to live with comparatively high interest rates, households are traditionally required to use a significantly greater portion of disposable income to service a given debt-to-disposable income ratio than would be the case if interest rates had been at developed country levels over the long term.”
When interest rates fall the average consumer would probably choose to spend part of the additional disposable income on cash purchases and part on increased debt servicing depending on a variety of concerns and constraints, Loos said.
”However, the more rapid the decline in interest rates the more rapid the rise in debt-to-disposable income is likely to be.
”With production capacity in the economy not able to expand as rapidly as borrowing-induced consumer spending could in times of extreme interest rate reductions, a surge in household debt-financed spending could be reflected either in supply-side bottlenecks or in a deteriorating current account balance, depending on whether it translates into increased demand for local goods and services or imports,” he said.
In South Africa there had been a strong increase in cash retail purchases and a raising of the debt-to-disposable income ratio following last year’s sharp drop in interest rates.
”Far better than comparing interest rate levels with other countries would be to compare the extent of interest rate reductions with that of other countries, and 550 basis points is aggressive by almost anyone’s standards.
”Not surprisingly, these cuts have caused real retail sales growth that, late in 2003, was strong compared with that of all of the major economies,” Loos said.
”This would suggest that the current monetary stance in South Africa is an accommodative one and now very much in line with the global situation.”
Until South African households are less sensitive to interest rate reductions, consumers would react strongly to aggressive interest rate cuts. This is ”unlike the highly-indebted United States’ consumer whose reaction to the Fed’s last series of rate cuts was sluggish to say the least”.
Before South Africa can move to ”first world real interest rate levels without risking a major rise in demand-induced inflationary pressures, certain key structural changes will need to take place, an important one being the consumer’s move to a higher debt-to-disposable income ratio that would be appropriate for a low interest rate country”. – Sapa