North-West University Analyses The Latest Monetary Policy Committee Decision

The Monetary Policy Committee (MPC) unanimously decided on 25 May to increase interest rates by a further 50 basis points (bsp), citing risks to the inflation outlook as still being on the upside. The MPC’s major concerns continue to revolve around the possible second-round effects of higher headline inflation and exchange rate risks.

In commenting on the decision, Prof Raymond Parsons, economist from the North-West University (NWU) Business School, says with the latest sharp fall in the rand, it was difficult to see how the MPC could have remained entirely supine in the face of recent inflation shocks.

“Some response was necessary from the South African Reserve Bank (SARB) to the challenging economic circumstances outlined in the latest MPC statement. At the same time, both headline inflation and factory-gate inflation have now eased in April from March.”

According to Prof Parsons, it seems likely that inflation will continue, for various persuasive reasons, to gradually trend lower over the next few months. “To subdue inflation, goes the adage, central banks must tighten monetary policy until something breaks. As global and domestic risks to the inflation outlook have risen in recent times, the SARB has understandably been seized with its basic anti-inflation mandate.”

However, he says we need to recall that, since starting its interest-rate-raising cycle early in November 2021, the MPC has now hiked borrowing costs by 475 bsp. Borrowing costs in South Africa are therefore now at their highest since 2010.

“In an attempt to squeeze inflation out of the system, monetary policy over time invariably makes lenders nervous, consumer and business credit costly and firms more risk-averse, and invites unemployment, which comes at a cost, at least in the short term. And adjusting to shocks, such as a sharp fall in the currency, is also never easy or painless.”

In the media interview after the MPC meeting, the SARB governor acknowledged that the risk existed of a recession emerging in the South African economy. Prof Parsons points out that although there may be some short-term export winners from an undervalued rand, in a worst-case scenario, a country may do well if it escapes with only a temporary recession or temporary bout of inflation rather than a sustained reduction in growth prospects and persistent inflation, or even avoids a spell of stagflation.

Prof Parsons says in South Africa’s case, there fortunately remains a fuller mix of policy options available to promote sustained stable growth if they are promptly implemented to support the economy. SARB governor Lesetja Kganyago again emphasised in a public lecture earlier this month that the government is making it harder for the bank to combat inflation due to the negative economic effects of Eskom’s rolling blackouts and an underperforming economy.

“There are remedial structural factors in the South African economy that may indeed be said to lie hidden in plain sight. These include successfully mitigating the shock of heavy Eskom load-shedding, gradually lessening the impact of administrative prices, nuancing controversial geopolitical choices, as well as expediting other economic reforms.”

He explains that the remedies require urgent but equal emphasis for a more balanced policy approach to South Africa’s inflation outlook. Specifically, increasing the supply of energy would enhance the effectiveness of monetary policy and its links to the broader economy. “The SARB has

therefore had to combat inflation when several of the drivers of both inflation and growth in South Africa lie outside its control. The burden of reducing inflation in the economy therefore cannot continually be placed entirely on the shoulders of the SARB. It needs a holistic approach.” According to Prof Parsons, a more cohesive and coordinated overall official effort to reduce highly elevated policy uncertainty (and related fiscal issues) in South Africa would help to lower the costs of doing business, boost investor confidence and underpin growth.

In his Nobel Prize lecture in Stockholm last December on “Banking, Credit and Economic Fluctuations”, former US Fed chairman Ben Bernanke to a large extent could have been referring to South Africa’s present economic dilemmas by emphasising that “when there’s a shock to the economy, an energy crisis, that drives down income and wealth, that increases the external finance premium on the economy, that is, it makes it harder, credit markets become less efficient, borrowers are more stressed, banks are becoming more conservative, and that reduces the available credit and amplifies the shock. It makes the economy even weaker than the initial shock did.” This analysis broadly resonates with the risks and dilemmas now confronting the South African economy in general and the MPC in particular.

The SARB’s forecasting model (now to be updated) suggests that every 1% hike in the repo rate reduces GDP growth by about 0,17% annually. This must, however, at present be viewed within a business cycle context in which the MPC’s latest GDP growth forecast for 2023 as a whole is at 0,3%.

Prof Parsons points out that the SARB’s composite leading business cycle indicators continued their downward trend in recent months. “With the acknowledged global and domestic headwinds at present facing the South African economy, diminishing returns are now setting in for monetary policy – given the myriad of uncertainties over which it does not have control or the ability to forecast.”

He says we must therefore hope that the latest 50 bsp repo rate increase is the last for now and is sufficient to further nudge the anticipated downward trend in inflation.

“An ongoing concern for the MPC, both now and in the past, has been its desire to maintain higher interest rates in order to attract short-term foreign capital, a factor which is also linked to the MPC’s exchange rate worries.”

As a small open economy, South Africa cannot ignore global trends, but the latest data shows the rand is now being driven down mainly by domestic factors. “This shock,” said economist Brian Kantor, “is entirely of our own making, the punishing result of a failure to keep the lights on and choose our friends more carefully” (Business Day, 18 May).

Prof Parsons explains that a further aggressive repo rate rise of even 50 bsp or 75 bsp may not offer longer-term support to the rand unless other policies are implemented to address some of the risks at present priced into the currency.

Cambridge economist Gracelin Baskaran recently cautioned that “you can only raise interest rates so much before you stifle productivity, innovation and growth more broadly as the cost of capital increases precipitously … while of the utmost importance, monetary policy can’t solve the energy dilemma” (Business Day, 25 May).

“Taken together with the SARB’s recent Monetary Policy Review warning that, allowing for the usual time lags, ‘the full impact of the cumulative rate hikes is yet to be felt’ – and in also describing GDP growth in South Africa as ‘fragile’ – the latest MPC decision therefore inevitably raises the risk of ‘overkill’ in the economy.”