The main factors that have recently led to the heightening of the inflationary risks, namely high levels of consumer spending, adverse movements in the exchange rate, a larger current-account deficit, higher food prices and high oil prices, serve as the backdrop to the tightening cycle in South Africa, Tito Mboweni, Governor of the South African Reserve Bank (SARB), told a meeting of the Central Bank Governors’ Club in Irkusk, Russia on the weekend.
“The favourable inflation trend over the last couple of years has allowed for nominal interest rates to fall to levels last seen some three decades ago. Between June 2003 and April 2005, the repo rate was lowered to 7%, representing a total reduction of 650 basis points over the period.
“After remaining unchanged for 13 months, the repo rate was increased by 50 basis points at each of the monetary policy committee [MPC] meetings in June and August this year. Given the increase in inflationary pressures and the resultant deterioration in the risks to the inflation outlook, the MPC considered it necessary to tighten policy at the last two meetings,” Mboweni said.
He stated that consumer spending is one of the factors that had led to heightened risk for the country.
“Consumer spending has been increasing at robust levels for some time now. The low interest-rate environment has fuelled rising levels of credit extension to the private sector. Growth in bank loans and advances extended to the private sector measured at annual rates have recently increased to levels exceeding 20%.
“While the inflationary effects are limited at this stage, the impact is manifesting itself via the deficit on the current account of the balance of payments, which had increased to 64% of GDP by the first quarter of this year. “
Mboweni noted that while the deficit was currently more than adequately financed by capital inflows, these were mainly portfolio inflows, which increased the risks of adverse movements in the exchange rate, especially if the current-account deficit was perceived to be unsustainable.
“This situation makes the exchange rate particularly vulnerable to changes in investor sentiment and risk tolerance, which can result in a tapering off or even withdrawal of portfolio inflows. This issue is of particular relevance given the way in which international markets have been re-rating emerging -market risk recently.
“In such circumstances, there is an increased risk of a significant exchange-rate adjustment, which could threaten the longer-term attainment of the inflation target. However, the best way to avoid this happening is by maintaining sound and prudent macroeconomic policies.
Mboweni said that while the SARB did not target any specific level of the exchange rate, exchange-rate developments impact significantly on inflation.
“For a small and open economy like South Africa, the pass-through effects of exchange-rate changes on inflation are significant and rapid. Hence, monetary policy has to take due cognisance of the fluctuations in the exchange rate of the rand insofar as its effect on the inflation forecast is concerned.”
On the issue of oil prices, the governor said that these had been at sustained high levels “for some time now”.
“Given the prevailing geopolitical tensions, there is little doubt that oil prices pose the single biggest threat to global growth and inflation.
“However, the challenges for monetary policy emanating from high oil prices are not so straightforward. The textbook recommendation is that monetary policy should not react to first-round oil-price effects but rather prevent second-round effects from taking hold.
“The pass-through effects from oil-price increases to the different indicators of inflation have been relatively low, with the result that pre-emptive monetary policy decision-making has not been easy.
“However, there are indications that secondary inflationary pressures from the oil price increases are starting to occur in South Africa, as is evident in the recent acceleration in domestic producer price inflation,” said Mboweni.
Mboweni pointed out that the recent tightening of monetary policy should thus be viewed in the context of the deterioration in the risks to the inflation outlook and the objective of the SARB to ensure the credibility of monetary policy and sustainable economic growth in South Africa. — I-Net Bridge