SARB’s gradual tightening stance calls for rate hike in May

By Rafiq Raji, PhD

Just a week before the monetary policy committee (MPC) meeting of the South African Reserve Bank (SARB) on 17-19 May, deputy governor Daniel Mminele had some interesting choices of words to describe the South African economy: ‘flat on its back,’ he calls it. It was one of those rare occasions when a central banker unwittingly says what had long overwhelmed his thoughts. That is the truth in fact – most growth forecasts for 2016 are now closer to 0.5 percent than they were to almost 1 percent earlier in the year. Incidentally, Mr Mminele’s comments are at odds with those by his boss, SARB governor Lesetja Kganyago, who days before had tried to project a sense of optimism about the economy: ‘turning a corner,’ he says – more the patriot than central banker talking in my view. Governor Kganyago – as were other key government officials – was trying to reinforce Moody’s decision to affirm its two-notch above junk status sovereign credit rating for South Africa, albeit with a negative outlook. I find Moody’s decision very curious indeed – and that is putting it mildly. Standard and Poor’s – a consistently credible rating agency, in my view – was more candid: ‘dismal growth,’ its senior analyst calls the South African outlook. Such uninspiring comments just a few weeks to its ratings assessment is ominous; suggests an imminent downgrade in June in my view. South African authorities have not been totally helpful either. This past weekend, a South African newspaper revealed that there were plans to arrest finance minister Pravin Gordhan for espionage and that a cabinet reshuffle was imminent. The official reaction was swift. Denying the rumour, the authorities reiterated that no such moves were being contemplated – no matter that they made sure to point out that it remains within the powers of President Jacob Zuma to appoint his cabinet. Still, revelations by newspapers in the past have been vindicated more often than not. Authorities’ denial reinforces the rumour unfortunately. The inevitable outcome is that market participants would be spooked in any case.

I have revised my 2016 growth forecast for South Africa to 0.7 percent from 0.9 percent previously. Recent data have not been encouraging – the only credible bright spot is probably the declaration by the state-run power utility provider that there would be no load-shedding for the remainder of the year. In April, the International Monetary Fund (IMF) cut its 2016 growth forecast for South Africa to 0.6 percent from 0.7 percent in January, identifying likely continued lower Chinese demand and probable sovereign credit rating downgrades as key downsides to its outlook. Even as growth of about half a percent in 2016 is certainly dismal, it does not help very much that the risks to the outlook are more to the downside. Unemployment rose to 26.7 percent in the first quarter of 2016 from 24.5 percent in the prior quarter, the highest on record: Statistician-General Pali Lehohla believes ‘the economic climate is not helping.’ Mining (7 percent of GDP) contracted 18 percent year-on-year in March, the highest year-on-year contraction on record. Manufacturing (13 percent of GDP) also contracted in March, by 2 percent year-on-year. Furthermore, agricultural output (2 percent of GDP) has been hard hit by drought effects with expectations of a poor maize harvest in 2016 – previously a net maize exporter, South Africa would need to import 3.8 million tonnes of maize (about 30 percent of its average annual production hitherto). Similarly, the final estimate of the 2015 winter wheat crop harvest (released on 12 May) was 18 percent lower year-on-year at 1.44 million tonnes due to drought. Business confidence also remains low (index was 82.5 in April, down 7.4 points year-on-year; albeit an improvement from a record low of 79.6 in December 2015). Compounding all of these is the political uncertainty around President Jacob Zuma’s legal troubles and divisions within the ruling African National Congress (ANC) party. With the ultra-leftist Economic Freedom Fighters (EFF) opposition party all but set to make significant gains in municipal elections in August, the ANC has begun to resort to populism: on the campaign trail last week, President Jacob Zuma promised the return of land to blacks – an all too familiar populist tactic and a key EFF campaign promise.

As these happenings swirl in the thoughts of SARB MPC members this week, they would also be focusing on their primary task: keeping inflation in check. Their forecasts were relatively subdued at their last meeting. What did not change was that inflation would likely remain in breach of the SARB’s 6 percent upper bound target into 2017. To avoid a sharp rate hike later in the year – only three meetings (in July, September and November) left for 2016 after that in May – another 25 basis point bump may be necessary at this meeting. If the SARB’s inflation forecasts in March are anything to go by, a 7.3 percent end-2016 headline suggests a need to raise rates by at least 50 basis points to 7.5 percent before the end of the year from 7 percent currently. As risks to their inflation forecasts are more to the upside – my forecasts see headline inflation accelerating to 7.6 percent in December, a prudent approach would be to raise rates by at least 75 basis points to 7.75 percent (in quarter percent increments) before the end of the year to anchor these expectations and to ensure real interest rates remain positive. For April (data out on 18 May), I see headline inflation at 6.3 percent. Additionally, SARB research (published in its monetary policy review report in April) estimates an increase in short-term interest rates by about 80 basis points in the aftermath of a potential sovereign credit rating downgrade to junk status – the Bank expects long-term yields to rise by 104 basis points on this event. These are the considerations – upside risks to inflation and interest rates and a sustained breach of the upper bound of the SARB’s inflation target – that underpin my view that a 25 basis point rate hike may be necessary at the meeting this month. Analysts are divided on the likely outcome, however. In the Reuters poll ahead of the meeting, twenty-two economists thought the SARB would likely prefer to keep its benchmark interest rate unchanged at 7 percent – this economist and nine others took the minority view of a likely 25 basis point rate hike to 7.25 percent.

Also published in my BusinessDay Nigeria newspaper back-page column. See link viz.

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