Monetary policy ignorant of inflation's short-term nature

The Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) raised South Africa’s official bank rate (the repo rate) by 25 basis points to 4.25% at its March 24 policy meeting.

This was the third consecutive increase in the repo rate, following a decline to the lowest rate in half a century early in 2020, induced by the Covid pandemic and fears over a steep recession. According to the SARB’s projections, the country’s consumer price index (CPI) will rise to 5.8% this year, but then decline to 4.6% in 2023.

The prime overdraft rate has now increased to just below 8%. Although the concomitant increased monthly repayments on mortgage loans and other credit instruments should still be manageable for high income groups, households in the middle and lower income groups have been dealt a significant blow by the MPC’s premature shift to contractionary monetary policy.

Little doubt exists over the short- to medium-term nature of the current upward trend in price levels, as these have mainly been caused by a combination of supply-chain disruptions flowing from the uneven global pattern of lockdown restrictions as well as higher energy prices in the wake of the war in Ukraine.

The imminent easing of constraints on manufacturing industries and international shipping is widely expected to lead to further global economic recovery and also facilitate an upward trend in merchandise trade activity. Combined with the likelihood of a swift ending to Russian hostility in Ukraine and the approach of summer in the northern hemisphere, the price of oil may start dropping like a stone by mid-2022, thereby reversing the current trend of higher inflation.

Low capacity utilisation in manufacturing

The Reserve Bank continues to side-step issues that signal the need for a more accommodating monetary policy stance, including the continued low level of capacity utilisation in the manufacturing sectors, most of which have not yet fully recovered from the effects of the pandemic.

The country’s manufacturers cite insufficient demand as the main reason for the fact that many factories around the country are not remotely operating at full capacity, which also serves to constrain the pipeline for capital formation in new productive capacity.

The most glaring evidence of an unbalanced policy perspective by the MPC is the ignorance of the supercharged performance of the South African currency since the beginning of the year. Apart from the Brazilian real, no other currency of note has been able to match the performance of the rand over the past three months. Between 3 January and 24 March, the rand has appreciated by between 7.5% and 13.6% against the currencies of the world’s six largest economies.

As an inference, South Africa currently has nothing to fear from inflationary pressures induced by currency weakness. This point is underscored by the Reserve Bank’s acknowledgement of balance of payments stability, as it expects the trade balance to remain in a sizeable surplus territory.

Real prime rate out of kilter

Ever since the retirement of the previous governor of the Reserve Bank, Gill Marcus, the MPC’s monetary policy approach has doggedly been pursuing low inflation, with an apparent disregard for the need to stimulate growth and employment creation. Even during the marginally more lenient approach during the worst of the pandemic, South Africa’s prime commercial bank lending rate was higher, in real terms, than most of its key trading partners.

This is still the case, with the current real prime rate of just above 2% way above the negative real prime rates of countries like the UK (-4.5%), the US (-4.7%) and the Netherlands (-5.9%).

Another quantifiable argument against the notion of higher interest rates is the continued weakness of private sector credit extension, which is sitting at a level of just above R4.1 trillion - 2.3% lower than two years ago. The South African economy has never been able to grow at rates commensurate with meaningful employment creation unless private sector credit extension is expanding.

For the first time in decades, South Africa is enjoying a significantly larger degree of price stability than many of its trading partners and emerging market peers. When contrasting this to a country-wide comparison of unemployment rates, it becomes fairly obvious that economic growth should be afforded a higher priority in South Africa than trying to drive inflation down to levels that are not attainable in the current cost-push inflationary environment.

Pres. Ramaphosa and Finance Minister Godongwana must be terribly frustrated by the MPC’s decision to increase the cost of capital at a time when new investment in productive capacity is desperately needed.