/ 7 September 2006

Reserve Bank warns of rate hike to cool spending

South Africa’s central bank warned on Thursday that interest rates may have to rise again to curb soaring consumption in the continent’s biggest economy and said the rand is adjusting to a widening current account gap.

The South African Reserve Bank has already raised its key repo rate by a full percentage point to 8% in two moves since June to dampen price pressures, fanned by oil price hikes, strong domestic demand and the rand’s depreciation.

”The only way to deal with conspicuous consumption is by raising interest rates,” Reserve Bank Governor Tito Mboweni told a business breakfast in Johannesburg.

Economists expect rates to climb by another percentage point this year, but the impact on growth is likely to be muted, given strong domestic demand and government spending.

Mboweni said South Africa’s spending spree during periods of low interest rates has put a floor on how low rates can go. Rates were cut from 2003 to 2005 to their lowest levels in more than two decades.

”I still think South Africa’s interest rates are high but the sociology [of spending] doesn’t permit me to go as low as I would like to,” he said.

Minister of Finance Trevor Manuel also said on Thursday that recent high credit and car-sales data, despite the rate hikes, indicated that ”the message isn’t getting through”.

Rand adjusting to current account

The International Monetary Fund (IMF) predicted in its annual country report on Thursday that South Africa’s current account gap, which has weakened the rand this year, should narrow from the first-quarter 6,4% to end 2006 at 4,9%.

Mboweni said the exchange rate seems to be adjusting to the deficit.

”I don’t take any view on the level of the exchange rate, but clearly when you have an imbalance … something has to give,” he said, adding that while the deficit had narrowed in the second quarter, at more than 5,5%, it remained large.

The rand weakened after his comments, trading at about R7,39 per dollar, near 11-week lows. It has lost about 14% against the greenback so far this year after three years of gains that hit exports and cut profits for miners and manufacturers.

Mboweni said manufacturers are already benefiting from the currency’s latest depreciation and can no longer argue that the rand is stifling the sector.

Official figures show that manufacturing, the second-biggest sector in South Africa’s economy, grew by 6,1% in the second quarter of the year, bouncing back from a contraction in the final quarter of 2005.

The IMF said near-term economic prospects remain ”broadly positive”, predicting 4,2% growth in 2006.

The forecast was a touch lower than that of the National Treasury and down on the 4,9% recorded in 2005 — the fastest rate since 1984.

The IMF said the rand’s relative strength over the past few years has not hampered growth — a point backed by the National Treasury.

”We see it as a possible constraint as well, but there isn’t compelling evidence that the exchange rate is a constraint to growth,” Treasury Director General Lesetja Kganyago told reporters after the release of the IMF’s report.

South Africa’s growth has been largely driven by domestic demand, financed by credit that Mboweni said shows little sign of retreating, despite the higher rates.

Growth in demand for credit by the private sector sped up to 24,68% in July, data showed last week — the latest in a raft of data that has cemented the case for another rate hike in October. — Reuters