By Rafiq Raji, PhD
Divergent South African and Kenyan central banks to both hold fire
Lower, but still high inflation expectations, allow room for SARB tightening pause
The South African Reserve Bank (SARB) holds it monetary policy committee (MPC) meeting this week (19-21 July). It is likely to keep its repo rate unchanged at 7 percent. Not that it is about to give up its tightening stance. Far from it. However, inflation has eased somewhat – monthly pace was 0.2 percent in May from almost 1 percent on average since January. The most recent headline – to be released on 20 July – before it announces its decision, may border on the upper-end of its target range (3-6 percent): my June inflation forecast is 6 percent. I reckon the headline would be below 6 percent in July and just about 6 percent or lower in August. From September onwards, the SARB’s target would probably be breached, with inflation likely ending the year at above 7 percent. Above-inflation wage expectations – as mineworkers’ union demands in ongoing negotiations suggest – are certainly concerning for the SARB. And the rand, though now below the 15.0 psychological level to the US dollar, remains extremely sensitive to increasingly negative global headlines. Then there are those potentially troubling local elections in August. Food imports may also not be adequate – due to potential short supply abroad – to fill expected drought-induced domestic production shortfalls, white maize in particular. So food prices may rise still. All these suggest inflation expectations would remain high. In public commentary, SARB officials have been very hawkish, albeit they have allowed room for the possibility that inflation may have begun to steady. As there is yet a sustained trend to suggest that this is the case, they are understandably cautious. Even so, committee members have another opportunity to not make a rate move. At the last meeting, it wasn’t so clear cut. Notwithstanding, the committee would likely adopt a similarly hawkish tone. Still, MPC members would no doubt be encouraged by recent manufacturing and retail sales data, both of which surprised to the upside. Manufacturing production expanded by 4 percent year-on-year in May, from 3.1 percent in April. In spite of being highly indebted, consumers did not hold back on spending. Retail sales expanded by 4.5 percent year-on-year in May, from 1.6 percent a month earlier. Mining remains problematic: production contracted by 4.4 percent in May, though slower than an upwardly revised contraction of 7.7 percent in April. Troubles in the mining sector would probably remain, as commodity prices remain lower for longer and disproportionate wage demands continue to weigh on performance.
There is suggestion that the economy might have begun to turn the corner. Not so fast, if the IMF’s July 2016 country report is anything to go by – released prior to recent positive data. I am sceptical as well. The IMF sees the economy growing by 0.1 percent in 2016, a half-percent cut from its earlier forecast. I think it would be slower; a 0.2 percent contraction is my reckoning. There is some justification for this. Structural imbalances – infrastructure bottlenecks, skill mismatches, governance concerns, and policy uncertainty are some the IMF identifies – would take time to rectify. External factors – China’s slowdown and rebalancing, continued weak commodity prices and still likely tighter global financial conditions – also weigh. There is also worry that finance minister Pravin Gordhan may not get the political support he needs to implement cogent reforms. To his credit, he has made some progress. Avoiding a credit ratings downgrade to junk status in June was no small feat. But now the ruling African National Congress (ANC) party needs to win elections, especially as polls suggest it might lose key strongholds, in the capital city, Pretoria, no less. Populism by the ruling party is almost inevitable. An antsy ANC would be little swayed by Mr Gordhan’s call for restraint. More worrying is that there seem to be no new ideas about how to spur growth. And it is not unreasonable to be sceptical about this being addressed in the period to December when the most hawkish of the rating agencies, SPGlobal Ratings, next assesses the creditworthiness of the country.
The SARB would certainly seize any opportunity it gets to not be the reason growth flounders more than necessary. But it would loathe discovering later that inflation got out of control because of the slightest accommodation it allowed; and hurting its credibility consequently. Still, if it ever desired allowing even the tiniest room for growth, a window has opened at this meeting. Quite naturally, there is overwhelming consensus that it would hold rates. My expectation is that at the only other MPC meeting this quarter, in September that is, it would need to tighten rates further, on likely continued rand volatility, renewed US Fed rate hike expectations, and likely above 7 percent inflation by year-end. Brexit would also feature prominently amongst its considerations. It remains my view that while there are risks in this regard, they have been somewhat overblown. And now it is increasingly clear that the European Union would itself not be immune from Brexit risks. Then there is the bizarrely intermittent political incident that makes things go awry every now and again.
Resurgent upside inflation risks to prompt CBK easing pause
Fuel prices rose in mid-July. Security concerns have re-emerged. Already – in early July – the American government has issued a travel warning. There are also concerns about the health of Kenyan banks, judging from the recent disproportionate non-performing loans’ (NPLs) provisions made by some of the country’s biggest banks. The supervisory capacity of the Central Bank of Kenya (CBK) has been questioned. There is also worry about Kenya’s increasing foreign debt profile, albeit this remains less than half of total public debt. Such concerns motivated the downgrade of the shilling by Fitch Ratings in mid-July. Even so, inflation would probably remain below the upper-end of the CBK’s target range (2.5-7.5 percent) for the remainder of the year. Still, resurgent upside inflation risks – even if potentially one-off, like the road maintenance levy-induced July fuel price hike – are sufficient motivations for a pause in the CBK’s easing stance when its MPC meets on 25 July. The higher than expected annual June inflation headline of 5.8 percent, almost 1 percent higher than that a month earlier, is certainly instructive. Nonetheless, the 100 basis point rate cut to 10.5 percent at the meeting in May, means keeping the benchmark rate unchanged this time, would be both accommodative and balanced. And in regard of another power tariff hike in the near future, considering the most recent hike request by KenGen, the power utility provider, was cut quite significantly by the regulator, there are indications there might not be a need for one. In early July, KenGen announced it would discontinue its costly emergency power arrangement with Aggreko, a private provider, as the 30MW Muhoroni gas turbine to make up for it is ready. There are other risks worthy of consideration, which although not within the control of the CBK, could potentially throw its inflation forecasts off-balance. The risk of political violence is all too real. Effects are likely to be seen in intermittent food and transportation price hikes, when or if it comes about. Additionally, there has not been as much fiscal discipline as planned. President Uhuru Kenyatta has not shown the needed sobriety in this regard. Mr Kenyatta’s office and that of his deputy reportedly spent one billion shillings each on hospitality in the first three quarters of the 2015/16 fiscal year. And with control of the budget now squarely under the president’s purview, more spending overruns are likely as he campaigns harder and tries to finish infrastructure projects ahead of elections next year. There are indications that even after this, some projects may still not be completed in time for his testimonials during campaigns – already under way, by both sides actually. These considerations may not weigh significantly, if at all, on the CBK decision this month, however. And in any case, there is still time for the magnitude of the highlighted risks to become clearer or in fact diminish.
In sum, credible upside risks to the inflation outlook emanate from likely election-motivated fiscal spending overruns, potential shilling volatility – a scenario the CBK is amply prepared for – and probable intermittently volatile food and transportation prices. Even so, my inflation forecasts still put end-2016 inflation below the CBK’s upper-bound target. Nonetheless, the CBK would probably not be able to ease rates further before the end of the year. Thus, what would probably be looked forward to at this meeting is commentary on the state of Kenyan banks. Although the CBK would likely try to allay fears, it would be wise to use the opportunity to clear the air on the extent of the problem. Significant bad loan provisions by some of the country’s biggest banks are almost certainly symptomatic of a deeper malaise, one the CBK would do well to address head on.
Also published in my BusinessDay Nigeria newspaper back-page column (Tuesdays).