The race to zero

Although South Africa faces a dramatic economic slowdown with plunging consumer spending, it has one of the highest interest rates in the world. This is in a climate when 16 countries are cutting rates to support economic growth.

Midweek the US Federal Reserve cut its benchmark interest rate to 1%. It joined China and Norway, which earlier had kicked off the latest round of interest rate cuts as fears of a global recession grows. Central banks in Japan, Britain and Europe are also expected to cut their key rates.

Observers see this week’s cuts as a continuation of a move to cut rates all the way to zero if necessary to combat what many see as a severe recession. In the US there are concerns that economic growth could decline by as much as two percentage points in the fourth quarter.

Policymakers globally now fear deflation rather than inflation and have moved quickly to re-stimulate their economies by slashing rates.

In South Africa inflation is predicted by the treasury to fall to just 6% by mid-year 2009, but the consensus among economists is that the Reserve Bank will not cut rates until April, once there is clear evidence that inflation is trending downwards.

But one would not want to repeat the mistakes of the US government in 1929 when its refusal to loosen monetary policy was seen as a significant trigger for the resulting Great Depression.

One needs to question whether inflation targeting—a solid monetary policy during normal times—should dogmatically be adhered to during a global event that Alan Greenspan has described as a “once-in-a-century credit tsunami”, which has turned out “to be much broader than anything I could have imagined”. Do South Africa’s authorities run the risk of underestimating this “tsunami”?

In February this year Finance Minister Trevor Manuel downgraded South Africa’s growth rate for 2008 from 4,5% to 4%. Economists argued he was too optimistic and most argued that economic growth would fall to around 3,5% to 3%.

During the medium-term budget, the finance minister revised economic growth down to 3,5%. Next year Manuel is forecasting growth of 3%. Again economists believe this will be lower, below 3% with some forecasting growth as low as 2%. They argue that the real growth forecast in fixed investment of 9% over the medium term is overstated.

Announcements made by companies such as Anglo American and Mittal state that they will be reviewing their capital expenditure. This supports the argument that private sector projects may be hit worse than expected.

Since the medium-term budget, the United Kingdom announced that its GDP had declined by more than expected in the third quarter, falling 0,5% - the first contraction since 1992 and the largest slide since 1990. The key here is that the figures were worse than anticipated. It has confirmed fears that the UK is going to experience a severe recession, in other words two consecutive quarters of declining GDP.

The UK is one of South Africa’s major trading partners and this recession will impact negatively on South Africa’s exports.

Forecasts are preparing for the G3 countries, Japan, Germany and the US to experience a recession and that the combined economies of the G7 will experience the most coordinated recession in decades.

The US alone constitutes 19% of the world’s consumers. China and India—although nowhere close to a recession—forecast lower economic growth next year, which is why both countries cut interest rates in October.

From July to September this year, most sectors of the South African economy cut jobs. This is before the full impact of the global recession has hit us. Given the global outlook, government’s growth forecasts are more likely to be overstated rather than understated.

The September inflation figures came in below expectation, falling from 13,6% in August to 13% in September, marginally below expectations of 13,3%.

Although still way above the inflation target, government forecasts inflation will fall dramatically next year to average 6,5% and that inflation will return to target by the third quarter next year. Interest rate decisions are based on an 18-month inflation view as it takes time for interest rate policy to feed through to the economy.

Reserve Bank Governer Tito Mboweni will argue that he needs to see more evidence of inflation coming under control before cutting rates. But the only benefit of the higher interest rate is to slow down the consumer. The negative consequence is a dramatic slowdown of the economy and major job losses.

Data releases show that consumers have stopped spending and that demand for credit is slowing. September’s private sector credit fell to 16,4% from 18,6% in August, while forecasts were for a more moderate fall to 17,6%. Mortgage credit is now growing at only 16,6% - well down from the peak two years ago of 30,9%.

Stanlib economist Kevin Lings says most of these mortgage advances are coming from draw downs on existing home loans rather than the issuing of new loans. “Credit card growth has fallen to an annual rate of only 6,8%, which is actually negative in real terms compared to 35% growth in 2007. I expect household credit to slow to well below 10% in the early part of 2009. This is partly because of base effects, but also reflects the sluggish conditions,” says Lings.

Even if government’s optimistic forecast of 1,6% growth in consumer expenditure materialises, it is hardly inflationary. Easing interest rates will not delay a spate of hedonistic spending, but it would rather take pressure off households struggling to survive.

There is evidence that consumers are starting to default on outstanding debt. This is expected to worsen.

If we leave rates unchanged until April, will we be reading statements a year later from our Reserve Bank governor that the extent of the slowdown was something he could not have imagined?

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