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Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at Lyons Companies, the University of Delaware's Center for Economic Education and Entrepreneurship, and Alfred Lerner College of Business and Economics, Newark, DE, 11 February 2014. | Charles I Plosser: Monetary policy and a brightening economy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at Lyons Companies, the University of Delaware’s Center for Economic Education and Entrepreneurship, and Alfred Lerner College of Business and Economics, Newark, DE, 11 February 2014. * * * President Plosser presented similar remarks at the Simon Business School in Rochester, NY, on 5 February 2014. The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser provides his economic outlook for 2014 and reports that the decision of the Federal Open Market Committee (FOMC) to reduce the pace of asset purchases was a step in the right direction. • President Plosser expects growth of about 3 percent in 2014. He also expects the unemployment rate to continue its steady decline and to reach about 6.2 percent by the end of 2014. Inflation expectations will be relatively stable, and inflation will move up toward the FOMC target of 2 percent over the next year. • Based on the economic progress that has been made and his economic outlook, President Plosser believes it is appropriate to end asset purchases, and he supported the FOMC’s decision in January to continue to reduce the pace of purchases. • A case can be made for ending the current asset purchase program sooner to reflect the improvement in the economic outlook and to lessen some of the communications problems the FOMC will face with its forward guidance. Introduction I am delighted to return once again to the University of Delaware to speak at this annual event. This is a great event for the region and I am pleased to see it grow year after year. I would like to begin my remarks this morning with a bit of history. We are observing the 100th anniversary of the Federal Reserve and that gives me the opportunity, or the excuse, to offer a perspective on this important, but sometimes misunderstood, institution. I should note that my views are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee. On December 23, 1913, President Woodrow Wilson signed the act that created the Federal Reserve System, and the 12 Federal Reserve Banks opened their doors on November 16, 1914. I have often described the Federal Reserve as a uniquely American form of a central bank – a decentralized central bank. To understand why, we need to consider two earlier attempts at central banking in the United States. Just a few blocks from the Philadelphia Fed’s present building on Independence Mall, you will find the vestiges of both institutions, dating back to the early years when Philadelphia was the major financial and political center of the country. Alexander Hamilton, our first secretary of the Treasury, championed the First Bank of the United States to help our young nation manage its financial affairs. The First Bank received a 20-year charter from Congress and operated from 1791 to 1811. Although this charter was not renewed, the War of 1812 and the ensuing inflation and economic turmoil convinced Congress to establish the Second Bank of the United States, which operated from 1816 to BIS central bankers’ speeches 1836. However, Congress could not override the veto of President Andrew Jackson, and the Second Bank’s charter also lapsed. Both institutions failed to overcome the public’s mistrust of centralized power and special interests. Nearly 80 years later, Congress tried again. To balance political, economic, and geographic interests, Congress created a Federal Reserve System of 12 regional Reserve Banks with oversight provided by a Board of Governors in Washington, D.C. This decentralized central bank was structured to overcome concerns that its actions would be dominated either by political interests in Washington or by financial interests on Wall Street. These 12 Reserve Banks perform several roles. They distribute currency, act as a bankers’ bank, and generally perform the functions of a central bank, which includes serving as the bank for the U.S. Treasury. They also play a critical role in supervising many banks and bank holding companies across the country. Each Reserve Bank has a nine-member board of directors selected in a nonpartisan way to represent a cross-section of banking, commercial, and community interests. Pat Harker, president of the University of Delaware, serves on our board. These directors fulfill the traditional governance role, but they also provide valuable insights into economic and financial conditions, which contributes to our assessment of the economy. The Reserve Banks seek to stay in touch with Main Street in other ways. Some have Branch boards, and all have advisory councils. Reserve Banks also collect and analyze data and conduct surveys of economic activity. This rich array of information and the diverse views from across the country help policymakers paint a mosaic of the economy that is essential as we formulate national monetary policy. Within the Federal Reserve, the body that makes monetary policy decisions is the Federal Open Market Committee, or the FOMC. Here again, Congress has designed the system with a number of checks and balances. Since 1935, the composition of the FOMC has included the seven Governors in Washington, who are appointed by the President of the United States and confirmed by the Senate, as well as the president of the New York Fed, and four other Reserve Bank presidents who serve one-year terms as members on a rotating basis. Whether we vote or not, all Reserve Bank presidents attend the FOMC meetings, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options. The FOMC has eight regularly scheduled meetings each year to set monetary policy. The first one in 2014 was held just two weeks ago. In normal times, the Committee votes to adjust short-term interest rates to achieve the goals of monetary policy that Congress has set for us. Congress spelled out the current set of monetary policy goals in 1978. The amended Federal Reserve Act specifies that the FOMC “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Since moderate long-term interest rates generally result when prices are stable and the economy is operating at full employment, many have interpreted these instructions as being a dual mandate to manage fluctuations in employment in the short run while preserving price stability in the long run. Economic conditions In order to determine the appropriate monetary policy to promote these goals, the FOMC must monitor and assess economic developments. So, let me turn to an assessment of our economy as we enter 2014. In a nutshell, my view is that the economy is on firmer footing than it has been for the past several years. So let’s look at some of the details of how last year ended and the implications for the coming year. BIS central bankers’ speeches Real output grew at a 3.2 percent annual pace in the fourth quarter of last year, following a 4.1 percent growth rate in the third quarter. That means economic growth doubled in the second half of 2013 compared with the first half. Consumer spending and business investment in equipment ended the year with strong increases. Inventory investment and net exports also contributed to growth. On the other side of the ledger, a decline in residential investment and a sharp decrease in federal government spending subtracted from growth in the fourth quarter of the year. Going forward, I expect that there will be less fiscal drag in 2014 than we saw in 2013 and that housing will continue its recovery. Personal consumption, which accounts for more than two-thirds of GDP, advanced at an annual rate of 3.3 percent in the fourth quarter, the highest personal consumption growth rate since fourth quarter 2010. Rising house prices and stock prices have helped improve consumer balance sheets, and steady job growth has added to wage and salary growth, all of which have supported spending. On the job front, the January employment report showed payroll gains of 113,000 jobs, following an increase of 75,000 jobs in December, which was below many analysts’ expectations. Yet, these numbers were affected by the unseasonably cold and snowy weather. Indeed, winter weather has continued to be unusually disruptive, and that is making it difficult to assess underlying economic trends. I suspect it may be another couple of months before we have a better read on the economy – hopefully the weather will turn better before that! We have to remember that these employment numbers are subject to revisions, and such revisions can be significant. For instance, in the latest report the November jobs number was revised up by 33,000, from 241,000 to 274,000, while the December number was also revised up by 1,000 to 75,000. Because of month-to-month volatility and data revisions, I prefer not to read too much into the most recent numbers but, instead, look at averages over several months. Here the news remains positive. Based on the latest revision, firms added an average of 194,000 jobs per month in 2013, somewhat better than the pace in 2012. This consistent pace of job growth was enough to drop the unemployment rate 1.2 percentage points last year. In January, it fell a bit further to 6.6 percent. This is noticeably lower than the FOMC anticipated in its Summary of Economic Projections in September 2012, when we started the current asset purchase program. That is, the labor market has performed better than expected, according to the unemployment rate measure. Should we be sceptical of the unemployment rate as an indicator of labor market conditions? Some people are because the decline in the unemployment rate reflects not only increases in employment but declines in labor force participation as well. Declines in participation can include discouraged workers who have stopped looking for work because it is difficult to find a job. There is concern in some quarters that the unemployment rate will move back up significantly when these discouraged workers reenter the labor force. Based on research by my staff, I am less concerned about this possibility.1 First, it is important to realize that labor force participation rates can decline for reasons other than a rise in discouraged workers. Indeed, we have seen steadily declining participation rates since 2000 that reflect demographic changes, most notably the aging of the baby boomers. This trend is continuing and has long been expected to accelerate. Second, detailed analysis of the Current Population Survey’s micro data indicates that about three-quarters of the decline in participation since the start of the recession in December 2007 can be accounted for by increased retirements and movements into disability. Some of Shigeru Fujita, “On the Causes of Declines in the Labor Force Participation Rate,” Research Rap Special Report, Federal Reserve Bank of Philadelphia, February 6, 2014. BIS central bankers’ speeches these increases might have been driven by the state of the economy. For example, some baby boomers may have moved their retirement decision forward after losing a job. Nevertheless, few of these individuals are likely to reenter the labor force. So, while I do expect some discouraged workers to reenter the labor force as the economy improves, I still believe the overall unemployment rate remains a good summary statistic of labor market conditions. The business sector is also entering the year on a positive note. At the national level, manufacturing activity accelerated over the final three months of 2013. The Philadelphia Fed’s Business Outlook Survey of regional manufacturing, which is a reliable indicator of national manufacturing trends, also showed that manufacturing activity picked up in the second half of 2013. In January, the survey’s general activity index posted its eighth consecutive positive number. Expectations for manufacturing activity six months ahead also remained positive. This gives me some hope that business fixed investment, which has been generally lackluster during the course of the recovery, will pick up somewhat this year. Indeed, we saw a nice rebound in equipment spending in the fourth quarter. Inflation has been running below the FOMC’s long-run goal of 2 percent. The Fed’s preferred measure of inflation is the year-over-year change in the price index for personal consumption expenditures, or PCE inflation. It came in at 1.1 percent last year. It is important to defend our 2 percent inflation target from both below and above. But I believe inflation is likely to move up. Economic growth is firming, and some of the factors that have held inflation down, such as the one-time cut in payments to Medicare providers, are likely to abate over time. An additional and important determinant of actual inflation is consumer and business expectations of inflation. I am encouraged that inflation expectations remain near their longer-term averages and consistent with our 2 percent target. Thus, I anticipate, as the FOMC indicated in its most recent statement, that inflation will move back toward our target over time. Indeed, given the large amount of monetary accommodation we have added and continue to add to the economy, I think there is some upside risk to inflation in the longer term. Although growth in the first quarter is likely to be somewhat slower than the rapid pace we saw in the second half of last year, overall, I anticipate economic growth of around 3 percent this year, a pace that is slightly above trend. Everyone would like to see robust growth of 5 to 6 percent, but I don’t see that happening. Nevertheless, I do see steady progress and an improving economy. This growth is sufficient to result in a continued decline in the unemployment rate, which should reach about 6.2 percent by the end of 2014. Of course, with any forecast, there are risks. The current volatility in emerging market currencies could pose a risk if it were to spill over more broadly into other financial markets. But at this point, I do not consider it a significant risk to the U.S. economy. While there continues to be some downside risks, for the first time in a few years, I see a potential for some upside risks to the economic outlook. We need to consider this possibility as we calibrate monetary policy. Monetary policy The Federal Reserve has taken extraordinary policy actions to support the economic recovery. The Fed has lowered its policy rate – the federal funds rate – to essentially zero, where it has been for more than five years. Since the policy rate cannot go any lower, the Fed has attempted to provide additional accommodation through large-scale asset purchases. We are now in our third round of this quantitative easing, or, as it is commonly called, QE3. These purchases have greatly expanded the size and lengthened the maturity of the assets on the Fed’s balance sheet. The Fed is also using forward guidance as a policy tool, which is intended to inform the public about the way monetary policy is likely to evolve in the future. In this dimension, the BIS central bankers’ speeches FOMC has indicated that it intends to leave the policy rate near zero well past the time that the unemployment rate falls below the 6.5 percent threshold. The FOMC had previously indicated this was the earliest point at which it would consider raising interest rates, especially if projected inflation continues to run below the Committee’s 2 percent target. On asset purchases, the FOMC has indicated that it will continue the purchases until the outlook for the labor market has improved substantially in the context of price stability. Yet, with the economy having improved substantially over the last year and the outlook brightening, the time has come for the FOMC to slow the pace at which it is adding monetary accommodation, which is to say, ease our foot off the accelerator.2 My personal view is that the process should have started sooner and proceeded more expeditiously. Nevertheless, the FOMC did decide in December to take a very modest step by reducing asset purchases from $85 billion to $75 billion per month, and then reduced this by another $10 billion to $65 billion a month in January. The FOMC indicated that if incoming information broadly supports the expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, then we’ll likely reduce the pace of purchases further in measured steps at future meetings. Former Chairman Ben Bernanke indicated in his December press conference that if we are making progress in terms of inflation and continued job gains, then the program would be concluded late in 2014. Notice that even though we are reducing the pace at which we are purchasing longer-term assets, we are still adding monetary policy accommodation. So, the foot is still on the accelerator. My preference would be that we conclude the purchases sooner rather than later. I believe a good case can be made for speeding up the pace of our taper if the economic outlook plays out as I expect. As I noted earlier, the unemployment rate fell 1.2 percentage points last year, and again in January to 6.6 percent. This is a much sharper decline than anticipated when we started the purchase program in September 2012. We are now only one-tenth of a point from the 6.5 percent threshold in our forward guidance for interest rates. The FOMC has indicated that it doesn’t anticipate raising rates when the economy crosses that threshold. However, I do believe that we have a communications challenge. We have not described how policy will be conducted after the unemployment rate passes 6.5 percent. Last summer, it was thought that we would stop asset purchases by the time unemployment reached 7 percent. Well, that didn’t happen. What is the argument for continuing to increase monetary policy accommodation when labor market conditions are improving more quickly than anticipated and inflation has stabilized and is projected to move back to goal? The longer we continue purchases in such an environment, the more likely we will fall behind the curve in reducing the extraordinary degree of monetary policy accommodation. With the economy awash in reserves, the costs of such a misfire could be considerably higher than usual, fomenting higher inflation and perhaps financial instability. My preference was, and remains, to scale back our purchase program at a faster pace to reflect the strengthening economy. Given the falling unemployment rate, our communications should be focused on how economic conditions will determine the interest rate path. Continuing to buy assets is neither helpful nor essential. For more on the subject, see Charles I. Plosser, “The Outlook and the Hazards of Accelerationist Policy,” remarks before The University of Delaware Center for Economic Education and Entrepreneurship, Newark, DE, February 14, 2012. BIS central bankers’ speeches Conclusion In summary, I believe that the economy is continuing to improve at a moderate pace. We are likely to see growth of around 3 percent in 2014. Prospects for labor markets will continue to improve, and I expect the unemployment rate will continue its decline, reaching 6.2 percent by the end of 2014. I also believe that inflation expectations will be relatively stable and that inflation will move up toward our goal of 2 percent over the next year. On monetary policy, we must back away from increasing the degree of policy accommodation in a manner commensurate with an improving economy. Reducing the pace of asset purchases to $65 billion a month is moving in the right direction, but that may prove to be insufficient if the economy continues to play out according to the FOMC forecasts. I believe the economy has met the criteria for ending the asset purchases as there has been significant improvement in labor market conditions. I also believe that further increases in the balance sheet are unlikely to provide appreciable benefits for the recovery and may have unintended consequences. A case can be made for ending the current asset purchase program sooner to reflect the improvement in the economic outlook and to lessen some of the communications problems we will face with our forward guidance. Even after the asset purchase program has ended, monetary policy will still be highly accommodative. As the expansion gains traction, the challenge will be to reduce accommodation and to normalize policy in a way that ensures that inflation remains close to our target, that the economy continues to grow, and that we avoid sowing the seeds of another financial crisis. This means the Fed still has considerable work to do. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 2 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, before the 2014 US Monetary Policy Forum - "Initiative on Global Markets", at the University of Chicago Booth School of Business, New York City, 28 February 2014. | Charles I Plosser: Communication challenges Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, before the 2014 US Monetary Policy Forum – “Initiative on Global Markets”, at the University of Chicago Booth School of Business, New York City, 28 February 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser believes the Federal Open Market Committee has to revamp its current forward guidance regarding the future federal funds rate path because the 6.5 percent unemployment threshold has become irrelevant. • President Plosser points out that before offering new forward guidance, the FOMC ought to be clear about its purpose. Is it purely a transparency device, or is it a way to commit to a more accommodative future policy stance to add more accommodation today? • President Plosser notes that commitment is required to be successful in either approach to forward guidance. Policymakers cannot maintain discretion and simultaneously commit to forward guidance and expect that guidance to be effective. Introduction It is a pleasure to return to this event. The organizers have put together another great and timely program with distinguished participants. However, with Governor Stein and Presidents Kocherlakota, Evans, and myself all here, I am beginning to wonder if we are in Washington rather than in New York. Nevertheless, it is great to be on the program with so many of my fellow policymakers. If you listen carefully to each of us, you will understand why I start with the usual caveat that my remarks represent my own views and not necessarily those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Communication and transparency have been important themes in monetary policy discussions over the past decade or more. Indeed, in 2007 this Monetary Policy Forum began with Alan Blinder’s keynote address titled “Making Monetary Policy and Talking about It.” In part, this emphasis on communication and transparency reflects the steady evolution in the theory and science of monetary policy. Reflecting this emerging consensus, the Federal Reserve during the tenure of Chairman Bernanke has taken a number of actions to promote increased transparency about its actions and policies. In fact, President Evans and I served on a subcommittee led by current Chair Yellen specifically focused on improving communication. Our efforts to improve communication took on heightened importance as the FOMC responded to the financial crisis and recession. Since December 2008, the federal funds rate target has been near zero. Since the nominal funds rate cannot go below zero, we had to develop alternative policy tools in an effort to provide further accommodation to support the recovery. We also had to figure out how and what to communicate about these new tools. Thus, well-understood communication practices about traditional policy tools gave way to untested ways to describe these new tools. The task was further complicated because one of the unconventional tools was so-called forward guidance. Forward guidance seeks to inform the public about the future path of policy rather than describing a policy action taken today. BIS central bankers’ speeches Thus, effective forward guidance is all about communication and what it conveys or doesn’t convey. In my brief time today, I will focus on why I think communication is such a challenge and discuss some of the choices the Committee faces going forward. Current state of affairs First, communication is difficult because monetary policy is more complicated than it used to be. With the traditional policy tool at the zero lower bound, the Committee has focused on two unconventional tools. The first is the purchase of long-term assets, and the second, as I mentioned, is forward guidance. The asset purchase program has had many dimensions, such as the overall volume of purchases, the pace of purchases, the kinds of assets targeted for purchase, and the criteria for starting and stopping the purchases. Policymakers have tried to fine-tune the program along each dimension while assessing the trade-offs among them and the trade-offs with other policy tools, such as the traditional funds rate decision. With so many moving parts to our policy framework, it is not surprising that communication is very complicated. We are now in the third round of asset purchases, or quantitative easing. Since September 2012, the FOMC has added some $1.3 trillion in long-term Treasuries and mortgage-backed securities to its balance sheet through this program, buying at a pace of $85 billion a month in 2013. This program, known as QE3, is already twice the size of the last round of asset purchases that was initiated in November 2010, known as QE2. In December 2013, the Committee announced that it would reduce the pace of purchases from $85 billion to $75 billion per month. In January, it announced a further reduction to $65 billion. The FOMC is now on a path of measured reductions, which, if continued, will end the purchase program late this year. If the economy continues to improve, we could find ourselves still trying to increase accommodation in an environment when history suggests that policy should perhaps be moving in the opposite direction. Communication about the future path of asset purchases has, at times, been imprecise and confusing. Last June, the Committee suggested that it might begin to reduce the pace of purchases in the fall and perhaps end them when the unemployment rate reached 7 percent. However, the Committee did not even begin the tapering process until unemployment had reached 7 percent. It now seems unlikely that the program will end until the unemployment rate is below – or as indicated in the FOMC statement, perhaps “well below” – 6.5 percent. Why is the 6.5 percent unemployment rate important? Because the Committee made it important. The Committee, in essence, told the markets that the 6.5 percent unemployment rate was an important quantitative marker. In December 2012, the FOMC indicated that it intended to keep the federal funds rate target near zero at least as long as the unemployment rate was above 6.5 percent, the inflation rate between one and two years ahead was projected to be no more than 2.5 percent, and inflation expectations remained well anchored. However, it is important to remember that these guideposts were thresholds, not triggers. The FOMC had not made a commitment to act once a threshold was reached, nor did it indicate how policy would evolve after a threshold was reached. It simply signaled that it would not act prior to crossing one of the thresholds. Yet, the 6.5 percent threshold will soon become irrelevant, and it probably is already. So the Committee, at a minimum, has to revamp its communications regarding the future federal funds rate path. Given that we are still easing policy by buying assets, it is pretty clear that even though the threshold will soon come and go, the Committee is unlikely to contemplate raising rates as long as it is buying assets. Put another way, the practical constraint at this point for raising the policy rate is no longer the unemployment rate but the fact that we are still buying assets. Indeed, the Committee has acknowledged that it will likely be appropriate to keep rates at their current low rates well past the time unemployment falls below BIS central bankers’ speeches 6.5 percent. Therefore, in my view, the threshold has already lost its meaning as a guidepost. It needs to be replaced with something that is more relevant and informative. This poses the challenge of how and what to communicate about policy going forward. Our actions and the data have made the current form of forward guidance outdated and mostly irrelevant. Indeed, one could reasonably wonder whether the inflation threshold has any meaning at this point. In other words, by allowing the unemployment threshold to pass without taking action, the public might conclude that the Committee could easily decide to let the inflation threshold pass without taking action as well. Competing roles for forward guidance Before we offer further forward guidance, it is important to be clear about what this forward guidance is intended to accomplish. As Yogi Berra is reported to have said, “You have to be careful if you don’t know where you’re going because you might end up somewhere else.” One way to think of forward guidance is that it is just another step toward increased transparency and effective communication of monetary policy. This approach seeks to clarify how policymakers will alter policy as economic conditions change, that is, to describe a reaction function. By being more transparent about how policy will evolve as a function of economic conditions, this approach can help the public form more accurate expectations about the future path of monetary policy. Economists have learned that expectations play an important role in determining economic outcomes. When businesses and households have a better understanding of how monetary policy is likely to evolve, they can make more informed spending and financial decisions. If monetary policymakers can reduce uncertainty about the course of monetary policy, the economy is likely to perform more efficiently. Of course, in order to communicate something about the reaction function, you have to have one. That means in order to be successful with this approach to forward guidance, policymakers must be able to agree on how they will systematically respond to changes in economic conditions. To be useful, however, the reaction function need not be mechanistic. Qualitative information about such a function and how it will be implemented can also be useful and meaningful. Nevertheless, some degree of commitment to abide by the specified reaction function is necessary, if the communication is to achieve the desired result of reducing policy uncertainty and providing meaningful forward guidance. The excuse that “this time is different” undermines the commitment and the credibility of the information that the communication is seeking to provide. I would add that a committed and credible approach to such a systematic approach to policy is helpful and informative regardless of whether you are at the zero lower bound or not. A somewhat different rationale or view of forward guidance is that it is a way of increasing accommodation in a period when the policy rate is at or near the zero lower bound. Some models suggest that when you are at the zero lower bound, it can be desirable, or optimal, to indicate that future policy rates will be kept “lower for longer” than might otherwise be the case. Thus, policymakers intentionally commit to deviating from what they would otherwise choose to do in normal times, such as following the Taylor rule. In these models, such a commitment would tend to raise inflation expectations and lower long-term nominal rates, thereby inducing households and businesses to spend more today. This approach asks more of forward guidance than just articulating a reaction function. It takes more credibility and commitment because it requires policymakers to directly influence and manage the public’s beliefs about the future policy path in ways that are different from how they may have behaved in the past. As I have indicated in previous speeches, this BIS central bankers’ speeches approach to forward guidance can backfire if the policy is misunderstood. 1 For example, if the public hears that the policy rate will be lower for longer, it may interpret this news as policymakers saying that they expect the economy to be weaker for longer. If that is the interpretation of the message, then the forward guidance will not succeed and may even weaken current spending. The FOMC has not been clear about the purpose of its forward guidance. Is it purely a transparency device, or is it a way to commit to a more accommodative future policy stance to add more accommodation today? This lack of clarity makes it difficult to communicate the stance of policy and the conditionality of policy on the state of the economy. Note that most formulations of standard, simple policy rules suggest that the federal funds rate should rise very soon – if not already. In other words, the zero lower bound no longer appears to be binding. However, the FOMC has provided forward guidance indicating that the federal funds rate will need to be low for some time to come. How do we reconcile this apparent incongruity? It could be that the FOMC is using its forward guidance as a commitment device or signal for a more accommodative policy well into the future, as in the second approach I have discussed. Or, it could be the FOMC views forward guidance as a device for increased transparency but that it doesn’t think the standard rules apply in the current environment. Then what rules do apply? If policymakers are not relying on a rule or a rule-like reaction function, policy is purely discretionary and forward guidance becomes ineffective. In either case, we have an opportunity and an obligation to provide more transparency and better communication. This leads me to suggest that there is a more fundamental tension underlying our forward guidance and communication challenges. Forward guidance in either of the two approaches that I have discussed requires a degree of commitment to conduct future policy in some particular manner. That commitment is central to the success of either approach. Yet, I would suggest that the old “rules versus discretion” debate is alive and well. This, of course, is not a new tension within the FOMC, nor is it one that is likely to go away in the near term. But the heightened weight and prominence given to forward guidance as a policy tool has certainly shined a spotlight on this longstanding debate. The desire to maintain flexibility to respond to “events on the ground” is a strong one. One can make the case that discretion is deeply ingrained in most policy institutions, particularly the Fed. Yet, the desire to maintain discretion is anathema to the commitment required for successful forward guidance. Policymakers cannot maintain discretion and simultaneously commit to forward guidance and expect that guidance to be effective. So, I conclude as I began: Forward guidance and clear communications remain important challenges for monetary policymakers. See Charles I. Plosser, “Forward Guidance,” speech to the Stanford Institute for Economic Policy Research’s (SIEPR) Associates Meeting, February 12, 2013, Stanford, CA. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 3 |
Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Official Monetary and Financial Institutions Forum (OMFIF), London, 6 March 2014. | Charles I Plosser: Perspectives on the US economy and monetary policy Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Official Monetary and Financial Institutions Forum (OMFIF), London, 6 March 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Summary • President Plosser expects growth of about 3 percent in 2014. He also expects the unemployment rate to continue its steady decline and to reach about 6.2 percent by the end of 2014. Inflation expectations will be relatively stable, and inflation will move up toward the FOMC target of 2 percent over the next year. • President Plosser believes the Federal Open Market Committee has to revamp its current forward guidance regarding the future federal funds rate path because the 6.5 percent unemployment threshold has become irrelevant. • President Plosser favors providing more information on policymakers’ reaction function, which indicates how policy will evolve as economic conditions change. • President Plosser favors a more systematic, less discretionary approach to monetary policy. He believes it is time to switch from an interventionist mode for monetary policy to one that is more systematic. Introduction I am honored to participate in the Golden Series lectures and to be here in such a historic hall. The Official Monetary and Financial Institutions Forum is a relatively new organization, yet it is already establishing itself as an important venue for the exchange of views and ideas among policymakers and the private sector. It is similar to the Global Interdependence Center, a think tank based in Philadelphia, which is hosting a conference at the Banque de France next week, where I will join my friend Governor Christian Noyer. I note with interest that Governor Noyer will be speaking to you in just a few weeks’ time. Our venue today has an impressive history. The Worshipful Company of Armourers and Brasiers has been operating at this location since 1346. That is nearly 350 years before the Bank of England was founded in 1694. Its original building survived the Great Fire of 1666, and this current building survived the 1940 Blitz. With so much history steeped in these halls, I hesitate to mention that the Federal Reserve is marking its 100th anniversary this year. The Federal Reserve Act of 1913 created a uniquely American approach to a central bank – a decentralized central bank – with 12 independent Federal Reserve Banks around the country and a Board of Governors in Washington, D.C. This unique governance structure requires that I forewarn you that the views I express are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Economic conditions The U.S. economy is now nearly five years into a recovery that began in June 2009. The recovery has been lackluster in many ways, yet it has made considerable progress nonetheless. The unemployment rate, for example, has fallen from its peak of 10.0 percent to 6.6 percent. Employment gains have restored some 7.8 million jobs since the trough, representing about 90 percent of the jobs lost since the peak. Stock prices have recovered, BIS central bankers’ speeches housing prices are up, and earnings at many businesses are healthy. It is my general view that the U.S. economy is on firmer footing today than it has been in several years. This is a cause for some optimism for continued progress in 2014. In recent weeks, there has been a blizzard of economic reports, which have come in weaker than expected. I believe that weakness largely reflects the severe winter weather rather than a frozen recovery. So, we must be wary of attaching too much significance to the latest numbers. As a monetary policymaker, I prefer to take a longer view rather than let our decisions be whipsawed by the most recent statistics, which are often noisy and subject to revision. Because monetary policy tends to work with a lag, we must keep our attention focused on the intermediate- to longer-term underlying trends if we are to make wise decisions. Based on the latest GDP numbers revised last week, the U.S. economy performed noticeably better in the second half of 2013 than in the first half. Specifically, real output grew at a 3.3 percent pace in the second half of the year compared with 1.8 percent in the first half. While this is far from the robust growth that many would like to see, it continues to represent steady progress and an improving economy. My forecast calls for about 3 percent growth in 2014. This is in line with the central tendency of 2.8 to 3.2 percent growth reported by my colleagues on the FOMC in December 2013. There has been discussion of some recent weakness in consumer spending, housing starts, and housing sales. For instance, in January, total retail sales fell by 0.4 percent; housing starts dropped sharply in January by 2 percent compared with the level of a year ago; and existing home sales dropped about 5 percent from a year ago. While some softening in home sales might be expected from the rise in mortgage rates, those rates are still very low by historical standards, and new home sales surged in January, rising to their highest level since 2008. Despite the mixed housing data, continued household formation constitutes a source of growth in housing demand. So, I expect that housing will continue its recovery in 2014, once we get past the severe weather. Consumer spending, which accounts for more than two-thirds of U.S. GDP, proved to be quite resilient in 2013, despite the rise in payroll taxes at the start of the year, a government shutdown, significant uncertainties about future tax policy, and the implications of health-care reform. Going forward, I expect that there will be less fiscal drag on the economy in 2014 than we saw in 2013. Moreover, rising home prices and stock prices have helped improve consumer balance sheets. I have frequently noted that one reason for the less-than-robust growth in consumption during this recovery has been the deleveraging efforts by consumers. With consumers carrying too much debt, spending was inevitably going to give way to more saving as consumers attempted to restore the health of their balance sheets. That process has been playing out, and the drag from deleveraging is waning. In addition, steady, moderate job growth has led to modest increases in income. I foresee somewhat more robust spending by consumers in the coming year as these trends continue. Weather also affected recent manufacturing numbers in the U.S. The Philadelphia Fed’s Business Outlook Survey of manufacturers in our region has been a reliable indicator of national manufacturing trends in the U.S. In February, the diffusion index of current activity fell into negative territory for the first time in nine months. However, most respondents attributed the weakness to the severe winter weather. Consistent with such comments, expectations for manufacturing activity six months ahead increased in February. On the job front, the January employment report posted payroll gains of 113,000 jobs, following an increase of 75,000 jobs in December, again most likely reflecting in part the effect of the unusually severe winter weather. BIS central bankers’ speeches As we look at the employment averages over several months, the news remains positive. Based on the latest revision, firms added an average of 194,000 jobs per month in 2013, which is a somewhat better pace than in 2012. This consistent pace of job growth was enough to drop the unemployment rate to 6.6 percent in January. I expect that the unemployment rate will reach about 6.2 percent by the end of 2014, and, if anything, that may prove too pessimistic. Given the recent trends, an unemployment rate below 6 percent is certainly plausible. In terms of the other part of the Fed’s mandate, inflation has been running somewhat below the FOMC’s long-run goal of 2 percent. The Fed’s preferred measure of inflation is the yearover-year change in the price index for personal consumption expenditures, or PCE inflation. It came in at 1.1 percent last year. It is important to defend our 2 percent inflation target both from below and above. Yet, I anticipate, as the FOMC indicated in its most recent statement, that inflation will move back toward our target over time. Economic growth is firming, and some of the factors that have held inflation down, such as the one-time cut in payments to Medicare providers, are likely to abate over time. An additional and important determinant of actual inflation is consumer and business expectations of inflation. I am encouraged that inflation expectations remain near their longer-term averages and consistent with our 2 percent target. Given the large amount of monetary accommodation that we have added and continue to add to the economy, I think there is some upside risk to inflation in the longer term. Of course, with any forecast, there are risks. While there continues to be some downside risk to growth, for the first time in years, I see the potential for more upside risk to the economic outlook. We need to consider this possibility as we calibrate monetary policy. Monetary policy So let me turn to some issues for monetary policy. The Federal Reserve has taken extraordinary policy actions to support the economic recovery. The Fed has lowered its policy rate – the federal funds rate – to essentially zero, where it has been for more than five years. Since the policy rate cannot go any lower, the Fed has attempted to provide additional accommodation through large-scale asset purchases. We are now in our third round of this quantitative easing. Since September 2012, the FOMC has added about $1.3 trillion in long-term Treasuries and mortgage-backed securities to its balance sheet through this program, buying at a pace of $85 billion a month in 2013. This program, known as QE3, is already twice the size of the last round of asset purchases initiated in November 2010, known as QE2. In December 2013, the Committee announced that it would reduce the pace of purchases from $85 billion to $75 billion per month. In January, it announced a further reduction to $65 billion. The FOMC is now on a path of measured reductions, which, if continued, will end the purchase program later this year. If the economy continues to improve, we could find ourselves still trying to increase accommodation in an environment in which history suggests that policy should perhaps be moving in the opposite direction. In addition to asset purchases, the Fed is using forward guidance as a policy tool, which is intended to inform the public about the way monetary policy is likely to evolve in the future. In this dimension, the FOMC has indicated that it intends to leave the policy rate near zero well past the time that the unemployment rate falls below the 6.5 percent threshold. The FOMC had previously indicated that this was the earliest point at which it would consider raising interest rates, especially if projected inflation continues to run below the Committee’s 2 percent target. Even though the FOMC has said that it doesn’t anticipate raising rates when the economy crosses that threshold, I believe that with the economy so close to the unemployment BIS central bankers’ speeches threshold, we face a communications challenge. In particular, we have not described how policy will be conducted after the unemployment rate falls below 6.5 percent. Communication challenges But before we offer further forward guidance, it is important to be clear about what this forward guidance is supposed to accomplish. As that famous American baseball player Yogi Berra is reported to have said, “You have to be careful if you don’t know where you’re going because you might end up somewhere else.” One way to think of forward guidance is that it is just another step toward increased transparency and effective communication of monetary policy. This approach seeks to clarify how policymakers will alter policy as economic conditions change, that is, to describe a reaction function. By being more transparent about how policy will evolve as a function of economic conditions, this approach can help the public form more accurate expectations about the future path of monetary policy. Economists have learned that expectations play an important role in determining economic outcomes. When businesses and households have a better understanding of how monetary policy is likely to evolve, they can make more informed spending and financial decisions. If policymakers can reduce uncertainty about the course of monetary policy, the economy is likely to perform more efficiently. Of course, in order to communicate something about the reaction function, you have to have one. That means in order to succeed with this approach to forward guidance, policymakers must be able to agree on how they will systematically respond to changes in economic conditions. To be useful, however, the reaction function need not be mechanistic. Qualitative information about such a function and how it will be implemented can also be useful and meaningful. Nevertheless, some degree of commitment to abide by the specified reaction function is necessary if the communication is to achieve the desired result of reducing policy uncertainty and providing meaningful forward guidance. A somewhat different rationale or view of forward guidance is that it is a way of increasing accommodation when the policy rate is at or near the zero lower bound. Some models suggest that when you are at the zero lower bound, it can be desirable, or optimal, to indicate that future policy rates will be kept “lower for longer” than might otherwise be the case. Thus, policymakers may want to deliberately commit to deviating from what they would otherwise choose to do under normal conditions, such as following a Taylor-like rule. In these models, such a commitment would tend to raise inflation expectations and lower long-term nominal rates, thereby inducing households and businesses to spend more today. This approach asks more of forward guidance than just articulating a reaction function. It takes more credibility and commitment because it requires policymakers to directly influence and manage the public’s beliefs about the future policy path that differs from how policymakers behaved in the past. As I have indicated in previous speeches, this approach to forward guidance can backfire if the policy is misunderstood.1 For example, if the public hears that the policy rate will be lower for longer, it may interpret this news as policymakers saying that they expect the economy to be weaker for longer. If that is the interpretation of the message, then the forward guidance will not succeed and may even weaken current spending. The FOMC has not been clear about the purpose of its forward guidance. Is it purely a transparency device, or is it a way to commit to a more accommodative future policy stance See Charles I. Plosser, “Forward Guidance,” speech to the Stanford Institute for Economic Policy Research’s (SIEPR) Associates Meeting, February 12, 2013, Stanford, CA. BIS central bankers’ speeches to add more accommodation today? This lack of clarity makes it difficult to communicate the stance of policy and the conditionality of policy on the state of the economy. I believe there is another – perhaps more fundamental – tension underlying forward guidance and communication. Forward guidance in either of the two approaches I have discussed requires a degree of commitment to conduct future policy in some particular manner. Commitment is central to the success of either approach. Yet, I would suggest that the old “rules versus discretion” debate is alive and well. This, of course, is not a new tension within the FOMC, nor is it one that is likely to go away in the near term. But the heightened weight and prominence given to forward guidance as a policy tool has certainly shined a spotlight on this longstanding debate. The desire to maintain flexibility to respond to “events on the ground” is a strong one. One can make the case that discretion is deeply ingrained in most policy institutions, particularly the Fed. Yet, the desire to maintain discretion is anathema to the commitment required for successful forward guidance. Policymakers cannot maintain discretion and simultaneously commit to forward guidance and expect that guidance to be effective. Conclusion In summary, I believe that the U.S. economy is continuing to improve at a moderate pace. We are likely to see growth of around 3 percent in 2014. Prospects for labor markets will continue to improve, and I expect the unemployment rate will continue to decline, reaching 6.2 percent or lower by the end of 2014. I also believe that inflation expectations will be relatively stable and that inflation will move up toward our goal of 2 percent over the next year. On monetary policy, we must back away from increasing the degree of policy accommodation in a manner commensurate with an improving economy. Reducing the pace of asset purchases in measured steps is moving in the right direction, but the pace may leave us well behind the curve if the economy continues to play out according to the FOMC forecasts. Even after the asset purchase program has ended, monetary policy will still be highly accommodative. As the expansion gains traction, the challenge will be to reduce accommodation and to normalize policy in a way that ensures that inflation remains close to our target, that the economy continues to grow, and that we avoid sowing the seeds of another financial crisis. Let me conclude with this thought. Over the past five years, the Fed and, dare I say, many other central banks have become much more interventionist. I do not think this is a particularly healthy state of affairs for the central banks or our economies. The crisis in the U.S. has long passed. With a growing economy and the Fed’s long-term asset purchases coming to an end, now is the time to contemplate restoring some semblance of normalcy to monetary policy. In my view, the proper role for monetary policy is to work behind the scenes in limited and systematic ways to promote long-term growth and price stability. But since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment where “it is all about the Fed.” Market participants focus entirely too much on how the central bank may tweak its policy, and central bankers have become too sensitive and desirous of managing prices in the financial world. I do not see this as a healthy symbiotic relationship for the long term. If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than economic fundamentals, our capital markets will cease to deliver the economic benefits they are capable of providing. And if central banks BIS central bankers’ speeches do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus, instead, on the next actions of the central bank. I hope we can find a way to normalize the role of monetary policy to one that is less interventionist, less discretionary, and more systematic. I believe our longer-term economic health will be the beneficiary. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 3 |
Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Money Marketeers of New York University, Inc., Down Town Association, New York, 25 March 2014. | Charles I Plosser: Systematic policy and forward guidance Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Money Marketeers of New York University, Inc., Down Town Association, New York, 25 March 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser highlights the relationship between systematic monetary policy and forward guidance. His goal is to help underscore how a systematic approach to monetary policy can improve the effectiveness of monetary policy in both normal times and in more unusual or extreme circumstances, such as when policy is constrained by the zero lower bound on nominal interest rates. • President Plosser’s preference for dealing with forward guidance is for the FOMC to articulate a reaction function as best it can. This entails describing a systematic approach to policymaking, where policy decisions are based on available information in a consistent and predictable way. • President Plosser believes the most recent FOMC statement took a step in this direction when it moved to a qualitative form of forward guidance by stating that the Committee will be assessing progress – both realized and expected – toward its policy objectives. Introduction I want to thank William Kanto and the Money Marketeers for inviting me to speak again this evening. Your series of guest speakers over the years has been quite illustrious, and it has included many Federal Reserve governors and presidents, not to mention distinguished economists and a wide array of others. So, before I share some thoughts on monetary policy with you tonight, I will begin with the usual disclaimer that my views are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Of course, that disclaimer is a two-way street, and you should not necessarily associate the views of my colleagues with my views. I believe that this diversity of views among FOMC participants does more than assure variety among your guest speakers. It is one of the great strengths of our decentralized central bank. Open dialogue and diversity of views leads to better policy decisions and is the primary means by which new ideas are gradually incorporated into our monetary policy framework. Thus, I believe diversity of thought is a sign of thoughtful progress. As I noted in 2009 when I last spoke to you, the famous American journalist Walter Lippmann once said, “Where all men think alike, no one thinks very much.” Tonight I would like to focus on a particular aspect of current monetary policy that has been a source of much discussion and debate – forward guidance – that is, the practice of providing information on the way monetary policy is likely to evolve in the future. Forward guidance has taken on greater significance since the FOMC lowered the target federal funds rate to essentially zero more than five years ago. Facing this zero lower bound constraint on its primary policy instrument, the FOMC has been attempting to implement monetary policy, in part, by influencing expectations of future policy. The logic for this approach derives from the important role expectations play in shaping economic outcomes. If monetary policy can affect those expectations in specific ways, it can influence current economic conditions. BIS central bankers’ speeches The approach I want to take in my discussion is to highlight the relationship between such forward guidance and systematic monetary policy. By systematic, I mean setting policy in a rule-like or largely predictable manner in response to changes in economic conditions. Forward guidance and systematic monetary policy are closely related. Understanding this relationship can provide insights into effective monetary policy in both normal times and in more unusual or extreme circumstances, such as when policy is constrained by the zero lower bound on nominal interest rates. So, I will begin with a brief review of the benefits of systematic policy. I will highlight why I think most academic economists have concluded that conducting monetary policy in a rulelike manner is preferable to regimes that are more discretionary. Systematic policy For someone my age, it doesn’t seem all that long ago when it was taken for granted that central banking was supposed to be mysterious and secretive – the less said about monetary policy the better. Indeed, it wasn’t until 1994 that the FOMC began to publicly announce the policy changes made at an FOMC meeting. Up until then, the markets were left to infer the policy action from the Fed’s behavior in the market. 1 But times have most definitely changed. Transparency has replaced secrecy, and open communications have replaced mystery. While there are those who long for those thrilling days of yesteryear when central bankers said little and communicated even less, I don’t think we can turn back the clock – nor should we. Economic science has come a long way in the past 30 years, and one of the most important developments has been the recognition of the important role that expectations play in understanding economic outcomes. This is particularly evident in financial markets, where investment decisions and the valuation of securities depend on assessments of future economic outcomes. But this is also true for individuals buying homes and businesses making capital investments. When businesses and households have a better understanding of how monetary policy is likely to evolve, they can make more informed spending and financial decisions. If policymakers can reduce uncertainty about the course of monetary policy, the economy is likely to perform more efficiently. Thus, monetary policy that is more systematic and predictable can reduce expectational errors and contribute to a more stable and efficiently functioning economy. This recognition of the important role played by expectations has led many academics and policymakers to stress the importance of credibility and commitment to well-articulated monetary policy objectives. It has also led to extensive research on monetary policy rules that can enhance the predictability of policy. In fact, virtually all of the mainstream macroeconomic models are built upon the presumption that monetary policy is conducted in a rule-like manner that is well understood by all agents in the economy. In their Nobel Prize-winning work, Finn Kydland and Ed Prescott demonstrated that a credible commitment by policymakers to behave in a systematic, rule-like manner over time leads to better outcomes than discretion. 2 In monetary policy, less discretionary behavior and a commitment to a more systematic approach have been shown to lead to more economic stability – lower and less volatile inflation and less volatile output. Yet, the science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy and turn decisions over to a computer. Judgment is See the Federal Reserve Bank of Philadelphia, “Timeline to Transparency.” Finn E. Kydland and Edward C. Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (January 1977), pp 473–91. BIS central bankers’ speeches still required. Moreover, optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived. For example, the optimal rule for one model can produce very bad outcomes in another model. In addition, optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. In other words, they may not be very transparent. However, these limitations to implementing optimal policy rules should not prevent us from adopting a systematic approach to the conduct of policy. There has been a great deal of progress in identifying simple, robust rules that appear to perform well in a variety of models and environments. Such robust rules can form a basis for developing more systematic, rulelike policymaking. This rule-like approach does not mean one can know the future or what future policy decisions will be. You often hear policymakers speak of policy as being data dependent, and indeed, it is. But the data should feed into a systematic decision-making process so that policy will be similar in similar environments. One way to think about this systematic part of policy is as a reaction function with parameters that are largely stable over time. One important and desirable characteristic of such a reaction function is that it can be easily articulated to the public. This greatly improves the transparency and predictability of monetary policy, which reduces surprises. Everyone is more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances. The most well-known simple rule is that proposed by John Taylor in 1993. 3 The Taylor rule calls for setting the nominal fed funds rate based on three factors. The first represents the economy’s long-run real interest rate, perhaps the steady-state real interest rate, plus the Fed’s target rate of inflation. This is sometimes referred to as the normal, or neutral, nominal rate of interest. The second factor is a function of the deviation of inflation from the central bank’s target or goal. If inflation is above the target, the Taylor rule says the funds rate should be higher, and if it is below target, the funds rate should be lower. The third element in the Taylor rule calls for an adjustment of the funds rate to departures of real GDP from some measure of “potential” GDP. Simply put, when GDP is below “potential,” the funds rate should be reduced, and when it is above, it should increase. I will point out that our recent thresholds did not provide a reaction function. They simply suggested a range of economic conditions under which we would not act. They conveyed nothing about our actions in other states of the economy. In my view, this was one of the major drawbacks to the approach and the reason changes were needed. Over the past 20 years, the Taylor rule has garnered a great deal of attention and study. Many variations have been proposed and their properties investigated. Almost all the simple rules that have been found to be robust over a range of models have very similar constructions and can be expressed as variants of Taylor’s original specification. Of course, the Fed has never adopted a formal reaction function or simple rule for setting monetary policy. But the FOMC does look at the implications of various rules for interest rates when it makes its policy decisions. The fact that the FOMC has not adopted a formal reaction function might reflect the desire for discretion on the part of some policymakers. But it also reflects the difficulty in reaching a consensus. The Committee is composed of 19 members with varying views about how the economy functions, the shocks affecting the economy, and how policy should be set to meet the FOMC’s monetary policy goals. Despite not having formally adopted a particular rule, the John B. Taylor, “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Series on Public Policy, North-Holland, 39, 1993, pp. 195–214. BIS central bankers’ speeches Fed appeared to behave in a systematic way at various times in the past. Indeed, Taylor’s 1993 article noted that his rule approximated Federal Reserve policy setting over the 1987–1992 period, save for a deviation during the stock market crash of 1987. I believe that despite the challenges, there would be large benefits to the FOMC reaching a consensus on a reaction function that could serve as a useful guide to understanding its behavior. Those benefits would be in the form of increased transparency and in the alignment of the public’s expectations with policymakers’ intentions. As I’ve discussed before, there are limitations to the use of simple rules, and no central bank can be constrained by one simple rule in all circumstances. Rules are basically intended to work well on average, but any central bank looks at many variables in determining policy. There will be times when policy must deviate from a reaction function or policy rule. However, simple rules do provide valuable benchmarks for assessing the appropriate stance of policy. They also provide guidance about the likely path of policy and thus are intended to reduce volatility. However, this outcome cannot happen unless the central bank is willing to publicly communicate a reaction function or rule. Another benefit of articulating a rule is enhanced accountability. There will inevitably be times when economic developments fall outside the scope of our models and warrant unusual monetary policy action. Events such as 9/11, the Asian financial crisis, the collapse of Lehman Brothers, and the 1987 stock market crash may require departures from the simple rule. Having articulated a rule guiding policymaking in normal times, the policymaker will be expected to explain the departures from the rule in these unusual circumstances. With the rule as a baseline, departures can be quantified and inform us how excessively tight or easy policy might be relative to normal. If the events are temporary, policymakers will have to explain how and when policy is likely to return to normal. Thus, I see several benefits to the FOMC reaching a consensus on a reaction function or policy rule, including aligning expectations for policy and enhancing transparency and accountability of the policymaking process. Forward guidance One way to think about the policy reaction function is as a form of forward guidance. Indeed, it is perhaps the best and most useful form of forward guidance. In normal times, forward guidance provides the public with information about the expected path of policy. As I’ve discussed, forward guidance is a form of transparency that reduces volatility by reducing policy uncertainty relative to discretionary decision-making. However, with the policy rate at or near zero, forward guidance can play a role in increasing the degree of accommodation. When the policy rate is constrained by the zero lower bound, the future policy rate becomes potentially more important than the current policy rate in influencing current economic conditions through its impact on expectations. In some models, when faced with the zero lower bound, it can be desirable to indicate that future policy rates will be kept lower for longer than might otherwise be the case. 4 Thus, policymakers may want to deliberately commit to deviating from what they would otherwise choose to do under normal conditions, such as following a Taylor-like rule or their normal reaction function. In these models, such a commitment would tend to raise inflation expectations and lower longrun nominal rates, thereby inducing households and businesses to spend more today. This use of forward guidance asks more of policymakers than just articulating a reaction function. In a sense, it requires more of a commitment from policymakers; it requires them to commit to a future path that will not be time consistent if policymakers were only forward Gauti B. Eggertsson and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, no. 1, 2003, pp. 139–211. BIS central bankers’ speeches looking. Instead, policymakers need to commit to a policy path that is history dependent. As I noted, you can think of this as a commitment to deviate from a prior reaction function, particularly if that reaction function makes no provision for operating at the zero lower bound. If such a commitment can be made credible, it can yield better economic outcomes. But managing the public’s beliefs about the future policy path is challenging if policymakers must convince the public that they will not behave as they have in the past. And I would argue that that is the circumstance that the FOMC faces. 5 Managing expectations is even more challenging when policymakers have not been clear about the reaction function they use in normal times. How can policymakers credibly commit to deviate from something they have never committed to in the first place? How can policymakers convey that they will be implementing policy that is more accommodative than normal when they have not been clear about what would constitute the normal degree of accommodation? Managing the public’s expectations may be not only difficult but also counterproductive. Without the public’s understanding of policymaking in normal times, trying to pursue a commitment to looser-than-normal policy may send the wrong signal. For example, if the public hears that the policy rate will be lower for longer, it may interpret the message as policymakers saying that they expect the economy to be weaker for longer. If this is the interpretation, then the forward guidance will weaken rather than strengthen current spending. Where do we go from here? My preference for dealing with forward guidance is for the FOMC to articulate a reaction function as best it can. This entails describing a systematic approach to policymaking where policy decisions are based on available information in a consistent and predictable way. I believe the most recent FOMC statement took a step in this direction when we moved to a qualitative form of forward guidance by stating that we will be assessing progress – both realized and expected – toward our policy objectives. The idea that policy will change as we approach our objectives has the flavor of a reaction function. But, of course, there is more work to do. Because we do not know the true model of the economy, I would suggest the Committee begin by considering a set of robust policy rules designed to have good results in a variety of models and across various stages of the business cycle. Such robust rules recognize that data are measured imprecisely and are subject to revision. These robust rules typically indicate that policy should respond to changes in the gap between inflation and the inflation goal, and to changes in the deviation of output from a measure of potential output, or to changes in unemployment from the steady-state or the natural rate of unemployment. Most robust rules suggest that the reaction to the changes in the inflation gap be more than one-for-one and should exceed the reaction to changes in the output or unemployment gap. The rules also suggest that policy should be somewhat inertial. By recognizing the fundamental difficulty in measuring potential output or the natural rate of unemployment, I think a good case can be made to consider rules that rely on the growth of output or changes in the unemployment rate or employment growth. I want to stress that these rules suggest that policy should respond to changes in the output or unemployment gap not because policy is seeking to fine-tune the real economy but This would not be the case if the reaction function or rule explicitly described how policy would be conducted at the zero lower bound. In that case, new forward guidance would not be required, as the reaction function would have already notified the public what to expect. BIS central bankers’ speeches because doing so allows the economy to efficiently use resources given the economic disturbances that it experiences. By considering such robust rules, the FOMC might be able to move toward a consensus on a qualitative description of its reaction function as an important first step. For example, we would not have to specify the precise mathematical rule but would provide assessments of key variables and then communicate our policy decisions in terms of changes in these key variables. If policy were changed, then we would explain that change in terms of how the variables in our response function changed. If we choose a consistent set of variables and systematically use them to describe our policy choices, the public will form more accurate judgments about the likely course of policy – thereby reducing uncertainty and promoting stability. The FOMC has kept the federal funds rate at effectively zero since December 2008. For much of this time, interest rate rules suggested that the zero lower bound on nominal interest rates was constraining policy; in other words, that nominal rates should be negative if that were possible. However, many robust rules now suggest that given the progress the economy has made over the past year, policy either is no longer constrained or will soon not be constrained by the zero bound. That is, they indicate that the policy rate should be above zero. Rule-based policymaking would require the FOMC to indicate how it plans to adjust policy to a more normal stance. The Committee could decide to simply follow the prescriptions offered by the reaction function. Or instead, the Committee might decide that normalization will be delayed with a more gradual adjustment of rates relative to the prescriptions of the reaction function. But even if the FOMC were not prepared to choose a particular rule, it could articulate more clearly a qualitative reaction function that would serve as a baseline for future changes in policy as we exit the zero lower bound. It is my belief that doing so would be a more understandable form of forward guidance, less subject to misinterpretation as policy transitions from unusual times to more normal times. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 3 |
Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the conference on "Enhancing Prudential Standards in Financial Regulations", cohosted by the Federal Reserve Bank of Philadelphia, the Wharton Financial Institutions Center, and the Journal of Financial Services Research, Philadelphia, Pennsylvania, 8 April 2014. | Charles I Plosser: Simplicity, transparency, and market discipline in regulatory reform Remarks by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the conference on “Enhancing Prudential Standards in Financial Regulations”, cohosted by the Federal Reserve Bank of Philadelphia, the Wharton Financial Institutions Center, and the Journal of Financial Services Research, Philadelphia, Pennsylvania, 8 April 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser believes simple regulations are easier for financial firms to follow, increase the likelihood that supervisors will consistently enforce them, and are more likely to foster financial stability. • President Plosser argues that revealing more information about an individual firm’s risk will reduce the likelihood of contagion and runs because such events are generally a result of a lack of information, rather than too much information. • President Plosser continues to advocate for a new bankruptcy mechanism suitable for all financial firms, whether systemically important or not, because it would restore the incentives of market participants and creditors, in particular, to monitor risk taking by these institutions. Introduction I am delighted to welcome you to the Federal Reserve Bank of Philadelphia. We are very pleased to partner with the Wharton School and the Journal of Financial Services Research in this joint conference on “Enhancing Prudential Standards in Financial Regulations”. I want to acknowledge and thank the organizers for assembling such a distinguished group of academics and practitioners to discuss the ongoing efforts to improve our financial system. I am going to take advantage of my role as host to offer some of my own thoughts on financial regulations and financial stability. I will present a high-level perspective of the subject. I don’t plan to let the messy details get in the way of lofty thoughts. Instead, I believe it is helpful to step back from the complicated details of financial regulation to think more broadly about the goals and objectives of reform and the strategies that might best get us there. Of course, these views are my own and should not be interpreted as representing the Federal Reserve System. I think we all agree that financial markets and intermediaries play an important economic role by pooling funds from savers and investors and allocating these resources to their most productive uses. Such allocations require financial intermediaries to assess and price various risky claims. They then can sell some of the risks, either duration or credit risk, to investors and others who are willing to bear that risk. Thus, intermediaries help allocate resources and risks throughout the economy, thereby improving efficiency and productivity. At times, however, financial intermediation can result in risks becoming concentrated in ways that increase rather than reduce the fragility of the financial system more broadly. This is what many people mean when they refer to systemic risk. While today I will use the term in this fashion, I would note that the concept is quite vague. One of the major difficulties we face in managing systemic risk is defining what it is and how to measure it. Ideally, one important goal of financial supervision and regulation is to monitor risk in the financial system BIS central bankers’ speeches and reduce the chances that it inadvertently leads to financial fragility or instability. Regulation, however, should seek to do so without impeding the healthy functioning of financial markets and institutions. In response to the financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which included enhanced capital and liquidity standards and risk-management requirements for large financial institutions thought to be systemically important. In addition to new regulations, the crisis brought about important changes in supervision. Supervisors are taking a macroprudential approach to their responsibilities. Rather than focusing on the risk in a single institution, supervisors are spending more time analyzing risks across firms. Large financial firms are now required to have stronger data and information systems so they can better monitor and manage their own risks. And these firms are required to report higher quality data to supervisors. The Federal Reserve now utilizes these data as well as other information it receives to conduct more in-depth and timely assessments of emerging risks. Access to better data has also enabled supervisors to conduct the supervisory stress tests required by Dodd-Frank, which assess the ability of these large institutions to withstand a severe economic downturn. This conference will address the efficacy of many of these individual elements of Dodd-Frank and of supervisory reforms, which are still evolving nearly four years after the legislation was first enacted. For the remainder of my remarks, I wish to explore three broad principles that I believe we need to consider as we search for ways to improve the stability of our financial system. The first is simplicity. Our regulatory framework is becoming increasingly complex, which has led to rising compliance costs as well as enforcement costs. The second principle is transparency. Financial markets and instruments have also become increasingly complex and in some cases occasionally opaque. Ensuring that financial instruments and firms are sufficiently transparent can contribute to greater efficiency and awareness of risks exposures. The third principle I will stress is the role that market forces can play in effectively controlling risk-taking and enhancing supervision. Simplicity Let me begin with simplicity. The financial world has become very complex and so has financial regulation. It is easy to claim that complex regulation is necessitated by the increasing complexity of the financial markets. After all, regulations are, in part, shaped by evolving market structures. In some cases, new regulations arise in response to a crisis or a perceived failure of some kind. Unfortunately, markets often evolve faster than the regulations; detailed rule writing that underlies much of the complex regulation can become obsolete, which then requires more rule writing. Yet, we should consider that causality can work both ways. Regulations themselves give rise to incentives to evade the rules. Such regulatory arbitrage can result in increasingly complex financial structures designed to fall outside existing rules. This activity then begets more complex rules that markets once again seek to avoid. Consider the increasing complexity and granularity of the Basel risk-weighting classifications. The logic of assessing capital requirements based on the risk of an institution’s assets is sensible in principle; however, it creates incentives for institutions to structure assets in ways that minimize the use of capital, perhaps resulting in risks that become hidden in opaque or complex structures that are not addressed by specific rules or classifications found in the Basel framework. Such a cycle of increasing complexity raises both compliance costs and enforcement costs. Thus, I believe, there is merit in developing simpler, more transparent regulatory solutions designed to work reasonably well in a wide range of situations. For example, higher capital requirements based on the leverage ratio, as opposed to overly complex risk-weighting schemes, might lower both compliance and enforcement costs while achieving similar or BIS central bankers’ speeches better outcomes in terms of the safety and soundness of individual institutions as well as overall financial stability. Moreover, there are examples of how market participants’ reactions to regulation may have contributed to the recent financial crisis. For instance, the expansion of the shadow banking system was in many ways a result of attempts to circumvent regulations placed on banking institutions. Similarly, the use of bond ratings in setting bank capital requirements for securities holdings or in making eligible certain structured products for various investment purposes created incentives to inflate ratings of collateralized debt obligations, or CDOs, and other structured products backed by subprime mortgages. Consider bankruptcy rules that exempt overnight swaps and repurchase agreements from the traditional stays when a company files for bankruptcy. Such rules reduce the incentive for lenders to monitor counterparty risk and thus effectively lower the relative cost of using short-term funding to finance an intermediary’s or investment firm’s balance sheet. As we know, the reliance on short-term funding from sources totally immune from counterparty risk can contribute to increasing risks of contagion and runs on financial institutions. Increased regulatory complexity can make consistent enforcement of the rules more difficult. Inconsistent enforcement can make it harder for financial institutions to predict how regulators are likely to behave. Such uncertainty can make the financial system less efficient and can undermine the credibility of the regulatory regime, thereby making the regime less effective in fostering financial stability. In contrast, simple regulations are easier for financial firms to follow, increase the likelihood that supervisors will consistently enforce them, and are therefore more likely to have the desired effect. Transparency Next, let me turn to transparency. Economists for the most part think transparency is a good thing, and I am no exception. I will talk about transparency from two perspectives. The first is transparency regarding financial institutions and financial products. The second is transparency by regulators. As is true of financial regulations, financial instruments have become increasingly complex, whether due to market demands or incentives created by regulation. Whatever the reason, it is entirely appropriate to require adequate disclosure and transparency regarding the structure and risk of both the instruments and the institutions. Such transparency allows markets to better price the inherent risks of the securities and the firms. So put me in the camp of more disclosure and transparency. But just as markets can use information on securities and firms to improve market prices and assess risk exposures, markets are also likely to find value in regulatory information. As a bank regulator, the Federal Reserve gets a detailed view of how large financial institutions measure and manage risk. Banks and supervisors now use a host of sophisticated models and techniques to assess risks. There has been a long debate about the potential costs and benefits of releasing some regulatory information once treated as confidential. Many policymakers now believe that public disclosure of additional information concerning the financial condition, risk exposures, and supervisory assessments of firms would be beneficial to financial stability. Greater transparency would enable market participants to better assess the risks of counterparties and thereby exert more effective market discipline. Increased transparency about supervisory practices would also allow financial firms to have greater confidence about the “rules of the road”. This would reduce regulatory uncertainty and the inefficiencies of regulatory arbitrage as firms try to guess what’s on the minds of regulators. When firms have a better understanding of regulatory requirements, they can appropriately evaluate the economic costs and benefits of their decisions. BIS central bankers’ speeches Of course, there are concerns that too much transparency can have unintended consequences. The added information could lead to instability by creating runs on financial institutions if market participants misunderstand or overreact to negative news. Increased transparency might reduce the quality and quantity of information that financial firms would share with regulators. While these concerns may be legitimate, I would argue that revealing more information about individual firms will reduce the likelihood of contagion and runs, as such events generally arise from a lack of information, rather than too much information, about the riskiness of an individual firm. Market discipline The final principle I would like to stress is the role of market discipline. I believe that market discipline can be a powerful tool in controlling the risk-taking of financial institutions. Notice that transparency is an important ingredient in effective market discipline, since a more informed market is likely to function more efficiently and set the prices of securities and firms more accurately. As we seek to improve and strengthen financial stability, we should think about mechanisms to make market forces more effective, not just write rules that attempt to substitute for market forces. Creating incentives for markets to monitor and price risk-taking by financial institutions, rather than have markets simply assume that regulators have monitored the risk for them, is a desirable outcome. A complex and nontransparent regulatory regime can create its own form of moral hazard. Thus, efforts to enhance the effectiveness of market discipline are beneficial as they reduce the necessity of rules and interventions that can create perverse or unintended consequences and the potential for moral hazard. As one example of how regulation could harness market forces to promote financial stability, some have proposed that financial institutions be required to issue subordinated debt. Owners of subordinated debt have a strong incentive to monitor risk-taking by these firms, as they are last in line in the event of failure. Others and I have argued for contingent debt that would convert to capital, in response to specific market triggers indicating that the firm was under stress. Such automatic recapitalization would help prevent firms from failing in the first place. Managers would have a strong incentive to avoid taking on risks that might lead to such events, as they would dramatically dilute existing shareholders. Another way markets can aid supervision is through the information they can provide to supervisors. Markets aggregate many risk assessments into a single measure, such as the price or quantity traded of a security. These market measures can be compared across institutions to provide an indication of relative risk. The measures can also be monitored over time to provide indications of changes in risk. Market participants have strong financial incentives to correctly price a firm’s risk. Since market prices of securities tend to be forwardlooking, they reflect investors’ expectations given the current information. There are several examples of how market signals could be incorporated into the regulatory process. For instance, if financial firms were required to issue subordinated debt, as I have just discussed, supervisors could monitor a bank’s subordinated debt spreads for indications of emerging risk and take appropriate actions in response. This strategy is supported by evidence that subordinated debt spreads do increase with the risk profile of the issuers. Others have argued for using credit default swap spreads or market-based capital measures in the supervisory process. In particular, the Federal Reserve has proposed using market signals in establishing thresholds for “early remediation” under the Dodd-Frank Act. The argument for greater use of market data in bank supervision is not that market signals are always superior to supervisory assessments, but that market data can complement information gathered by examiners. There is still much to learn about how best to combine market data with examiner data to improve supervisory assessments of risk in the financial system, and additional research in this area could prove highly useful. BIS central bankers’ speeches Of course, if we want to effectively leverage market discipline, then we have to address the problem of too big to fail. If creditors perceive they will be rescued, then market discipline is undermined and moral hazard will lead to greater risk-taking by the institutions. It is important to recognize that the moral hazard problem is not mitigated by eliminating the potential for government support. It doesn’t matter where the money comes from to rescue creditors. Any means of providing an implicit or explicit subsidy to protect creditors undermines market discipline and creates moral hazard. Without an effective and credible resolution regime that ensures no subsidies to creditors, there is less incentive for markets to monitor a firm’s risk – thus, the firm’s risk would not be accurately reflected in security prices. Title II of the Dodd-Frank Act expanded the existing authority of the Federal Deposit Insurance Corporation (FDIC) to resolve failing banks including those that are deemed systemically important. While the objective is to end too big to fail, I have argued that the reforms as currently envisioned are unlikely to do so. The expansive discretionary power given to the FDIC under Title II could make it vulnerable to political pressure regarding the bailout of individual institutions or creditors. Keep in mind that Title II resolution is triggered only when there are concerns about systemic risks. The discretionary aspect of Title II could cause creditors to perceive that their payoffs would be determined through a regulatory resolution process, in which political pressure can be brought to bear, independent of the rule of law. Some have suggested that there be a tax on the financial industry to provide support for the resolution scheme proposed by the FDIC. While this may get the taxpayer off the hook, it does not solve the too-big-to-fail problem. On a number of occasions, I have advocated a new bankruptcy mechanism suitable for all financial firms, whether systemically important or not, to alleviate most of the potential problems caused by the discretionary and targeted nature of Title II.1 A bankruptcy process tailored for financial institutions would restore the incentives of market participants and creditors, in particular, to monitor risk taking by these institutions. I find this a more appealing and effective path to ending too big to fail. Conclusion To conclude, simplicity and transparency are important principles to enhance prudential standards in financial regulations and financial stability. Simple, transparent regulatory mechanisms make it easier for market participants to predict how regulators are likely to behave. This, in turn, makes it easier for regulators to credibly commit to implementing the regulations in a consistent manner, thereby increasing the effectiveness of the regulatory regime. An increased role for simple regulatory mechanisms that are harder to evade – and even better, mechanisms that utilize market forces to discipline firm behavior – is superior to an ever-expanding list of complex rules that seeks to cover every possible outcome. In many circumstances, simpler and more transparent regulatory approaches, that also enhance the effectiveness of market discipline, can better achieve financial stability while maintaining a dynamic financial system that meets the needs of our economy. See Charles Plosser, “Reducing Financial Fragility by Ending Too Big to Fail”, speech before the Eighth Annual Finance Conference, Boston College Carroll School of Management , Boston, MA, June 6, 2013. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 4 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Council on Foreign Relations, New York City, 8 May 2014. | Charles I Plosser: Communication and transparency in the conduct of monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Council on Foreign Relations, New York City, 8 May 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights 1. President Plosser outlines his views that policy transparency and forward guidance could be enhanced if the central bank would be more explicit about its reaction function. 2. President Plosser notes that one way to be more explicit would be to indicate the likely behavior of the policy rate based on a few different Taylor-like rules that have been consistent with past conduct of monetary policy and are robust to our uncertainties regarding the true economic model. 3. President Plosser believes that the Federal Reserve Board staff’s model, called FRB/US, seems to be a reasonable starting point for providing economic forecasts based on those rule-based policies. Introduction Thank you for the kind introduction. It’s a pleasure to return to the Council on Foreign Relations. I know that the value of these sessions often arises during the discussion, so I will try to keep my opening remarks brief. Before I go any further, though, I should begin with the usual disclaimer that my views are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee. The topic I want to address today is communication and transparency in the conduct of monetary policy. Some of you can recall when it was taken for granted that the central bank was supposed to be secretive and mysterious. The guiding principle was simple: The less said about monetary policy, the better. Indeed, it was not until 1994 that the Federal Open Market Committee (FOMC) began to announce policy changes made at its meetings. But times have changed. Transparency has replaced secrecy, and open communication has replaced mystery. The extent of this transformation is, in many ways, remarkable. Today, the issues of communication and transparency are front and center on the agenda of many meetings and conferences on central banking. A major reason for the focus on these issues is the recognition that the stance of monetary policy encompasses not just the current level of the short-term policy rate but its expected future path as well. More broadly, economists have come to understand that expectations, including expectations about monetary policy, play an important role in determining economic outcomes, such as real economic growth and inflation. One element of communication that has received a good deal of attention is forward guidance. Forward guidance is central bankers’ speak for communication about the future course of monetary policy, and particularly about the likely path of the short-term policy rate. One reason for this increased attention on the future path of policy is that short-term rates have been constrained by the zero lower bound. So when, or under what conditions, the nominal policy rate might eventually rise takes on greater significance. BIS central bankers’ speeches However, forward guidance is not a separate or independent tool of policy. Its effectiveness is intimately related to other features of monetary policy. In particular, a credible, systematic approach to policy and the general openness and transparency of the policy process are essential elements in shaping expectations. Even with this recognition, there are various views about how best to communicate information about the intended path of policy and how to ensure that such information is credible. If it is not credible, then it will not shape expectations in a beneficial way. More generally, a central bank can and often does communicate on a host of important issues, including its view of the current state of the economy, its assessment of risks, and its outlook for key economic variables. Perhaps most important, from my perspective, is communication about how the evolution of key economic variables systematically shapes current and future policy decisions. In my remarks this morning, I want to stress the importance of the FOMC articulating such a systematic approach to policy. Doing so is likely to make forward guidance more effective, by helping the public to better interpret what that guidance means. The benefits of systematic monetary policy So what do I mean by a systematic approach to policy? Quite simply, I mean conducting policy in a more rule-like manner. The antithesis of such rule-like behavior, of course, is discretion; that is, policymaking conducted period by period with great latitude to take whatever actions seem best at the time. The rules-versus-discretion debate in economics is an old one, dating back at least to Henry Simons in 1936. 1 Yet, following the Nobel Prize-winning work of Finn Kydland and Ed Prescott in 1977, most academic economists – but, unfortunately, far fewer policymakers – have come to accept the benefits of adhering to rule-like behavior in monetary policy. 2 These benefits arise, in part, because consumers and businesses are forward looking, and credible commitments concerning the determinants of the future path of policy can alter expectations in ways that make policy more effective and less uncertain. The ability to behave systematically and to align the public’s expectations with that systematic behavior can allow the central bank to increase current economic activity, while simultaneously lowering inflation. But a credible commitment to honor past promises is an essential element of rulelike policy. Discretionary decision-making undermines such commitments. The appropriate way to make policy systematic, or rule-like, is to base policy decisions on the state of the economy. That is, policymakers should describe the reaction function that determines how the current and future policy rate will be set depending on the state of the economy. Policymakers are, of course, no more certain about future economic conditions than anyone else is, and therefore cannot realistically commit to particular future values of the policy rate. Nonetheless, describing a reaction function or rule that explains how the policy rate will be determined in the future as a function of economic conditions can be highly informative. Unfortunately, the science of monetary policy has not reached the point where we can specify a rule for setting policy and turn decision-making over to a computer. Judgment is still required. Nevertheless, I place a great deal of importance on systematic behavior both as prescription for good policy and in terms of my own policy deliberations. Henry C. Simons, “Rules versus Authorities in Monetary Policy,” Journal of Political Economy, 44:1 (January 1936). Finn E. Kydland and Edward C. Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (June 1977), pp. 473–91. BIS central bankers’ speeches Much study has been done on various rules, but the most well-known rule is attributable to John Taylor. 3 The Taylor rule is a reaction function that indicates how to set the policy rate as a function of deviations of inflation from the inflation target and some measure of economic slack. The attractiveness of Taylor-like rules for monetary policy goes beyond their intuitive appeal or the fact that they seem to describe the actual behavior of monetary policy reasonably well. The reality is that Taylor-like rules yield very good results in a variety of theoretical settings. While this is surprising to some, it is of enormous practical importance. Given our uncertainty about the true model of the economy, knowing that systematic policy in the form of a Taylorlike rule delivers good outcomes in a variety of models means that these simple, robust rules can provide useful guidance for policy. Systematic policies that provide important information about the policymakers’ reaction function combined with other information, such as the policymakers’ economic forecasts, can sharpen forward guidance in a way that reduces policy uncertainty and enhances economic performance. Thus, well-designed communications are valuable, and behaving systematically has the added advantage of making those communications easier for the public to understand. Increasing transparency But what else should the central bank convey? For example, should it publish forecasts of variables in its policy reaction function and should these forecasts be based on the most likely path that the policy rate will follow or on some other assumption? While many central banks publish forecasts in detailed inflation or monetary policy reports, there is still debate about the nature of the forecasts and the assumptions that underlie them. For example, who owns the forecast? At some central banks, the forecast is that of the policy committee and thus represents a type of consensus forecast. In other cases, the forecast is that of the central bank staff. Individual policymakers who do not fully buy into the forecast are then free to express their own independent views about the outlook. A critical piece of a forecast emanating from the central bank is the nature of the future path of the policy rate. Should a central bank’s published forecast be based on its assessment of what the policy rate path is likely to be, perhaps based on its reaction function, a so-called unconditional forecast? Or should the forecast be based on an interest rate path that is more arbitrary, such as a constant interest rate path or one that is related to market expectations inferred from forward interest rates. Others question whether the central bank should reveal the forecast’s assumed interest rate path at all. Perhaps the greatest fear preventing most central banks from publishing the best assessment of its future interest rate path is that the public will assume the projections will be taken as a commitment to that path rather than a projection influenced by the evolution of the economy. In my view, such fears could be mitigated if policymakers would articulate the way they systematically expect to adjust policy in response to changes in economic conditions. While I have suggested potential problems if the central bank publishes its assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, there is also a major benefit; namely, the added discipline that it places on the policy process itself. As I alluded to in my introduction, monetary policy does not just affect the economy through the current setting of the interest rate, but also through the expected path that the policy rate will take over time. Providing information about how that path is likely to evolve forces policymakers to think more deeply and systematically about policy. Communication about John B. Taylor, “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Series on Public Policy, North-Holland, 39, 1993, pp. 195–214. BIS central bankers’ speeches that path, in turn, gives the public a much deeper understanding of the analytical approach that guides monetary policy. Again, my view is that policy transparency and forward guidance could be enhanced if the central bank was more explicit in articulating its systematic approach to policy. Conclusions and going forward I am fully aware that great care needs to be taken in providing more specific forms of forward guidance so that we avoid a false sense of certainty and a mistaken sense of commitment. Yet I believe systematic monetary policymaking can enhance economic performance, and therefore I favor clearer communication concerning the formulation of policy. In a stylized world, where there is a single monetary policymaker who has considerable confidence in a model of the economy, effective communication would include a forecast derived from this model. This forecast would incorporate a policy path that yields the best economic outcomes based on that single policymaker’s views. However, we don’t live in such a simple world. Monetary policymaking is often conducted by committee, and divergent views can and often do exist. While this can be clumsy at times, such governance mechanisms have great strength in preventing institutions from lapsing into groupthink by ensuring that various views are heard in an environment that promotes better decisions and outcomes and helps to preserve central bank independence and accountability. Thus, it may be difficult for the FOMC to achieve a consensus forecast or policy path. One way to enhance its communication would be to indicate the likely behavior of interest rates based on a few different Taylor-like rules that have been consistent with the conduct of monetary policy. Doing so would require agreement on a particular model in order to produce the resulting rule-based behavior. For the Fed, the Board staff’s economic model, called FRB/US, seems like a reasonable place to start. The FOMC could then articulate whether and why it anticipates policy to be somewhat more restrained or more accommodative relative to the projections given by the rules. A monetary policy report that might accompany such a forecast could include various views that may differ from the baseline summaries. Performing this exercise would indicate the inherent uncertainty that policymakers face, yet it would also provide a better sense of the likely direction of policy and the variables most related systematically to that policy. Further, this type of communication would push the FOMC to conduct policy in a more systematic manner, which I believe will lead to better economic outcomes over the longer run. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 5 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the 2014 Reinventing Older Communities biennial conference, Philadelphia, Pennsylvania, 12 May 2014. | Charles I Plosser: Reinventing older communities – bridging growth & opportunity Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the 2014 Reinventing Older Communities biennial conference, Philadelphia, Pennsylvania, 12 May 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights 1. President Charles Plosser welcomes participants to the 2014 Reinventing Older Communities biennial conference. 2. President Plosser highlights emerging trends in the labor market, demographics, and educational system and discusses how understanding them can help prepare communities for growth and prosperity. 3. President Plosser says it is important to think about how we can continue to upgrade the skills and productivity of young people and the workforce more broadly to successfully reinvent our communities. Introduction It is my pleasure to welcome you to the Reinventing Older Communities conference. This is the sixth biennial conference hosted by the Federal Reserve Bank of Philadelphia. It has grown to become an important event for the Federal Reserve System as we bring together a rich and diverse mix of stakeholders who are interested in understanding the interaction between older industrial communities and the broader economy. The Federal Reserve System, which is marking its centennial year, is a decentralized central bank, with 12 individual Reserve Banks throughout the country that are overseen by a Board of Governors in Washington, D.C. As Theresa Singleton mentioned, we are delighted that seven of those Federal Reserve Banks are partnering with us to sponsor this year’s conference. I thank them and the other sponsors who have helped us create what promises to be an outstanding event. I also want to thank you for taking the time to join us for this conference. Your participation here and your ongoing work in communities around the nation demonstrate your commitment to bridge growth and opportunity. In that way, we can reinvent our communities to ensure they are places where people can lead fulfilling and successful lives. But this work requires a creative forward-looking approach. Maybe it’s the fact that the Stanley Cup playoffs are still going on in mid-May, but I’m reminded that Wayne Gretzky was once asked about his success in hockey. The Great One responded by saying, “I skate to where the puck is going to be, not to where it has been.” He scored many goals with this strategy, and I believe his philosophy can be helpful in many disciplines. For example, I have talked about the need for monetary policy to be forward looking. But I believe this approach also applies to the revitalization of older communities. Now, I am by no means a community development expert or a hockey player. During my lifetime, I have lived in several older communities, including Rochester, NY, and Birmingham, AL, where I was born. I attended college in Nashville, TN, and graduate school in Chicago. I have lived and worked in New York City, as well as in and around Los Altos, CA, near the heart of Silicon Valley, and for almost eight years now, I have lived here in Philadelphia. BIS central bankers’ speeches It occurs to me that often older communities seek to turn back the clock to restore their past glories. A variation is to chase the puck. But in so doing, they find themselves perpetually in the past, never quite catching up and usually falling further behind. These are unlikely to be successful strategies. It is appropriate to learn from the past. But trying to restore the past is not a strategy for success. As most of you are aware, rebuilding and revitalizing our older cities is not about the past but our ability to seize the future. The Philadelphia of tomorrow will not the Philadelphia of the past, nor should it be. There are many opportunities for productive transitions and improvements. Indeed, we should seek to exploit the latest innovations to make Philadelphia, like many of our postindustrial cities represented here today, wonderful places to live, work, and play. We have to acknowledge that our world has changed, and it continues to change at a very rapid pace. Embracing that change in order to reinvent the future of our cities is hard work, but it can pay off handsomely. The extent to which we are able to see where emerging trends are headed – where the puck will be, if you will – gives us the chance to take advantage of the opportunities they present. That will allow our communities to be more successful and more effective. I want to spend the remainder of my brief time discussing a few emerging issues for you to consider over the next few days, as you participate in the conference workshops and plenary sessions. Emerging trends My comments will focus on the labor market and the importance it plays in shaping the future of our nation, but more relevant for this group, how it is shaping the future of our cities. The financial crisis and Great Recession led to severe dislocations in many sectors of our economy, including the housing sector, financial markets, and the labor market. Monetary and fiscal authorities responded in myriad ways to help the economy and our nation recover. But we should resist the temptation to implement programs with the goal of recreating the past. The unemployment rate has slowly recovered and is now 6.3 percent from its peak of 10 percent in October 2009. Some are skeptical, though, because the decline in the unemployment rate reflects not only increases in employment but declines in labor force participation. Many interpret such declines in the participation rate as representing discouraged workers who have stopped looking for work. Yet, labor force participation rates can also decline for demographic reasons. Indeed, we have seen steadily declining participation rates since 2000, and we can account for about three-quarters of this decline in participation since the start of the recession in December 2007 because of increased retirements and movements into disability. Demographic trends, driven largely by an aging baby boomer generation, are altering the age distribution of our population. More specifically, we are getting older, and the size of the working age population is shrinking relative to those over 65. It is widely recognized that this fundamental shift will require major changes in the structure of Social Security and Medicare programs. Yet even as we solve such fiscal challenges associated with an aging population, we have to face up to the changing skills that employers are seeking. We are seeing a mismatch of skills in the workforce and the jobs that are being created. Many employers I have spoken to around the country talk about the fact that while they are hiring new workers, they are hiring a new type of worker: a worker who is more technologically sophisticated and productive. Going forward our educational system needs to be upgraded to prepare young people for this changing labor market. We are simply not keeping pace. More specifically, business leaders I have met talk repeatedly about having trouble finding qualified candidates in the areas of science, technology, engineering, and math, or so-called BIS central bankers’ speeches STEM jobs. As you know, the increasing needs for STEM-trained workers is one of the trends that will drive labor demand and productivity growth in our future. The Department of Commerce estimates that STEM employment grew at three times the rate of non-STEM employment in the previous decade and is projected to grow at twice the rate of non-STEM jobs through 2018. Sadly, we are not doing an adequate job of preparing our workforce for these jobs. Manufacturing is one sector in which firms have implemented new production technologies and are in need of STEM workers. The Philadelphia Fed’s April Business Outlook Survey of manufacturers included a special question about the factors influencing their decisions to remain in the region. Respondents identified the availability of skilled labor as the most important factor. They also ranked the availability of skilled labor as becoming a more important factor in recent years. These concerns highlight the importance of our educational system in equipping our young people with the skills necessary to improve their own lives and improve the communities in which they live and work. Better wages accrue to a more productive employee. Firms will not locate in communities where they cannot find workers with the right skills and work ethic. For our older communities, successful revitalization will mean seeing to it that the workforce is up to the task. The standard of living in our nation as well as our communities is inextricably tied to the productivity of our workforce. As we look to the future, we have to think about how we can continue to upgrade the skills and productivity of young people and the workforce more broadly. If we are to successfully reinvent our communities, we must focus on preparing our workforce for the future. Conclusion Let me conclude by reminding you that the theme of this year’s conference is Bridging Growth and Opportunity. And I can think of no better bridge to opportunity than education. Education is a bridge for our young people and a bridge for our local economies. As someone who has spent over three decades in the teaching profession, I firmly believe that education is one of our most important investments. It is critical for the long-term health and prosperity of our nation. Education expands opportunity, leads to more innovation, and enhances productivity. In the end, this leads to better economic outcomes. I am excited that this year’s conference will highlight the critical role that education and workforce development play in reinventing older communities. We are honored to host a Sit Down with the Superintendents, a panel session that will give you an opportunity to engage in a dialogue with school superintendents from several older industrial cities. This is your chance to discuss how community development and educational leaders can work together to connect people with the right skills to the jobs ahead. This is another example in which those of you who think about workforce development can get ahead of the puck. And score a goal for all older communities. The work that you do – building these bridges to opportunity – is about creating a better future for all of us who live in these special places. It will not be easy, and there is no quick fix, but it will be one of the most important things we can do. Thank you for participating in our program this year. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 5 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Women in Housing & Finance, Inc., Washington DC, 20 May 2014. | Charles I Plosser: The economic outlook and housing Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Women in Housing & Finance, Inc., Washington DC, 20 May 2014. * * * The view expressed today are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the sustainable improvement in housing in the context of a broader economic recovery. He also discusses the Fed’s monetary policy issues, including forward guidance. • President Plosser is optimistic about the housing recovery. He believes that even though sales have leveled off recently, prices are still rising, and fundamentals remain sound, including stronger household formation, solid job growth, and consumers with stronger balance sheets. • He thinks that the U.S. economy is on firmer footing today than it has been in several years. He expects continued progress in 2014. He adds that one of the more encouraging signs for the economy comes from the labor market. • President Plosser believes reducing the pace of asset purchases in measured steps is moving in the right direction, but the time may come sooner than many expect when interest rates may have to rise if we are to avoid falling behind the curve. Introduction Thank you for inviting me here today. Women in Housing & Finance meetings have featured a number of Federal Reserve policymakers in recent years. A review of their speeches traces an arc through the turmoil in the U.S. housing market, which led to the worst financial crisis and economic downturn since World War II, the regulatory reform that followed, and the moderate but steady recovery over the past five years. In January 2008, then-Chairman Ben Bernanke addressed your group a month after the Great Recession began, following sharp and dramatic declines in the U.S. housing market during 2007. Then, in June 2009, former Governor Elizabeth Duke described the actions that the Federal Reserve had taken to contain the financial crisis and promote economic recovery. In February 2011, former Kansas City Fed President Tom Hoenig asked whether the Dodd-Frank Act would actually improve the financial regulatory climate and solve the yetunresolved issue of too-big-to-fail institutions. Today, I am delighted to join you at a time when, despite the effects of the severe winter weather, the economy is on the firmest footing it has been on since the recovery began. But this does not mean that we are likely to see, nor should we seek to see, a return to the unsustainable levels of residential real estate activity that preceded the financial crisis. That did not end well. Instead, the perspective I will offer today is one of sustainable improvement in housing in the context of a broader economic recovery. Then, I will close with some thoughts on monetary policy. Before I continue, though, I will note that my views are my own and not necessarily those of the Federal Reserve Board or my colleagues on the Federal Open Market Committee (FOMC). BIS central bankers’ speeches Economic conditions So, let me begin with an overview of the U.S. economy. We are almost five years into a recovery that began in June 2009. Growth accelerated in the second half of 2013 but faced some stiff winter headwinds in the first quarter of this year. Yet, I think most of us now view this as a temporary weather-related slowdown and not a risk to the underlying recovery. Snowstorms and frigid temperatures affected every aspect of the economy, from sales and hours worked to logistics and supply chains during the first quarter of the year. You can’t sell a house if buyers can’t get in the front door. You can’t sell a car if it is buried in snow. And even if your factory is producing goods, you can’t deliver them to your customers as scheduled if trucks can’t navigate the highways or if trains have to slow down to half their normal speed. My own view is that it will take another month or two before we can hope to see a somewhat clearer picture of the economy. The first estimate of GDP growth for the first quarter of 2014 showed that the overall economy was essentially flat, expanding at an annualized rate of just 0.1 percent. The underlying details are more encouraging. Consumer spending increased 3 percent, marking the 19th consecutive quarter of growth. This growth is supported by the fact that households have reduced their debt and strengthened their balance sheets over the past few years. And as the values of equities and real estate have risen, consumer savings rates have fallen and consumption spending has increased. The weakness in the overall GDP figure comes predominately from lackluster investment, both by businesses and homebuilders, as well as some pullback in exports and imports. Our business contacts as well as our surveys confirm that economic activity was greatly hampered by the winter weather in the Northeast and in other parts of the country. The Philadelphia Fed’s Business Outlook Survey of manufacturers in our region has been a reliable indicator of national manufacturing trends in the U.S. The survey results indicate that manufacturing activity has been expanding for 11 of the past 12 months. The only aberration was in February 2014, when respondents ascribed their declines to the severe weather. But the survey has since indicated positive growth in March, April, and May. The ISM manufacturing index, which measures nationwide activity, similarly dropped in the winter months and has since bounced back. Thus, I continue to believe that the U.S. economy is on a firmer footing today than it has been in several years. This is a cause for some optimism for continued progress in 2014. My forecast has been for growth of about 3 percent in 2014, and while the weather-related softness in the first quarter may temper this full-year outlook somewhat, it hasn’t led me to downgrade my outlook for the remainder of the year. One of the most encouraging signs for the economy comes from the labor market, believe it or not. Employers added 288,000 jobs in April, the strongest gain since January 2012, and job growth in February and March were revised upward by a total of 36,000. The gains in April were broad-based across sectors, including 32,000 net new jobs in construction. Indeed, net job growth has exceeded 200,000 in five of the past seven months, with only the frozen months of December and January showing disappointing numbers. Even if we include those weak months, the economy has added more than 200,000 jobs per month on average over the past seven months. The unemployment rate dropped to 6.3 percent in April, down more than a full percentage point from a year ago and the lowest rate recorded in more than five years. This month’s decline was particularly sharp and was driven, in part, by a decline in labor force participation. I would note that the household survey, which gives us the unemployment rate, is more volatile than the establishment survey, which measures the number of new jobs added. I would not be surprised if the unemployment rate moved up a bit next month, but the downward trend continues, and we are making significant improvement. The number of those unemployed for more than 27 weeks dropped by 287,000 in April, and by 1.25 million BIS central bankers’ speeches since January 2013. While this is an improvement in labor markets, everyone will readily agree that the long-term unemployed remain a serious concern. I expect that the unemployment rate will fall below 6.2 by the end of 2014. If anything, this forecast may prove to be too pessimistic. Given the recent trends, an unemployment rate below 6 percent is certainly plausible. Inflation remains benign. It is running somewhat below the FOMC’s long-run goal of 2 percent. The Fed’s preferred measure of inflation is the year-over-year change in the price index for personal consumption expenditures, or PCE inflation. That figure came in at 1.2 percent last year and is running at about the same pace over the first two months of this year. It is important to defend our 2 percent inflation target both from below and above. Yet, I anticipate, as the FOMC indicated in its most recent statement, that inflation will move back toward our target over time. Indeed, we learned last week that the CPI moved up in April and is now running at 2 percent over the past year and at a 2.3 percent annual rate during the past three months. I am encouraged that inflation expectations remain near their longer-term averages and consistent with our 2 percent target. Given the large amount of monetary accommodation that we have added and continue to add to the economy, I think there is some upside risk to inflation in the longer term. There are risks with respect to my growth forecast as well. While there continues to be some downside risk to growth, for the first time in years, I see the potential for more upside risk to the economic outlook. So as the economy gradually moves toward our 2 percent inflation target and the labor market continues to improve, we will need to calibrate monetary policy to reflect the improvements. Construction and housing markets Let me offer some further observations on the housing market. Residential real estate is a focus of many economists because it was ground zero for the financial crisis and the ensuing Great Recession. In the past, we tended to see housing lead the economy out of the recession, but for a number of reasons, that was not the case this time. As we know, sales of existing homes plummeted from unsustainable peaks during the housing boom. Sales bottomed out at an annual rate of 3.5 million houses in July 2010 and then climbed steadily for three years to 5.4 million in July 2013. That was about the same annual rate that we averaged in the years preceding the boom. Sales have fallen somewhat since mid-2013, due in part to rising mortgage rates, but those rates remain low by historical standards. The fundamentals of the housing market remain sound, including stronger household formation, solid job growth, and consumers with stronger balance sheets. Home prices are well below their peaks, but they continue to improve as the market recovers. Two national measures were up recently: The S&P Case Shiller Home Price Index was up 12.8 percent year over year in its latest February number, and the CoreLogic National House Price Index was up 11.1 percent in March. Some have expressed concern over the housing recovery in recent months, but I am more optimistic. As I said, the fundamentals remain sound, and even though sales have leveled off recently, prices have continued to rise even over the past three months. That suggests that supply may be restricting sales more than weaker demand. But we will have to wait and see how the remainder of the spring and summer plays out. The structure of housing finance in our country remains a topic of intense discussion as it was before, during, and after the crisis. As I have argued in the past, the governmentsponsored enterprises, or GSEs, were permitted to operate for private profit but with an implicit guarantee from the government, and so they were able to take extraordinary risk at BIS central bankers’ speeches the taxpayers’ expense. 1 This was a classic case of moral hazard, and it must not be repeated. There are many proposals for a new system of housing finance with varying levels of government support. There is no clear or easy answer to the degree of government involvement in the housing market; that is a decision we must make as a nation, carefully weighing the benefits of homeownership with the costs of the misallocation of scarce capital and the risks of unintended consequences. The U.S. subsidizes homeownership, more than any other developed country. We do so by providing an interest deduction for home mortgages and by underwriting housing debt through an explicit taxpayer support for the GSEs, which is reflected in mortgage rates. There are debates about the quantitative effects of these subsidies. But we should not be afraid to ask hard questions. Most financial advisors would tell you to diversify your asset holdings, yet our housing policies incentivize families to do just the opposite: put your savings in your home. The policies encourage homeownership over other asset classes. The results for many families were devastating. The GSEs were at the center of the housing storm and we have to date not addressed the fundamental reforms required. However, if as a nation we choose to continue the subsidies to homeownership, the government involvement and subsidies must be explicit, transparent, and well understood. Burying those subsidies in complex financial arrangements or in new semigovernment enterprises will be counterproductive. Markets work best when the risks and rewards of decisions are clearly defined so that prices can accurately reflect each transaction and the appropriate risk monitoring takes place. Monetary policy So let me turn to some issues for monetary policy. The Federal Reserve lowered its policy rate – the federal funds rate – to essentially zero more than five years ago. Since the policy rate cannot go any lower, the Fed has attempted to provide additional accommodation through large-scale asset purchases. We are now in our third round of this quantitative easing. Since September 2012, the FOMC has added about $1.4 trillion in long-term Treasuries and mortgage-backed securities to its balance sheet through this program, known as QE3. It is already twice the size of the last round of asset purchases, known as QE2. In December 2013, the Committee announced that it would reduce the pace of purchases from $85 billion to $75 billion per month. It announced another $10 billion reduction in January, March, and April and is now purchasing $45 billion a month. If the FOMC continues this path of measured reductions, the purchase program will end sometime this fall. If the economy continues to improve, though, we could find ourselves still trying to increase accommodation in an environment in which history suggests that policy should perhaps be moving in the opposite direction. In addition to asset purchases, the Fed is using forward guidance to try and inform the public about the way monetary policy is likely to evolve in the future. In the March and April statements, the FOMC reaffirmed its highly accommodative stance. The statement used qualitative language to describe the economic conditions that would lead to action. The Committee reported that it will look at a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments, to assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation. Charles I. Plosser, “Some Observations About Policy Lessons from the Crisis,” remarks at the Philadelphia Fed Policy Forum, Philadelphia, PA, December 4, 2009. BIS central bankers’ speeches The FOMC also noted, based on its assessment of these factors, that it likely will be appropriate to keep its target federal funds rate near zero for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the 2 percent goal and longer-term inflation expectations remain well anchored. My own view is that, as we continue to move closer to our 2 percent inflation goal and the labor market improves, we must be prepared to adjust policy appropriately. That may well require us to begin raising interest rates sooner rather than later. Conclusion In summary, I believe that the U.S. economy is continuing to improve at a moderate pace. We are likely to see growth return to around 3 percent through the rest of 2014. Prospects for labor markets will continue to improve, and I expect the unemployment rate will continue to decline, reaching 6.2 percent or lower by the end of 2014. I also believe that inflation expectations will be relatively stable and that inflation will move up toward our goal of 2 percent over the next year. I expect the housing and construction sectors will continue to recover. But we should not seek to return to the heady days of last decade’s real estate boom. On monetary policy, reducing the pace of asset purchases in measured steps is moving in the right direction, but the pace may leave us behind the curve if the economy continues to play out according to FOMC forecasts. Even after the asset purchase program has ended, monetary policy will still be highly accommodative. As the expansion gains traction, the challenge will be to reduce accommodation and to normalize policy in a way that ensures that inflation remains close to our target, that the economy continues to grow, and that we avoid sowing the seeds of another financial crisis. Let me conclude with this thought. Over the past five years, the Fed and, dare I say, many other central banks have become much more interventionist. I do not think this is a particularly healthy state of affairs for central banks or our economies. The crisis in the U.S. has long passed. With a growing economy and the Fed’s long-term asset purchases coming to an end, now is the time to contemplate restoring some semblance of normalcy to monetary policy. In my view, the proper role for monetary policy is to work behind the scenes in limited and systematic ways to promote price stability and long-term growth. Since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment in which “it is all about the Fed.” Market participants focus entirely too much on how the central bank may tweak its policy, and central bankers have become too sensitive and desirous of managing prices in the financial world. I do not see this as a healthy symbiotic relationship for the long term. If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than on economic fundamentals, our capital markets will not deliver the economic benefits they are capable of providing. And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank. I hope we can find a way to make monetary policy decision-making less interventionist, less discretionary, and more systematic. I believe our longer-term economic health will be the beneficiary. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 5 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the 2014 Bank of Japan-Institute for Monetary and Economic Studies Conference "Monetary policy in a post-financial crisis era", Tokyo, 28 May 2014. | Charles I Plosser: Influencing expectations in the conduct of monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the 2014 Bank of Japan-Institute for Monetary and Economic Studies Conference “Monetary policy in a post-financial crisis era”, Tokyo, 28 May 2014. * * * The view expressed today are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights President Charles Plosser discusses his views on the role of forward guidance and transparency in influencing expectations. President Plosser outlines his proposals to be more explicit about a reaction function. President Plosser notes that one way to be more explicit would be to indicate the likely behavior of the policy rate based on a few different Taylor-like rules that have been consistent with past conduct of monetary policy and are robust to our uncertainties regarding the true economic model. President Plosser believes that the model created by the Federal Reserve Board staff, called FRB/US, seems to be a reasonable starting point for providing economic forecasts based on those rule-based policies; however, other models would be useful to consider. Introduction I would like to thank Governor Kuroda for inviting me to participate in this thought-provoking conference. I would also like to thank Professor Maury Obstfeld for suggesting a number of interesting topics for us to consider. He has highlighted some issues that I believe are intimately related to one another: namely, the central bank’s ability to influence expectations through forward guidance, the role of quantitative easing, and the process of exiting from that easing. Indeed, I think it is important that we think about monetary policy more holistically, if you will. How effective we are with forward guidance or quantitative easing can only be assessed in the broader context of a central bank’s overall approach to policy, including its approach to communication and transparency. However, before I go any further, I should begin with the usual disclaimer that my views are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). I want to focus my remarks today on communication and transparency in the conduct of monetary policy. One major reason for this emphasis is the recognition that the stance of monetary policy encompasses not just the current level of the short-term policy rate but its expected future path as well. Economists have come to understand that expectations about monetary policy can play an important role in determining economic outcomes, such as real economic growth and inflation. For example, today’s decision to save or to spend is influenced by the current interest rate as well as tomorrow’s expected future consumption. In turn, tomorrow’s expected future consumption is influenced by next period’s interest rate and next period’s expected future consumption. Therefore, the entire expected path of interest rates, not just the current interest rate, influences today’s consumption. This is not only true BIS central bankers’ speeches for personal consumption, but also business investment decisions, and the setting of prices and wages. An element of communication that has received a good deal of attention is forward guidance. Forward guidance relates to the communication about the future course of monetary policy, both the likely path of the short-term policy rate as well as path of balance sheet actions associated with quantitative easing. Of course, one reason for this increased focus on future policy actions is that the current short-term policy rate conveys little information, as it has been constrained by the zero lower bound. Thus, forward guidance in the U.S. has evolved to include information about the future pace and duration of asset purchases, as well as under what conditions, and how quickly, the policy rate might eventually lift off from the zero lower bound. However, forward guidance is not a separate or independent tool of policy. Its effectiveness is intimately related to other features of monetary policy. For example, a credible, systematic approach to policy and the general openness and transparency of the policy process are essential elements in shaping expectations and thus must be considered when formulating forward guidance. For forward guidance to be successful, it must be credible. And it is difficult to make it credible if it is inconsistent with other features of the policy framework. One of the most important ways to support credibility and thus the effectiveness of forward guidance is to practice it as part of a systematic policy framework. I believe that indicating how the evolution of key economic variables systematically shapes current and future policy decisions is critical to such a policy framework. Indeed, a commitment to a policy framework that is systematic and rule-like provides the foundation for establishing expectations for the future path of policy and thus forward guidance. If we only had a reaction function The appropriate way to make policy systematic and rule-like is to make policy history dependent and base policy decisions on the state of the economy. Doing so does not commit the policymakers to particular future values of the policy rate, but describing a reaction function explains how the policy rate will be determined by economic conditions. Unfortunately, the science of monetary policy has not reached the point where we can specify a precise or optimal rule for setting policy. That would require an agreed-upon model of the economy – something we don’t have yet. Nevertheless, I believe systematic policy can be guided by various forms of robust rules, such as the one proposed by John Taylor – with which we are all familiar. The attractiveness of Taylor-like rules for monetary policy goes beyond their intuitive appeal or the fact that they seem to describe the actual behavior of monetary policy reasonably well. The reality is that Taylor-like rules yield very good results in a variety of theoretical settings. This feature of the rules is of enormous practical importance. Given our uncertainty about the true model of the economy, knowing that systematic policy in the form of a Taylor-like rule delivers good outcomes in a variety of models means that these simple rules can provide useful guidance for policy. Systematic policies that provide important information about the policymakers’ reaction function combined with other information, such as the policymakers’ economic forecasts, can sharpen forward guidance in ways that reduce policy uncertainty and enhance economic performance. Thus, well-designed communications are valuable, and behaving systematically has the added advantage of making those communications easier for the public to understand. BIS central bankers’ speeches Balance sheet policies I have focused my discussion on forward guidance with respect to the setting of the policy rate, but these principles apply equally to balance sheet policies. There is room to debate how effective balance sheet policies, such as quantitative easing, have been, and indeed, just how they affect interest rates and economic activity. Some think balance sheet policies work through portfolio balance effects that alter risk premia. The quantitative effects on macroeconomic outcomes, however, are unclear. And the theoretical underpinnings for this channel depend on the model and the assumptions made regarding the extent of financial market frictions and the degree and form of market segmentation. Others believe that quantitative easing acts through the potential signaling effects associated with large changes in the balance sheet. Namely, adding to the balance sheet could signal a more accommodative future policy, which lowers longer-term nominal and real interest rates, and thereby spurs current economic activity, including expected inflation. Of course, if the policies and communications regarding the future path of the policy rate were transparent and fully credible, such signaling would not be necessary. Moreover, if signaling is the primary channel through which large-scale asset purchases act, there remains much that we don’t understand about how to calibrate such operations. In any event, it will be important that the signals conveyed by balance sheet policies are consistent with the forward guidance about future interest rate policies. This has been a difficult communications challenge at times for the FOMC. And it will likely remain a communications challenge as the Committee coordinates the unwinding of the Fed’s balance sheet with the gradual increase in the policy rate. Implementing forward guidance I have indicated conceptually why a systematic approach to communications is important but have yet to discuss how a central bank might implement such an approach. This issue has received increased attention in recent years, with various central banks adopting different strategies. The differences are based on alternative economic viewpoints as well as on varying institutional structures. I think the Fed can learn a great deal from the various approaches. Many of you in this room are very knowledgeable, and have thought deeply about the costs and benefits of the various approaches. A forecast is, of course, a critical piece of information emanating from the central bank, and the nature of the policy rate’s future path is an important element of that forecast. These forecasts are often presented and discussed by central banks in the form of published inflation or monetary policy reports. Such reports can and should be an important element of a central bank’s communication and transparency about the policy process. But a number of interesting questions arise. Should a central bank’s published forecast be based on its assessment of what the policy rate path is likely to be, or should the forecast be based on an interest rate path that is more arbitrary, such as a constant interest rate path or one that is related to market expectations? I am fully aware that great care needs to be taken in providing more specific forms of forward guidance. We must avoid a false sense of certainty regarding future policy or a mistaken sense of commitment to a specific path of policy rates. Yet, I believe there are approaches, like the one I am about to suggest, that can avoid or mitigate these pitfalls. Because I believe systematic monetary policymaking can enhance economic performance, I am in favor of clearer communication concerning the formulation of policy. Now, in our stylized models, there tends to be a single monetary policymaker who knows the structure of the economy. Therefore, the approach for communication would be a forecast derived from the policymaker’s model as well as a policy path that yields the best economic outcomes based on that model of the economy. BIS central bankers’ speeches Unfortunately, we don’t live in such a world. Monetary policymaking is often conducted by committee, and divergent views can and often do exist. While this can be clumsy at times, such governance mechanisms ensure that various views are heard. This promotes better decisions and outcomes and helps preserve central bank independence and accountability. Thus, it may be difficult for a large committee like the FOMC to achieve a consensus forecast or policy path. Yet, we can enhance our communication by indicating the likely behavior of interest rates based on a few different Taylor-like rules that have been consistent with the conduct of monetary policy. Doing so would require agreement on a particular model in order to produce the resulting rule-based behavior. For the Fed, the economic model called FRB/US, which was developed by the Board’s staff, seems like a reasonable place to start. Such an exercise could also be enhanced, I believe, by using some of the dynamic stochastic general equilibrium, or DSGE, models that have been developed within the Federal Reserve System. The FOMC could then articulate whether and why it anticipates policy to be somewhat more restrained or more accommodative, relative to the projections given by the rules. The current monetary policy report that the Fed delivers each February and July could be adapted to include those exercises as well as a discussion of the opinions of Committee members regarding the results. It is important that in performing this exercise we illustrate the various dimensions of uncertainty that policymakers face. For example, there is model uncertainty, forecast uncertainty, and the variations implied by different rules. Many central banks use fan charts and other devices to highlight such uncertainty, and we, the Fed, would be wise to do the same. Even acknowledging the uncertainty, the exercise will provide a better sense of the likely direction of policy and the variables most related systematically to that policy. I believe these steps toward greater transparency and communication would be significant progress, and would encourage the FOMC to conduct policy in a more systematic manner. I believe this would lead to better economic outcomes over the longer run. 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Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Frameworks for Central Banking in the Next Century Policy Conference, Hoover Institution, Stanford, CA, 30 May 2014. | Charles I Plosser: Monetary rules – theory and practice Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Frameworks for Central Banking in the Next Century Policy Conference, Hoover Institution, Stanford, CA, 30 May 2014. * * * The view expressed today are my own and not necessarily those of the Federal Reserve System or the FOMC. President Plosser presented related remarks on May 28, 2014, at the 2014 Bank of Japan – Institute for Monetary and Economic Studies Conference. Highlights • President Charles Plosser discusses his views on the benefits of a systematic and rule-like approach to monetary policy. • President Plosser outlines his proposals to indicate the likely behavior of the policy rate based on a few different Taylor-like rules that have been consistent with past conduct of monetary policy and are robust to our uncertainties regarding the true economic model. • President Plosser believes that the model created by the Federal Reserve Board staff, called FRB/US, seems to be a reasonable starting point for providing economic forecasts based on those rule-based policies; however, other models would be useful to consider. Introduction I would like to thank John Taylor for inviting me to participate in this panel discussion about a subject that I feel is very important. Rules-based policy is a topic that I have discussed numerous times in the past few years, urging policymakers to seek a more systematic approach to policymaking. I am particularly honored to be on a panel with my colleague John Williams, whose research in this area has been an important influence on my views, as well as Tom Sargent. In Tom’s case, there probably isn’t an economist in this room who hasn’t been influenced by his work and his contributions to economics. But before I go any further, I should begin with the usual disclaimer that my views are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). The theoretical justification for rules The theory part of this session’s title is well established. In their Nobel Prize-winning work, Finn Kydland and Ed Prescott demonstrated that a credible commitment by policymakers to behave in a systematic, rule-like manner over time leads to better outcomes than discretion.1 Since then, numerous papers using a variety of models have investigated the benefits of rule-like behavior in monetary policy and found that there are indeed significant benefits.2 Policies characterized by commitment have been shown to lead to more economic stability – lower and less volatile inflation and less volatile output. In fact, the mainstream theoretical Finn E. Kydland and Edward C. Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (June 1977), pp. 473–91. For an excellent overview, see Richard Clarida, Jordi Gali, and Mark Gertler, “The Science of Monetary Policy,” Journal of Economic Literature (December 1999), pp. 1661–1707. BIS central bankers’ speeches models that we use for monetary and macroeconomic analysis are built on the notion that monetary policy is conducted in a rule-like manner. The practice The practice part of the session title has proven to be a bit more elusive. The science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy. The reason is that optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived, and there is no broad-based consensus for the right model. More relevant is the finding that the optimal rule for one model can produce very bad outcomes in another model. In addition, optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. In other words, they may not be very transparent. However, these limitations to implementing optimal policy rules should not deter us from efforts to adopt a more systematic rule-like approach to the conduct of policy. There has been a great deal of progress made in identifying simple rules that appear to perform well in a variety of models and environments. Such robust rules can form a basis for developing more systematic, rule-like policymaking. One important and desirable characteristic of a systematic and rule-like approach to policy relates to communication. In particular, it is an approach that is easily communicated to the public and thus greatly improves the transparency and predictability of monetary policy, which reduces surprises. The public and markets are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances. Equally important in my view is that greater clarity about the policymakers’ reaction function strengthens accountability and thus can serve to preserve the central bank’s independence. The most well-known simple rule, of course, is the one proposed by John Taylor in 1993.3 The Taylor rule and the family of rules it has inspired call for setting the nominal fed funds rate based on three factors: the economy’s long-run real interest rate plus the Fed’s target rate of inflation, the deviation of inflation from the central bank’s target, and the departure of real GDP from some measure of “potential” GDP. The rule implies, for example, that when inflation is above target, the funds rate should increase by more than one-for-one with the deviation, and when GDP is below “potential,” the funds rate should be reduced. The attractiveness of Taylor-like rules for monetary policy goes beyond their intuitive appeal or the fact that they seem to describe the actual behavior of monetary policy reasonably well. Taylor-like rules tend to fall in the class of those rules that are robust. That is, they yield good results in a variety of theoretical settings. This feature is of enormous practical importance. Given our uncertainty about the true model of the economy, knowing that systematic policy in the form of a Taylor-like rule delivers good outcomes in a variety of models means that simple, robust rules can provide useful guidance for policy. Given model uncertainty and data measurement problems, there are, of course, limitations to the use of a simple rule. The rule is basically intended to work well on average, but central banks look at many variables in determining policy. There inevitably will be times when economic developments fall outside the scope of our models and warrant unusual monetary policy action. Events such as 9/11, the Asian financial crisis, the collapse of Lehman Brothers, and the 1987 stock market crash may require departures from a simple rule. Having articulated a rule guiding policymaking in normal times, however, policymakers will be expected to explain the departures from the rule in these unusual circumstances. With a rule John B. Taylor, “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Series on Public Policy, North-Holland, 39, 1993, pp. 195–214. BIS central bankers’ speeches as a baseline, departures can be quantified and inform us how excessively tight or easy policy might be relative to normal. If the events are temporary, policymakers will have to explain how and when policy is likely to return to normal. Thus, a simple rule provides a valuable benchmark for assessing the appropriate stance of policy. That makes it a useful tool to enhance effective communication and transparency. Rules and forward guidance In addition to providing important guidance for current policy decisions, Taylor-like rules can also be extremely useful in providing guidance for the expected future path of policy. Such forward guidance has received a good deal of attention recently. One reason for this increased attention is that short-term rates have been constrained by the zero lower bound. Thus, forward guidance and communication regarding future policy decisions take on greater significance. However, forward guidance is not a separate or independent policy tool. Its effectiveness is intimately related to other features of monetary policy. Monetary policy should be thought of more holistically, if you will. How effective we are with forward guidance, for example, can only be assessed or thought of in the context of a central bank’s overall approach to policy, including its approach to communication and transparency. In particular, I see a credible, rule-like approach to policy and the general openness and transparency of the policy process as essential elements in shaping expectations. Indeed, a commitment to a policy framework that is systematic and rule-like provides the foundation for establishing expectations concerning the future path of policy and thus forward guidance. Rules as benchmarks: A step forward So from my perspective, using Taylor-like rules to shape current and expected future policy is an important and useful part of any monetary policy framework. The operational question is how might one go about such an effort? This is not a trivial assignment. As I mentioned at the outset, it has proved to be quite elusive. In a stylized world, where there is a single monetary policymaker who has considerable confidence in a model of the economy, communication would include a forecast derived from this model. This forecast would incorporate a policy path that yields the best economic outcomes based on that single policymaker’s views. Unfortunately, we don’t live in such a world. Monetary policymaking is often conducted by committee, and divergent views can and often do exist. While this can be clumsy at times, such governance mechanisms ensure that various views are heard in an environment that promotes better decisions and better outcomes. Nevertheless, I believe that given the nature of U.S. institutional arrangements, Taylor-like rules can serve a very useful purpose. Specifically, they could underpin the construction of a periodic detailed monetary policy report, a feature of communication that has been adopted by many central banks around the world. However, while these reports have many similarities, there are some key differences. Many central banks include detailed forecasts in their published reports and highlight risks along with the outlook. This communication about the evolution of key economic variables that shape policy is important, but there is still debate about the nature of the forecasts and the assumptions that underlie them. A critical piece of a forecast emanating from the central bank is the nature of the future path of the policy rate. Should a central bank’s published forecast be based on its assessment of what the policy rate path is likely to be, perhaps based on its reaction function, or should the forecast be based on an interest rate path that is more arbitrary, such as a constant interest rate path or one that is related to market expectations? BIS central bankers’ speeches An alternative approach that could easily be adopted would be to indicate the likely behavior of interest rates based on a few different Taylor-like rules that have been consistent with the conduct of monetary policy in the past or ones that are considered robust across various models of the economy. Doing so would require agreement on a particular model in order to produce the resulting rule-based behavior. For the Fed, the economic model developed by the Board’s staff, called FRB/US, seems like a reasonable place to start. Such an exercise could also be enhanced, I believe, by using some of the dynamic stochastic general equilibrium, or DSGE, models that have been developed within the Federal Reserve System. The FOMC could then use its biannual monetary policy reports to communicate the results and whether and why it anticipates policy to be somewhat more restrained or more accommodative relative to the projections given by the various rules. The monetary policy report could also include various views that may differ from the baseline summaries. Policy statements between reports can refer back to the reports to provide consistency in the Committee’s communications with the public. Performing this exercise would illustrate the various dimensions of uncertainty that policymakers face. For example, there is model uncertainty, forecast uncertainty, and the variations implied by different rules. Many central banks use fan charts and other devices to highlight such bands of uncertainty about the forecast, and the Fed should do the same. It would provide a better sense of the likely direction of policy and the variables most related systematically to that policy. Further, this type of communication would push the FOMC to conduct policy in a more systematic manner, which I believe will lead to better economic outcomes over the longer run. Conclusions I am fully aware that we need to take great care in providing more specific forms of forward guidance so that we avoid a false sense of certainty and a mistaken sense of commitment. Yet, I believe systematic rule-like monetary policymaking can enhance economic performance, and therefore, I favor clearer communication concerning the formulation of policy. Providing information about how the policy path is likely to evolve forces policymakers to think more deeply and more systematically about policy. Communication about that path, in turn, gives the public a much deeper understanding of the analytical approach that guides monetary policy. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 6 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Economic Club of New York, New York City, 24 June 2014. | Charles I Plosser: Systematic monetary policy and communication Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Economic Club of New York, New York City, 24 June 2014. * * * The view expressed today are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser gives his views on the economy and the FOMC’s most recent policy decisions. He also discusses the benefits of rule-like, systematic behavior in the design and conduct of monetary policy and how this behavior combined with greater transparency leads to more effective communication. • President Plosser explains how a detailed monetary policy report could promote the FOMC to conduct policy in a more systematic manner, which he believes will lead to better decisions and better economic outcomes over the longer run. When policymakers deviate, it would require that they explain why. • President Plosser uses five widely recognized simple rules to explore their implications for the future path of policy and highlights the real uncertainties that policymakers face making policy. Introduction Thank you, Roger Ferguson, for that kind introduction and congratulations on your term as chairman of this august organization. You have continued to deliver the great programs and speakers that so many have come to expect from the club. As many of you know, this is the centennial year for the Federal Reserve. In the spirit of such an anniversary, my hat goes off to The Economic Club of New York, which has been around for 107 years. What a great and storied history you have, and it is an honor to be here. I should note that Congress created our decentralized central bank 100 years ago. That decentralized structure is one of our great strengths, but it requires that I begin with the usual disclaimer that the views I express are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). In my remarks this morning, I want to discuss the benefits of rule-like, systematic behavior in the design and conduct of monetary policy. Such behavior, combined with greater transparency, leads to communication that is more effective. This, in turn, helps the public understand the FOMC’s strategies, individual policy decisions, and the likely path of policy. I will go one step further and illustrate how the FOMC might take a step toward a more systematic policy framework by producing a detailed monetary policy report, similar to those issued by many central banks around the world. One aspect of such a report could highlight the policy paths implied by a few Taylor-like or robust rules and use them as benchmarks to set and communicate policy in a more systematic, rule-like way. I will begin with a brief overview of my thoughts about the economy and the FOMC’s most recent policy decisions before I discuss the role that systematic policy can play in the communication of policy. The economy and the recent policy decision First, the economy. My overall view of the economy is fairly optimistic. After a first quarter buffeted by winter storms, I believe we are poised to grow at a rate somewhat above trend BIS central bankers’ speeches for the remainder of this year and next before reverting back to trend, which I see as about 2.4 percent. Steady employment growth and healthier household balance sheets will support consumption activity. The current data suggest economic strength is fairly broad based, as evidenced by recent indicators and the optimism expressed by firms in both the manufacturing and service sectors. As for inflation, recent readings have moved a bit higher, mitigating somewhat the concerns that low inflation will persist or decline further. We have ample monetary accommodation in the economy to ensure that we will be able to achieve our 2 percent target over time. It is important, however, that we continue to reinforce our commitment to that goal so that inflation expectations remain well anchored near our target. At the meeting last week, the FOMC released its latest Summary of Economic Projections (SEP). The outlook going forward was largely unchanged. While real GDP growth for 2014 was marked down, which reflected the disappointing first quarter, the outlook for the second half of the year and the projections for 2015 and 2016 were unchanged. Unemployment projections were reduced slightly, and the inflation forecast remained stable. My own submission for economic growth was generally in line with my colleagues. But my forecast for unemployment was a bit lower in the near term. Specifically, I think the unemployment rate may reach 5.8 percent by the end of this year and 5.6 percent by the end of 2015. My view of inflation is that it will stabilize at about 2 percent in 2015. Some market participants and commentators have focused on the so-called dot charts and the movement of the implied median funds rate for 2014–16. I would remind everyone that the dots are not a forecast of what policymakers think the Committee will actually do, but they are a reflection of the policymakers’ views of appropriate policy. Some have noted that the median path steepened ever so slightly. This should not come as a particular surprise as it likely just reveals greater confidence that the economy is improving. The rebound after the bad winter seems to be progressing, the outlook for unemployment is a bit better, and the inflation rate appears to be firming. The changes in the dots thus simply tell us something about individual policymakers reaction to the change in economic conditions. The FOMC statement notes that the Committee will adjust future funds rate decisions based on the progress toward our objectives. So, it is entirely reasonable that the expected path of “appropriate policy” should adjust as we close in on those objectives. Indeed, it would be surprising if they did not behave in such a manner. I believe that we are closing in on our goals – perhaps faster than some people might think. So, while I supported the recent policy statement, I have growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive, given underlying economic conditions. The benefits of systematic monetary policy Let me now turn to the importance of conducting monetary policy in a systematic manner. By systematic policy, I mean conducting policy in a rule-like manner as opposed to relying on discretion. Decisions are always made period by period, but in a rules-based approach, the decisions are guided by the rules. Discretion is the opposite of rules-based decisionmaking. Discretionary decisions are made without being constrained by past promises or previous forward-looking statements. The monetary policy debate over whether rule-like behavior is preferable to pure discretion dates back at least to Henry Simons in 1936.1 More recently, in their Nobel Prize-winning Henry C. Simons, “Rules Versus Authorities in Monetary Policy”, Journal of Political Economy, 44:1 (February 1936). BIS central bankers’ speeches work, Finn Kydland and Ed Prescott demonstrated that a credible commitment by policymakers to behave in a systematic rule-like manner leads to better outcomes than discretion.2 Since then, numerous papers using a variety of models have investigated the benefits of rule-like behavior in monetary policy and found that there are indeed significant benefits. Policies characterized by commitment have been shown to lead to more economic stability. In fact, the mainstream theoretical models that we use for monetary and macroeconomic analysis are built on the notion that monetary policy is conducted in a rulelike manner. The benefits of a rule-like approach arise, in part, because consumers and businesses are forward looking. When policymakers credibly commit to a rule-like approach to setting policy, they can alter expectations in ways that make policy more effective and less uncertain. The appropriate way to make policy systematic, or rule-like, is to base policy decisions on the state of the economy. That is, policymakers should describe the reaction function that determines how the current and future policy rate will be set depending on economic conditions. Policymakers are, of course, no more certain about future course of the economy than anyone else is; therefore, they cannot realistically commit to particular future values of the policy rate. Nonetheless, describing a reaction function or rule that explains how the policy rate will be determined in the future as a function of economic conditions can be highly informative. Unfortunately, the science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy. Given our current state of knowledge, judgment is still required in setting policy. One reason is that optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived, and there is no broad-based consensus for the right model. Another factor is that the optimal rule for one model can produce very bad outcomes in another model. A third reason is that optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. In other words, they may not be very transparent. However, these limitations to implementing optimal policy rules should not deter us from efforts to adopt a more systematic, rule-like approach to the conduct of policy. Indeed, there has been a great deal of progress made in identifying simple, robust rules that appear to perform well in a variety of models and environments. The most well-known rule is attributable to John Taylor.3 The Taylor rule is a reaction function that indicates how to set the policy rate as a function of deviations of inflation from the inflation target and some measure of economic slack. The attractiveness of Taylor-like rules goes beyond their intuitive appeal or the fact that they seem to describe the actual behavior of monetary policy reasonably well. The reality is that Taylor-like rules yield very good results in a variety of theoretical models. While this is surprising to some, it is of enormous practical importance. Given our uncertainty about the true model of the economy, knowing that systematic policy in the form of a Taylor-like rule delivers good outcomes in a variety of models means that these simple, robust rules can provide useful guidance for policy. Moreover, rule-like policies also play an important role in central bank communication. Finn E. Kydland and Edward C. Prescott, “Rules Rather Than Discretion: The Inconsistency of Optimal Plans”, Journal of Political Economy, 85 (June 1977), pp. 473–91. John B. Taylor, “Discretion Versus Policy Rules in Practice”, Carnegie-Rochester Conference Series on Public Policy, North-Holland, 39, 1993, pp. 195–214. BIS central bankers’ speeches Communication The fundamental reason that communication is so important is that monetary policy is more appropriately viewed as the path of the policy rate, not simply the current rate. This is evident today as the markets seem highly attentive to signals regarding the future path of the funds rate not simply its current setting. Because systematic policy is easily communicated to the public, it also greatly improves the transparency and predictability of monetary policy, which reduces policy surprises. Businesses and consumers are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances even if they are not certain what those economic conditions might be. Equally important in my view is that greater clarity about the policymakers’ reaction function strengthens accountability. Thus, systematic policy, communicated transparently, strengthens accountability and serves to preserve the central bank’s independence. In this regard, Taylor-like rules have many of these desirable features. They are systematic, based on a limited number of variables, perform well in a variety of models, and can therefore provide important guidance for policy decisions. If our policy is guided by statecontingent rules, then by reporting our assessment about the evolution or forecast of key economic variables, the public will get a better understanding and appreciation of the likely path of policy. Indeed, that is likely to be the best information we can provide regarding the future path of policy. Rules as benchmarks: a step forward Given model uncertainty and data measurement problems, there are, of course, limitations to the use of a simple rule. A robust rule is intended to work well on average, but central banks look at many variables in determining policy. Inevitably, there will be times when economic developments fall outside the scope of our models and warrant unusual monetary policy action. Events such as 9/11, the Asian financial crisis, the collapse of Lehman Brothers, and the 1987 stock market crash may require departures from a simple rule. However, in such unusual circumstances, policymakers will be expected to explain the departures from the rule. With a rule as a baseline, departures can be quantified and inform us how excessively tight or easy policy might be relative to normal. If the events are temporary, policymakers will have to explain how and when policy is likely to return to normal. Thus, a simple rule provides a valuable benchmark for assessing and communicating the appropriate stance of policy. The operational question is how might we go about the effort to implement a more rulesbased policy? One strategy could be to indicate the likely behavior of interest rates based on a few Taylorlike rules that have been consistent with the conduct of monetary policy in the past or ones that are considered robust across various models. Doing so would require agreement on a particular model in order to produce the resulting rule-based behavior. For the Fed, the economic model developed by the Board’s staff seems like a reasonable place to start. Such an exercise could also be enhanced, I believe, by using some of the dynamic stochastic general equilibrium, or DSGE, models that have been developed within the Federal Reserve System. As a start, the results of this type of exercise could be published in the FOMC’s current biannual monetary policy report to Congress. Perhaps we might consider releasing these reports on a quarterly basis in keeping with other central banks. The Committee could then indicate whether and why it anticipates policy to be somewhat more restrained or more accommodative relative to the projections given by the various rules. The monetary policy report could also include various views that may differ from the baseline summaries. BIS central bankers’ speeches A major benefit of this exercise would be to illustrate the various dimensions of uncertainty that policymakers face. Financial markets often prefer certainty about the future path of monetary policy, but that is unrealistic and not necessarily desirable. For example, this exercise would indicate the extent of model uncertainty, forecast uncertainty, and the variations implied by different rules. Many central banks use fan charts and other devices to highlight such bands of uncertainty about the forecast, and the Fed should do the same. Overall, this exercise would provide a better sense of the likely direction of policy and the variables most related systematically to that policy. It would also lead the FOMC to discuss policy in the context of rules and a systematic approach to decision-making, which I believe will lead to better decisions and better economic outcomes over the longer run. Moreover, it would require policymakers to explain why they choose to deviate from the benchmarks and the guidelines they provide. An example As I discussed, communication is an important aspect of monetary policy. I have long been an advocate of the Fed producing a periodic monetary policy report similar to other central banks. It is simply too difficult to convey monetary policy design and strategy within the confines of the brief statements issued at the conclusion of each FOMC meeting. Therefore, what I am about to suggest should not be viewed in isolation but as one part of such a periodic report to the public. So, let me illustrate how we might begin to incorporate a more systematic and transparent approach to rule-like decision-making. I view this as one step in a journey, not as the end result. My example uses five simple rules that have been discussed in the literature and describes their implications for the projected path of the funds rate from now through 2015. Since these rules are contingent on economic conditions, I will use the midpoint of the forecasts derived from the most recent SEP and apply an Okun’s law relationship to convert projections of unemployment into projections of economic slack. I should immediately note that this is not a completely coherent exercise as each participant’s projections were based on his or her own view of optimal policy and, as you are well aware, those views differ. Put differently, the midpoint of the projections arises from an amalgam of different models and thus represents no one’s forecast or model. Thus, the results are likely to be more diverse than otherwise expected. So my example is purely illustrative yet easily replicable. However, given the relevance of the SEP, I thought the exercise would be more interesting than if I used an offthe-shelf economic model. The rules I have chosen are these: first, the original Taylor 1993 rule; second, a variant of Taylor’s original rule, sometimes called the Taylor 1999 rule, which places greater emphasis on the output gap; third, a version of the Taylor 1999 rule that allows for considerable interest-rate smoothing and is called the inertial Taylor 1999 rule; fourth, a performance- or outcome-based rule developed by staff at the Philadelphia Fed that is simply an estimated rule that best mimics previous FOMC actions; and fifth, a first-difference rule that is based on academic work of Athanasios Orphanides and is designed to take into account the imprecision and uncertainties of our measurements of the level of the output gap or slack and the underlying or steady state real rate of interest.4 I have plotted the outcome of this exercise in Figure 1. So what can we take away from this picture? First, all the rules suggest that liftoff of the funds rate from the zero bound should occur next quarter. This is considerably sooner than many seem to be expecting. See the Appendix for the precise mathematical formulations of each of these rules and the relevant references. BIS central bankers’ speeches Second, we can also see that although the rules point to policy being tighter, they do present somewhat different profiles of the future path of interest rates. The Taylor 93 and Taylor 99 rules have a steeper path over the next several quarters than the other rules. The primary reason for this is that both of these rules are playing catchup as they would have had liftoff occur earlier. After catchup, they increase more slowly. This dispersion in the pace of tightening also reflects model uncertainty. But ignoring or dismissing the rules does not avoid the problem such uncertainty poses. Robust rules, such as the first-difference rule, tend to have better outcomes on average across models. Third, we see that three of the policy paths are not that different from each other. Taylor 93, Taylor 99, and the performance based rules tend to converge to between 2.5 and 3.0 percent by mid-2015 and remain close thereafter. My own assessment of appropriate policy is similar to that described by the first-difference rule. However, my point is not to decide which path is correct, but to illustrate how such benchmarks can be useful for communications. For example, the exercise might suggest that policy choices that fall outside the bounds of these rules should be viewed with some caution. That does not mean they would be wrong but they would require careful and substantial discussion and justification. Even for policy choices that might fall within the bounds, the exercise can provide meaning, quantitative and qualitative, to phrases such as rates are expected to be “lower than normal”. Another way of highlighting the uncertainty surrounding the future path of policy is to consider different paths for the economy. Consider Figure 2. Here I employ the first difference rule but consider the implications of a stronger and a weaker path for the economy. To illustrate the range of policy paths that could ensue, I use three different forecasts, the midpoint forecast from the SEP, as in the previous chart, as well as two hypothetical forecasts. The first takes a combination of the lowest inflation and highest unemployment forecasts (a weak forecast), and the second does just the opposite by combining the highest inflation and lowest unemployment forecasts (a strong forecast). Of course, neither represents a particular forecast or model; they combine various elements of different forecasts. Thus, the exercise represents a fairly extreme construction of forecast uncertainty. In any event, we observe a wide range for the predicted funds rate paths as in the first experiment. The weakest forecast anticipates a funds rate of nearly 1 percent by the end of 2015, while the strongest forecast envisions a funds rate of about 4.7 percent in part because both inflation and unemployment “overshoot” their long-run and sustainable values and corrections must follow. Note, however, that even the weakest economic view coupled with the first-difference rule has the funds rate rising above the zero lower bound next quarter. This picture is analogous, but not in a precise way, to a fan chart. I have indicated throughout my talk the imprecision of our knowledge about the economy. My understanding is no more precise than the understanding of colleagues or private-sector economists. These two exercises highlight the model and forecast uncertainty policymakers face. Rather than trying to target particular future values of the policy rate, a monetary policy report under a rules-based approach could convey the uncertainty and still assure that decisions will be driven by the state of the economy. These two exercises indicate a need to explain more fully why policy is deviating from what is suggested by these rules. No doubt, there is a variety of views on this issue, but I think the policy process itself and our communication of policy would benefit greatly from producing a detailed monetary policy report with some of the features I have discussed today. BIS central bankers’ speeches BIS central bankers’ speeches Appendix Taylor 1993 Taylor, John B. “Discretion Versus Policy Rules in Practice”, Carnegie-Rochester Conference Series on Public Policy, vol. 39 (December 1993), pp. 195–214. (http://web.stanford.edu/~johntayl/Papers/Discretion.PDF) Taylor 1999 Taylor, John B. “A Historical Analysis of Monetary Policy Rules”, in John B. Taylor, ed., Monetary Policy Rules. Chicago: The University of Chicago Press, 1999, pp. 319–341. (http://www.nber.org/chapters/c7419.pdf) First difference from Orphanides Orphanides, Athanasios. “Historical Monetary Policy Analysis and the Taylor Rule”, Journal of Monetary Economics, vol. 50 (July 2003), pp. 983–1022. (http://www.federalreserve.gov/pubs/feds/2003/200336/200336pap.pdf) Carlstrom and Fuerst Inertial Taylor Rule Carlstrom, Charles T. and Timothy S. Fuerst, “Inertial Taylor Rules: The Benefit of Signaling Future Policy”, Federal Reserve Bank of St. Louis Review 90(3, Part 2) (May/June 2008), pp. 193–203. (https://research.stlouisfed.org/publications/review/08/05/part2/Carlstrom.pdf) Philadelphia Fed estimated outcome-based rule This rule is estimated over the period of 1Q1988 through 4Q2007 using Greenbook forecasts. Where is the four-quarter average of core PCE. is a dummy variable with the values (Equation form on page 38 http://www.federalreserve.gov/monetarypolicy/files/FOMC20080130bluebook20080124.pdf) Estimation done by FRBP using Greenbook forecasts from 1Q1988 through 4Q2007. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 6 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Pennsylvania Association of Community Bankers' 137th Annual Convention, Amelia Island, Florida, 6 September 2014. | Charles I Plosser: The economic outlook Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the Pennsylvania Association of Community Bankers’ 137th Annual Convention, Amelia Island, Florida, 6 September 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the economy and shares some thoughts about the stance of monetary policy. • President Plosser believes that forward guidance should be adjusted to reflect economic realities and to give the FOMC the flexibility to respond gradually to the evolution of the economy. • President Plosser counters the view that rates cannot be raised because the labor market has not “completely” healed. He discusses two major risks with this strategy. First, economists do not know what maximum employment is and cannot easily measure it. Second, waiting until we are completely confident the labor market has fully recovered risks that monetary policy will be behind the curve and could lead to a return to abrupt “go-stop” policies of the past that led to unwelcome volatility. • While he is not suggesting that rates should necessarily be increased now, President Plosser sees that the first task is to change the language and to begin signaling that liftoff may occur sooner than many now anticipate and sooner than suggested by the current FOMC guidance. Introduction Good morning. Thank you for the opportunity to speak at this 137th annual convention of the Pennsylvania Association of Community Bankers. Community banks have a long and venerable history in our nation, and the 137 years of the PACB is a powerful testament to your roots as stalwarts in our financial system. I would note that the longevity of this convention means that your organization significantly predates the Federal Reserve System, which is observing its centennial this year. My suspicion is that there are a number of community bankers here today who can trace their corporate histories to firms that petitioned for the establishment of a Federal Reserve Bank in Philadelphia 100 years ago. I actually have two letters here. One from the New Tripoli National Bank dated December 27, 1913, and one from the First National Bank of Mifflintown dated December 26, 1913, both addressed to William McAdoo, Secretary of the Treasury, requesting the establishment of a Federal Reserve Bank in the City of Philadelphia. Over the years, community banking organizations, whether they are state member banks or not, have provided important links between the Federal Reserve Banks and the businesses and communities your institutions serve. We have reached out and listened to community bankers through their representation on our boards of directors and advisory councils, as well as through our ongoing contacts with individual firms and the business organizations you serve. The insights we gather from community bankers in our District help me as a policymaker bring Main Street perspectives to the national policy table each time the Federal Open Market Committee, or FOMC, meets in Washington. When such information from all the Districts comes together at our meetings, it forms a rich mosaic of our economy that helps shape our monetary policy decisions. BIS central bankers’ speeches So, I want to thank Nick DiFrancesco, president and CEO of the PACB, and Dennis Cirucci, your chairman, for inviting me here today. I also want to publicly thank Dennis for serving so ably on our Bank’s Community Depository Institutions Advisory Council, or CDIAC, and as our council’s representative to the Board of Governors. My last opportunity to address the PACB was in September 2007, a very different economic environment than we find ourselves in today. I used that speech seven years ago to discuss the Federal Reserve’s initial responses to growing financial instability in the housing sector. I explained that the Fed’s role in promoting financial stability rather than its monetary policy responsibilities had prompted the short-term injection of some $68 billion in liquidity through open market operations in early August 2007, a mere 12 months after I joined the Fed. That seems like a long time ago and much has transpired since then. At the time, the FOMC had yet to lower the federal funds rate from its target of 5.25 percent. Weeks later, though, the FOMC began to lower the federal funds rate target and then kept lowering it to essentially zero in December 2008, as the global financial crisis and the ensuing Great Recession enveloped economies around the world. The rate has been near zero for nearly six years now, and the Fed has augmented its aggressive policy actions through large-scale asset purchases, now tallying in the trillions, rather than in the billions of dollars. Today, I would like to give you my assessment of the U.S. economy and then share some thoughts about the stance of monetary policy. I should note that my views are my own and not necessarily those of the Federal Reserve Board or my colleagues on the FOMC, which will shortly become apparent. Economic conditions So, let me begin with an overview of the U.S. economy. We are more than five years into a recovery that began in June 2009. While the pace has been sluggish and uneven, I believe the progress is undeniable. In fact, despite a winter cold spell in the first quarter, I remain mostly positive about the prospects ahead. The severe winter led to a decline in gross domestic product (GDP) during the first quarter of the year, but second-quarter growth rebounded to 4.2 percent, according to the most recent estimate. This largely confirmed that the disappointing performance in the first quarter was mostly a temporary weather-related slowdown rather than a more persistent retrenchment in the ongoing recovery. In the second quarter, the strongest recoveries were in categories most directly affected by the first quarter’s severe weather, including investment in equipment, residential structures, inventory accumulation, and exports. Exports declined sharply at an annual rate of 10.1 percent in the first quarter and then jumped 9.5 percent in the second. Total private domestic investment fell 6.9 percent in the first-quarter freeze but then grew 17.5 percent during the second-quarter thaw. Personal consumption, the largest spending sector of the economy, slowed during the first quarter to 1.2 percent. In the second quarter, personal consumption growth approximately doubled to 2.5 percent. Durable goods, which advanced at an annualized rate of 14 percent, were the strongest component of personal consumption in the second quarter. I believe consumer and business spending will help real GDP to grow at about 3 percent for the remainder of this year and next before reverting to trend, which I see as about 2.4 percent. The Philadelphia Fed’s Manufacturing Business Outlook Survey in our region has proven to be a reliable indicator of national manufacturing trends in the U.S. In August, the diffusion index of current activity increased for the third consecutive month and had its strongest reading since March 2011. The survey also indicated that expectations for manufacturing activity six months ahead remained strong. Underlying details of the report included strong BIS central bankers’ speeches results for new orders and shipments. The current indicators for labor conditions also suggested continued expansion in employment. The employment index has been positive for 14 months, and the workweek index was positive for the sixth month. These data suggest continued improvement in U.S. labor market conditions, despite a somewhat softer August number yesterday, which showed that 142,000 jobs were added to nonfarm U.S. payrolls. However, I prefer to look at longer-term trends rather than monthly numbers that are still subject to revision. Year-to-date monthly average job growth has amounted to 215,000 jobs this year, compared with a monthly average of 194,000 jobs added last year. Despite the slowdown in August, job creation has improved markedly this year. The economy has created 1.7 million jobs since the start of the year, nearly 10 percent more than the same period in 2013, 20 percent more than in 2012, and 30 percent more than in 2011. The unemployment rate was 6.1 percent in August, down more than a full percentage point from a year ago. This means the unemployment rate continues to fall faster than many policymakers had been forecasting. For instance, in the Summary of Economic Projections (SEP) submitted in December 2013, the central tendency of FOMC participants was to end 2014 with an unemployment rate of 6.3 to 6.6 percent, and by the end of 2015, the central tendency was expected to be 5.8 to 6.1 percent. We have clearly exceeded expectations. The unemployment rate is below where the Committee thought it would be at the end of 2014 and is now within the range expected at the end of 2015. Thus, it is fair to say that we are at least a year ahead of where we thought we would be when we started to taper asset purchases. In Pennsylvania, job growth has been positive as well. The state added more than 54,000 jobs over the past 12 months. July’s unemployment rate in Pennsylvania was 5.7 percent, down from 7.5 percent a year ago and from a peak of 8.7 percent immediately following the recession. It is not just that the unemployment rate has fallen, other measures of labor market conditions have improved as well. Long-term unemployment in the nation, those unemployed for more than 27 weeks, has dropped by about 1.3 million from a year ago; the duration of unemployment spells has declined; job openings have returned to prerecession levels; and the rate at which employees voluntarily leave their jobs, called the quit rate, has risen. This is not to claim that all is rosy in the labor markets. Many Americans remain frustrated and disappointed in their jobs and job prospects. For example, there remains a large contingent of those working part time for reasons economists don’t fully understand. Nonetheless, we have to acknowledge that significant progress has been made. Inflation remains somewhat below the FOMC’s long-run goal of 2 percent, but it appears to be drifting upward. Headline inflation as measured by year-over-year change in the consumer price index, or CPI, was 2 percent in July, the fourth month at or above that level. The Fed’s preferred measure of inflation is the year-over-year change in the price index for personal consumption expenditures, or PCE inflation. In December of last year, that figure stood at 1.2 percent. The most recent reading for July 2014 was 1.6 percent. Compare that with December 2013 SEP estimates for 2014, and you will find that we are already at the top of the FOMC’s central tendency of 1.4 to 1.6 percent for PCE inflation. In the June SEP, FOMC participants modestly increased their assessment of inflation, raising the central tendency for PCE inflation by the fourth quarter of 2014 to between 1.5 and 1.7 percent. The Philadelphia Fed’s most recent Survey of Professional Forecasters also increased its average estimate of headline PCE inflation to 1.8 percent in 2014, up from 1.6 percent in the last survey. The survey also increased the estimate of PCE inflation to 2.0 percent in 2015, up 0.1 percentage point from the previous estimate. All of these figures suggest that inflation appears to be gradually moving closer to our target of 2 percent and doing so more quickly than anticipated in December 2013. BIS central bankers’ speeches Monetary policy Let me turn to some thoughts on monetary policy, including why I departed from the majority view at the July FOMC meeting. As I noted in the beginning of my remarks, the Fed has taken extraordinary monetary policy actions, keeping the federal funds rate near zero for nearly six years and expanding its balance sheet to more than $4 trillion. Indeed, the balance sheet continues to expand, so the Fed is still trying to increase accommodation even though the pace of purchases is slowing and is expected to end in October. Yet, the recovery began over five years ago, and the unemployment rate has declined from 10 percent in October 2009, to 6.1 percent now. Whether you believe that the labor market has fully recovered or not, it is clear that we have made considerable progress toward full employment and price stability. We are no longer in the depths of a financial crisis nor is the labor market in the same dire straits it was five years ago. In its July statement, the FOMC reaffirmed its highly accommodative stance. The statement noted that “in determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation.” In assessing this progress, the Committee reported that it will look at a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The FOMC also noted, based on its assessment of these factors, “that it likely will be appropriate to keep its target federal funds rate near zero for a considerable time after the asset purchase program ends ...” I objected to this forward guidance regarding the expected timing for raising the funds rate because I believe this language is no longer appropriate or warranted. Appropriate monetary policy must respond to the data. I believe that by indicating that the FOMC continues to anticipate that it will be a “considerable time” after the end of asset purchases before it is likely that the Committee will raise interest rates does not reflect the significant progress toward our goals. It also limits the Committee’s flexibility to take action going forward. We have moved much closer to our goals since last December, and, as we do so, the stance of monetary policy should reflect such progress and begin to gradually adjust. That is the essence of being data dependent. In the current context, we must acknowledge and thus prepare the markets for the fact that interest rates may begin to increase sooner than previously anticipated. I felt that adjusting our language was the appropriate first step in responding to better-than-anticipated economic conditions. My view is informed, as I have indicated, by realized and projected economic progress toward our goals. But it is also influenced by guidance gained from the historical conduct of past monetary policy. In particular, my views on the appropriate funds rate setting are – and continue to be – informed by Taylor-type monetary policy rules that depict the past behavior of monetary policy. I find such rules useful for benchmarking my policy prescriptions. These rules have been widely investigated and have been shown to be robust, in that they deliver good results in a wide variety of models and circumstances. The guidance I take from such robust rules is that we should no longer consider monetary policy as being constrained by the zero lower bound. A variety of these rules, which I discussed in a speech earlier this summer, indicates that under current conditions the funds rate should already be above zero or should be lifting off in the very near future.1 I am not Charles I. Plosser, “Systematic Monetary Policy and Communication,” remarks to the Economic Club of New York, New York, NY, June 24, 2014. BIS central bankers’ speeches suggesting that rates should necessarily be increased now. Our first task is to change the language in a way that allows for liftoff sooner than many now anticipate and sooner than suggested by our current guidance. Raising rates sooner rather than later also reduces the chance that inflation will accelerate and, in so doing, require policy to become fairly aggressive with perhaps unsettling consequences. Thus, I believe that our forward guidance should be adjusted to reflect economic realities and to give us the flexibility to respond sooner and more gradually to the evolution of the economy. There is a point of view that rates cannot be raised because the labor market has not completely healed. That is, we must wait, maintaining our current stance of policy until we have achieved our goals. I think this is a risky strategy for two reasons. First, we do not know how to confidently determine whether the labor market is fully healed or when we have reached full employment. In January 2012, the FOMC affirmed in its statement of longer run goals and strategies that, “The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable.” Chair Yellen gave an excellent speech at the Jackson Hole conference just a couple of weeks ago that highlighted some of the structural and nonmonetary factors affecting the labor market. Economists don’t fully understand how these factors may be influencing our efforts to assess the meaning and measurement of full employment. Second, if monetary policy waits until it is certain that the labor market has fully recovered before beginning to raise rates, policy will be far behind the curve. One risk of waiting is that the Committee may be forced to raise rates very quickly to prevent an increase in inflation. In so doing, this may create unnecessary volatility and a rapid tightening of financial conditions – either of which could be disruptive to the economy. This would represent a return of the so-called “go-stop” policies of the past. Such language was used to describe episodes when the Fed was viewed as providing lots of accommodation to stimulate employment and the economy – the go phase – only to find itself forced to apply the brakes abruptly to prevent a rapid uptick in inflation – the stop phase. This approach to policy led to more volatility and was more disruptive than many found desirable. For these reasons, I would prefer that we start to raise rates sooner rather than later. This may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act. Conclusion To summarize, my own forecast is positive. Second-quarter growth has rebounded, confirming that the disappointing performance in the first quarter was mostly weather related rather than a retrenchment to the ongoing recovery. Unemployment continues to improve more quickly than many had expected, and inflation appears to be drifting up toward our 2 percent goal. If monetary policy is to be truly data dependent, then our stance of policy must begin to change. I’m not suggesting a rate increase now, but changing the forward guidance would at least afford us the flexibility to gradually raise rates beginning earlier than currently anticipated. Waiting too long to begin raising rates – especially waiting until we have fully met our goals for maximum employment – is risky because we cannot know when we have arrived. That could also put monetary policy behind the curve and could lead to a return to abrupt go-stop policies that in the past led to unwelcome volatility. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 9 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Society of American Business Editors and Writers Fall Conference, City University of New York (CUNY) Graduate School of Journalism, New York, 10 October 2014. | Charles I Plosser: Communicating a systematic monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Society of American Business Editors and Writers Fall Conference, City University of New York (CUNY) Graduate School of Journalism, New York, 10 October 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser discusses how effective communications and a systematic, rulelike monetary policy lead to better economic outcomes. • President Plosser believes the appropriate way to make policy systematic, or rulelike, is to base policy decisions on economic conditions. He thinks policymakers should describe the reaction function that determines how the current and future policy rates will be set depending on economic data. Monetary policy should be data dependent, not date dependent. • President Plosser also believes the Fed should think of forward guidance as part of a systematic approach to decision-making and not an independent policy tool that attempts to bend expectations. As monetary policy becomes normalized, the Fed has the opportunity to ensure the public understands that forward guidance is an integrated part of a systematic approach to policy. Introduction Thank you. As you may know, this is the centennial year for the Federal Reserve. On December 23, 1913, President Woodrow Wilson signed into law the act that created the Federal Reserve System, and on November 16, 1914, the 12 Reserve Banks officially opened their doors as independently chartered banks. Oversight was assigned to a Board of Governors in Washington, D.C. That decentralized structure is one of our great strengths, but it requires that I begin by reminding you that the views I express this morning are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Since this is a professional society of business editors and writers, I thought I would discuss the benefits of clear communications as part of a systematic, rule-like approach to setting monetary policy. During the past eight years, I have spoken and written frequently about ways to improve the framework we use for making monetary policy decisions. In my view, the monetary policy framework is most effective when the central bank: • Commits to a set of clearly articulated objectives that can be feasibly achieved by monetary policy; • Conducts monetary policy in a systematic or rule-like manner; • Communicates its policies and actions to the public in a clear and transparent way; and • Protects its independence by maintaining a clear separation of monetary policy from fiscal policy. These four principles are interrelated, and, as you will see, communication is a key ingredient for a sound policy framework. To its credit, the Federal Reserve has sought to strengthen its BIS central bankers’ speeches communications and its monetary policy framework in recent years. I have described the process as like a journey, with each step contributing to a more informed public and a more transparent central bank. While we have made strides over the past several decades, I also recognize that the journey in recent years has taken us into unchartered territory. Extraordinary actions by the Fed in response to the Great Recession have presented unique communications challenges, which have made clarity more difficult. Yet, I believe we have nonetheless made progress. The journey thus far Just consider how far we have come. It was once taken for granted that the central bank was supposed to be secretive and mysterious. The guiding principle was simple: The less said about monetary policy, the better. Indeed, it was not until 1994 that the FOMC began to announce policy changes made at its meetings. Before then, the markets were left to infer the policy action from the Fed’s behavior in the market. 1 Since then, the FOMC has issued statements at each meeting, which include a vote tally, along with the views of dissenters. The FOMC now expedites the release of the minutes, publishing them three weeks after each meeting. It also reports the economic projections of Committee participants four times a year. These meetings are followed by press conferences with the chair of the FOMC. In 2012, the FOMC issued a statement clarifying our longer-run goals and strategy, including an explicit 2 percent target for inflation. And the economic projections now include information about the policy path assumptions of participants. These last two initiatives were based on the recommendations of a subcommittee on communications led by then Vice Chair Yellen, which included President Evans of Chicago, former Governor Raskin, and myself. This summer, Chair Yellen asked Vice Chair Fischer to lead a new subcommittee on communications, with Governor Powell, President Williams of San Francisco, and President Mester of Cleveland, to continue to find ways to improve communications. Clearly articulating objectives Let’s consider how communications support each of the four principles of sound central banking, beginning with clearly articulating the objectives of monetary policy. But before doing so, it is useful to spell out exactly what the FOMC is supposed to do. The Federal Reserve Act specifies the Fed “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Since moderate long-term interest rates generally result when prices are stable, many have interpreted these goals as a dual mandate to manage fluctuations in employment in the short run while preserving price stability in the long run. However, most economists are dubious of the ability of monetary policy to predictably and precisely control employment in the short run, and there is a strong consensus that monetary policy cannot determine employment in the long run. As the FOMC noted in its statement on longer-run goals adopted in 2012, the maximum level of employment is largely determined by nonmonetary factors, such as changing demographics, which affect the structure and dynamics of the labor market. In my view, excessive focus on short-run control of employment weakens the credibility and effectiveness of the Fed in achieving its price stability objective. We learned this lesson most dramatically during the 1970s when, despite the extensive efforts to reduce unemployment, See the Federal Reserve Bank of Philadelphia, “Timeline to Transparency,” www.philadelphiafed.org/aboutthe-fed/transparency/ (accessed October 9, 2014). BIS central bankers’ speeches the Fed essentially failed, and the nation experienced a prolonged period of high unemployment and high inflation. The economy paid the price in the form of a deep recession, as the Fed sought to restore the credibility of its commitment to price stability. When establishing the longer-term goals and objectives for any organization, and particularly one that serves the public, it is important that the goals be achievable. Assigning unachievable goals to organizations is a recipe for failure. For the Fed, it could mean a loss of public confidence. I fear that the public has come to expect too much from its central bank and too much from monetary policy, in particular. We need to heed the words of Nobel Prize winner, Milton Friedman. In his 1967 presidential address to the American Economic Association, he said, “we are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve, and as a result, in danger of preventing it from making the contribution that it is capable of making.” 2 In my view, the dual mandate has contributed to a view that monetary policy can accomplish far more than it is, perhaps, capable of achieving. Even though the FOMC’s 2012 statement of objectives acknowledged that it is inappropriate to set a fixed goal for employment and that maximum employment is influenced by many factors, the FOMC’s recent policy statements have increasingly given the impression that it wants to achieve an employment goal as quickly as possible through aggressive monetary accommodation. I believe that assigning multiple objectives for the central bank opens the door to highly discretionary policies, which can be justified by shifting the focus or rationale for action from goal to goal. That is why I have argued that Congress ought to redefine the Fed’s monetary policy goals to focus solely, or at least primarily, on price stability. I base this on two facts: Monetary policy has a very limited ability to influence real variables, such as employment. And, in a regime with fiat currency, only the central bank can ensure price stability. Indeed, it is the one goal that the central bank can achieve over the longer run. Setting clear, achievable objectives is part of the framework. Asking policymakers to pursue those objectives in a systematic, rule-like approach is the second key principle. The benefits of systematic monetary policy So, what do I mean by a systematic approach to policy? Quite simply, I mean conducting policy in a more rule-like manner. It is difficult for policymakers to choose a systematic rulelike approach that would tie their hands and thus limit their discretionary ability. Yet, economists have long been aware of the benefits of rule-like behavior. Dating as far back as 1936, Henry Simons discussed how rule-like behavior is preferable to pure discretion. 3 More recently, Finn Kydland and Ed Prescott in their Nobel Prize-winning work showed that a credible commitment by policymakers to behave in a systematic rule-like manner leads to better outcomes than discretion. 4 Since then, numerous papers using a variety of models have investigated the benefits of rule-like behavior in monetary policy and found that there are indeed significant benefits. One of the reasons that rules work better than discretion is that they are transparent and therefore allow for simpler and more effective communication of policy decisions. Moreover, a large body of research over the last 40 years has emphasized the important role expectations play in determining economic outcomes. That means more effective See Milton Friedman, “The Role of Monetary Policy,” American Economic Review, 58:1 (March 1968), pp. 1-17. Henry C. Simons, “Rules Versus Authorities in Monetary Policy,” Journal of Political Economy, 44:1 (February 1936). Finn E. Kydland and Edward C. Prescott, “Rules Rather Than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (June 1977), pp. 473-491. BIS central bankers’ speeches communication of the decision-making process leads to more accurate expectations. When policy is set systematically, the public and financial market participants can form more accurate expectations about policy. Policy is then less of a source of instability or uncertainty. The appropriate way to make policy systematic, or rule-like, is to base policy decisions on observable economic conditions. That is, policymakers should describe the reaction function that determines how the current and future policy rate will be set depending on economic data. I want to emphasize that a reaction function does not mean a timetable or a threshold for action. Monetary policy should be data dependent, not date dependent. And the use of that data must recognize that policymakers are no more certain about future economic conditions than anyone else is. Thus, the future path of policy will always be highly uncertain. However, a reaction function should explain how the policy rate will be determined in the future as a function of economic conditions. I also want to clear up some confusion about whether a reaction function is somehow mechanical. The science of monetary policy has not reached the point where we can specify a single optimal rule for setting policy and turn decision-making over to a computer. Judgment is still required. Because we do not know the true model of the economy, I would suggest the FOMC begin by considering and reporting on a set of robust policy rules designed to have good results in a variety of models and across various stages of the business cycle. Such robust rules recognize that data are measured imprecisely and are subject to revision. By considering such robust rules, the FOMC might be able to move toward a consensus on a qualitative description of its reaction function as an important first step. For example, we would not have to specify the precise mathematical rule but would provide assessments of key variables and then communicate our policy decisions in terms of changes in these key variables. If policy were changed, then we would explain that change in terms of how the variables in our response function changed. If we choose a consistent set of variables and systematically use them to describe our policy choices, then the public will form more accurate judgments about the likely course of policy. That will reduce uncertainty, promote stability, and lead to greater transparency. Increasing transparency As I mentioned at the outset, communications has been the subject of considerable discussion in recent years. It took on heightened importance as the FOMC responded to the financial crisis and recession. Since December 2008, the federal funds rate target has been near zero. Since the nominal federal funds rate cannot go below zero, we had to develop alternative policy tools in an effort to provide further accommodation to support the recovery, such as the large-scale asset purchase program. We also had to figure out how and what to communicate about these new tools. The asset purchase program has had many dimensions, such as the overall volume of purchases, the pace of purchases, the kind of assets targeted for purchase, and the criteria for starting and stopping the purchases. Policymakers have tried to fine-tune the program along each dimension while assessing the tradeoffs among them and the tradeoffs with other policy tools, such as the traditional funds rate decision. With so many moving parts to our policy framework, it is not surprising that communication is very complicated and challenging. The task was further complicated because one of the unconventional measures employed by the FOMC was so-called forward guidance. Forward guidance is the central banker’s term for communications about the future path of policy. One way to think of forward guidance is that it is just another step toward increased transparency and effective communication of monetary policy. However, another rationale for forward guidance is that it is a way of increasing accommodation in a period when the policy rate is at or near the zero lower bound. Some models suggest that when you are at the zero lower bound, it can be desirable, or optimal, to indicate that future policy rates will be kept “lower for longer” than might BIS central bankers’ speeches otherwise be the case. In this approach, such a commitment would tend to raise inflation expectations and lower long-term nominal rates, thereby inducing households and businesses to spend more today. This approach asks more of forward guidance than just articulating a reaction function. It takes more credibility and commitment because it requires policymakers to directly influence and manage the public’s beliefs about the future policy path in ways that are different from how they may have behaved in the past. As I have indicated in previous speeches, this approach to forward guidance can backfire if the policy is misunderstood. 5 5 For example, if the public hears that the policy rate will be lower for longer, it may interpret this news as policymakers saying that they expect the economy to be weaker for longer. If the message is interpreted in that way, then the forward guidance will not succeed and may even weaken current spending. I believe we should think of forward guidance as part of systematic approach to decisionmaking and not an independent policy tool that attempts to bend expectations. As monetary policy becomes normalized, we have the opportunity to ensure the public understands that forward guidance is an integrated part of a systematic approach to policy. So, what additional steps can we take to increase transparency? I think that the FOMC could improve communication and transparency by preparing a more comprehensive monetary policy report on a regular basis, perhaps quarterly. Currently, the Chair testifies before Congress twice a year and submits an accompanying written report. In addition, the Chair holds press briefings four times a year when participants present their economic projections. I think there is an opportunity to combine these efforts into a more comprehensive report on monetary policy as many other countries do. The report would offer an opportunity to reinforce the underlying policy framework and how it relates to current and expected economic conditions. Ideally, this report would incorporate a discussion of robust systematic rules I referred to a moment ago. Such a discussion would provide the opportunity to inform the public about the expected future path of policy conditioned on how the economy evolves. Publishing a monetary policy report with an assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, would also provide added discipline for policymakers to stick to a systematic, rule-like approach. Providing information about how that path is likely to evolve forces policymakers to think more deeply and systematically about policy. Communication about that path, in turn, gives the public a much deeper understanding of the analytical approach that guides monetary policy. While I am discussing transparency, I also want to touch on another misconception. Some commentators express the view that dissent causes dissonance and therefore confuses the communications. In fact, letting the public know about our debates and differing views is more transparent than hiding behind false consensus. Monetary policymaking is conducted by committee, and divergent views can and often do exist. While this can be clumsy at times, such governance mechanisms have great strength in preventing institutions from lapsing into groupthink by ensuring that various views are heard in an environment that promotes better decisions and outcomes, and they help to preserve the central bank’s independence and accountability. Open dialogue and diversity of views leads to better policy decisions and is the primary means by which new ideas are gradually incorporated into our monetary policy framework. Thus, I believe diversity of thought is a sign of thoughtful progress. I have often quoted the famous American journalist Walter Lippmann who said, “Where all men think alike, no one thinks very much.” I think it is healthy for the American public to know that we debate some See Charles I. Plosser, “Forward Guidance,” speech to the Stanford Institute for Economic Policy Research’s (SIEPR) Associates Meeting, February 12, 2013, Stanford, CA. BIS central bankers’ speeches of the same issues that those outside the Fed debate. Hiding such debate behind a unanimous vote does nothing to promote true transparency. Preserving independence Finally, I believe that the fundamental concept of a decentralized central bank has great merit, in part, because it helps to preserve the independence and maintain the public trust in the institution. Independence is essential if a central bank is to play its fundamental role in preserving the purchasing power of a fiat currency. History is replete with examples of governments using the power to print money as a substitute for making tough fiscal choices, and the results are almost always disastrous. Central bank independence is a fundamental tenet of sound central banking and leads to better economic outcomes. But independence must be accompanied by accountability. And accountability is more easily achieved when there is transparency. The public can best hold a central bank accountable when its goals are clearly stated and achievable. Transparent and clear communications of monetary policy goals and a decision-making framework help ensure accountability and preserve central bank independence. Transparency can also enhance a central bank’s credibility. A central bank that is transparent will be less willing to make promises it cannot keep. When policy pronouncements are more credible, policy is more effective. Transparency can also make it easier to explain changes in policy without damaging the central bank’s credibility. Conclusion To summarize, the FOMC is on a journey to improve communications and the transparency of its monetary policy decision-making process. The benefits of transparency are now accepted by policymakers across the globe. Transparency not only improves the effectiveness of monetary policy, it also improves the central bank’s credibility and accountability with the public. The FOMC’s recent moves to publish guidelines on its longerrun goals and policy strategy and the policy assumptions that underlie FOMC projections are great strides toward this goal. However, more can be done. In particular, I believe the FOMC should continue to work toward increasing the public understanding of how policy will react systematically to changes in economic conditions. I believe the FOMC should move forward to describe a reaction function and then communicate our actions and decisions in terms of this reaction function. A detailed monetary policy report could be a useful vehicle for such enhanced communication. Because systematic policy is easily communicated to the public, it will improve the transparency and predictability of monetary policy, which reduces policy surprises. Businesses and consumers are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances even if they are not certain what those economic conditions might be. Equally important in my view is that greater clarity about policymakers’ reaction function strengthens accountability. Thus, systematic policy, communicated transparently, strengthens accountability and serves to preserve the central bank’s independence. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 10 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Lehigh Valley Partnership and Lehigh Valley Economic Development Corporation, Allentown, Pennsylvania, 16 October 2014. | Charles I Plosser: The economic outlook and monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Lehigh Valley Partnership and Lehigh Valley Economic Development Corporation, Allentown, Pennsylvania, 16 October 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the regional and national economy and discusses why he remains optimistic about the economic prospects ahead. • President Plosser shares some thoughts about the stance of monetary policy. He also explains why he departed from the majority view at the July and September Federal Open Market Committee (FOMC) meetings. • While he is not suggesting that rates should necessarily be increased now, President Plosser believes that the FOMC’s forward guidance should be adjusted to reflect economic realities and to give the Fed the flexibility to respond sooner and more gradually to the evolution of the economy. Introduction I want to thank Scott Fainor, the Lehigh Valley Partnership, and the Lehigh Valley Economic Development Corporation for sponsoring this breakfast. One month from today, on November 16, 2014, we will mark the 100th anniversary of the date when the 12 Federal Reserve Banks, each independently chartered by Congress, first opened their doors to begin serving our nation’s economy. That opening day in Philadelphia and in the other 11 cities was the outcome of the Federal Reserve Act, which was signed into law by President Woodrow Wilson on December 23, 1913. Wilson is credited with engineering a compromise that created our nation’s decentralized central bank. To balance economic and geographic interests, Congress created a Federal Reserve System of regional Reserve Banks with oversight provided by a Board of Governors in Washington, D.C. This decentralized structure is one of our great strengths and mirrors the federalist framework of the nation. However, it requires that I begin by reminding you that the views I express this morning are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Since we are so close to this centennial milestone, I thought I would begin with a little background about how the Fed works and how we are structured before I offer some thoughts on the economic outlook and monetary policy. Exactly what are these nearly 100-year-old institutions? The Reserve Banks perform several roles. They distribute currency, act as a bankers’ bank, and serve as the bank for the U.S. Treasury. They also play a critical role in supervising many banks and bank holding companies across the country. The 12 Reserve Banks also serve as the eyes and ears of our central bank in assessing the economic pulse of Main Street as it formulates and implements monetary policy. Each Reserve Bank has a nine-member board of directors selected to represent a crosssection of banking, commercial, and community interests. These directors fulfill the traditional governance role, but they also provide valuable insights into economic and financial conditions, which contribute to our assessment of the economy. BIS central bankers’ speeches The Reserve Banks seek to stay in touch with Main Street in other ways. Some have Branch offices with their own boards, and all have a variety of advisory councils. The Federal Reserve Banks also collect and analyze data about economic activity. However, published data are generally looking backward at the last month or the last quarter. So, the viewpoints we gather through our boards and advisory councils, and our outreach to businesses and communities through events like this help us add a real-time perspective to the data and help us form a rich and detailed mosaic of our nation’s economy. Within the Federal Reserve, the body that considers this mosaic as it makes monetary policy decisions is the FOMC. Here again, Congress has designed the System with a number of checks and balances. Since 1935, the composition of the FOMC has included the seven Governors in Washington, D.C., who are appointed by the President of the United States and confirmed by the Senate, as well as the president of the New York Fed, and four other Reserve Bank presidents, who serve one-year terms as members on a rotating basis. Philadelphia votes this year, but whether we vote or not, all Reserve Bank presidents attend the FOMC meetings, participate in the discussions, and contribute to the Committee’s assessment of the economy and the policy options. The FOMC has eight regularly scheduled meetings each year to set monetary policy. In normal times, the Committee votes to adjust short-term interest rates to achieve the goals of monetary policy that Congress has set for us. The goals for monetary policy are articulated in the Federal Reserve Act and specify that the FOMC “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Since moderate long-term interest rates generally result when prices are stable, many have interpreted these instructions as being a dual mandate to promote maximum sustainable employment and price stability. Economic conditions So, with that background, let me turn to an overview of the U.S. economy as we enter the fourth quarter of 2014. The economic expansion began more than five years ago in June 2009. While the pace has been sluggish and uneven, I believe progress is undeniable. In fact, I remain optimistic about the prospects ahead. This year began with a harsh winter, which proved to be highly disruptive to the economy. Gross domestic product (GDP) declined at a 2.1 percent annual rate in the first quarter. But second-quarter GDP growth rebounded to 4.6 percent, according to the most recent estimates. In the second quarter, the strongest recoveries were in categories that were most directly affected by the first quarter’s severe weather, including investment in equipment, residential structures, inventory accumulation, and exports. Personal consumption, the largest spending sector of the economy, slowed during the first quarter to 1.2 percent. After all, it is hard to go shopping when snow and ice keep you from getting out of your house or driveway. In the second quarter, personal consumption growth roughly doubled to 2.5 percent. Purchases of durable goods, such as automobiles, advanced at an annualized rate of 14.1 percent. I anticipate that consumer and business spending will help real GDP to grow at about 3 percent for the remainder of this year and next before reverting to trend, which I see as about 2.4 percent. The Philadelphia Fed’s Manufacturing Business Outlook Survey has proven to be a reliable indicator of national manufacturing trends in the U.S. We will get October’s reading just after this meeting at 10 a.m., but September’s reading was the seventh consecutive month in positive territory. The survey’s future activity indexes remained at high readings, suggesting continued optimism about manufacturing growth. In late September, the Bank also officially launched a monthly Nonmanufacturing Business Outlook Survey, which we have been BIS central bankers’ speeches conducting since March 2011. The latest results from nonmanufacturing firms suggest continued expansion in the region. The jobs report for September was also very strong, with employers adding 248,000 jobs in the month nationwide. Additionally, the initial low estimate for August was revised upward, as was the estimate for July. These revisions added 69,000 more jobs. In all, employers have added more than 2 million jobs thus far in 2014, at an average pace of 227,000 per month through September. The unemployment rate fell to 5.9 percent, marking its lowest level since July 2008 and well below the 6.7 percent we experienced in December 2013. Even the broader U6 measure, which includes discouraged workers and involuntary part-time workers, dropped to 11.8 percent, its lowest since October 2008 and down from 13.1 percent in December 2013. The unemployment rate continues to fall faster than many policymakers had been forecasting. For instance, in the Summary of Economic Projections (SEP) submitted in December 2013, the central tendency of FOMC participants was an unemployment rate of 6.3 to 6.6 percent at the end of 2014, and by the end of 2015, the central tendency was expected to be 5.8 to 6.1 percent. We have clearly exceeded these expectations. The unemployment rate is now below where the Committee thought it would be at the end of 2014 and is now within the range expected at the end of 2015. Thus, it is fair to say that we are at least a year ahead of where we thought we would be when we started to taper asset purchases. In fact, in September, the central tendency was lowered yet again to 5.9 from 6.0 percent for 2014 and to 5.4 from 5.6 percent by the end of 2015. We reached our yearend number for 2014 weeks later. How soon will we reach the year-end 2015 number? In Pennsylvania, job growth has been positive as well. The state added more than 47,000 jobs over the past 12 months. The August unemployment rate in Pennsylvania was 5.8 percent, down 1.6 points from a year ago and down from a peak of 8.7 percent immediately following the recession. This is not to claim that all is rosy in the labor markets. Many Americans remain frustrated and disappointed in their jobs and job prospects. For example, a large contingent of those working part time for economic reasons would like to be working full time. Nonetheless, we have to acknowledge that significant progress has been made. Inflation remains somewhat below the FOMC’s long-run goal of 2 percent, but it appears to be drifting upward. Headline inflation as measured by year-over-year change in the consumer price index, or CPI, was 1.7 in August, down from 2 percent in July. That broke a four-month streak of inflation at or above the 2 percent level. The Fed’s preferred measure of inflation is the year-over-year change in the price index for personal consumption expenditures, or PCE inflation. In December 2013, inflation stood at 1.2 percent. The most recent reading for August 2014 was 1.5 percent. Compare that with the December 2013 SEP estimates for 2014, and you will find that we are currently in line with the FOMC’s central tendency of 1.4 to 1.6 percent for PCE inflation. In the September SEP, FOMC participants left their assessment of inflation unchanged with a central tendency for PCE inflation by the fourth quarter of 2014 to between 1.5 and 1.7 percent. The Philadelphia Fed’s most recent Survey of Professional Forecasters also increased its average estimate of headline PCE inflation to 1.8 percent in 2014, up from 1.6 percent in the last survey. The survey also increased the estimate of PCE inflation to 2.0 percent in 2015, up 0.1 percentage point from the previous estimate. The FOMC has stated that it expects the inflation rate to gradually rise to the 2 percent target, and I agree with that assessment. Since last year, the economy has moved closer to the Committee’s goals and has done so more quickly than anticipated. Yet, the stance of policy and its projected path provided by the Committee have not changed. BIS central bankers’ speeches Monetary policy So, let me turn to some thoughts on monetary policy, including why I departed from the majority view at the July and September FOMC meetings. The Fed has taken extraordinary monetary policy actions, keeping the federal funds rate near zero for nearly six years and expanding its balance sheet to more than $4.5 trillion. Yet, the recovery began over five years ago, and the unemployment rate has declined from 10 percent in October 2009 to 5.9 percent now. Whether you believe that the labor market has fully recovered or not, it is clear that we have made considerable progress toward full employment and price stability. We are no longer in the depths of a financial crisis nor is the labor market in the same dire straits it was five years ago. In its July and September statements, the FOMC reaffirmed its highly accommodative stance. The statements noted that “in determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation.” In assessing this progress, the Committee reported that it will look at a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The FOMC also noted, based on its assessment of these factors, “that it likely will be appropriate to keep its target federal funds rate near zero for a considerable time after the asset purchase program ends ...” I objected to this forward guidance regarding the expected timing for raising the funds rate because I believe this language is no longer appropriate or warranted. Appropriate monetary policy must respond to the data. I believe that by indicating that the FOMC continues to anticipate that it will be a “considerable time” after the end of asset purchases before it is likely that the Committee will raise interest rates does not reflect the significant progress made toward our goals. It also limits the Committee’s flexibility to take action going forward. We have moved much closer to our goals since last December, and, accordingly, the stance of monetary policy should reflect such progress and begin to adjust gradually. That is the essence of being data dependent. In the current context, we must acknowledge and thus prepare the markets for the fact that interest rates may begin to increase sooner than previously anticipated. I felt that adjusting our language was the appropriate first step in responding to better-than-anticipated economic conditions. My view is informed, as I have indicated, by realized and projected economic progress toward our goals. But it is also influenced by guidance gained from the historical conduct of past monetary policy. In particular, my views on the appropriate funds rate setting are – and continue to be – informed by Taylor-type monetary policy rules that depict the past behavior of monetary policy in response to deviation from its desired inflation target and economic activity from its natural or efficient level. I find such rules useful for benchmarking my policy prescriptions. These rules have been widely investigated and have been shown to be robust in that they deliver good results in a wide variety of models and circumstances. The guidance I take from such robust rules is that we should no longer consider monetary policy as being constrained by the zero lower bound. A variety of these rules, which I discussed in a speech earlier this summer, indicates that given the current inflation rate of just under our target of 2 percent and the current unemployment rate of 5.9 percent, the funds rate should be above zero or should be lifting off in the very near future. 1 In fact, maintaining a funds rate target near zero is unprecedented under such circumstances and as Charles I. Plosser, “Systematic Monetary Policy and Communication,” remarks to the Economic Club of New York, New York, NY, June 24, 2014. BIS central bankers’ speeches such could pose risks to the economy in the years ahead, including higher inflation and financial instability. I am not suggesting that rates should necessarily be increased now. Our first task is to change the language in a way that allows for liftoff sooner than many now anticipate and sooner than suggested by our current guidance. Raising rates sooner rather than later also reduces the chance that inflation will accelerate and require policy to become fairly aggressive with perhaps unsettling consequences. Thus, I believe that our forward guidance should be adjusted to reflect economic realities and to give us the flexibility to respond sooner and more gradually to the evolution of the economy. There is a point of view that rates cannot be raised because the labor market has not completely healed. That is, we must wait, maintaining our current stance of policy until we have achieved our goals. I think this is a risky strategy for three reasons. First, we do not know how to confidently determine whether the labor market is fully healed or when we have reached full employment. In January 2012, the FOMC affirmed in its statement of longer run goals and strategies that, “The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors, such as demographics or advancements in technology, may change over time and may not be directly measurable.” Chair Yellen gave an excellent speech at the Jackson Hole conference in August that highlighted some of the structural and nonmonetary factors affecting the labor market. Economists don’t fully understand how these factors may be influencing our efforts to assess the meaning and measurement of full employment. Second, if we wait until we are certain that the labor market has fully recovered before beginning to raise rates, policy will be far behind the curve. One risk of waiting is that the Committee may be forced to raise rates very quickly to prevent an increase in inflation. In so doing, this may create unnecessary volatility and a rapid tightening of financial conditions – either of which could be disruptive to the economy. This would represent a return of the so-called “go-stop” policies of the past. Such language was used to describe episodes when the Fed was aggressively providing monetary accommodation to stimulate employment and the economy – the go phase – only to find itself forced to apply the brakes abruptly to prevent a rapid uptick in inflation – the stop phase. This approach to policy led to more volatility and was more disruptive than many found desirable. A third risk to waiting is that the zero interest rate policy has generated a very aggressive reach for yield as investors take on either credit or duration risk to earn higher returns. While the Fed is attempting to monitor such behavior, it is difficult to know how or where the consequences of such actions may show up. It seems to me that the law of unintended consequences looms large in this arena. For these reasons, I would prefer that we start to raise rates sooner rather than later. This may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act. Conclusion In conclusion, I remain positive about the economic outlook. Second quarter growth has rebounded after the disappointing first quarter caused by the harsh winter. At the end of this month, we will get the first look at the third quarter, which I expect will help us reach an average of about 3 percent for the remainder of this year and in 2015, before settling back down to long-term growth levels of about 2.4 percent. BIS central bankers’ speeches The unemployment rate continues to improve more quickly than many had expected. We are now approaching the rate that many policymakers view as a long-run sustainable value. Inflation appears to be drifting up toward our 2 percent goal. Raising rates sooner rather than later reduces the chance that inflation will accelerate and, in so doing, require policy to become fairly aggressive with perhaps unsettling consequences. Waiting too long to begin raising rates – especially waiting until we have fully met our goals for maximum employment – is risky because we cannot know when we have arrived. That could also put monetary policy behind the curve and could lead to a return to abrupt go-stop policies that in the past have led to unwelcome volatility. Finally, delay is likely to increase the risk of overstaying our welcome at the zero bound, thus fostering unintended consequences for financial stability. If monetary policy is to be truly data dependent, then our stance of policy must begin to change. I’m not suggesting a rate increase now, but changing the forward guidance would at least afford us the flexibility to gradually raise rates beginning earlier than currently anticipated. 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Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the George Washington University and Princeton University s Griswold Center for Economic Policy Studies, Philadelphia, Pennsylvania, 13 November 2014. | Charles I Plosser: Economic growth and monetary policy – is there a new normal? Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, at the George Washington University and Princeton University’s Griswold Center for Economic Policy Studies, Philadelphia, Pennsylvania, 13 November 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the debate about a new normal for economic growth in the U.S. economy. • While some economists believe we are in a secular stagnation with low growth and reduced productivity that may persist for some time, President Plosser sides with those who think it is impossible to predict the state of future technology. • President Plosser notes, though, that monetary policy is not a tool that can fix such a secular stagnation in any case. Introduction I would like to thank George Washington University and Princeton University’s Griswold Center for Economic Policy Studies for organizing this event. I also am delighted to be here with my fellow panelists, Frank Schorfheide of the University of Pennsylvania, who is a regular visiting scholar at the Philadelphia Fed, Neal Soss of Credit Suisse, and, of course, our moderator, Binyamin Appelbaum of the New York Times. As usual, I should remind everyone that my remarks today are my own views and not necessarily those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). The question of whether we are facing the prospect of some sort of new economic normal or steady state growth path is a challenging one. Some have pondered whether the severity of the financial crisis and recession, or perhaps even the policy responses to these events, have ushered in a period of low growth and reduced productivity that may persist for some time. Others have suggested the seeds of a secular decline in growth predate the recession. This view stresses an evolving secular decline arising from a weakening in the rate of innovation and the productivity gains that such innovation often fosters. This view also points to demographic factors, such as an aging population, that will strain government programs that transfer resources from workers to the elderly. The evolution of longer-run growth also has implications for the longer-term real interest rate, which is largely determined by the growth in per capita consumption and the growth rate in population. In turn, the growth in per capita consumption depends on productivity gains and the share of the population engaged in production. The implications of these factors on the real interest rate is, of course, relevant for central bankers as they seek to set a policy rate to stabilize prices and promote sustainable growth. Yet, it is important to note that monetary policy is not capable of reversing or mitigating such secular slowdowns. Consequently, it is at best tangential to the efforts of a nation seeking to address secular declines in growth. In my brief time, I will highlight some of the issues underlying the views of a secular slowdown. That said, however, I want to emphasize that it is very hard to determine with any precision the longer-term growth rate of the economy. It often takes many years of data to BIS central bankers’ speeches establish any degree of confidence in asserting a change in a trend. As a result, it should come as no surprise that I do not have an answer for the question whether we are facing a new normal. Instead, I will offer observations on what I believe are some of the key issues that make such assessments so challenging. Long-run trends Let me start with the question of future productivity growth, since it is the most fundamental determinant of economic prosperity. Recently, Robert Gordon has advanced the notion that we are in for a bout of long-term secular stagnation. 1 His writings reflect the idea, also proposed by Tyler Cowen, that all the low-hanging fruit has been picked and that technological advances will become increasingly more difficult. 2 On the other hand, scholars such as Joel Mokyr, Erik Brynjolfsson, and Andrew McAfee do not see any reason to anticipate a long-lasting decline in human ingenuity. Gordon has produced some provocative research concerning the demise of economic growth in this country. He describes a number of headwinds, four of which are relevant for my discussion: slowing innovation, reduced growth in human capital due to a dysfunctional education system, slower population growth, and the associated changing age distribution. These four components are important because economic growth and the natural level of the real interest are directly affected by growth in total factor productivity. Further, slower growth in population or declines in participation rates due to aging, other things being equal, can reduce the natural or long-run real rate of interest and lower per-capita economic growth. Gordon’s view of stagnation is based on his evaluation of data over a long sweep of economic history. He has noted a decrease in total factor productivity, a decline in the growth rate of human capital, reduced hours per worker, and a decline in labor force participation rates. He dates the beginning of stagnation in these factors to 1972. For the 80 years before then, Gordon asserts that economic growth was sparked by three great inventions: the electric light bulb, the internal combustion engine, and wireless signals. He noted that these three inventions eventually led to rounds of spinoffs that transformed society. Gordon sees no such round of spinoffs from the IT revolution, biotech, or such advances as 3-D printing. 3 Economic historians such as Joel Mokyr are a bit more cautious, believing much as I do that it is nearly impossible to predict the state of future technology. 4 He notes that the 20th century experienced considerable technological advancement, even in the face of considerable headwinds, including two world wars, a cold war, and the Great Depression. Some might argue, however, that the world wars were not a headwind but a boost to technological advancement. It also may be that some impediments to innovation are not endemic to the nature or science of technological progress, but instead they are created by governments and thus can be reversed. For example, does increased regulation make the development of new drugs more costly and risky? Could the significant increase in financial regulation after the financial crisis reduce the productivity of intermediation and thus impede investment and possibly the rate of See Gordon, “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds” and “The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections.” See Cowen, The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better. Gordon believes that future developments from existing or even yet-to-be-invented technologies are reasonably predictable, for instance, citing Jules Verne as one such visionary. I don’t see why he then chooses to ignore the imagination of Gene Roddenberry: Think iPhones, needleless injections, and touchscreen computers, to name a few. See Mokyr, “The Next Age of Invention.” BIS central bankers’ speeches growth? Or have increased taxes on the returns to saving and investment to support transfer programs potentially reduced productivity growth? Regulatory and tax burdens can often act to reduce entrepreneurial activity and innovation and thus retard productivity growth. Such costs must be weighed against any perceived benefits of such burdens. Brynjolfsson and McAfee are very optimistic about the future. They believe that we are at an inflection point and that a substantial period of more robust economic growth awaits us in the not-too-distant future. 5 They point out that many revolutionary discoveries, such as DNA sequencing, occurred by creatively stringing together prior scientific procedures. They point out that the improvements in computational speeds and algorithmic developments are making computers capable of stringing together ideas, which could result in significant improvements in productivity. I believe technological advancement and the increased productivity it can foster is the overwhelming driving force behind economic growth. Demographic factors that may drive hours per worker and labor force participation are relatively insignificant when compared with innovation’s effects on productivity. After all, the remarkable growth of the 20th century occurred with a significant decline in the workweek from 60 hours to less than 40, as well as a significant increase in vacation or leisure time. It is hard to envision a decline of similar magnitude going forward. Thus, I continue to have faith in the promise of human ingenuity and do not envision the dire outcomes envisioned by Gordon. 6 That does not mean that we won’t experience spurts of unusually high- and low-productivity growth, but those periods are likely to be identified and understood only well after the fact. The arguments presented by both sides of the secular stagnation debate highlight that the future could unfold in very different ways. I think there is no doubt that longer-term growth rates can and do vary, and thus, longer-term real interest rates also vary. Yet, such movements tend to occur gradually and are very difficult to assess with any precision in real time. As my discussion suggests, we should focus on policies designed to enhance innovation and productivity if we are to continue to improve per capita consumption and general economic welfare. Monetary policy How do variations in the longer-term growth rate of the economy, and thus the longer-term real rate of interest, affect monetary policy? First, I want to reiterate that long-term growth is primarily determined by productivity growth. Monetary policy is not an appropriate tool for addressing perceived declines in productivity. However, assessments of long-run potential growth can influence the setting of monetary policy because they influence the steady-state or long-run real interest rate. If steady-state real rates are lower, then the so-called “neutral setting of monetary policy” would also be lower. That is, the neutral funds rate would be lower. The debate about a secular decline in growth today thus translates into a discussion of where, or how high, the neutral policy rate should be. So, the higher it is relative to the current funds rate, the more aggressive policy might have to be and vice versa. But there are other factors that could complicate the policy path. If potential output is lower in the future than previously thought, then there is likely to be less “slack” in the current economy than one might think. So, “output gaps” are likely to be smaller, which in many policy rules would suggest higher interest rates, other things being equal. While a lower steady-state real rate See Brynjolfsson and McAfee, The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies. Summers in “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound” offers different concerns. He argues that the real rate of interest may have declined to very low, or even negative, levels leading to the possibility of an inefficient equilibrium and a form of secular stagnation. BIS central bankers’ speeches may act to shift down the neutral rate, the effects on the dynamic path of policy as it returns to the neutral are somewhat more complex. While the expected neutral funds rate is something that may be relevant, estimating and communicating a value with any confidence would be challenging. Measuring longer-run trends is a difficult and delicate issue. Because expectations about monetary policy are important, particularly in financial markets, it may be useful for the FOMC to indicate what ranges are likely for the neutral federal funds rate. But given the uncertainties, this may be difficult and conveying a false sense of precision may prove to be counterproductive. So, I believe, adjustments to the perceived neutral funds rate should be done with great care and discipline. They should not be done in response to the typical cyclical fluctuations in real rates. Our ability to truly assess a significant shift in the longer-term real rate is quite limited, and, in the presence of such uncertainty and measurement error, one should be careful not to confuse the public. Conclusions In summary, there is a lively debate about the future of innovation and other factors that shape our prospects for growth. My own view is that human ingenuity and innovation will continue to be a source of productivity growth. But that does not mean we should be complacent about our future. Productivity is the ultimate means to economic prosperity, and we should undertake policies that promote innovation and technological progress and eliminate practices that discourage such progress. Monetary policy has a limited role to play in this endeavor except as it can promote a stable environment to allow these long-run forces to succeed. Yet, the appropriate setting of monetary policy can be affected by the longer-term trends. Failure to adjust to such trends can lead to deviations from a central bank’s inflation target. Yet, distinguishing short-run or transitory fluctuations from more permanent or persistent movements in growth and real interest rates is a tricky and difficult task. It is near impossible in real time. These considerations lead me to believe that monetary policymakers should take great care in making significant adjustments in their view of the neutral policy rate. We live in a constantly changing world and one that will hopefully be full of surprising new developments that enhance economic welfare. References Brynjolfsson, Erik, and Andrew McAfee. The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies. New York, NY: W.W. Norton & Company, 2014. Cowen, Tyler. The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better. New York, NY: Dutton Adult, 2011. Gordon, Robert J. “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds,” NBER Working Paper 18315, (August 2012). Gordon, Robert J. “The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections,” NBER Working Paper 19895, (February 2014). Mokyr, Joel. “The Next Age of Invention,” City Journal, (Winter 2014); www.cityjournal.org/2014/24_1_invention.html. Summers, Lawrence H. “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound,” Business Economics, Vol. 49:2 (April 2014), pp. 65–73. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 12 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Charlotte Economics Club, Charlotte, North Carolina, 3 December 2014. | Charles I Plosser: A longer-term view of the US economy and monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Charlotte Economics Club, Charlotte, North Carolina, 3 December 2014. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the U.S. economy and discusses why it is important to take a longer-term view of economic data. • President Plosser shares some thoughts about the stance of monetary policy and the advantages of raising rates gradually and starting sooner rather than being forced to raise them abruptly later. • President Plosser also discusses how policy rules can offer useful guideposts for policymakers and the public in assessing and communicating the stance of monetary policy. Introduction Thank you for the invitation to be here today. The Charlotte Economics Club has welcomed many leading Federal Reserve voices to this podium over the years, including a number of my fellow Fed presidents. You have heard from President Jeff Lacker of the Richmond Fed, which has its Charlotte Branch over on East Trade Street, as well as Presidents Richard Fisher of Dallas and Dennis Lockhart of Atlanta. So I am pleased to have been included among your distinguished guests. On November 16, the Federal Reserve observed the 100th anniversary of the opening of all 12 Federal Reserve Banks around the country on the same day. These institutions along with the Board of Governors in Washington, D.C., comprise our nation’s decentralized central bank. This decentralized structure is one of the System’s great strengths. Not only does it promote a diversity of views, but it also helps to build public trust and preserve independence. However, it requires that I begin by reminding you that the views I express today are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). Your program chair, Professor Rob Roy McGregor, has spent a great deal of his academic career studying the workings of the FOMC – including the use of power by the Chair and the nature of consensus building and dissent within the Committee. Interestingly, some of this work has been coauthored with a former colleague of mine at the Philadelphia Fed, Todd Vermilyea, who now works at the Board of Governors. Today, I plan to talk about the importance of taking a longer-term view in setting monetary policy. We live in a 24-hour news cycle that focuses a lot of time and energy on analyzing the tea leaves from the daily onslaught of new economic data at our disposal. Yet, I believe it is a mistake for policymakers to focus too intently on the most recent numbers to justify a policy decision. Our data are always noisy and often subject to substantial revision, as we just witnessed with last week’s GDP revisions and as we see regularly with the monthly employment report. Instead, we must focus our attention on the underlying trends and the likely path of the economy over the intermediate to longer-term horizon. BIS central bankers’ speeches One reason why policymakers must think long term is that the effects of monetary policy actions on inflation and employment may not be felt for many quarters and maybe years in the future. Thus, the near term path of the economy is unlikely to be altered in any significant way by today’s policy choices. We must look further ahead in assessing the appropriate stance of monetary policy. Of course, there is a great deal of uncertainty about the future and that too has implications for how we should approach policy. I will begin with a brief overview of the economy as one policymaker sees it as we near the end of 2014. Economic conditions Over the past year, we have seen encouraging signs in the economy. The most recent estimate of annualized real GDP growth in the third quarter was 3.9 percent, which followed strong growth in the second quarter of 4.6 percent. Taking a longer view, growth from the third quarter of last year to this year was 2.4 percent. But this includes a negative 2.1 percent growth rate in the first quarter of 2014 that was a consequence of a severe winter and was largely transitory in nature. We are seeing continued strength in personal consumption, especially in durable goods, as well as business fixed investment, which marked the strongest two quarter growth in investment by businesses in nearly three years. GDP growth has averaged 2.3 percent over the 21 quarters of the recovery since mid-2009. That is a half point below the 5-year growth rates measured during most of the 2000s before the recession, which is, in part, why this recovery is often seen as being moderate or modest from an historical perspective. Nonetheless, we have seen a sustained improvement in the manufacturing sector. The November reading from the Philadelphia Fed’s Manufacturing Business Outlook Survey indicated very strong growth in manufacturing activity. Even more encouraging are the sustained increases we have witnessed in this sector. After a mediocre performance from mid-2011 to mid-2013, the index has now been positive for nearly 18 consecutive months, with the only aberration in February 2014 during the depths of our severe winter weather. Our index is often viewed as a useful indicator of national manufacturing activity, and indeed the national ISM manufacturing index has also shown solid performance over the past 18 months. The labor market has also strengthened over the year. Employers added jobs at an average rate of 229,000 per month in the first 10 months of the year, which is 18 percent higher than the rate in 2013, and it’s the highest we have seen at any point in the recovery. This acceleration in job growth has helped bring the unemployment rate down to 5.8 percent as of October, compared with 7.2 percent a year ago. Over the course of this recovery, the unemployment rate has fallen from a peak of 10 percent in October 2009 to 5.8 percent today. Other measures of unemployment have also declined. For example, the measure called U6, which includes marginally attached workers and those working part time for economic reasons, has fallen from its peak of 17.2 percent to 11.5 percent. Inflation, for the moment, remains well contained. The personal consumption expenditures, or PCE, price index, the measure of inflation preferred by the FOMC, registered a 1.4 percent increase over the 12 months through October. It is running somewhat below the FOMC’s stated longer-term target of 2 percent, but it remains above the level that should stoke concerns of sustained deflation. Falling energy prices are generally good news for consumers and a favorable development for the economy going forward. In the short term, the decline in the relative price of energy will show up in lower headline inflation, but as energy prices stabilize, headline inflation will increase. Policymakers tend to look through such volatile and transitory price changes to assess the underlying trend in inflation. The core PCE index, which excludes food and BIS central bankers’ speeches energy, is a bit higher than the overall measure, increasing 1.6 percent over the 12 months through October. Other measures of inflation, including those that attempt to reduce the weight given to large outliers in any given month, all tend to suggest that inflation is running between 1.5 percent and 2 percent. Given the precision with which we can measure such things, I find this outcome satisfactory. Nevertheless, I anticipate that the FOMC will conduct policy over time in such a manner that inflation will gradually move toward the Fed’s 2 percent target. Private sector forecasters seem to share this view as the Philadelphia Fed’s most recent Survey of Professional Forecasters shows that long-term inflation expectations remain stable at 2 percent. Monetary policy In my discussion of the economy, I have emphasized the longer-run path of the recovery rather than the month-to-month fluctuations. Viewed in this context, it is clear that the economy has come a long way since the recovery began in June 2009. To me, that means we should no longer be conducting monetary policy as if we were still in the midst of a financial crisis or in the depths of a recession. The financial crisis was an extraordinary event, and much of the commentary on monetary policy has focused on the actions of central banks in response to the financial crisis. That is appropriate and understandable. Yet, there is another lesson to be learned from the past six years that I think is important to recognize. And that is how difficult it is for monetary policy to fine-tune real growth in the economy. Despite the FOMC’s stated desire and aggressive actions to accelerate the pace of the recovery, growth has proceeded at a moderate pace since the end of the crisis. Monetary policy has simply not proved to be the panacea that many had hoped. As I have argued on a number of occasions, I believe we have come to expect too much from monetary policy. We would be better served by greater humility and lowered expectations of the potential for monetary policy to manage real economic growth and employment. Ten years ago, I suspect most commentators would have told you that six years of a nearzero federal funds rate target and more than $3.5 trillion of long-term asset purchases by the Fed would likely produce an economic boom in the near term and would risk inflation in the longer term. Well, although we have experienced modest growth, we have not experienced a boom, and the jury remains out as to whether inflation will materialize as a consequence. Some argue that the absence of the boom is because the Fed didn’t do enough – more was needed to offset the constraint of the zero lower bound on nominal interest rates. Of course, there is an alternative hypothesis: Monetary policy was not capable of offsetting or mitigating the sorts of real challenges the economy was facing. Distinguishing between these two hypotheses will undoubtedly be the subject of intense research in the coming decades. After all, economists are still studying the policy choices and their effects during the Great Depression eight decades ago. But let me turn our attention to how monetary policy should evolve going forward. I began my remarks by noting that monetary policy should focus on the intermediate to longer term and be less sensitive or reactive to short-run and transitory movements in the data. To that end, I see the economy continuing to improve with real growth averaging about 3 percent in 2015 before coming back down to its long-term trend growth rate of about 2.4 percent. Employment will continue to expand, and inflation will move closer to our 2 percent target. While people can disagree about the extent to which the labor market has healed, it is clear that the labor market is in much better shape than it was in 2009 when unemployment reached its peak of 10 percent. The economy has come a long way, and monetary policy should reflect such progress. This progress suggests that monetary policy should begin to normalize. Keeping the funds rate target near zero when inflation is close to our goal and the economy is near full employment is both unprecedented and risky in my view. Waiting too long to begin the BIS central bankers’ speeches process of raising the policy rate risks facing the possibility that the rate may have to increase rapidly when the time comes and that could prove unnecessarily disruptive. And waiting could also risk a more rapid pickup in inflation. Of course, policymakers face many uncertainties, and so they must be prepared to adjust policy as the underlying trends in inflation and the real economy evolve. So, how should a central bank best inform the public about those uncertainties and the prospective path of policy? The appropriate way to communicate the future of policy is to describe in a general way a reaction function. That is to describe what key economic variables influence the setting of policy and to give a sense of how policy will change in response to changes in those variables. Over the past several years, I have criticized policy messages that suggest that calendar time is a relevant metric for determining a policy action. We must avoid such datebased forward guidance, whether it uses specific calendar dates or more vague references alluding to a “considerable period” of time. As policymakers, we do not know what the future holds, so forward guidance in this form cannot be very credible. Unfortunately, it is unlikely that policymakers will adopt a specific reaction function in the near term. Yet, there are numerous examples of such systematic approaches or reaction functions that can help us to gauge the stance of policy. Some of these reaction functions have been shown to be robust in a variety of circumstances and useful in describing past monetary policy behaviors. They can, I believe, provide useful guidelines for assessing the stance and the likely path of monetary policy. They can also be useful in communicating policy to the public. I frequently consider such reaction functions as I think about policy. These are typically Taylor-like rules named for the Stanford University economist John Taylor who first proposed them in the early 1990s. These policy rules typically call for the targeted funds rate to respond to deviations of inflation from some desired target and to deviations of output from some measure of potential – sometimes referred to as economic “slack” or the “gap.” Sometimes such gaps are translated into deviations from full employment. These policy rules can offer useful guideposts for policymakers and the public in assessing the stance of monetary policy, and communicating more about such guideposts would enhance transparency and help make policy more systematic. Thus, there is no need to mechanically follow any particular rule, and judgment will always be required. Yet, policymakers and the public should be very cautious when they call for policy rates to deviate in important or significant ways from these guideposts. Making such judgments should require careful analysis, and the justification for deviating from such guidelines should be clearly communicated to the markets and to the public. A monetary policy strategy such as I have just described could be communicated through a regular Monetary Policy Report, perhaps published quarterly. The report would offer an opportunity to reinforce the underlying policy framework of the Committee and how it relates to current and expected economic conditions. Publishing a Monetary Policy Report with an assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, would also provide added discipline for policymakers to stick to a systematic, rule-like approach. Communication about that path, in turn, gives the public a much deeper understanding of the analytical approach that guides monetary policy, thus making policy more transparent and predictable. In the current environment, an assessment of a variety of these robust rules suggests that the funds rate target is no longer constrained by the zero lower bound. These rules indicate that liftoff of the funds rate target from zero should have already occurred or should occur in the very near future. It is important to point out that all of these rules recognize and take into account the fact that the inflation rate remains somewhat below the FOMC’s target of 2 percent. Nevertheless, they do not call for maintaining the funds rate target near zero. BIS central bankers’ speeches These rules are helpful because they not only suggest when liftoff should occur, but they offer guidance about the future path of rate changes, given the likely direction of the economy – that is, forecasts of inflation and employment “gaps.” Even more important is that if the forecasts of the future change, these guideposts can highlight how the entire policy path is likely to evolve. As such, they are capable of better aligning the public’s expectations of policy with those of the FOMC, making the conduct of monetary policy more accountable and more efficient. Conclusion In conclusion, the U.S. economy continues to recover at a moderate pace. Although we have not witnessed the strong bounce back from the depths of the recession that some anticipated, the recovery has been somewhat remarkable in the steadiness with which it has progressed. Labor markets continue to heal, and their stronger-than-expected recovery should serve to underpin continued economic expansion. Consumer balance sheets are much improved, and individuals have regained significant fractions of the wealth they lost during the crisis. That gives me additional confidence that the economy is now operating fairly normally and that policy should reflect that normalization. Policy can also be made more transparent and effective by specifying more completely the variables that guide policy and the general way that one can expect policymakers to react to those variables. To this end, I believe the FOMC should move forward to describe in a qualitative way its reaction function and then communicate our actions and decisions in terms of this reaction function. A detailed Monetary Policy Report could be a useful vehicle for such enhanced communication by discussing a range of robust policy rules. Placing policy choices in such a context will lead to a more systematic approach to policy and one that is more transparent and predictable. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,014 | 12 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Greater Philadelphia Chamber of Commerce, Philadelphia, Pennsylvania, 14 January 2015. | Charles I Plosser: A perspective on the economy and monetary policy Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Greater Philadelphia Chamber of Commerce, Philadelphia, Pennsylvania, 14 January 2015. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Charles Plosser gives his views on the U.S. economy and discusses the importance of four principles to sound monetary policy. • President Plosser believes that the appropriate way to make policy systematic, or rule-like, is to base policy decisions on economic conditions. Monetary policy should be data dependent, not date dependent. • He thinks policymakers should describe the reaction function that determines how the current and future policy rates will be set depending on economic data. • President Plosser proposes the creation of a regular monetary policy report to help improve communication while enhancing the transparency and accountability of the Fed. Introduction Thank you, Richard (Green, CEO and vice chairman of Firstrust). I am delighted to speak with so many of Philadelphia’s business leaders this morning. A couple of years ago, Richard served on the Philadelphia Fed’s advisory council of community bankers and as our District’s representative to a similar council at the national level. So, he knows firsthand about the intricacies of the Fed’s structure as America’s decentralized, central bank, with 12 independently chartered Federal Reserve Banks, overseen by the Board of Governors in Washington, D.C. It is a model that has worked for a century, bringing together a rich mosaic of perspectives as we discuss policy. Yet, it requires that I remind the audience that the views I express today are my own and do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). I will begin with a brief overview of the economy. Yet, because you have already heard several views of the year ahead – including the report of your membership survey – I plan to spend most of my time giving you a longer-term perspective on what I think is a sound approach to monetary policy. Economic overview We began 2014 with a severe winter, which led to a first-quarter decline in GDP of 2.1 percent. After that bleak start, though, we saw robust GDP growth in the second and third quarters of 4.6 percent and 5.0 percent, respectively. The third-quarter estimate was the strongest quarterly growth in more than a decade. More important, four of the past five quarters have seen growth rates of 3.5 percent or more, with only the wintry first quarter as the exception. The Philadelphia Fed’s Survey of Professional Forecasters estimated that fourth-quarter growth would moderate to 2.7 percent. Some recent tracking estimates are now placing it over 3 percent. We won’t know what the official first estimate will be until the end of this month, but even that slight slowdown would lead to full-year growth in 2014 that is a bit higher than many had expected. BIS central bankers’ speeches Looking forward, I believe we will see growth averaging about 3 percent in 2015 before edging down to a long-term trend growth rate of about 2.4 percent. Recent data also show a stronger contribution from consumer spending, which accounts for more than two-thirds of the GDP. Significant improvement in household balance sheets and a stronger employment picture have helped support a more confident consumer. Real personal consumption expenditures (PCE) have grown at a 4.5 percent annual pace over the past three months. Manufacturing also continues to show strength. Recent figures from the Philadelphia Fed’s Manufacturing Business Outlook Survey, the national ISM manufacturing index, and industrial production all indicate that the manufacturing sector is expanding at a healthy pace. Strong consumer and business spending has supported consistent gains in the labor market. Nonfarm employment expanded by 252,000 jobs in December, giving us 11 consecutive months of 200,000-plus job growth. For the full year, we had average monthly gains of 246,000 in 2014, compared with 194,000 in 2013. In fact, we added nearly 3 million jobs in 2014, the most in a calendar year since 1999. Those job gains have led to a steady decline in the unemployment rate, which is now 5.6 percent, down more than a point from a year ago. Even the broader measure of unemployment, referred to as U-6, which includes marginally attached workers and those working part time for economic reasons, has fallen to 11.2 percent. Inflation is running at about 1.5 percent, which is below the Fed’s long-term target of 2 percent, as measured by the year-over-year change in the price index for PCE. Yet, I and many other economists anticipate that inflation will gradually move toward the target as the transitory effects of lower oil prices fade. In summary, I believe the economy has returned to a more normal footing, and as such, I believe that monetary policy should follow suit. In doing so, I believe we should strengthen our commitment to four fundamental principles of sound central banking. During the past eight years, I have spoken and written frequently about ways to improve the framework we use for making monetary policy decisions. In my view, the monetary policy framework is most effective when the central bank: • commits to a set of clearly articulated objectives that can be feasibly achieved by monetary policy; • conducts monetary policy in a systematic, rule-like manner; • communicates its policies and actions to the public in a clear and transparent way; and • protects its independence by being transparent and credible in pursuit of its goals. Clearly articulating objectives Let’s consider these four principles, beginning with clearly articulating the objectives of monetary policy. Congress set our monetary policy goals in the Federal Reserve Act, which specifies that the Fed “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate longterm interest rates.” Since moderate long-term interest rates generally result when prices are stable, many have interpreted these goals as a dual mandate to manage fluctuations in employment in the short run while preserving price stability in the long run. In my view, this dual mandate has contributed to a view that monetary policy can accomplish far more than perhaps it is capable of achieving. I believe that assigning multiple objectives for the central bank has opened the door to highly discretionary policies, which can be BIS central bankers’ speeches justified by shifting the focus or rationale for action from goal to goal. That is why I have argued that Congress ought to redefine the Fed’s monetary policy goals to focus solely, or at least primarily, on price stability. I base this on two facts: Monetary policy has a very limited ability to influence real variables, such as employment. Even the FOMC’s own statement of longer-run goals adopted in 2012 notes that the maximum level of employment is largely determined by nonmonetary factors, such as changing demographics and changing tax and regulatory policies that influence the labor market. Conversely, in a regime with fiat currency, only the central bank can ensure price stability. Indeed, it is the one goal that the central bank can achieve over the longer run. Setting clear, achievable objectives is the first part of the framework. Asking policymakers to pursue those objectives in a systematic, rule-like approach is the second key principle. The benefits of systematic monetary policy So, what do I mean by a systematic approach to policy? Quite simply, I mean conducting policy in a more rule-like manner. You often hear Fed officials say that policy decisions are “data dependent” and, indeed, they are. This means that future policy actions are conditional on how the economic data unfold. We may not know what the future holds or what future policy decisions will be, but we can choose to make those decisions in a systematic way based on the incoming economic data. I have long advocated this approach to “rule-like” policymaking. 1 Of course, the alternative to rule-like policy is discretionary policy, in which policymakers are free to choose whatever action seems appropriate or convenient at the time. Rules act as restrictions on policymakers’ choices – limiting the degree of discretion. But this is not a bad thing; rather, it can result in better economic outcomes in the long run. This is accomplished in part by reducing the risk of very bad discretionary decisions, such as those that occurred in the 1970s. Moreover, for more than 30 years, we have known that a credible commitment by policymakers to behave in a systematic rule-like manner leads to better outcomes than discretion by reducing policy uncertainty. 2 More specifically, rules work better than discretion because they are transparent and therefore allow for simpler and more effective communication of policy decisions. This allows households and businesses to more accurately form expectations and thus make better decisions. As a result, systematic policy promotes a more stable, predictable, and efficient economy. I want to emphasize that monetary policy should be data dependent, not date dependent. In my last vote as a member of the FOMC in December, I dissented, in part because I believe the language of the statement was still trying to communicate policy in terms of time. Whether the Committee states that it will be “patient” or that it will wait a “considerable time,” the language continues to stress the passage of time as a key determinant of policy, rather than making clear that policy will depend on the data. Describing policy in terms of time could also risk limiting the Committee’s flexibility to respond to the data if we continue to see an improving economy. Instead, I believe we should describe how we will respond to the data; that is, we should describe a reaction function. I frequently consider such reaction functions as I think about policy. These are typically Taylor-like rules, named for Stanford University economist John See Charles I Plosser, “The Benefits of Systematic Monetary Policy,” speech given to the National Association for Business Economics, Washington Economic Policy Conference, Washington, D.C. (March 3, 2008). Finn E Kydland and Edward C Prescott, “Rules Rather Than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, 85 (June 1977), pp. 473–491. BIS central bankers’ speeches Taylor who first proposed them in the early 1990s. These policy rules typically call for the targeted funds rate to respond to deviations of inflation from some desired goal and to deviations of output from some measure of potential – sometimes referred to as economic “slack” or the “gap.” Sometimes such gaps are translated into deviations from full employment. Such robust rules recognize that data are measured imprecisely and are subject to revision. Moreover, they have been shown to perform well in a variety of models and conditions. I believe these robust rules can be useful guideposts for policymakers and the public in assessing the stance of monetary policy and its expected path. Communicating about such guideposts would enhance transparency and help make policy more systematic. However, I don’t believe that we need to follow rules mechanically. Judgment will always be required. Yet, policymakers and the public should be very cautious when they call for policy rates to deviate in significant ways from these guideposts. Making such judgments should require careful analysis, and the justification for deviating from the guidelines should be clearly communicated to the markets and to the public. Thus, policymakers will still be able to exercise discretion, but using rules as guideposts will enhance transparency and effective communication. Improving transparency This leads me to my third important principle for monetary policy – communicating in a clear and transparent way. In recent speeches, I have proposed that the FOMC could improve communication and transparency by publishing a more comprehensive monetary policy report on a regular basis, perhaps quarterly. 3 This report could incorporate a discussion of such robust systematic rules I referred to a moment ago in its description of the underlying policy framework. The rules could serve as a benchmark for the current stance of policy and the expected path of policy, based on economic data. At the end of December, the Philadelphia Fed issued an example of what such a discussion might look like in a monetary policy report. We used a set of policy rules to benchmark the current stance and path of policy and discussed the implications. 4 The report showed that the federal funds rate is no longer constrained by the zero lower bound under a number of these rules. In fact, the rules indicate that maintaining the federal funds rate at the zero lower bound is unusually accommodative by historical standards. The benchmarks suggest that as the economy transitions to full employment and moves closer to its long-run inflation target, we should begin to gradually reduce accommodation by raising the funds rate target. Delaying liftoff runs the risk of requiring more aggressive future monetary policy than would otherwise be needed. However, if the Committee felt it was desirable to further delay the initiation of interest rate increases, such a report would provide the opportunity, indeed the obligation, for a thorough and thoughtful discussion about why discretionary deviations from the guideposts were appropriate. Thus, publishing a monetary policy report with an assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, would be a useful exercise and See Charles I Plosser, “Systematic Monetary Policy and Communication,” remarks to the Economic Club of New York, New York, NY, June 24, 2014; and Charles I Plosser, “Monetary Rules: Theory and Practice,” remarks to the Hoover Institution, Stanford, CA, May 30, 2014. See http://www.philadelphiafed.org/research-and-data/publications/special-reports/2014/1231-using-rules-forbenchmarking.pdf. BIS central bankers’ speeches enhance communications. It would also provide added discipline for policymakers to stick to a systematic, rule-like approach. And it would force policymakers to think more deeply and systematically about policy and the justification for significant deviations from the guideposts. Preserving independence I believe such communication would ultimately strengthen the independence of the central bank, which is the fourth and final principle of sound central banking. Central bank independence leads to better economic outcomes. But in a democratic society, independence must be accompanied by accountability. Transparent and clear communication of monetary policy goals and a decision-making framework help ensure accountability and preserve central bank independence. Transparency can also enhance a central bank’s credibility. A central bank that is transparent will be less willing to make promises it cannot keep. And accountability is more easily achieved when there is transparency. The public can best hold a central bank accountable when its goals are clearly stated and achievable. Broad, ill-defined goals, on the other hand, reduce accountability and invite discretionary policies that can undermine the public trust and thus jeopardize independence. This is one reason why I have been concerned about credit allocation initiatives by the Fed that treated some creditors more favorably than others in bailouts and that sought to provide special support to the housing sector through its purchases of mortgage-backed securities. Such credit allocation decisions more appropriately rest with the fiscal authorities, not the central bank. By pushing these boundaries, the Fed puts its independence at risk. Conclusion In conclusion, the U.S. economy continues to improve. Although we have not witnessed the strong bounce back from the depths of the recession that some anticipated, the recovery has been remarkably steady. Labor markets continue to heal, and their stronger-than-expected recovery should serve to underpin continued economic expansion. Consumer balance sheets are much improved, and households have regained much of the wealth they lost during the crisis. That gives me additional confidence that the economy is now operating normally and so should monetary policy. As we normalize policy, I believe we should follow four principles. The Fed should ensure that it has clearly articulated objectives that can be achieved by monetary policy, with price stability as the primary objective. It should pursue its objectives in a systematic, rule-like manner and help the public understand how policy will react systematically to changes in economic conditions. I believe a detailed monetary policy report could be a useful vehicle for such enhanced communication of policy, which will improve the transparency and predictability of monetary policy, which ultimately reduces policy surprises. Businesses and consumers are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances, even if they are not certain what those economic conditions might be. Equally important in my view is that greater clarity about policymakers’ reaction function strengthens accountability. So, systematic policy, communicated transparently, strengthens accountability and credibility and, thus, serves to preserve the central bank’s independence. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,015 | 1 |
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Union League of Philadelphia, Philadelphia, Pennsylvania, 17 February 2015. | Charles I Plosser: An appreciation of the Fed’s 12 banks Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, to the Union League of Philadelphia, Philadelphia, Pennsylvania, 17 February 2015. * * * The views expressed are my own and not necessarily those of the Federal Reserve System or the FOMC. Highlights • President Plosser highlights the history of the Federal Reserve and why he believes our central bank’s unique structure has withstood the test of time. • He believes a key strength of the Federal Reserve is the vibrant role the 12 independent Reserve Banks maintain in operations and policymaking. • President Plosser defends central bank independence. He discusses the importance of the central bank in making monetary policy decisions without fear of direct political interference. • He explains that he does not support the “audit the Fed” movement because he believes it would lead to greater political interference in monetary policy decisions. He states this proposal would reduce the independence of the central bank through the threat of a political action in real time. Introduction Thank you, Dr. (Karen) Lawson, for that kind introduction and thanks to the Union League’s Public Affairs Committee and the Business Leaders Forum for inviting me here today for what will be my final public speech as president of the Federal Reserve Bank of Philadelphia. For more than eight years, I have had the honor of working alongside many talented colleagues here in Philadelphia and throughout the Federal Reserve System during an extraordinary period in this nation’s economic history. I came to Philadelphia in 2006 after more than three decades in academia, where much of my research and teaching centered on the subjects of macroeconomics, monetary theory, and finance. Serving as president of the Philadelphia Fed has given me a rare opportunity to combine three roles: first, to lead an extraordinary organization, as I did as dean of the Simon School of Business in Rochester; second, to serve as a monetary policymaker, and third, to continue a lifelong role as an educator, through speeches like this one today, to help people understand the economy, monetary policy, and the role of the Fed. It has been a fascinating yet challenging time to serve. As I look back, I had about a year to settle in before facing a global financial crisis, the ensuing recession, and more than five years of a slow, but steady, climb back to normalcy. Today, I would like to take a step back from the day-to-day economic picture and give you a personal appreciation of America’s decentralized, central bank, made up of 12 independently chartered Federal Reserve Banks and the Board of Governors in Washington, D.C. It is customary to mention that these views do not necessarily reflect those of the Federal Reserve System or my colleagues on the Federal Open Market Committee (FOMC). But it won’t be long until such a caveat will no longer be necessary. BIS central bankers’ speeches Historical roots It is not unusual to hear questions like, “Why are there 12 Federal Reserve Banks and do we really need so many?” “Why are the 12 presidents involved in monetary policy?” “Wouldn’t policy be more effective if it was delivered without the “cacophony” of so many voices expressing different views?” While I understand these perspectives, I think these arguments miss the fundamental point driving the Federal Reserve’s governance structure. Americans have a long history of suspicion toward the concentration of authority. So, our uniquely American form of a central bank seeks to strike a balance between centralization and decentralization, between the public and private sectors, and among Washington, Wall Street, and Main Street. This balancing is critical to ensuring accountability and reducing the risk that the institution would be captured by private or political interests. To understand how it came to be, it is useful to review a little history. Just a few blocks from the Philadelphia Fed stand the vestiges of our country’s two earlier attempts at a central bank, dating back to the early years of our nation when Philadelphia was the major financial and political center of the country. The first institution was the brainchild of our first Treasury secretary Alexander Hamilton. His efforts led to the creation of the First Bank of the United States, which was awarded a 20-year charter by Congress in 1791. Although the First Bank’s charter was not renewed, the inflation and economic turmoil following the War of 1812 convinced Congress to establish the Second Bank of the United States. It was also given a 20-year charter and operated from 1816 to 1836. However, its charter was not renewed – Congress could not override the veto of President Andrew Jackson, who led the opposition to the central bank. Public distrust of centralized power was an important factor in the demise of both banks. Both became entangled in politics, and both failed to gain the public’s confidence to serve our vast and diverse country of bakers and bankers, farmers and financiers, and manufacturers and merchants. It took Congress nearly 80 years to try again to establish a central bank. After the severe bank panic in 1907, Congress began several years of study to come up with a model that would work. When Congress finally passed the Federal Reserve Act of 1913, it included a unique political compromise. It established a system of semi-independent Federal Reserve Banks around the country with oversight provided by a public Federal Reserve Board in Washington, D.C. Many in Washington and on Wall Street favored a more centralized central bank, either dominated by bankers or politicians, but Congress passed the law requiring a decentralized organization with eight to 12 reserve banks to disperse authority. That tension between centralization and decentralization has waxed and waned over the past 100 years and continues even today. In the end, Congress and the Reserve Bank Organizing Committee opted for 12 Districts. Their size was based on the number of banks in their Districts and their relative size in the economy. Since the organizers wanted the 12 Districts to begin with roughly similar capital bases, the Districts in the East, where more capital was concentrated, were geographically smaller than the Districts in the West, where capital was more dispersed. Congress has debated and changed the governance structure from time to time, including the 1927 decision to give the 12 Federal Reserve Banks permanent charters rather than 20-year charters. Following the Great Depression, the passage of the Banking Acts of 1933 and 1935 brought about the biggest changes in governance. The Banking Act of 1935, in particular, renamed the Federal Reserve Board the Board of Governors and granted the Washington-based entity greater powers. It specified that the Board of Governors should BIS central bankers’ speeches have seven members appointed by the U.S. president and confirmed by the Senate. 1 Governors could serve 14-year terms to insulate them from short-term political pressures and to encourage a long-term perspective on the economy and the financial system. The 12 Federal Reserve Banks, of course, were, and still are, independently chartered institutions. They each have a nine-member board of directors drawn from citizens in their respective Districts to represent a cross-section of banking, commercial, and community interests. Three directors represent the banking community. Six other directors, all nonbankers by law, come from a wide variety of backgrounds and perspectives. These directors not only fulfill the traditional governance role of overseeing the Bank’s performance but also provide valuable insights into economic and financial conditions in the District and the nation. One recent change in the directors’ roles came under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Only the six nonbank directors on each board may vote to select a Reserve Bank president, subject to the approval of the Board of Governors. Operational advantages When the Fed was first established, the U.S. and much of the developed world operated on a gold standard. The primary objective of the new central bank was to provide an “elastic currency” so that banks could meet the cash demands of businesses and consumers. Before the Federal Reserve, circulating cash was predominately in the form of private bank notes, which could become scarce in times of panic. The Reserve Banks were given the authority to issue Federal Reserve Notes that were declared legal tender and so they could meet these cash needs by short-term lending to banks against collateral. Thus, for the most part, the Board in Washington had little role to play in the primary responsibilities of the Federal Reserve System. The Reserve Banks remain the operating arm of the Federal Reserve System. It is the 12 Banks and not the Board of Governors that distribute currency, act as a bankers’ bank, and generally perform the functions of a central bank. This includes serving as the bank for the U.S. Treasury. It is the Reserve Banks that have assets and a balance sheet. The earnings on these assets fund the operations of the 12 Banks as well as the operations of the Board of Governors to give the Federal Reserve System independence from the Congressional appropriations process. In fact, the System turns over any excess earnings above the cost of its operations to the U.S. Treasury. So, from the beginning, the Reserve Banks have played an integral role in their regions’ economies. In addition to providing currency and coin services to banks, the Reserve Banks handle other basic payment services, such as wire transfers and clearing checks. In fact, if you look at the development of payment systems in America, many of the innovations in electronic funds transfer have been led by the 12 Federal Reserve Banks, including championing the passage of the Check Clearing for the 21st Century Act in 2003, which has accelerated the migration from paper checks to electronic check images and electronic payments. So, rather than having 45 check-processing locations at its peak, the Federal Reserve has just one location today for paper checks and one for electronic payments. While supervisory and regulatory authority for many banks and bank holding companies rests with the Board of Governors by statute, not the Reserve Banks, the Board delegates authority to the staff in the 12 Reserve Banks to provide the boots on the ground for effective supervision of the covered institutions in their Districts. As of February 17, 2015, there were five Governors serving, with one more nominee awaiting Senate confirmation. BIS central bankers’ speeches The Reserve Banks also act as the bank for the U.S. Treasury. They work closely with the Treasury to develop payment processes, such as making payments on the public debt, distributing payments to Social Security recipients, and so forth. The Banks also support community development activities, including research and engaging organizations to find effective and impactful development solutions that promote the Federal Reserve System’s economic growth objectives in low- and moderate-income communities. Setting monetary policy Of course, most people think of the Federal Reserve as being responsible for setting and executing monetary policy. Here, too, the Reserve Banks play an important role. In the early decades of operations, the Reserve Banks came to learn that buying and selling assets on the open market had an influence on the money supply. In fact, they found that if they didn’t coordinate their actions, they could encounter unintended consequences as they may act at cross purposes. So, in 1923, early leaders, such as Benjamin Strong in New York and George Norris here in Philadelphia, helped organize a committee to coordinate open market operations. This eventually led Congress to formally create the Federal Open Market Committee, or FOMC, as the formal body within the Fed responsible for monetary policy. Since the Banking Act of 1935, the composition of the FOMC has included the seven Governors in Washington, D.C., the president of the New York Fed, and the presidents of four other Reserve Banks, who serve one-year terms as members on a rotating basis. These rotations ensure that all regions are represented in the formation of monetary policy. The composition gives the Board of Governors the majority of votes. However, whether we vote or not, all Reserve Bank presidents attend the FOMC meetings, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options. The FOMC has eight regularly scheduled meetings each year to set monetary policy. It discusses economic conditions and, in normal times, decides the path of short-term interest rates to achieve the goals of monetary policy that Congress has set for us in the Federal Reserve Act. When preparing for the FOMC meetings, participants rely on their economic research departments to brief them on regional and national economic conditions and provide support and insight on appropriate monetary policy. The independent presidents and their research departments also help ensure that a wide variety of perspectives are brought to the table when we make policy. This helps prevent monetary policy from adopting a “groupthink” mentality. The separate teams of research economists in the Reserve Banks also ensure a useful diversity in academic pursuit. Research teams at the Banks have advanced many economic concepts that have been adopted by the Federal Reserve System, such as the value of inflation targeting or the latest use of economic modeling. This has led to centers of excellence in the Districts, such as the Payment Cards Center and the Real-Time Data Research Center here in Philadelphia. In addition to economic research, the Reserve Bank presidents also gather information from their boards of directors and advisory councils and through conversations with local and international business leaders. All this helps to contribute to a rich and comprehensive mosaic of the national economy. Monetary policymaking is conducted by committee by design, and divergent views can and often do exist. As we worked our way through the financial crisis and through the recovery, we found ourselves in uncharted territory dealing with many economic challenges. So, there is little wonder why there are often differences of opinion around the table. Some commentators express the view that dissent causes dissonance and therefore confuses the communications. I disagree. I believe that open dialogue and diversity of views lead to better BIS central bankers’ speeches policy decisions and are the primary means by which new ideas are gradually incorporated into our monetary policy framework. Thus, I believe diversity of thought is a sign of a thoughtful process. I have often quoted the famous American journalist Walter Lippmann, who said, “Where all men think alike, no one thinks very much.” I think it is healthy for the American public to know that we debate some of the same issues that those outside the Fed debate. Hiding such debate behind a unanimous vote does nothing to promote true transparency. By being open and transparent about these various perspectives, our decentralized model for the Federal Reserve helps strengthen public confidence and preserve its independence. Defending central bank independence So, why is central bank independence so important? It strikes many people as odd that in a democratic society we leave monetary policy decisions in the hands of nonelected policymakers who can act with independence. I think this view stems from confusion about what is really meant by central bank independence. Central bank independence means that the central bank can make monetary policy decisions without fear of direct political interference. It does not mean – nor should it – that the central bank is not accountable for its policies. It is important to remember that the Federal Reserve does not select its own goals. Instead, Congress sets the goals it wants the Fed to pursue with monetary policy. Since 1978, Congress has mandated that the FOMC “shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” The goals of monetary policy are rightly a subject of legitimate debate. I have frequently argued that these goals are too broad, and they risk making the Fed responsible for more than it can actually deliver. That, from my perspective, risks undermining the Fed’s credibility and invites policymakers to lurch from one goal to the next when it seems convenient, thus making it more susceptible to political pressure. As a consequence, I have favored a single mandate for the Fed – price stability – to increase the clarity of the objective and make it easier to hold the Fed accountable. Nevertheless, given a mandate, what central bank independence means is that Congress has left the decisions of how best to achieve this mandate to Fed policymakers. Why did Congress design the Fed this way? There are two very important reasons. First, monetary policy affects the economy with sometimes long and variable lags, but elected politicians, and even the public, often make decisions with the next month, next quarter, or the next election in mind. Monetary policy actions taken today will often not have their full effect on the economy for at least several quarters and perhaps as long as several years. That is why monetary policy choices today must focus on the intermediate to long term and anticipate what the economy might look like over the next one to three years. Indeed, the mandate itself stresses the long run focus of monetary policy. Moreover, there can be a conflict between what monetary policy may be able to achieve over the short term versus its impact over the long term. For example, in the short term, it might seem expedient or even desirable to try to spur economic growth and employment by conducting excessively accommodative monetary policy. Yet, this could lead to very bad economic outcomes in the long term, including higher inflation, higher interest rates, and an eventual tightening of policy to control inflation that may be detrimental to the economy. These outcomes would be inconsistent with the long-term goals set by Congress. Delegating the decision-making to an independent central bank that can help focus on long-term policy goals is a way of limiting the temptation for short-term gains at the expense of the future. BIS central bankers’ speeches The second important reason to give monetary policy decision-making to an independent central bank is to separate the authority of those in government responsible for making the decisions to spend and tax from those responsible for printing the money. This lessens the temptation for the fiscal authority to use the printing press to fund its public spending, thereby substituting a hidden tax of inflation in the future for taxes or spending cuts. History is replete with examples of what happens when central banks are not independent or become agents for a nation’s fiscal policy. Just think of the hyperinflation in Germany between the World Wars of the last century, or in Italy before the euro, or in the numerous financial crises and high inflation rates in Latin American in more recent years, to name just a few. The consequences – higher inflation, currency crises, and economic instability – are not good. This is why so many countries have structured their central banks with a great deal of independence from political interference. Despite the strong arguments for political independence, there continue to be proposals that would make monetary policy subject to more political interference. In recent years, this effort has manifested itself in the movement in Congress to pass an “Audit the Fed” bill. Since 1978, Congress has specifically exempted monetary policy decisions from such “audits” by the Government Accountability Office, or GAO, with good reason. The bill is not really about an audit in the usual accounting or financial sense of the term, since the Fed’s financial statements and indeed its operations in supervision and payment services are already subject to extensive outside audits by the GAO, the Board of Governors’ Office of the Inspector General, and an outside public accounting firm. Rather, this proposal to strike that exemption for monetary policy is an attempt to reduce the independence of the central bank through the threat of a political action in real time. For example, under the provisions of the bill, the GAO could be called on to investigate a monetary policy decision whenever any member of Congress opposes a decision to change interest rates. This possibility would change the dynamics of the FOMC’s internal discussions and undermine the Fed’s credibility and its ability to conduct monetary policy in the long-term interests of the American public. Over the past 30 years, many countries have acted to increase the degree of independence of monetary policymaking from short-term political influences. In a democracy, though, independence must be accompanied by accountability. In recent years, the Fed has increased its transparency. The FOMC issues a statement after every meeting. It publishes the minutes three weeks after each meeting. It also reports the economic projections of Committee participants four times a year. These meetings are followed by press conferences with the chair of the FOMC. In 2012, the FOMC issued a statement clarifying our longer-run goals and strategy, including an explicit 2 percent target for inflation. And the economic projections now include information about the policy path assumptions of participants. Finally, after five years, verbatim transcripts are available for every FOMC meeting. The Reserve Banks’ structure also helps increase transparency by communicating economic and monetary policy objectives and actions through educational outreach and speeches such as this one, as well as discussions with their boards of directors and other groups. I support these ongoing efforts to increase accountability and transparency, but I do not support efforts that would lead to greater political interference in monetary policy decisions. Such efforts include the audit-the-Fed movement but also those efforts that would make Reserve Bank presidents political appointees. I do not believe the Fed is perfect or that it is infallible. As you know, I have been a vocal critic at times. But I have also been explicit over the years about steps that could be taken to strengthen the Fed as an institution. I have argued for a narrow mandate that is achievable so the Fed can be held accountable. I have stressed the importance of transparency and a systematic approach to policy that reduces uncertainty and makes policy more predictable. These could be helpful in strengthening credibility and the public’s trust in the institution. But BIS central bankers’ speeches steps that undermine the Fed’s independence or make it more susceptible to political control and influence in the short run are counterproductive. I also believe that a key strength of the institution is the vibrant role the 12 independent Reserve Banks play in operations and policymaking. They are a safeguard, not a straightjacket. Too much power or authority concentrated in Washington or Wall Street could make the central bank more susceptible to capture by political or private interests. Conclusion So, I believe the Federal Reserve System, with 12 Reserve Banks and a central Board of Governors, has withstood the test of time, in part because it has checks and balances to protect and serve our diverse nation. Americans have a long history of suspicion toward the concentration of authority. So, Congress has created a uniquely American form of a central bank to find a middle ground between centralization and decentralization, between the public and private sectors, and among Washington, Wall Street, and Main Street. My time as president of the Federal Reserve Bank of Philadelphia has deepened my appreciation of our nation’s decentralized central bank. I have great respect for the institution and the people who serve here in Philadelphia and around the Federal Reserve System. I hope that you – and our nation more broadly – come to appreciate the unique role of the 12 Federal Reserve Banks as integral parts of our nation’s central bank. Thank you. BIS central bankers’ speeches | federal reserve bank of philadelphia | 2,015 | 2 |
Address by the Governor of the South African Reserve Bank, Dr. C.S. Stals, at the Twentieth Annual Investment Conference of Société Générale Frankel Pollak (Pty) Ltd. in Johannesburg on 18/2/97. | Dr. Stals looks at the options and strategies for monetary policy in South Africa Address by the Governor of the South African Reserve Bank, Dr. C.S. Stals, at the Twentieth Annual Investment Conference of Société Générale Frankel Pollak (Pty) Ltd. in Johannesburg on 18/2/97. 1. A sharp decline in the net capital inflow from abroad set the financial scene for 1996 The most important change in the financial situation in South Africa last year was the sudden decline in the net inflow of capital from abroad that occurred in the first quarter. A number of adverse developments at the time combined to trigger an outflow of short-term capital. Coming after three years of rather strong rises in total domestic expenditure and a growing deficit in the current account of the balance of payments, the deterioration in the capital account led to an overall balance of payments deficit that created immediate shortages in the market for foreign exchange. After a record net capital inflow of more than R6 billion occurred in the fourth quarter of 1995, to bring the total net inflow for the year close to R20 billion, there was a small net outflow in the first quarter of 1996. The current account deficit was no longer covered by a net capital inflow and the exchange rate of the rand came under immediate pressure. With a low level of official foreign reserves, a growing deficit in the current account of the balance of payments and deteriorating prospects for a renewed inflow of capital into the country, participants in the market for foreign exchange became very nervous and reacted wildly to rumours, adverse political developments and negative news about the balance of payments, the foreign reserves, and domestic economic developments. The initial depreciation of the rand created negative expectations which became self-fulfilling, particularly as leads and lags in short-term trade financing also moved strongly against South Africa, and South Africans became more reluctant to enter into new foreign currency denominated commitments. The exchange rate of the rand, which in nominal terms showed an effective appreciation of 4.4 per cent from May 1995 up to the end of December 1995, then depreciated by 8 per cent in the first quarter of 1996, by 7.2 per cent in the second quarter, and by a further 9.5 per cent in the four months up to the end of October 1996. Over the first ten months of 1996, the effective depreciation of the rand in nominal terms exceeded 22 per cent. In real terms, this represented a depreciation of about 15 per cent. An ex post analysis of the composition of the capital in- and outflows of last year provides interesting information for a better understanding of the changes that took place. Initially, it was mainly a sudden reversal in the inflow of short-term capital in the form of inter-bank and trade related financing arrangements that triggered the shortages in the market for foreign exchange. As the exchange rate depreciated and South African residents became more concerned about possible losses on foreign currency exposures, long-term foreign loans were repaid without replacement or extensions. South Africans with existing short- and long-term foreign currency commitments covered their positions forward, and the Reserve Bank’s forward exchange book showed a sharp increase of the net oversold position. In the fourth quarter of last year, when short-term capital began to flow back again, there was a net outflow from the private sector of R6 billion in the form of longer-term capital, mostly for the repayment of maturing loans. Another interesting feature of the international capital flows last year was that foreigners remained important net portfolio investors in South African securities. Non-residents increased their holdings of South African equities listed on the Johannesburg Stock Exchange by R5.3 billion, and added a net amount of R3.4 billion to their holdings of South African bonds acquired through the South African bond market. This ostensibly “volatile” element of the capital flows was therefore not responsible for the problems that developed in the South African balance of payments last year. 2. Monetary policy faced with new challenges in a situation of a deteriorating balance of payments The abrupt decline in the capital inflows from abroad in the first quarter of 1996 confronted the monetary policy authorities with an unexpected new challenge. Since 1994, the Reserve Bank’s policy on international financial relations was to rebuild the country’s depleted official foreign reserves gradually, to relax the exchange controls on a step-by-step basis, and to restructure the market in foreign exchange gradually with the objective of enabling a more efficient market to determine not only the spot foreign exchange rate of the rand, but also the forward rate. Good progress was made on this road during 1994 and 1995, but the country was surely not yet in a position to withstand the adverse developments of early 1996, or to protect the exchange rate of the rand against a series of determined attacks in a rather vulnerable situation. The Reserve Bank realised that it was not in a position to defend the exchange rate of the rand by providing large amounts of foreign exchange from the official foreign reserves. At the time of the dramatic decline in the net capital inflow in February 1996, the Reserve Bank held about R15 billion in official foreign reserves, while the private banking sector held an additional amount of about R4 billion in liquid foreign assets. The total of R19 billion was the equivalent of about 8 weeks’ imports. Taking account of the growing deficit in the current account of the balance of payments, the Bank could only make limited amounts of foreign exchange available to ensure that no serious shortage of liquidity would develop that could create a panic on its own. The longer-term objectives of building up the foreign reserves to a more comfortable level, of reducing the role of the Reserve Bank in the forward foreign exchange market, and of phasing out the remaining foreign exchange controls were temporarily forced on the backburner, whilst monetary policy had to be directed more decisively towards an adjustment programme that would gradually restore stability in the market for foreign exchange. 3. The monetary policy adjustment programme Three basic deficiencies in the underlying economic fundamentals were identified at the time that contributed to the lack of confidence in the South African economy, and in the ability of the South African authorities to restore stability in the market for foreign exchange. Firstly, the growing deficit in the current account of the balance of payments had to be reversed, particularly after it became evident that the country could not rely on a permanent and sustainable large capital inflow from the rest of the world to cover an everincreasing current deficit. Secondly, the imminent danger of escalating inflation, particularly after some depreciation in the exchange rate of the rand, had to be avoided. There was a real and perceived danger that South Africa was destined for a new vicious circle of depreciation-inflationdepreciation that would unavoidably lead to a further erosion of the country’s competitive position in the world markets. Thirdly, the escalating growth rates in the domestic monetary aggregates, such as the money supply and bank credit extension, had to be reversed. By accommodating the new inflationary pressures emanating from the depreciation of the rand on a continuous basis, monetary policy would obviously aggravate the situation. With only limited means at its disposal to finance the external deficit, South Africa had no alternative but to adjust the disequilibrium, mainly by reducing or eliminating the current account deficit. To achieve this objective, the following monetary policy strategy was followed: Not being in a position to fix the exchange rate at any predetermined level, a depreciation of the rand was unavoidable and had to be accepted as part of the solution to the problem. The Bank sold some foreign exchange from its official reserves, not with the intention to fix the exchange rate, but rather to provide liquidity to the market and to smooth the adjustment process. As the Reserve Bank sold foreign exchange to the market to partly finance the overall balance of payments deficit, domestic rand liquidity was drained from the banking system. It was imperative for the effective working of the adjustment process that the Reserve Bank would not replace the lost liquidity through, for example, purchases of financial assets from the banks through more active open-market operations. The decline in the domestic liquidity had to be reflected in the level of interest rates. Higher interest rates would not only serve to discourage the outflow of capital, but would also reduce the domestic demand for bank credit. The market trend for interest rates to rise could not be resisted. Monetary policy was therefore directed towards a reinforcement of and active support for a market adjustment process that would eventually restore equilibrium to the balance of payments. It was well understood that this process would not be painless, that the depreciation of the currency, the drainage of liquidity and the rising interest rates would all demand costs and sacrifices that would not be popular, and that the monetary authorities would be blamed by some ill-disposed observers for the dilemma. Any country that had established a good economic performance in one year on the basis of net capital inflow of R20 billion, and is then in the next year forced to perform on a net inflow of only R4 billion, is bound to go through some painful adjustment. South Africa was no exception. 4. The success of the monetary adjustment programme Important changes took place towards the end of last year, and particularly after October, in the underlying economic conditions that contributed to the financial disturbances of the preceding nine months. There was a marked slow-down in the rate of increase in real gross domestic expenditure. Official national accounts statistics for the fourth quarter are not yet available, but preliminary indications are that all the major components of gross domestic expenditure increased at lower rates in the second half than in the first half of last year. Total real gross domestic expenditure indeed declined somewhat from the first half to bring the rate of increase for the year more or less in line with the established growth rate of about 3 per cent in gross domestic product. The deficit in the current account of the balance of payments progressively declined from a seasonally adjusted annualised peak of R13 billion in the second quarter to about R9 billion in the third, and R5 billion in the fourth quarter of the year. The rates of increase in both bank credit extension to the private sector and in the money supply peaked in October 1996, before declining marginally in both November and December. The quarter-to-quarter growth in credit extension to the private sector (at seasonally adjusted and annualised rates), decelerated from 22.4 per cent in the second quarter of 1996 to 16.6 per cent in the third quarter, and 11.8 per cent in the fourth quarter. In the case of the M3 money supply, the deceleration was from 21.2 per cent in the second, to 18.6 per cent in the third, and a mere 7.6 per cent in the fourth quarter. Not only the current account of the balance of payments improved, but also the capital account. In the first nine months of the year, capital inflows and outflows almost cancelled out, to leave a small net inflow of less than R1 billion for the nine months’ period. In the fourth quarter, however, the net capital inflow increased again to an estimated R3 billion. This capital inflow once again exceeded the unadjusted current account deficit with the result that the country’s net foreign reserves recovered some of the losses of the first nine months of the year. The pressure in the foreign exchange market receded slightly and the rand started appreciating in November last year. Over the two months November and December 1996, the effective nominal exchange rate of the rand appreciated by 1 per cent, and during the first six weeks of 1997 by a further 9.2 per cent. This appreciation therefore partly neutralised the adverse effects of the sharp depreciation of last year. It will, of course, not only be premature but also preposterous to claim the successes achieved in this process so far for monetary policy alone. Many other changes also took place in South Africa over the past year. There is now more political stability than a year ago; much progress has been made with the framing and implementation of the Government’s Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR); the Minister of Finance has confirmed and showed his determination to continue with the required policy of financial discipline that will gradually reduce the deficit in the Budget as a percentage of gross domestic product. There is, however, still the danger of escalating inflation that cannot be swept under the carpet at this juncture. After reaching an acceptable low level of only 5.5 per cent over the twelve months up to April 1996, the rate of increase in the consumer price index escalated to 9.4 per cent in December 1996. Inflation, however, lags behind changes in the monetary aggregates and is, at this stage, still stimulated by the depreciation of the rand last year, and the relatively large increases in the money supply during the 1995/96 period. It is of the utmost importance, however, that a restrictive monetary policy shall now be retained to make sure that the rate of inflation will also gradually be tamed again. 5. Monetary policy options for 1997 It remains the main task and priority of monetary policy in South Africa to fight against inflation. During 1996, the disturbances in the foreign exchange market temporarily diverted the attention from this prime objective of monetary policy. Indeed, in the longer term, greater stability in the foreign exchange market will only become sustainable once the rate of inflation has been brought more or less in line with the average rate of inflation in the economies of our major trading partners and international competitors. Despite the periodic efforts of media reporters to extort a commitment from the authorities to a certain pre-defined exchange rate for the rand, it remains our view that in the contemporary complex market for foreign exchange, it is not possible to define an equilibrium exchange rate a priori, or, in the case of the South African Reserve Bank, with the limited amount of foreign exchange at its disposal, to manipulate the exchange rate of the rand permanently in any direction against market forces. As far as the Bank’s policy on foreign exchange is concerned, it is hoped that the more favourable conditions now experienced in the market will continue throughout 1997, and will enable us to pursue the longer-term objectives of: building up the total foreign reserves to a more comfortable level; reducing the Reserve Bank’s role in the forward foreign exchange market; and gradually phasing out the remaining exchange controls. To the extent that these three objectives provide conflicts within themselves, important policy decisions will have to be taken between the Bank and the Minister of Finance on the relative importance that should be attached to each one of the objectives in an appropriate policy matrix. With the attention now being refocused on domestic policy objectives, the rising rate of inflation has become a matter of major concern. In this situation, the Reserve Bank regards it as a minimum precondition for arresting this imminent threat to financial stability that the rates of increase in bank credit extension and in the money supply will be reduced soon to more acceptable levels. With the prospects for real growth in the economy at a rate of between 2 and 3 per cent, and the desire to keep inflation to below 10 per cent, the money supply should obviously not increase by more than about 10 per cent during the current calendar year. This will require the Reserve Bank to persist with a relatively restrictive monetary policy for the time being. | south african reserve bank | 1,997 | 2 |
Presentation by the Governor of the South African Reserve Bank, Dr. C.Stals, to the NEDLAC Executive Council in Johannesburg on 28/2/97. | Dr. Stals elucidates the functions of the South African Reserve Bank Presentation by the Governor of the South African Reserve Bank, Dr. C.Stals, to the NEDLAC Executive Council in Johannesburg on 28/2/97. 1. The mandate to the South African Reserve Bank The South African Reserve Bank was established in 1921 in terms of a special Act of Parliament. At that time, central banks existed mainly in Europe, and the SA Reserve Bank was only the fourth central bank founded outside Europe. There already existed central banks in the United States of America, Japan and Java. Since its establishment, the Reserve Bank was always privately owned. Today, the Bank has more than 700 shareholders. The shares of the Bank are listed on the Johannesburg Stock Exchange and, in terms of the Act, no individual shareholder is allowed to hold more than one-half per cent of the capital of the Bank. The Bank may also never pay a dividend of more than 10 per cent per annum on the nominal value of its capital. The market price of the share therefore behaves like a government bond with a 10 per cent coupon. The Bank is managed by a Board of 14 Directors, seven of whom are elected by the shareholders to represent them on the Board. Without holding any shares in the Bank, the Government (President) has the right to appoint the other seven Board members. The seven appointed by the President includes the Governor and three Deputy Governors, who are full-time executive members, plus three part-time Directors. The functions of the Bank changed over time. When the Bank was originally established in 1921, its main task was to develop money and capital markets and a banking system in South Africa that would be independent of London. Today its main task, as defined in terms of the South African Reserve Bank Act and in the Constitution of the Republic of South Africa, is to defend the value of the rand, that is, to keep inflation as low as possible. This is very much in line with contemporary central banking all over the world. Since 1980, most central banks have accepted a similar mission. The latest example is perhaps the People’s Bank of China, whose mandate has been changed as from March 1995 to maintain the stability of the Chinese yuan, and in this way to promote economic growth. The Board of the Reserve Bank has been given an important degree of autonomy for the execution of its duties. In terms of the Constitution: “The South African Reserve Bank, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters”. In terms of Section 32 of the Reserve Bank Act, the Bank must submit a monthly statement of its assets and liabilities and an annual report to Parliament. The Bank is therefore accountable to Parliament. The Governor of the Reserve Bank holds regular discussions with the Minister of Finance, and appears before the Parliamentary Standing Committee on Finance from time to time. The Board of the Bank has delegated its powers on important monetary policy decisions to a sub-committee of the Board, known as the Governors’ Committee and comprising the Governor and three Deputy Governors. There is also an Audit Committee and a Human Resources Committee of the Board that meet regularly on aspects of internal finance and administration. The full Board meets four times a year. The Bank has a total staff of about 1900 people and operates from its Head Office in Pretoria and seven branches maintained in the major cities of South Africa. 2. Why must inflation be controlled? The main task of the Reserve Bank is to protect the value of the currency. The business of a modern central bank is the business of money. Central banks are given the right to issue money by their governments. That is why the Reserve Bank is accountable to Parliament and why its surplus profits are paid over to the Treasury. The right to issue money (bank notes and coin) makes the central bank a very powerful institution that can easily be misused for sectoral interests. That is why it must be able to act in the national interest -- what is good for the total economy is important, and not what any specific group or sector may desire. In modern sophisticated financial systems, surrogates for real money (bank notes and coin) developed, such as bank cheque accounts, credit cards and electronic transfers. Private banking institutions now create more money (means of payment) than the central bank. In order to fulfil its task of protecting the value of the currency, the Reserve Bank must therefore also have some powers to control the money creation capacity of the banking sector. In South Africa today, bank notes and coin in circulation account for less than 5 per cent of the money supply. The rest is money created by banking institutions over which the Reserve Bank has but an indirect control. Money serves the purpose of a means of payment. It is also a unit of account in terms of which the value of goods and services are measured. It serves thirdly as a store of value for the savings of the community. These three functions of money make it essential that the value of money shall remain as stable as possible. No modern market-oriented economy can function well if the value of its currency is not kept stable. Inflation is a continuous decline in the value of money. This will be reflected in a continuous rise in the prices of goods and services. In a market economy, certain prices of specific goods and services will always change to reflect changes in underlying forces of demand and supply. It is indeed essential that relative prices of goods and services will change in a market economy to bring about equilibrium and support maximum economic growth. It becomes a problem for the efficient functioning of the economy if all prices generally increase over time, because this will confuse the signals emitted by the market system through the mechanism of relative price changes. The many disadvantages of inflation therefore include: the distortion of the efficient working of the market system through its disruptive effects on the price mechanism; a reduction in the usefulness of money as a unit of account. You cannot properly measure and compare values of goods and services if you have to use a variable or elastic yardstick; and an erosion of the value of money as a store of wealth. Savers will not be prepared to accumulate wealth in an asset that loses its value over time. Because of these effects of a decline in the value of money, high rates of inflation inevitably lead to a decline in the efficiency of the market economy, a decline in savings and, in the longer term, a lower rate of growth for the economy as a whole. Other more direct disadvantages of inflation can be summarised as follows: People with fixed incomes, for example salaries or pensions, are affected more by inflation than the wealthy who can partly protect themselves against inflation, for example by investing in property or equities. Inflation therefore leads to an increase in the disparity between the “haves” and the “have-nots”. Inflation makes forward planning more difficult. A person may, for example, save for his whole working life for a pension, just to find at the end of his career that his savings have been eroded by inflation. Inflation in one country at a level higher than inflation in other countries create many difficulties for international financial relations. The exchange rate of the country that becomes out of line because of this difference, must depreciate continuously to keep local industries and other producers (e.g. gold mines) competitive. Depreciation in itself can lead to more inflation and a vicious circle of more-inflation-more-depreciation can easily get out of control and destroy the whole economy. Inflation is inclined to feed on itself. It is almost impossible to keep a little bit of inflation always just a little bit. As long as there is inflation in the economy, monetary authorities must remain on their guard. Even if relatively low inflation can be tolerated, there is always a danger that the rate of price rises will increase. Because of all these adverse characteristics of inflation, this illness of the market economy often leads to serious social disruption which brings with it political instability. It is therefore in the interest of the economy, the social structure and the political system that a government and its people shall always be prepared and ready to fight inflation. 3. The causes of inflation Inflation is a rather complex phenomenon of the economy. There is no single cause of inflation. It can find its origin in the rest of the world, and can therefore be imported from abroad. It can be caused by excess demand, that is, by a desire of an economy to absorb more goods and services than it can afford to supply (from domestic production plus imports). The excessive demand can emanate from government expenditure, private sector consumption expenditure, or even fixed investment. It can be caused by wage increases in excess of productivity rises that will lead to an increase in the labour cost per unit of production. It can be generated by monopolistic practices that can be misused to generate surplus profits for entrepreneurs. Whatever the basic causes of inflation might be, it is normally accompanied or accommodated by excessive increases in the money supply. Indeed, inflation may often find its origin in excessive increases in the money supply when monetary policy is used as a deliberate instrument to provide artificial stimulation to the economy. In any national programme to keep inflation down, the control of the money supply must be included as an indispensable component of the total package. Restricting the growth in the money supply will make it impossible for inflationary impulses, even of a non-monetary origin, to escalate and permeate in continuous price rises. In the South African economy, there are many inflationary forces at work at all times. The task of the South African Reserve Bank is therefore not an easy one. Because of these many inflationary forces, the Bank must apply a policy that at times seems to be over-restrictive -- an approach that is necessary in order to neutralise the inflationary effects of many non-monetary actions that are exerting upward pressure on prices all the time. 4. The monetary policy model of the Reserve Bank Most central banks in the world pursue the same prime objective of protecting the value of their currencies. Not all central banks, however, follow the same model in the implementation of monetary policy. The Reserve Bank’s policy is a “monetarist” approach based on the direct control of the money supply. Controlling the money supply is seen as an intermediate objective in reaching the ultimate objective of controlling inflation. Some countries target inflation directly in the monetary policy model. Taking account of the many causes of inflation, direct targeting of inflation requires broad co-ordination of macroeconomic policies such as fiscal policy, trade and industrial policies, labour policies, and international economic relations policies. It should indeed be based on a broad accord of a consistent macroeconomic policy framework that will support the need for keeping inflation down. Low inflation is no guarantee for higher economic growth and development, but it is an important precondition for attaining better standards of living for all the people of the country on a sustainable basis. In some other countries, monetary policy is anchored to a fixed or stable exchange rate formula, instead of to the money supply. This is perhaps good for countries with a relatively open economy (such as South Africa is now becoming). It is a precondition for the successful implementation of this type of model that the country will be able to stabilise the exchange rate through regular intervention in the foreign exchange market. To begin with, the central bank must have access to a substantial amount of foreign reserves to enable it to intervene in the market for foreign exchange in a meaningful way. The South African model for monetary policy is, however, based on controlling the money supply. Within the family of monetarists, there will always be differences of opinion on what the most appropriate definition is for the money supply, on how this money supply should best be controlled, on when and how actions by the central bank must be triggered, etcetera. The basic objective remains, however, to keep the rate of increase in the money supply within reasonable limits. The Reserve Bank’s policy is seen to be rather accommodative and does not comply with the strict money rule of not tolerating any inflation. Guidelines for an acceptable rate of increase in the M3 money supply are announced at the beginning of each year on what growth in the money supply will be good or tolerable in the South African economy. For 1996, guidelines were set at between 6 and 10 per cent, providing for real growth of 3 to 4 per cent, and inflation of 6 to 7 per cent. Pure monetarists would have required growth in the money supply of not more than 4 per cent (the growth in the real economy in a similar situation). The money supply guidelines set by the Reserve Bank should not be seen as targets that must be achieved at all cost. They only serve as guidelines and contribute towards making monetary policy more transparent. As long as the actual growth in the money supply exceeds the guidelines, monetary policy must remain restrictive. Scope for an easier monetary policy develops only as and when actual growth in the money supply moves to within the guideline range. As previously indicated, money is created in South Africa mainly through the actions of private banking institutions. When they give credit to their clients, they create money. The Reserve Bank’s obligation to control the money supply, therefore, extends to a control over the total amount of new credit extended by banking institutions. The rate of increase in the total amount of bank credit outstanding is determined by two sides of a market formula: the amount of credit that banks can supply at any time, and the total demand of funds emanating from the borrowers of funds. The supply side of the formula depends on how much liquidity the banks have at their disposal for funding their lending operations. The Reserve Bank therefore has a vested interest in influencing or managing the amount of liquidity available to the banks. The Reserve Bank has a number of instruments at its disposal to influence the liquidity of the banking system, such as open-market operations, discount window facilities, and cash reserve requirements. The demand side of the formula is very much interest rate driven. Higher interest rates will depress the demand, and lower interest rates will increase demand. The level of interest rates is to an important extent determined by forces of demand and supply operating through financial markets, but can also be influenced by the Reserve Bank’s own intervention in the markets. To meet its obligation of controlling the money supply, the Reserve Bank must ensure that the amount of liquidity available in the banking system and the level of interest rates will be such that there will be no excessive increase in the money supply. Excessive increases in the money supply will eventually, after a time lag which can be as long as two years, accommodate rising, or cause higher, inflation with all the disadvantages thereof. Interest rates therefore play a vital role in the fight against inflation. It is one of the main operational instruments used by central banks to ensure an acceptable rate of growth in the money supply. In summary, the monetary policy model followed by the Reserve Bank can be seen as follows: To support maximum sustainable economic growth and development; the rate of inflation must be kept low (the value of the currency must be protected); to achieve this objective, the rate of growth in the money supply must be kept within an acceptable range (the guidelines); as money is created, mainly through bank credit extension, monetary policy must be directed towards some control over bank credit extension, which requires some management of the amount of funds available in the banking system, and a consistent interest rate policy. If this model is applied consistently and with success, the rate of inflation will be low, which will lead to a more stable exchange rate of the rand. The exchange rate therefore becomes a result of the model and not a starting point. In such an environment of overall financial stability, it will be possible to achieve and sustain a maximum real rate of growth and development in the economy. 5. Successes achieved in the past The present model of monetary policy was designed by the Commission of Inquiry into the Monetary System and Monetary Policy (De Kock Commission) during the course of the 1980’s and was implemented in South Africa more vigorously since 1989. The results achieved since then can be summarised as follows: In 1988 total credit extended to the private sector increased by 28 per cent which was, of course, far out of line with growth in the nominal value of the total gross domestic production of South Africa. The M3 money supply increased by 27 per cent and released massive inflationary pressures in the economy. Through a continuous and consistent restrictive monetary policy, the rate of increase in bank credit extension was gradually reduced, and in 1992 and 1993 it dropped below 10 per cent per annum. The rate of increase in the money supply also declined to 8 per cent in 1992 and 7 per cent in 1993. The rate of inflation followed and declined to below 10 per cent for the first time in 20 years in 1993. For the past four years, the average annual rate of inflation has now stayed below the 10 per cent level, and last year inflation of 7.4 per cent (average for the twelve months) represented the lowest annual average rate of inflation in South Africa for the past 24 years. Ominous signs developed over the past two years, however, with the rate of increase in bank credit extension escalating again to 18.7 per cent in June 1996. The rate of increase in the M3 money supply also rose to 16 per cent in October 1996, while inflation gradually crept up from a low of 5.5 per cent over the twelve months up to April 1996, to 9.4 per cent over the twelve months up to December 1996. The current stimulus for inflation emanated mainly from the depreciation of the rand last year, but there is a danger that, if not checked at this stage, it could easily be converted into a new cycle of a continuous rise in the rate of inflation. The Reserve Bank was therefore forced once again during the past year to pursue a more restrictive monetary policy that led to an increase of approximately 3 percentage points in the level of interest rates. Towards the end of 1996, the more restrictive policies began to produce results when both the rates of increase in bank credit extension and in the money supply slowed down. Over the twelve months up to December 1996, bank credit extension to the private sector rose by 15.7 per cent, and the M3 money supply by 13.7 per cent, both marginally down from the peaks established earlier in the year. Inflation is, however, still creeping upwards and it will take some time before the full effect of the depreciation of the rand will work itself out. In the meantime, it is of great importance that all other inflationary impulses in the economy, such as excessive rises in government expenditure or real wage rises in excess of productivity increases, and of course, a continuation of the excessive rates of increase in the monetary aggregates, must be avoided. The depreciation of the rand can bring many benefits for economic growth and development, provided the advantages for international competitiveness will not be dissipated very quickly by rising costs of production and a rising rate of inflation in the domestic economy. The year 1997 is indeed a testing period for the Reserve Bank and for the monetary policy applied by the Bank. Should the Bank fail in its efforts to protect the value of the currency at this stage, the goals set by Government for economic reconstruction and development, and the implementation of the Government’s Strategy for Growth, Employment and Redistribution will not be attainable. | south african reserve bank | 1,997 | 3 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at a Business Breakfast Forum hosted by Marriott Merchant Bank and Deloitte & Touche in Durban on 17/3/97. | Dr. Stals assesses the new opportunities for South African investors in an environment of no exchange controls Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at a Business Breakfast Forum hosted by Marriott Merchant Bank and Deloitte & Touche in Durban on 17/3/97. 1. Background The announcement on the further relaxation of exchange controls by the Minister of Finance, Mr. Trevor Manuel, on Wednesday last week received as much, if not more, attention as his announcements on fiscal policy for the 1997/98 fiscal year. For more than 35 years, South African residents were not permitted, at least within the rules of the law, to make investments outside of the country without prior approval from the exchange control authorities. Approval was seldom given, particularly not before 1994 when the besieged South African economy had to contend with international sanctions, boycotts and disinvestment campaigns. Following upon the political and social reforms in the country and the withdrawal of punitive international economic actions, the Reserve Bank and the Department of Finance started with a gradual phasing out of the exchange controls. A major constraint remained an acute shortage of foreign exchange reserves which were completely depleted by the time the Government of National Unity came into power in April 1994. Looking back over the past three years, good progress has nevertheless been made with the gradual phasing-out of the exchange controls. As a first priority, all restrictions on non-residents to repatriate their investment funds from South Africa were removed. Various ways and means were introduced to enable South African corporates to acquire foreign investments in branches or subsidiaries controlled by them. They were, for example, allowed to use the proceeds of foreign equity or convertible debenture issues to finance foreign investments. The Reserve Bank has approved a cumulative amount of more than R18 billion for this purpose. In June 1995, a scheme was introduced to enable South African insurers and pension and mutual funds to diversify part of their existing asset portfolios into foreign currency denominated investments. Approval has been given for more than R30 billion of asset swap transactions in terms of which institutional investors could exchange South African assets for foreign assets in this process. According to information available to the Reserve Bank, more than R17 billion of these transactions have been executed. A number of internal arrangements were introduced to reduce the administrative burden of exchange controls, for example to grant the authorised dealers in foreign exchange more scope for discretionary decisions on exchange control applications, without prior reference to the Reserve Bank. In the process, virtually all exchange controls on current account transactions in the balance of payments (i.e. payments for goods and services) were removed. The announcement made by the Minister of Finance last week extended the exchange control relaxation programme now also to foreign investments by private individuals. A basis has been established for a continuation of the gradual removal of the exchange controls through the periodic lifting of limits and other administrative measures over a wide front to cover the corporate sector, institutional investors and private individuals. There remains but the blocked assets of emigrants (former South African residents) that need to be addressed at some stage. 2. The relaxations announced last week The announcement of some further exchange control relaxations last week by the Minister of Finance was very important, not only for the substance of the relaxations but also for the clear policy direction indicated. This was the first major relaxation of the exchange controls announced by Mr Manuel since he became Minister of Finance in April 1996 and confirmed his endorsement of the policy of the gradual removal of the exchange controls. Secondly, the Minister himself regarded the announced relaxations as an important change in the underlying philosophy held by the Government on exchange controls. In his Budget Speech the Minister said: “The package of exchange control reforms placed before this House today moves South Africa to a system with a positive rather than a negative bias ....... The objective is to reach a point where there is equality of treatment between non-residents and residents in relation to inflows and outflows of capital.” The Minister, in other words wants to indicate that South Africa now has a free foreign exchange system with a number of temporary exceptions, instead of a controlled system with a few special concessions. The wide-ranging concessions now made give South African corporates more freedom to make direct investments outside of South Africa, with some special dispensation for investments in other members of the Southern Africa Development Community (SADC); increase the scope for institutional investors to diversify part of their portfolios into foreign assets and for the first time enable South African private individuals to make foreign investments, either directly or through South African authorised dealers in foreign exchange. Some of the details of these relaxations must still be worked out, but the Minister indicated that all the relaxations announced will be implemented by 1 July 1997. 3. New options for the investor In the past, many South Africans wanted to invest part of their savings outside of the country for non-financial reasons, and this may still be so in future. The more rational investor, however, may think twice before making an investment in a foreign currency, in a foreign country and perhaps also in the shares of a foreign company. In considering such a possibility, a few important macroeconomic realities will have to be taken into account. The first is that markets, the more free they become and the more efficient they function, also work more effectively as a catalyst for equalisation. For example, if the average rate of inflation in South Africa over time is 10 per cent per annum and the average rate of inflation in the rest of the world is 3 per cent, nominal interest rates in South Africa will on average be about 7 per cent above the level of nominal interest rates in other countries. Differences in real rates of interest will reflect differences in the risk factor attached to investment in different countries. In the same example, the exchange rate of the South African rand will depreciate over time by about 7 per cent per annum. The depreciation in the exchange rate will therefore make sure that the converted rand value of a foreign investment will keep up with the value of a similar South African investment, adjusted for inflation. There are therefore no special gains to be made from the investment in a foreign currency. Thirdly, taxation in South Africa will be levied on income earned on foreign investments on the same basis as income earned in South Africa. (The taxation on “passive income” earned in foreign countries as referred to by the Minister in his Budget Speech.) Foreign investments will, however, hold new risk exposures for South African investors, particularly in an environment of volatile international exchange rates. The timing of the transfer of an investment into a foreign currency can be detrimental. A South African investor who may have transferred his savings into a sterling investment earlier this year when the exchange rate between the rand and the pound was R8.00 = £1.00 could have lost 10 per cent of his investment within a very short period of time. Last Friday the exchange rate was back to R7.10 = £1.00. This brings into any foreign investment a new speculative element that does not exist in the local investment market. Finally, very few private individuals in South Africa have the knowledge and the expertise to manage foreign investment portfolios, and to assess the alien risk exposures that are connected to such investments. We should not, just because of sentimental reasons, make use of a new freedom to invest funds abroad when a local investment will serve our needs better and more effectively. 4. Monetary policy in an environment of no exchange controls The new situation brings new challenges also for monetary policy. The depreciation of the rand last year, and the appreciation of almost 10 per cent since November 1996, gave us a taste of the new exposures of our financial system to the global markets. If South Africa wants to be part of the global village, we shall have to abide by the rules of the international markets. Without exchange controls, capital in and outflows will be dictated by market forces, and markets are inclined to put heavy penalties on errors made by governments and central banks in their macroeconomic policy decisions. It will be fatal for a country to liberalise its financial systems and to encourage the integration of its domestic financial markets into the global system, and then to balk at the disciplines of these markets. 5. Financial institutions without exchange controls Many South African financial institutions have already taken up the challenge of becoming part of the international financial community. Such institutions will also have to consider carefully how this new venture will affect their own security, liquidity and solvability. There are numerous examples in the world of the collapse and failure of major financial institutions because of international exposure. Governments or financial regulators and supervisors cannot protect multinational institutions against the many risks involved in being global. South African institutions were protected from these international risk exposures through the isolation of our country from the international markets. Now that the opportunities are being opened up for an outward movement, they have to tread with care and with caution. 6. Conclusion The removal of exchange controls opens up new opportunities for South African corporates, institutional investors and private individuals. All of them, however, must not be overwhelmed by emotional considerations inspired by a new freedom, but must give careful consideration before any decision is taken to invest hard earned savings in a foreign country, in a foreign currency and in a foreign institution. | south african reserve bank | 1,997 | 3 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at a Luncheon of the Rotary Club of Durban on 17/3/97. | Dr. Stals looks at current developments in monetary policy in South Africa Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at a Luncheon of the Rotary Club of Durban on 17/3/97. 1. Monetary policy and total economic activity At this stage, there is general expectation amongst economists in the private sector that monetary policy will be eased during the course of 1997. Differences of opinion may exist on how soon the easing will begin, or by how much interest rates will decline as a result of the easier conditions. This assumption is based, firstly, on a projection of some further slow-down in the rate of expansion of the total domestic economic activity. Last year, the rate of growth in gross domestic production declined to 3.1 per cent, down slightly from the 3.4 per cent of 1995. It must also be noted that the decline in the rate of growth in the non-agricultural sectors was even more pronounced, where the rate of increase in total real value added declined from 4½ per cent in 1995 to only 2 per cent in 1996. In the very important manufacturing sector, the decline was from 7½ per cent growth in 1995 to only ½ per cent in 1996. It was a strong recovery in the agricultural sector that maintained overall growth at the level of 3 per cent plus for last year. Agriculture will not make the same contribution to growth in 1997 and for economic analysis purposes it makes sense to assess the future prospects for non-agricultural production before deciding on a possible course for monetary policy during the rest of this year. There were some tentative signs that total manufacturing production may have started with a new expansionary phase in the fourth quarter of last year when a seasonally adjusted annualised decline of 1 per cent in the third quarter switched to a 2 per cent expansion in the fourth quarter. This expansion in production was boosted partly by a rising demand from the rest of the world for South African products, following the depreciation of the rand last year. This important development can make a further contribution to the maintenance of reasonable growth in 1997. Developments on the demand side of the economy also indicated a marked slow-down in total economic activity last year. The rate of increase in total domestic expenditure declined from 6.5 per cent in 1994 and 5.2 per cent in 1995, to 3.0 per cent in 1996. In this case, the decline was more broadly based and the rates of increase in gross domestic fixed investment, private sector consumption expenditure and accumulation of inventories all receded last year. There was only one exception, and that was consumption expenditure by general government which rose by 5 per cent in real terms, compared with an increase of only ½ per cent in 1995. This slower rate of increase in total domestic expenditure established better balance between production (supply) and expenditure (demand). With both sides of the economy now growing at about 3 per cent per annum, there is better equilibrium and less friction in the economy, which contributes also to more stable conditions in the financial markets. It is important that this balance between aggregate demand and aggregate supply be retained -- both should gradually be raised to a higher level, but the upward movement should be in tandem. Monetary policy has an important part to play in maintaining this equilibrium over time. Any artificial stimulation of the economy through a premature easing of monetary policy will lead to further tensions in the balance of payments and in the financial markets, and will lead to further upward pressure on inflation. At this stage, economists predict some further slow-down in the rate of increase in private sector consumption expenditure with continued growth at the current levels in gross domestic fixed investment. An important factor in this projection therefore will be the behaviour of government consumption expenditure. It is in this regard that the provision made by the Minister of Finance in his Budget Speech of last week for an increase in total government expenditure of only 6.1 per cent in 1997/98 is of vital importance. In real terms, that is after provision for depreciation, total government expenditure will indeed decline and therefore make an important contribution to the retention of macroeconomic equilibrium this year. 2. Monetary policy and the balance of payments Monetary policy decisions are obviously also affected by the overall balance of payments situation, and not only by developments in the domestic economy. Last year, international economic relations dominated the South African economic scene. Towards the end of the year, however, better equilibrium was also restored in the external accounts and this contributed to the expectation of an easier monetary policy in 1997. The current account of the South African balance of payments showed a substantial and growing deficit in the first half of 1996. In the second quarter, the seasonally adjusted annualised rate of the deficit reached R12.9 billion and there was justifiable concern that it could increase even further. Against the background of a slow-down in total domestic expenditure in the second half of the year, the growth in imports levelled off and, with some good increases in exports, the current account of the balance of payments improved to an annualised deficit of R4.7 billion in the fourth quarter of last year. Prospects are good that only a small deficit will be recorded in the current account of the balance of payments in 1997. The main reason for the balance of payments problems of last year was to be found in the capital account. The net capital inflow declined from R19.2 billion in 1995 to only R3.9 billion in 1996. The capital inflow was no longer sufficient to cover the deficit in the current account, and the official gross foreign reserves, which were at a very low level to begin with, declined by R5.4 billion. These developments exerted extreme pressures on the exchange rate of the rand and, as is well-known, the average weighted value of the rand against the basket of currencies of South Africa’s major trading partners depreciated by 21.9 per cent from 31 December 1995 to 31 December 1996. The balance of payments situation obviously demanded a restrictive monetary policy throughout the past twelve months. Here also, however, important changes took place after October 1996. The improvement in the domestic economic situation and in the current account of the balance of payments restored some confidence in the market for foreign exchange, particularly as the foreign reserves started rising again in the fourth quarter. The exchange rate of the rand reached a lower turning point in October 1996, stabilised in November and December and showed an impressive appreciation of about 9 per cent since the beginning of the new year. Optimism for the balance of payments for 1997 rests very strongly on the expectation that there will be a good net inflow of capital into the country during this year. So far, the results have been encouraging with a relatively strong demand for South African equities and bonds from non-residents. In January and February, non-residents were indeed net buyers of more than R5 billion of South African listed securities, but this total amount did not necessarily represent a net inflow of foreign exchange into the reserves. The announcements made by the Minister of Finance in his Budget Speech last week for the further relaxation of exchange controls can also have an important effect on the capital account of the balance of payments. It is difficult to forecast how much capital of residents may leave the country because of these relaxations, but it is generally assumed that this will be balanced by the inflow of more non-resident funds into the country. Indeed, it is not unreasonable to assume that a total net inflow of capital in excess of the projected current account deficit will add some amount to the official foreign exchange reserves during the course of this year. If these assumptions prove to be correct, the exchange rate of the rand, measured against the basket, should be more stable this year than the experience of last year. Such a balance of payments situation will also reduce pressure on monetary policy and will contribute to easier domestic financial conditions. 3. Monetary policy and the domestic financial situation In a more stable macroeconomic situation with better equilibrium in the balance of payments, monetary policy can be aimed more directly at influencing developments in the more important domestic financial aggregates. In a statement issued last Friday, the Reserve Bank indicated that the rate of increase in the M3 money supply should not exceed 10 per cent in 1997. This will provide for real growth in the economy at a rate of between 2 and 3 per cent, and inflation at a level well below 10 per cent. The Reserve Bank is concerned about the rising trend in inflation that gained substantial momentum during the course of 1996. The average rate of inflation for last year was 7.4 per cent, being the lowest rate of inflation South Africa had since 1972. The annual figure disguises the fact however, that inflation reached a lower turning point of 5.5 per cent in April 1996, and has since then risen to a level of 9.4 per cent in December 1996 and also in January 1997. In the fourth quarter of last year, the quarter-to-quarter seasonally adjusted annualised rate of inflation was as high as 12.7 per cent. The escalation in inflation was caused mainly by the depreciation of the rand, by sharp rises in food prices, by rising interest rates and also by a rise in the unit labour costs per unit of production. In this situation, however, it is imperative that the rate of increase in the money supply will be constrained, which requires a meaningful slow-down in the rate of increase in bank credit extension. Last year, the M3 money supply rose by 13.6 per cent, and total bank credit extended to the private sector by 16.1 per cent. If we want to make sure that the current trends in inflation will not be perpetuated, we must make sure that increases in the money supply will not automatically accommodate rising prices, or even further stimulate the inflationary pressures that are emerging from other sources. The most recent developments in the financial situation therefore do not emit the same optimistic signals emanating from the real economy and from the balance of payments for an early easing of monetary policy. On the contrary, the Reserve Bank would still want to see clear signs of a slow-down in the rates of increase in bank credit extension and in the money supply before lending official support to a decline in interest rates, or an easing in monetary policy in general. 4. Monetary policy and the Budget For monetary policy purposes, the most important aspect of the Fiscal Budget is the deficit that must be financed through borrowing by Government. A large deficit absorbs a greater share of the available savings of the private sector and therefore leaves less scope for expenditure in the private sector. A large deficit will force an increased demand from the private sector for more bank credit to replace what Government is withdrawing from the savings pool. More bank credit, however, creates more money and increases the risk of higher inflation in future. The Reserve Bank is therefore particularly pleased with the determined effort made by the Minister of Finance to reduce the deficit in the Budget from 5.4 per cent of gross domestic product in 1996/97 to 4.0 per cent in 1997/98. In absolute terms, the net borrowing requirement (i.e. the deficit after taking the opening cash balance into consideration) increased by only R1.3 billion, from R23.5 billion to R24.8 billion. Taking account of a much lower amount of maturing debt in the new fiscal year, the total gross borrowing requirement has in fact been reduced from R41.0 billion in the current fiscal year to R36.8 billion in the next. There are more reasons than just relieving pressure on monetary policy for reducing the deficit on the annual budget. One is, of course, the growing burden in the budget of the cost of servicing government debt. In the Budget Review Document, it was indicated that total Government debt as at the end of February 1997 amounted to R309.5 billion, equal to 55.3 per cent of gross domestic product. This is a relatively large deficit for a country with a relatively low overall savings ratio, and with massive needs for the development of infrastructure. For the 1997/98 fiscal year, total interest payments in the government debt will absorb R39 billion, or more than 20 per cent of the total expenditure. It is also laudable to note that the smaller deficit on the Budget is being achieved through constraints on government expenditure, and not through an increase in taxes. Both government expenditure at a level of 30 per cent and government revenue at 26 per cent of gross domestic product, are regarded as on the high side and there is a desire to reduce these levels over the next few years. This will further ease the burden on monetary policy. 5. Summary The 1997/98 Budget will, in summary, bring about a better balance in the monetary and fiscal policy mix that is required to maintain overall financial stability in the South African economy. In the longer term, as the implications of the Budget work through to the financial markets, it should reduce some pressure in monetary policy. In the short term, however, the main objective of monetary policy must be to force a similar mood of financial discipline also in the private sector. Not only government, but also private sector individuals and corporates must reduce their reliance on credit for the financing of their economic activity. Some decline in the rate of increase in the total amount of bank credit extension to the private sector, together with some slower growth in the total money supply, have become first priorities of monetary policy. This will be the only way to avoid the current inflationary pressures in the economy from being perpetuated into a new extended period of double digit inflation. | south african reserve bank | 1,997 | 3 |
Contribution by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Sixth Session of the Conference of African Ministers of Finance and Governors of Central Banks arranged by the United Nations Economic Commission for Africa and held in Addis Ababa on 31/3/97. | Mr. Stals comments on financial sector reforms in Africa Contribution by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Sixth Session of the Conference of African Ministers of Finance and Governors of Central Banks arranged by the United Nations Economic Commission for Africa and held in Addis Ababa on 31/3/97. I INTRODUCTION 1. Background to the South African financial sector reform process Unlike many other countries on the African continent, South Africa has a well-established financial structure which includes a relatively independent central bank, sophisticated modern banking institutions and competitive financial markets. There developed, nevertheless, a need for far-reaching financial reforms in recent years. The experience of South Africa in this regard provides an interesting case study from which some lessons can be learned. The South African financial sector and, for that matter, its total economy, was isolated to a high degree from the rest of the world for more than a decade because of unacceptable internal political and social policies, and international punitive actions taken against the country. In the circumstances, developments in the financial sector did not keep abreast with the evolutionary international changes of the past twenty years. With a lack of external competition and economic concentration in a few powerful corporate conglomerates, a stagnating economy, and a comprehensive protective exchange control system, a “hot-house” climate was created that contributed to a retarded adjustment process of the financial sector. Major political and social reforms in South Africa culminated in the democratic election of the Government of National Unity in April 1994. The scene was then set for major changes, also in the economy of the country. Indeed, not only was the scene set, but the expectations of the people of the country demanded major reforms that would, as a minimum, provide a better economic performance and an increase in the standard of living of millions of previously disadvantaged members of the community. Over the past five years, South Africa was therefore not only challenged with the need for reintegrating the South African economy, and more in particular, the financial sector in a rapidly changing global financial environment, but also with the challenge of adapting to a new domestic socio-political structure. These adjustments in the financial sector, which are still in progress, were facilitated by the existence of a sophisticated, albeit marginally retarded, financial system with a long history of more than a century. The Government’s policy approach to the needed reforms is based on a gradual but resolved transformation of the financial sector, mainly by exposing domestic institutions more to international competition, by integrating policy measures, the institutional framework, and the financial markets gradually into the global village, and by adapting at the same time to the changing needs of the local community. In the next part of this paper, the attention is focused on the reform process of the financial system to meet these policy objectives. The new South Africa was also confronted with a daunting further challenge, and that is to become, and to be part of, Africa. With the admission of South Africa during the second half of 1994 to the Southern African Development Community (SADC), comprising twelve countries in the Southern African region, new challenges were offered for the expansion of financial co-operation on a regional basis. The third part of this presentation will provide a brief summary of the progress so far made with co-operation amongst the central banks of the members of SADC in the implementation of financial reforms in the region. II FINANCIAL SECTOR REFORMS IN SOUTH AFRICA 2.1 Macroeconomic policy implications The integration of the South African financial system in the global economy obviously holds major implications for macroeconomic policies. A country that exposes itself to the whims and the fickleness of fund managers and financial traders operating in a technologically integrated global market system can no longer ignore the international norms and standards set for financial disciplines, prudent management, sound government and internal stability and security. Integration into the world financial system brings the advantage of access to a massive pool of excess saving in the mature economies of the world, but also demands from the individual participating country adherence to the disciplines of a global market economy. This presentation will, however not cover the consequences for macroeconomic policies of the financial reforms, but will rather concentrate on major institutional adjustments. Aspects of economic policy, such as exchange rate policies have been, or will be, covered in other sessions of this Conference. 2.2 The role and functions of the central bank The South African Reserve Bank was founded in 1921 as one of the first central banks to be established in the new world outside of Europe. The Bank therefore has a long history and experience, and has always operated with some autonomy from Government. Even today, the South African Reserve Bank is privately owned, with important restrictions on the rights of shareholders, for example that no individual shareholder may hold more than one-half per cent of the capital of the Bank, and that the Bank may not pay a dividend of more than 10 per cent per annum on the paid-up share capital of the Bank. Without going into the details of the functions and responsibilities of the South African Reserve Bank, the new South African Government recognised a few basic principles for the role of the central bank in the development of the economy. These can be summarised as follows: Monetary policy is part of overall macroeconomic policy for which Government takes final responsibility. There must therefore be good co-operation between the central bank and Government, and regular consultation must take place between the Governor of the Reserve Bank and the Minister of Finance. The task of the central bank must be clearly defined and must be restricted to the objective of creating a stable financial environment that will be conducive for optimum real economic development. The central bank must protect the value of the currency. For the implementation of monetary policy, the central bank must be given sufficient autonomy to enable it to make objective decisions on sensitive monetary policy issues, such as the level of interest rates, money supply guidelines, financial liquidity management and bank credit extension policies. The central bank must be accountable to Parliament. To give effect to this policy approach, the South African Government included the following mandate for the South African Reserve Bank in the new Constitution of the Republic of South Africa: “The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic. “The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters”. 2.3 The development of the banking system South Africa has always had a private sector banking system, based on private sector ownership and on effective competition in a free market environment. The major reforms introduced in recent years to adapt the banking system to the needs of the country’s changed philosophies, macroeconomic policy objectives and international relationships, were therefore concentrated on improving the existing structure. Firstly, recognition was given in the banking legislation to the existence and role of “informal” banking business that developed mostly in the less developed communities over many years. The Banks Act was therefore amended to provide for the continuation of numerous informal savings clubs (“stokvels”) outside the normal constraints of bank regulation and supervision, but also then, of course, without access to central bank accommodation at the discount window. New legislation to provide for communal ownership of a banking institution was introduced in the form of the Mutual Banks Act. Secondly, banking institutions adapted their own internal policies to provide for greater participation in the social upliftment programmes of the country, for example by entering into an agreement with Government to provide a minimum amount per year for low-cost housing. On the other end of the spectrum, banks also introduced new electronic data processing systems, for example automated teller machines, and “smart card” facilities for a gradual introduction of electronic money. Thirdly, bank regulation and supervision underwent major changes over the past ten years to apply the world-wide supported directives of the Basle Committee. At this stage, bank regulation and supervision is based primarily on risk identification and management, with clearly defined roles for shareholders, boards of directors, senior management and internal and external auditors. Fourthly, the South African banking scene was opened up for foreign banks, and South African banks, in turn, were allowed to establish branch offices, subsidiaries and representative offices in many countries around the world. Today, in addition to about 35 domestic banks, there are more than 10 established branches and subsidiaries of foreign banks operative in South Africa, and about 60 international banks with representative offices in the country. South African banks have opened up 29 branches/subsidiaries in 13 other African countries. It is still too early to judge the effect of this wider competition on the South African banking system. There are signs, however, that it is beginning to squeeze the margins of banking business. In particular, the share of foreign banks in wholesale banking, foreign exchange business and financial market activity increased significantly. This was accompanied, however, by an almost explosive increase in the total volumes of business in these markets, which provided for continued growth in existing and newly-established institutions. 2.4 The development of financial markets Once again, the new South Africa had the advantage of inheriting well-established and relatively sophisticated financial markets. This did not mean, however, that no reforms were required in these markets. The most striking adjustments occurred in the capital market. A “big-bang” revolution took place in the Johannesburg Stock Exchange last year when: the market for trading in equities was separated from the bond market; an electronic screen trading system replaced the traditional open-floor outcry system; corporates and non-residents were allowed for the first time to become broker-members of the Exchanges; provision was made for negotiated commissions and principal versus broking trade by members of the Exchange. Over the past few years, a market in derivatives also developed, originally as an over-the-counter market, but since the establishment of the South African Futures Exchange (SAFEX) in 1990, on a more formal basis. These reforms, together with the other socio-politico-economic changes in the country, boosted turnovers in the financial markets. In 1996, the total turnover in equities on the Johannesburg Stock Exchange exceeded US $27 billion; total turnover in the Bond Market amounted to US $703 billion, and 4.1 million contracts were traded through SAFEX. Major changes also took place in the South African market for foreign exchange, particularly in the light of the gradual removal of exchange controls. South Africa has a floating exchange rate system in which about 30 authorised dealers in foreign exchange (banking institutions) make prices on a competitive basis, for foreign currencies (mostly US dollar). The exchange rate is therefore determined by underlying forces of demand and supply, influenced to a diminishing extent by Reserve Bank intervention (through exchange controls and direct active participation). The Reserve Bank is gradually reducing its participation in the market, and is now in the process of encouraging the development of a more active market in forward foreign exchange outside of the central bank. The average daily turnover in the South African market for foreign exchange over the past six months amounted to US $6.1 billion. The policy of the Reserve Bank is to continue to encourage the development of the financial markets, and to monitor these markets on a regular basis. The central bank itself, however, is reducing its own direct participation in the market-making processes. This applies to the market for foreign exchange and also the capital market. Negotiations for the transfer to the private sector of responsibility for the primary funding of government and for market-making in government bonds have reached an advanced stage. The Reserve Bank will eventually confine its participation in these markets to transactions (such as open-market operations) aimed at the achievement of defined monetary policy objectives. 2.5 The national payment, clearing and settlement system Up to now, the national payment, clearing and settlement system was vested in a joint venture between the Reserve Bank and the major commercial banks in the country. Clearing takes place on a daily basis through an electronic data process in a communal banking service facility known as the Automated Clearing Bureau (ACB). The ACB is, however, no longer able to stand up to the emerging pressures of the expanded activity in the financial markets. The Reserve Bank has therefore taken the initiative to introduce a major reform to the national payments, clearing and settlement system. In April 1998, a new integrated system will be introduced to provide for real-time on-line settlement on a gross basis of large transactions, and for a daily netting-process and final settlement of smaller transactions. The intention with this major reform project is to reduce the risk exposure of possible default by any individual institution that could lead to the collapse of the whole system. At the same time, the new system must be compatible with global network systems for payments and clearing operations, and must provide a framework for an integrated cross-border settlement system for the SADC region. 2.6 The gradual removal of exchange controls At the centre of the South African programme for financial reform is the gradual phasing-out of exchange controls. Comprehensive exchange controls were introduced in South Africa over an extended period of time, ranging from 1961 to 1993. These direct control measures were intended to provide some protection to the domestic economy against the adverse effects of non-economic factors that afflicted South Africa over a long period of time. When the Government of National Unity came into power in April 1994, it was accepted as a policy objective to remove the exchange controls. At that time, however, South Africa had virtually no official foreign reserves at its disposal for this purpose. The pragmatic solution was therefore adopted to embark on a process of a gradual phasing-out of the exchange controls. Good progress has been made over the past three years with this programme. So far all effective exchange controls on current account transactions have been lifted; exchange controls applicable to non-residents have been fully removed; the two-tier exchange rate system for certain capital account transactions was formally terminated in 1995; South African resident corporates were given permission to make certain direct investments in branches and subsidiaries in foreign countries; South African resident institutional investors (insurers, pension funds and mutual funds) may now diversify up to 10 per cent of the total assets managed by them in foreign currency denominated assets; and South African resident private individuals will shortly be allowed to transfer limited amounts of capital from South Africa for foreign investment. The removal of the exchange controls is a process that has far-reaching effects for the financial sector and the development of the financial markets in South Africa. It is a process that must be applied with caution, and must be supported by other macroeconomic policy measures aimed at improving the international competitiveness of the South African economy. In the area of the financial sector, the authorities must make sure that level playing fields are created for all domestic and non-resident participants in the market. III REGIONAL FINANCIAL CO-OPERATION WITHIN SADC When it formally joined the Southern African Development Community in the second half of 1994, South Africa was given the task of managing the Financial and Investment Protocol for the region. A Sectoral Committee of Ministers of Finance was established within the institutional framework of SADC, and two sub-committees were created, one for Heads of Finance Departments, and a second for Governors of Central Banks. The Committee of Governors of the Central Banks of SADC met four times during the past eighteen months, finalised a Terms of Reference for its activities, established a Secretariat and Research Unit within the South African Reserve Bank, and agreed on a number of projects and programmes to be implemented. The basic approach of the Committee of Governors has been described as a “bottom-up” approach, where the attention is focused at this stage on financial co-operation amongst, and not integration of, the financial systems of the twelve independent members of SADC. Furthermore, the attention is focused on the development of the internal financial systems of members within a consistent and compatible framework that will pave the way for the co-ordination of macroeconomic monetary policies at some later stage, and perhaps some integration of systems further downstream. The programme of the Governors’ Committee therefore provides for an exchange of information on, and regular discussion of, macroeconomic structures and economic changes in member countries. To facilitate this programme, the Secretariat of the Committee has established within the South African Reserve Bank a computerised data bank for basic financial and economic statistics of each one of the members of SADC. All members will at some stage have direct real-time access to this data base; an exchange of information on the structure, the functions, the responsibilities and the relationships with the government of each one of the twelve participating central banks. For this purpose, the Secretariat of the Committee is busy with the compilation of an information data bank on the participating central banks; a co-ordinated training programme for central bank officials. The South African Reserve Bank Training Institute will this year offer three three-week specialised courses on central banking for officials from SADC central banks; co-ordination of the exchange control policies applied by members of SADC. At least two countries in the region have removed all exchange controls, and many others are in the process of gradually removing remaining controls; a work study on Information Technology (IT) develop-ments within each central bank. The exercise involved in by South Africa to revise is national payment, clearing and settlement system provides an opportunity to plan ahead and consider ways and means of introducing compatible and inter-changeable systems in the region; a concerted approach on efforts to reduce or avoid money laundering and illegal banking activities in the region; and a major initiative to improve the quality of bank supervision and regulation in the region, and to co-ordinate policies on the licensing of banking institutions. This work is undertaken jointly with the East and Southern Africa Banking Supervisors Group (ESAF), which includes a few more countries than just the SADC configuration. Whilst the work of the Governors’ Committee up to now was more institutionally-centred, more attention will be given in the next phase to the development of the financial markets in the region. There are obviously opportunities for a better utilisation of existing markets in a number of the participating countries in the interest of the whole region. In the third phase, the Committee of Governors will address the macroeconomic needs for the harmonisation of monetary policies such as inflation and interest and exchange rate policies of the member countries. The broad strategy of the SADC Committee of Governors is based on the premise that a sound financial basis must first be laid within the participating countries before it can be extended to the region as a whole. At this stage, the main objective is therefore to learn from each other and to help each other to create appropriate structures for the central bank, the private banking sector and the financial markets in each one of the twelve members of SADC. The domestic financial sector reforms introduced in each country must, however, even at this early stage, take cognisance of the development needs of the region, and the longer-term objective of a more co-ordinated and integrated regional financial sector. This will be the contribution of the central banks to the expansion of trade and investment, and to improved living conditions for the approximately 130 million people of the region. Finally, the Committee of Governors of SADC as a regional body has a great interest in establishing extended relationships with similar regional central banking forums in the rest of Africa, and other similar initiatives in the Southern African region. IV CONCLUSION The nature of current South African financial sector reforms is dictated by the special circumstances of the country. They may therefore differ substantially from those introduced in other countries. The South African reforms are needed to adapt the financial sector to major internal socio-political reforms, and to accommodate the challenges presented by an enhanced participation in the global financial markets. As far as regional developments are concerned, South Africa welcomes the opportunity of participating more actively through the Southern African Development Community in the development of the financial sector of the African continent. There is a growing need for some closer contact between the various regional financial sector arrangements on the African continent. From the level of financial reforms applied within each one of the more than fifty African countries, through the second tier of regional financial cooperation, the ultimate objective must be to establish a sound, stable and well-functioning financial system in support of economic development in the whole of Africa. Co-ordination on a continental basis of the financial reforms applied within the regions can, perhaps, become an important function of the Economic Commission for Africa, working under the auspices of the Economic and Social Council of the United Nations. | south african reserve bank | 1,997 | 4 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the official opening of the new Head Office Building for Mercantile Bank in Sandton on 9/4/97. | Mr. Stals discusses financial sector reforms and their implications for the banking industry in South Africa Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the official opening of the new Head Office Building for Mercantile Bank in Sandton on 9/4/97. 1. The need for financial sector reforms In many countries in the world there is at this stage a need for major reforms of the financial sector, which invariably holds important changes for the banking industry. Looking around the world, at least three reasons can be found for financial restructuring. Firstly, there are the countries of Central and Eastern Europe where major transitions are taking place in the economies of the former centrally-planned countries of the now defunct Communist world. The transition from socialist to market-oriented economies requires in most of these countries a major reform of the functions and of the role of the central bank, the introduction of private sector banking institutions driven by the profit motive, the development of financial markets, and the acceptance of macroeconomic monetary policies that played no role in the previously centrally-planned systems. In these countries, it was necessary to introduce certain basic minimum requirements first, such as a recognised system of business laws including corporate, bankruptcy, contract, consumer protection and private property laws that can be consistently enforced and will provide a mechanism for fair resolution of disputes. In most of these countries until a few years ago there did not exist well-defined accounting principles and rules, and independent auditors were not available to certify financial statements and accounts of banking institutions. In summary, the public infrastructure for the management and running of modern banking activity did not exist and had to be established before modern financial market systems could be developed. Secondly, a number of developing countries, particularly from the African continent, have recently embarked on major macroeconomic restructuring programmes, in many cases in collaboration with the International Monetary Fund and the World Bank. In a recent publication of the United Nations Economic Commission for Africa the need for the reform of the financial sectors of African economies was described as follows: “Financial systems in Africa are characterized by the low level of financial intermediation which takes place in the formal sector, the distressed nature of financial institutions, the high risk profile of financial asset portfolios due to the concentration of numerous countries’ economies in only a few commodities and industrial sectors and the vulnerability of financial asset portfolios to price and supply shocks. In addition, very few formal financial institutions have shown the capacity or willingness to provide financial services to the small-scale entrepreneur and the rural operators. “Furthermore, the range of financial institutions and instruments is narrow. Public ownership of financial institutions is pervasive. Institutions are plagued by a large proportion of non-performing loans in their portfolios. Management lacks the relevant management skills. Financial market depth and breadth is still very limited.” Reforms in these developing countries have focused on improving the legal, regulatory, supervisory and judiciary environment, reducing financial repression, restoring bank soundness, rehabilitating financial infrastructure, and have included programmes designed to downsize publicly-owned banks, privatising them where possible and encouraging new entrants. Thirdly, reference can be made to financial sector reforms in the emerging economies of the world. In these countries some stage of advancement has already been reached in the development of financial systems. However, new demands are now being made in light of a new global financial environment, characterised by a liberalisation of financial markets, an integration of major global markets and an exposure of individual countries to relatively large international capital movements. In these countries, exchange controls have been or are being removed, multinational financial institutions, including banks, are granted unrestricted entry, and international rules for financial regulation and supervision are being introduced that must be complied with to the satisfaction of international investors. Domestic monetary policy objectives must be brought to terms with the requirements of international market operators, and governments must accept some eroding of their sovereign autonomy for the management of the national economy. 2. Financial sector reforms in South Africa South Africa is part of the latter group of countries. Together with the major social and political reforms of the past few years, we also had to contend with some important restructuring of the financial system. Firstly, the South African financial sector, not unlike other countries on the African continent, had to adapt to the changes in the socio-political environment. Provision was made in the banking legislation for the existence and continuation of numerous informal savings clubs (“stokvels”) operating outside the normal constraints of bank regulation and supervision, but also then, of course, without access to central bank accommodation at the discount window. New legislation to provide for communal ownership of a banking institution was introduced in the form of the Mutual Banks Act. South African banking institutions also adopted their own internal policies to provide for greater participation in the social upliftment programmes of the country. Secondly, bank regulation and supervision underwent major changes over the past ten years to apply the world-wide supported directives of the Basle Committee. At this stage, bank regulation and supervision is based primarily on risk identification and management, with clearly defined roles for shareholders, boards of directors, senior management and internal and external auditors. Thirdly the South African banking scene was opened up for foreign banks. South African banks, in turn, were allowed to establish branch offices, subsidiaries and representative offices in many countries around the world. Fourthly, major changes were introduced in the operations of the financial markets. The Johannesburg Stock Exchange led the way with a major restructuring last year to provide for electronic screen trading, corporate and non-resident participation, and provision for negotiated commissions and principal versus broking trade by members of the Exchange. Fifthly, with the gradual removal of exchange controls, the South African market in foreign exchange became more competitive and volumes increased to an average of more than $6 billion per day. Sixthly, with South Africa’s active participation in the Southern African Development Community (SADC), the way has been opened up for South African banks to play an enhanced role in the Southern African region. The process of financial sector reform in South Africa is continuing. Exchange controls have only been removed partly, and South African banks are only gradually adapting themselves to the environment of greater freedom in their international financial operations. Further important changes will be introduced in the structure of the domestic capital market, particularly in so far as the primary issues of government bonds are concerned, and also in the secondary market-making activities of the Reserve Bank. A major revision of the national payment, clearing and settlement system is now under way to provide for real-time on-line settlement on a gross basis of large transactions, and a daily netting and settlement of small transactions in the money market. 3. Implications for the banking sector These financial reforms have important implications for the South African banking sector. Not only did the liberalisation of the markets bring greater competition for the traditional domestic South African banks, but they were also more exposed to the vicissitudes of volatile international capital movements. Our banks were forced to adopt a more open and global attitude in the daily management of their activities. Not only the policies of the South African monetary authorities, but also developments in, for example, the United States of America, the European Union, the Far East, and in other emerging economies of the world, now have a profound effect on the South African money, capital and foreign exchange markets. There are now more than ten foreign banks with formally established branches or subsidiaries in South Africa, and more than 60 international banks with representative offices in the country. These foreign banks provide enhanced competition for the South African banks, particularly in the field of wholesale banking, international trade financing, and in the market for foreign exchange. The liberalisation of the financial market also opened up opportunities for unscrupulous financial operators that are making use of the opportunity to exploit ignorant South Africans with offers of unrealistic yields on deposits, and promises of instant miraculous profits on financial investments. It is amazing that so many South Africans still fall for deceptions such as the ill-fated pyramid schemes that has just recently pushed Albania over the edge of complete social and political collapse. It is even more amazing that the efforts of the Registrar of Banks to protect the South African public against inevitable losses through these exploitations must be defended in courts and in time-consuming litigations. In his efforts to avoid an Albanian situation from developing here, the Registrar is even accused of acting against the Constitution. The changing financial environment also holds important implications for monetary policy in South Africa. The explosion in the volumes of transactions in all the financial markets, the greater participation of all South African residents in financial market operations, the reintegration of South Africa in the world financial system and the liberalisation of financial operations such as foreign exchange transactions, have had an important effect on the amount of bank credit extension and the money supply. These conventional anchors of monetary policy also increased at unacceptably high rates over the past two years, partly because of structural changes, and partly because of normal pressures of demand increasing at a rate in excess of real income increases. For both the Reserve Bank and the individual banking institution the changing environment brings many challenges. Banks operating in the new environment must be aware of the increased risk exposures that are inevitably associated with an extended process of change. Conventional bank prudency becomes even more important in this situation than under more stable conditions. In many other countries a period of major financial sector reforms ended in major restructuring and rationalisation of the banking sector, often because of unsustainable over-expansion in individual institutions. The Reserve Bank’s concerns about the excessive increases in bank credit extension are not only for the effect it has on the total money supply, but also because of the inherent dangers of a concerted future major default in the servicing of the debt under less favourable macroeconomic conditions. The capacity of borrowers to meet future commitments of interest and debt repayment must not be over-stretched during this period of structural change and rapid expansion in the financial markets. 4. Mercantile Bank and financial sector reforms in South Africa The Mercantile Lisbon Bank Holdings Group has been and continues to be part of the financial sector adjustment process in South Africa. With a substantial shareholding by the Banco National Ultramarino of Portugal, Mercantile is firmly linked to the expanding international participation in South Africa. Furthermore, this association brings to Mercantile Bank the experience of Portugal’s largest commercial bank in its participation in the structural financial adjustment of a country that is preparing itself for the major reforms demanded of prospective participants in the European Union’s integrated financial system and common Euro currency. South Africa obviously has a great interest in these developments now taking place in Europe. Our recent successful negotiations for qualified access to the Lomé Convention provide proof of the importance attached to our future relations with the European Union. The supportive role of Portugal in these negotiations was appreciated. We believe that Portugal will be able to comply with the Maastricht requirements for full participation in the first round of Economic and Monetary Union scheduled for 1 January 1999, and will therefore also continue to carry South Africa’s interests into the European Union. Mercantile Bank has also been part of the domestic South African financial sector reforms in recent years. Since the acquisition in 1994 of Central Registrars, the operations of the two companies were gradually integrated. The changes in the operations of the Johannesburg Stock Exchange last year had a significant impact on Mercantile Registrars, and its contribution to the non-interest income of the Group had increased considerably with the larger volumes traded on the JSE. Finally, Mercantile Bank is also expanding its interests to other African countries, for example Mozambique, and is therefore taking up the challenge of greater financial cooperation in the SADC region. I can only wish you well in your future operations, and may this new building contribute to your future successes, in the interest of the development of a sound and wellmanaged banking sector in South Africa. | south african reserve bank | 1,997 | 5 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, given at a Conference on Current Economic Policy Issues arranged by the Economics Department of the University of Durban-Westville and The Mercury in Durban on 25/4/97. | Mr. Stals looks at the role of central banks in today’s economies and discusses the experience of South Africa Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, given at a Conference on Current Economic Policy Issues arranged by the Economics Department of the University of Durban-Westville and The Mercury in Durban on 25/4/97. 1. The objective of monetary policy There is fairly general consensus in the world of central banking today that the objective of monetary policy should be to protect the value of the currency. There was a time up to the late ’seventies when economists and central bankers advocated a much wider role for monetary policy in the management of the macroeconomy. Under the influence of the Keynesian demand management approach, monetary policy was seen as a useful instrument to be used by the authorities to depress demand in times of an excessive rise in total real expenditure on goods and services, or to stimulate real demand in times of recessionary conditions. Monetary policy may have been an effective instrument for the purpose of demand management in the global system of fixed par values, or in the times of Keynes’ General Theory of Employment, Interest and Money, (1936), when a lack of overall demand caused production resources to remain under-utilised. During the 1970’s, however, the Bretton Woods System of fixed par values was replaced with the global system of floating exchange rates and over-stimulation with expansionary monetary and fiscal policies created inflationary pressures and persistent balance of payments crisis situations. The emphasis in macroeconomic policy gradually shifted from demand-side management to supply-side expansion in which monetary policy was assigned a different role. Monetary policy was no longer accepted as a useful short-term anti-cyclical policy instrument, but was tasked with the responsibility of creating on a continuous basis a financial environment that will be conducive to sustainable optimum economic growth in the longer term. This environment can be characterised by stable overall financial conditions in which the rate of inflation will at all times be low. In this new approach, central banks focused their attention on major financial developments such as changes in the money supply and in bank credit extension, the level and the structure of interest rates, changes in the official foreign reserves of the country, and movements in the exchange rate. The ultimate objective of monetary policy became the value of the currency, and whatever strategies were followed with the implementation of monetary policy, the success or failure of the policy was measured by the level of inflation. The major industrial countries were extremely successful with this new approach, and during the eighties most major economies succeeded in reducing inflation to relatively low levels, that is, in general to about 1 to 2 per cent per annum. This left but little choice for the smaller economies of the world to follow suit, particularly as the drive towards global financial integration gained more momentum during the ninety- nineties. The odd old-time economist who believes that contemporary monetary policy is on a wrong track, particularly in the developing economies, still surfaces from time to time. The counter-argument is often based on the so-called Phillips Curve or an assumed trade-off that is perceived to exist between inflation and economic growth. There is sufficient evidence to confirm, however, that in the longer term, maximum economic growth is invariably attained at the lowest possible rate of inflation. The development of the theory of rational expectations questions the validity of the existence of a Phillips Curve trade-off, even in the short term. Be that as it may, a country such as South Africa with its open economy can hardly maintain overall financial stability unless its rate of inflation stays more or less in line with the average rate of inflation in the economies of its major international trading partners and competitors. 2. The South African experience On recommendation of the De Kock Commission of Inquiry into the Monetary System and Monetary Policy in South Africa, the South African Reserve Bank adopted money supply targets as the anchor for its monetary policy model in 1986. After the money supply increased by 27 per cent in 1988, and the rate of inflation at one stage rose over 20 per cent, the new monetary policy model of the Reserve Bank was implemented with more vigour, and the rate of increase in the money supply was gradually reduced to below 10 per cent in 1992. For two years in succession, the M3 money supply rose by about 8 per cent. Almost as if by magic, the rate of inflation also declined to below 10 per cent in 1993, and stayed in single- digits for the next four years. In 1996, the average rate of inflation was only 7.4 per cent, the lowest level for any calendar year since 1972. The Reserve Bank seems to have lost some of its tight grip over the money supply over the past three years, when the rate of increase in M3 accelerated to a level of about 15 per cent during each of the years 1994, 1995 and 1996. These were, however, extremely difficult years with major political and social reforms and the gradual reintegration of South Africa in the global economy. The liberalisation of the foreign exchange market in South Africa, the access of more than fifty foreign banks to the South African financial market, and the easier access of South African banks to foreign sources of liquidity, brought major changes to the pattern of financial flows and banking activities. The consequences of these changes for monetary policy must still be digested and analysed in more detail, and some adjustments to the monetary policy model applied by the Reserve Bank may be necessary. Initially, the acceleration in the rate of increase in the money supply had little effect on inflation. The rate of inflation indeed continued to decline to reach a lower turning point of 5.5 per cent over the twelve months up to April 1996. A sharp depreciation in the exchange rate of the rand after February 1996 provided a new shock stimulus for inflation in South Africa and, assisted by a continuous excessive rate of increase in the money supply, the rate of increase in overall consumer prices accelerated to 9.8 per cent over the twelve months up to February 1997. The Reserve Bank is greatly concerned about these latest trends in the rate of increase in the money supply, the rate of increase in bank credit extension, and in the rate of inflation. It is accepted that the depreciation of the rand last year must inevitably lead to some price rises, but there is a real danger that these price adjustments (of internationally tradable versus non-tradable goods and services) will become embedded in a permanently higher rate of inflation. 3. The monetary policy model The South African experience with the “monetarist” approach applied since 1986 was relatively successful. The present threat of a new surge in inflation should not be seen as a failure of the policy approach, but rather as a result of an external shock -- the currency depreciation -- and a severe testing of the monetary policy model in light of the changing macroeconomic environment. Central bankers may concur in general on the main objective of monetary policy, namely to protect the value of the currency, but they do not all follow the same strategy in pursuing this objective. The South African model, which is also used by many other countries, is primarily linked to the growth in the M3 money supply, and predetermined guidelines for an acceptable rate of growth in M3 should be seen as an intermediate objective of monetary policy. It is based on the assumption that, over time, there is a link between the rate of expansion in the money supply and inflation. If the real economy, for example, expands by 3 per cent per annum, and the current rate of inflation is 7 per cent, a continuous increase in the nominal money supply at rates of more than 10 per cent per annum will eventually exert upward pressure on inflation. Increases in the money supply of less than 10 per cent will drag inflation downwards. Over the past few years, the Reserve Bank had indicated that an appropriate rate of increase for the South African money supply would be between 6 and 10 per cent. The realised rates of increase were, however, around the level of 15 per cent during each of the years 1994, 1995 and 1996. Initially, the Bank was less concerned about this excessive rate of increase in the money supply, particularly also in light of the relatively low rates of increase of well below 10 per cent established in 1992 and 1993. Inflation also remained on a downward path up to April 1996. It is only over the past twelve months therefore that inflation started moving up again, triggered by the depreciation of the rand last year. The persistently high rates of increase in M3 were partly caused by structural changes in the South African economy. More people were absorbed in the market economy, earned regular incomes, and opened bank accounts for the first time. More banks were established in South Africa, particularly foreign banks, and offered more banking services to the South African public. South African banks found easier access to foreign sources of credit, and made the conventional Reserve Bank instruments to control overall liquidity in the banking sector less effective. The main reason for the larger than desirable increases in the money supply was concentrated in relatively large increases of almost 20 per cent per annum in the total amount of bank credit extended to the private sector. The monetary policy model based on the control of increases in the money supply, requires some effective control over the amount of bank credit extension, because this is the main source of money creation in the South African market-oriented economy. Control over bank credit extension requires not only a restriction on the amount of liquidity available in the banking sector, but also the acceptance of realistic interest rates. Despite the maintenance of relatively high interest rates in South Africa, and a series of increases in interest rates since November 1995, the demand for bank credit remained relatively strong. This may indicate a less interest-rate sensitive demand for credit in South Africa that may be associated with the socio-political changes over the past few years already referred to above. The Reserve Bank remains concerned about the excessive rates of growth in the money supply, and remains committed to reducing this monetary stimulation of inflation during the course of 1997. Recent trends in the money supply and bank credit extension beg the question, however, whether monetary policy at this juncture is restrictive enough and whether even more stringent measures may not be required to reduce overall liquidity further, which could, of course, lead to even higher interest rates and hopefully also a decline in the demand for credit. 4. Other functions of the central bank Restricting the functions of the central bank to the monetary objective of creating a stable overall financial environment, vests a further important responsibility with the monetary authorities, and that is to encourage and support the development of sound and well-managed banking institutions. Banking institutions replace the central bank as the major supplier of money to the public, and therefore have become important conduits for the implementation of monetary policy. The South African Reserve Bank has therefore been vested also with the task of bank regulation and supervision. This task is becoming increasingly more difficult as banking institutions become more multi-national, and as cross-border financial operations increase. The Reserve Bank’s Bank Supervision Department works very closely with their counterparts in many other countries to ensure that uniform, compatible and effective prudential directives are complied with by all banks operating in South Africa, and also by the foreign branches and subsidiaries of South African resident banking institutions. The defined objective for monetary policy also requires of the central bank to accept some leading role in the development and administration of an efficient functioning national payments, settlement and clearing system. The Reserve Bank is now working with the other banking institutions to upgrade the South African payments, settlement and clearing system. Provision will soon be made for real-time on-line settlement of large transactions, and for the daily netting and settlement of smaller payment transactions done through the banking system. Efficient monetary policy in a market-oriented economy finally also requires well-functioning financial markets. The Reserve Bank therefore has a vested interest in the development of the money, capital and foreign exchange markets. In the case of the South African foreign exchange market, the Reserve Bank is working closely with the Minister of Finance gradually to phase out exchange controls, and to integrate the South African financial markets with international markets. 5. Conclusion The South African experience ratifies the international experience that monetary policy should primarily be aimed at financial objectives and should at all times be used to promote overall financial stability. This is the best contribution monetary policy can make to the promotion of economic growth and development in the interest of all the people of the country. In pursuing its strictly defined financial objectives, the central bank should have some autonomy from Government and should be enabled to take quick and objective decisions on the implementation of monetary policy. There must, however, always be close co- operation with the Minister of Finance, and monetary and fiscal policy should be closely co-ordinated. In the final situation, the Minister of Finance and the Governor of the Reserve Bank are jointly responsible for maintaining overall financial stability in the country. | south african reserve bank | 1,997 | 5 |
Lecture by the Governor of the South African Reserve Bank, Dr. C. Stals, presented to the Harvard Institute for International Development in Boston on 1/5/97. | Mr. Stals examines the role of financial cooperation in the development of the Southern African Development Community Lecture by the Governor of the South African Reserve Bank, Dr. C. Stals, presented to the Harvard Institute for International Development in Boston on 1/5/97. 1. Background to the formation of SADC The Southern African Development Community found its origin in 1980 when countries in Southern Africa decided jointly “to pursue policies aimed at economic liberation and integrated development of our national economies”. One of the main objectives of the association at that stage was to make the economies of these countries less dependent on South Africa -- a country that was then an unwanted ally because of its unacceptable internal political and social policies. nine1 After major political and social reforms in South Africa led to the fully democratic election of a Government of National Unity in April 1994, South Africa also joined SADC, to become the eleventh member, after a newly-independent Namibia already joined in 1990. Mauritius was the next country to join SADC, which now has twelve members with a total population of about 136 million people. In August 1992, a revised Treaty for SADC was approved by a Summit Meeting of the Heads of State of the participating countries. Included in the main objectives of the Community are the following economic goals: To achieve development and economic growth, alleviate poverty, enhance the standard and quality of life of the peoples of Southern Africa, and support the socially disadvantaged through regional integration; To promote and maximise productive employment and utilisation of resources of the region, and to achieve sustainable utilisation of natural resources and effective protection of the environment. To achieve its objectives, SADC shall • • • • • • Harmonise political and socio-economic policies and plans of member States. Mobilise the peoples of the region and their institutions to take initiatives to develop economic, social and cultural ties across the region, and to participate fully in the implementation of the programmes and operations of SADC and its institutions. Develop policies aimed at the progressive elimination of obstacles to free movement of capital and labour, goods and services, and of the peoples of the region generally among member States. Promote the development of human resources. Promote the development, transfer and mastery of technology. Improve economic management and performance through regional co-operation. The Treaty provides for other political, social and cultural objectives which are not of direct relevance for the enhancing of financial co-operation in the region. Angola, Botswana, Lesotho, Malawi, Mozambique, Swaziland, Tanzania, Zambia and Zimbabwe. 2. South Africa’s position within SADC The South African economy is by far the most advanced in the region. Although the total South African population of 42 million people accounts for but 31 per cent of the total population of all SADC countries together, the South African economy contributes about 80 per cent of the total gross domestic product of about $170 billion produced in the twelve member states. South Africa also accounts for almost 70 per cent of the combined total exports of $43 billion of the SADC region. South Africa’s dominance is even more pronounced in the financial markets. South Africa is about the only country in the region with well-functioning and independent specialised financial institutions such as banks, long- and short-term insurers, private sector pension funds, mutual funds, participation mortgage bond schemes and mining and industrial finance houses. With a total market capitalisation of about $280 billion, the Johannesburg Stock Exchange dominates the capital markets of the region, and with a daily turnover of about $7 billion, the foreign exchange market in Johannesburg is providing an increasing service for international settlements for a number of other countries of the region. With a turnover of more than $700 billion last year in the South African bond market and a growing market for derivatives, South Africa is in a favourable position to provide sophisticated financial services for the whole SADC region. This dominating position of the South African economy has certain advantages, but at the same time makes harmonious regional co-operation more complex. Some of the other partners in SADC hold an understandable fear that their economic independence will be jeopardised by a too aggressive policy of economic integration of the region. The role that South Africa plays within SADC must therefore be approached with tact and ingenuity. South Africa was given the responsibility for managing and developing the Finance and Investment Protocol2. For this purpose, there is a Council of Ministers of Finance that meet from time to time under the chairmanship of the South African Minister of Finance to give guidance to a programme for closer financial co-operation amongst the participating countries in SADC. Two sub-committees were also established, one a Committee of Treasury Officials, and the other a Committee of Governors of Central Banks and their officials, with clearly defined terms of reference for each one of these Committees. 3. The work and functions of the Committee of Governors of Central Banks When South Africa was given the special task of administering the Finance and Investment Protocol for SADC, the South African Reserve Bank saw in this arrangement a great opportunity for closer co-operation amongst the central banks of the region. In the beginning, however, it proved a major task to get recognition from the political leaders for the need of an independent Committee of Governors of Central Banks. In many of the participating countries the central bank is regarded, and often unfortunately also used, as just an extension of the Treasury Department of the central government. In succeeding to get the approval for the establishment of this Committee of Governors an important seed was sown in each one of these There are a number of other Protocols, co-ordinated by other countries, for example: Inland Fisheries (Malawi), Marine Fisheries and Resources (Namibia), Livestock Production and Animal Disease Control (Botswana), Environment and Land Management (Lesotho), Energy (Angola), Mining and Labour and Employment (Zambia), Tourism (Mauritius), Industry and Trade (Tanzania), Food, Agriculture and Natural Resources (Zimbabwe), Human Resource Development (Swaziland), and Culture and Information as well as Transport and Communication (Mozambique). countries for the acceptance of the undeniable advantages, also for the politicians, of an independent central bank. A second major obstacle was overcome when approval was granted for the establishment of a small specialised Secretariat and Research Facility within the South African Reserve Bank to serve the Committee of Governors. This avoided the need for adhering to the cumbersome procedure of communicating within the central banking fraternity through the conduit of the SADC Secretariat, based in Gaborone, the capital of Botswana. The SADC Finance and Investment Sector was formally established only in 1995, and the Committee of Governors held its first meeting on 24 November 1995 in Pretoria. Now, eighteen months later, this Committee can already look back on a number of accomplishments, and can report good progress with a number of projects being pursued in the interest of promoting economic development in the Southern African region. A number of Technical Subcommittees and Working Groups have been formed, consisting mainly of officials of the SADC central banks, to work on specialised projects. 4. The basic philosophy behind financial co-operation in the region Before the Governors’ Committee was established, SADC approached financial co-operation in the region on the basis of proposals made by European advisers, and was based mainly on the model of financial integration in the European Community. The folly of this approach was immediately grasped by the Governors at their first meeting. The divergencies in the stage of economic development of the members of SADC are so vast that there can be no talk at this juncture of a European type of economic integration in Southern Africa. The Governors’ Committee therefore had to design its own model for sensible financial co-operation in the region. In drafting its own mission statement, the Committee designed a model for financial co-operation that was described as a “bottom-up” approach. This approach is based on building financial co-operation by laying an appropriate foundation in the form of an effective institutional framework for the financial system in each country. More grandiose schemes for the harmonisation or integration of macroeconomic monetary polices can be considered once central banks, private banking sectors and financial markets have been established and are functioning effectively in most of the participating countries. A second challenge that had to be faced was the diverse roles and functions assigned by their Governments to the various central banks in the region. In finding an answer to the question of what contribution central banks can make towards the achievement of the goals of SADC, a consensus had to be found on what the task of the central banks should be in promoting optimum economic development and growth. There may not yet be full agreement on this daunting question, but the majority view now favours the contemporary approach of the more advanced economies that the central bank’s responsibilities should be restricted to the creation and maintenance of a stable financial environment that will be conducive for sustainable economic growth. Central banks must protect the value of the currency. This is gospel, not only in more industrialised, but also in developing and emerging economies. Overall financial stability may not be a guarantee for, but certainly is a precondition for, sustainable economic growth. 5. The framework for financial co-operation within SADC In terms of the bottom-up approach, the Committee of Governors kicked-off its work programme by exchanging views on the nature, structure and functions of each central bank in the region. In many developing countries, central banks, acting as extensions of Government Finance Departments, are often directly involved in normal commercial and development banking, and in many other macroeconomic activities such as export promotion, social upliftment programmes, and financing of government budgetary shortfalls. This, of course, often creates a conflict with the prime objective of central banking, and that is to protect the value of the currency. The powers of the central bank in such countries must first be reduced to improve the effectiveness of monetary policy. In the second phase of its deliberations, the Committee of Governors is concentrating on the quantity and quality of private banking in the region. The establishment of sound and well-managed privately-owned banking institutions must be encouraged to provide financial services in a competitive environment. The two tiers of banking, that is central banking and private banking, must be separated on a clearly-defined basis. In the third phase of financial co-ordination, the central bank Governors are working together in a joint effort to develop compatible and inter-linkable national payments, clearing and settlement systems for financial transactions. Eventually, the national systems must be linked to each other to provide for more effective cross-border settlement of inter-regional financial transactions. This project requires some co-operation in the development of compatible electronic data processing and technology systems in the twelve participating central banks. In a fourth phase, more attention will be focused on the development of financial markets in the region. A lot of research work must be done on the introduction of appropriate legal institutional frameworks, the introduction of financial instruments and the improvement of technological systems and human resource skills in the foreign exchange, money and capital markets. Some rationalisation in the use of the existing markets to the advantage of the whole region will be necessary. Only then will it become possible to consider greater harmonisation and even integration of macroeconomic financial policies such as interest and exchange rate policies, the management of bank liquidity and credit extension on a regional basis, and operations by central banks in a more integrated financial market environment. 6. The practical implementation of the programme for financial co-operation The SADC Committee of Governors is determined gradually to implement its plan for greater financial co-operation over the next few years in the whole region. On the African Continent, many ambitious plans for economic co-operation exist on paper, but are never executed. The Governors’ Committee has already embarked on the implementation stage, and is now actively involved in a number of the ground-work projects: 1. It has become necessary for the twelve Governors to have a better understanding of the regional economic environment within which they operate. For this purpose the Secretariat of the Governors’ Committee established a statistical data base for essential economic time series from the twelve countries in the computer capacity of the South African Reserve Bank. It is the intention to connect all the central banks in due course with realtime on-line linkages to the data base. 2. To enable Governors to learn from the experiences of each other, a data bank with information on issues such as legislation, relationships with Governments, functions and responsibilities, management, policy objectives, procedures and instruments of monetary policy, and administrative structures for each central bank, has been compiled and is now available to all the Governors. 3. Programmes are encouraged for the establishment of efficient and wellmanaged privately-owned banking institutions in all SADC countries. Assistance is being provided for the revision of the banking laws in some countries, and central banks are encouraged where necessary to withdraw themselves from private sector banking activity. 4. The South African Reserve Bank is playing a leading role in the development of the quality of, and capacity for, proper bank regulation and supervision. Some harmonisation is encouraged on policies such as bank licensing, minimum financial prudential requirements, and regular auditing of banking institutions. A joint effort is also being made to take the necessary action against illegal banking activities in the region, such as money laundering and pyramid schemes. 5. There is a great need for training and the development of skills in central banking in the region. The South African Reserve Bank has introduced a specialised Training Institute for Central Banking, and is now providing specialised courses in central banking and financial management for its own staff and officials of other central banks in the SADC region. The central banks of the region also formed an East and Southern Africa Banking Supervisors Group (ESAF) to standardise bank regulation and supervision in the region. ESAF is providing specialised courses for the development of the financial regulatory capacity in the region. There is also a more ambitious training programme provided through the Macroeconomic and Financial Management Institute (MEFMI). A number of Southern African countries, but not all members of SADC, participate in this venture. With its headquarters in Harare, MEFMI’s operational mandate covers two broad areas: “(i) In-depth capacity building, involving training, institutional development, networking and technical support, to strengthen countries’ ability to manage their debt and external reserves;” and “(ii) a training programme for public officials with duties relating to macroeconomic and financial management, providing courses in a wide range of high-priority fields.” MEFMI has the support of a number of international institutions, such as the World Bank, and has the potential to make an important contribution to the development of desperately needed skills for the management of the economic transformation of African countries. 6. The removal of remaining exchange controls in the region is a major priority of the Governors’ Committee. Arrangements have been introduced for the unrestricted repatriation of notes and coin used in participating countries amongst the members of SADC, and the movement towards an unrestricted flow of capital in the region is being promoted. South Africa is lifting its remaining exchange controls in respect of SADC countries faster than for the rest of the world. Two members, namely Zambia and Mauritius, have already removed all exchange controls in their countries. 7. Reference has already been made to the work that is being done in the area of electronic data processing and the development of a cross-border network for financial clearing, payment and settlement transactions. International assistance is now sought (through the World Bank) for the development of the national payment and clearing systems in the less-developed economies of the region. 7. The road ahead There is growing enthusiasm in Southern Africa for a regional approach to economic development issues. There are, unfortunately, more than one initiative for multinational regional economic co-operation arrangements in Sub-Saharan Africa, initiatives that often compete with each other. In Southern Africa itself, the SADC and COMESA (the Common Market for Eastern and Southern Africa), groupings provide many overlapping services and some countries belong to both organisations, and others to only one of the two. The time has come for Governments in the region to consider a merger of the two competing regional groupings in a more viable single regional association. Both SADC and COMESA have their own Secretariats with a strong bureaucracy that often inhibits initiatives because of unnecessary rigid procedural requirements. In the case of the Committee of Governors of SADC, we often live in sin because of non-compliance with the prescribed procedures of the SADC Secretariat. Forgiveness, however, can easily be extorted, as long as progress and successes can be claimed. There is among some governments still a strong suspicion of the motives behind closer economic co-operation in the region. The question arises whether it is perhaps not a real danger that the powerful South African economy will exploit the smaller economies for its own advantage: South Africa has to act with great discretion in performing its role in the programme. South Africa obviously has a vested interest in the economic development of the region as a whole. Internally, South Africa still has many serious economic problems that must be resolved to improve the living conditions of its own people. Unemployment is high, many communities live in great poverty, and there is a relatively wide spread between high and low incomes earned in the country. Many people therefore believe that South Africa should concentrate all its resources on the development of its own economy. There is, however, a basic fallacy in this approach. Whenever South Africa makes some progress in solving its own economic problems without a parallel development in other countries in the region, the unemployed from the other countries get sucked into the South African system. If South Africa is not prepared to accept more exports from other African countries and does not want to allow part of the South African savings to be invested in these countries, the country will have to absorb great numbers of unemployed people from the rest of the region. The region of SADC is gradually becoming an attractive place for foreign investors. Its potential for economic development is vast, and undeveloped human resources and the exploding demand for goods and services emanating from people who are now being absorbed for the first time in a real market economy, must lure many multi-national institutions to the Southern Africa region. It depends on us how attractive we can make our own region for the outside world as a place for long-term, durable, and productive investment. | south african reserve bank | 1,997 | 5 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Annual Dinner of the Pretoria branch of the Economic Society of South Africa held in Pretoria on 15/5/97. | Mr. Stals looks at the effects of the changing financial environment on monetary policy in South Africa Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Annual Dinner of the Pretoria branch of the Economic Society of South Africa held in Pretoria on 15/5/97. 1. The objectives of monetary policy The Gerhard de Kock Commission of Inquiry into the Monetary System and Monetary Policy in South Africa laid the foundation for the monetary policy model applied in South Africa over the past decade. Although the De Kock Commission’s final report on monetary policy was submitted in May 1985, it was only since 1986, when money supply targets were first introduced, that the implementation of the model took its course. Indeed, full implementation only came about after the untimely death of Gerhard de Kock in August 1989. In line with monetary policies applied in most developed economies, the South African monetary policy model is firmly directed towards the overall objective of creating and maintaining a stable financial environment. For central bankers, the ultimate price of a stable financial environment is a low rate of inflation -- a rate that, in the words of Alan Greenspan, will have no material effects on the macroeconomic decisions of consumers, investors, traders, producers and all other participants in total economic activity. This monetarist approach to monetary policy does not imply that central bankers have no interest in or sympathy for the national objectives of economic growth, job creation and the improvement of the living conditions of the people. On the contrary, central bankers believe that maximum economic development can only be achieved and sustained in an environment of stable financial conditions. The efforts of monetary policy must therefore be directed towards what central bankers can do best in support of the national objectives, and that is to manage the money system of the country in the interest of overall economic development. A stable financial environment is a precondition for sustainable economic development, but provides no guarantee that the real economy will indeed perform at maximum capacity. There are too many other macroeconomic (and non-economic) factors that will in the end determine the actual economic growth performance. There is, however, convincing theoretical logic and much empirical evidence to confirm that persistent unstable financial conditions are detrimental for growth, particularly in a country with an economy based on the principles of the market mechanism. The De Kock Commission therefore in 1985 summarised its findings as follows: “(The Commission) does not believe, for example, that anything can be gained in the long run in terms of real growth or employment by accepting higher inflation rates. The opposite is more likely to be true. Higher inflation will in the long run militate against growth and job creation. The objectives of external balance, growth and employment will over time be served best by creating and maintaining a climate of reasonable domestic price stability”. (Par 47) 2. The changing financial environment The deliberations of the De Kock Commission took place in an overall sociopolitical and economic environment that was completely different from what we have to contend with in South Africa today. With his wisdom and his foresight, Gerhard de Kock may have envisaged, and surely wished for, an environment in which monetary policy could be applied without the shackles of sanctions, boycotts, exchange controls, high inflation, social unrest and political distortions that characterised the period of his domain. Over the past decade, the situation has changed dramatically. The major socio-political reforms of the early 1990’s opened up the way for a normalisation of South Africa’s position in the world environment. Also in the field of economic and financial relations, South Africa has been reintegrated in the international community from which it was excluded over the preceding two decades. The international economic punitive actions against South Africa were repealed in great haste after the Government of National Unity took power in April 1994, and South Africa took its rightful place again in international forums such as the United Nations, the Bretton Woods Institutions (IMF and World Bank), the Organisation of African Unity, and the British Commonwealth of Nations. South Africa became reintegrated into a world financial system that was vastly different from the one it had left in the late 1970’s and early 1980’s. The explosive developments during its absence in electronics and in communications, and the revolutionary trans-formation from mainly manufacturing/trading economies to a new service/information based culture, led to a strong movement of globalisation in financial market activity. This process forced the liberalisation of domestic and international financial markets in many countries, led to the abolition of exchange controls and exposed countries more directly to the disciplines of international markets. Today in South Africa, there are more than 60 foreign banks that compete through representative offices, branches and subsidiaries with the domestic banks to provide financial services to the South African community. We are in the process of gradually removing our exchange controls to join the other approximately 60 (out of 185) countries of the world, that have already succeeded in removing all restrictions on current and capital account international transactions. Non-residents participate very actively in the South African market for foreign exchange and in the domestic money and capital markets. Prices on the Johannesburg Stock Exchange and the Bond Exchange of South Africa are affected almost instantaneously by developments in the rest of the world. Volumes in these markets have exploded to a level that a De Kock Commission of fifteen years ago could not anticipate, not even in the wildest flight of the imagination. Recent changes in the South African community led to the more active absorption of many South Africans in the market economy. Latent demands were stimulated by the reforms and many expectations were created by the new political dispensation. The emphasis in fiscal policy has changed dramatically, with the retention, fortunately, of basic sound disciplines. The South African banking sector had to be restructured to provide for thousands of informal savings clubs (Stokvels) and for community banking. There is even pressure on the Reserve Bank to legalise fraudulent pyramid schemes such as those that recently brought the country of Albania to anarchy. 3. The implications for monetary policy The question does arise whether all these changes did not make the findings of the De Kock Commission irrelevant. Should monetary policy still hold onto the same objective, and has the task and the functions of the central bank perhaps not also changed over the past few years? The Reserve Bank believes, however, that the main objective of monetary policy as defined by the De Kock Commission is as important and warranted today as it was in the mid-1980s. Indeed, in the environment of a greater involvement of international participants in the South African financial markets, it is of even greater importance that South Africa shall maintain overall financial stability, that our rate of inflation shall be brought more in line with the average rate of inflation in the economies of our major trading partners, and that internationally recognised sound monetary and fiscal policies shall be applied at all times. The main objective of monetary policy in the new South Africa must remain to protect the value of the currency. Critics of this unbending attitude of the Reserve Bank often confuse the objective of monetary policy with three other aspects of Reserve Bank operations, namely the strategy followed by the Bank in pursuance of its objective, the operational procedures applied by the Bank, and the instruments used to achieve its objective. There may be a need at this juncture, in light of the major changes of the past few years, to reconsider some of these aspects of monetary policy that have more to do with the implementation of the policy, and not with the objective. The strategy of a central bank can be described as the model it uses to pursue the non-negotiable objective of protecting the value of the currency. On recommendation of the De Kock Commission, the South African monetary policy model was based on monetary targeting which anchors monetary policy decisions to changes in the money supply. This model worked extremely well, particularly in the times of South Africa’s economic isolation from the outside world. It is doubtful, however, if this model is still the most effective strategy to maintain in the new environment. It has, for example, become much more difficult for the Reserve Bank to control the money supply in a situation where so many foreign banks operate in South Africa, and where South African banks have so much easier access to financial resources from correspondent banks in the rest of the world. It is also a debatable issue whether the demand for credit in South Africa is not in the new environment less sensitive to interest rate changes than before. And, furthermore, the relationship between changes in the money supply and eventual price changes may have become much weaker now that the volumes of transactions in the financial markets have increased so much relative to turnovers in the markets for goods and services. There is no doubt that the money supply has lost some of its usefulness as an anchor for monetary policy. With South Africa not yet being ready for direct inflation targeting, and with our inability to fix the exchange rate of the rand because of a lack of foreign reserves, the Reserve Bank is gradually moving to a more ecclesiastic approach where a wider range of monetary indicators are being used as a basis for monetary policy decisions. This wider range of indicators includes changes in bank credit extension, the overall liquidity in the banking system, the level and the yield curve of interest rates, changes in the official foreign reserves and in the exchange rate of the rand and, of course, actual and expected movements in the rate of inflation. The operational procedures of the central bank include the methods used for providing accommodation to banking institutions, open market operations, intervention in the foreign exchange market, the manipulation of interest rates, and the signalling to markets of policy intentions. The South African Reserve Bank’s main operational procedures over recent years have been what the De Kock Commission described as the “classical cash reserve system as a means of controlling bank credit creation, rather than the socalled American cash reserve system”. (Par. 76) Without going into the details, in the South African system the Reserve Bank uses its open market operations and other instruments of monetary policy to force banking institutions to borrow more from the discount window whenever it is regarded as necessary to apply a more restrictive policy. At some stage, the Reserve Bank will then also raise the Bank rate which, in a situation of great dependence on the central bank, will force the private banks to follow with increases in their lending and deposit rates. Many other central banks operating in sophisticated financial markets are now influencing short-term interest rates more directly with their operations in the markets. Instead of overnight loans provided at the discount window, they enter into repurchase transactions with banking institutions, with the added advantage that it can be coupled with a tender system for central bank money, and a variable Bank rate. The South African Reserve Bank will also have to introduce greater flexibility in the operating procedures for the implementation of monetary policy if we want to cope with the volatile international capital flows, exchange rate changes, and financial assets price movements. It is of some concern to the Reserve Bank that over the past year interest rates in the South African money market seem to have become more rigid. In the present system, the Bank no longer gets reliable signals from market interest rates on changes in the underlying financial conditions. If necessary, the operational procedures of the Bank will have to change to bring more interest rate flexibility into the money market. Finally, the instruments used for monetary policy may also have to be adapted to the changing financial environment. In the past, the Reserve Bank, for example, often used the Exchequer Account of the Government for the short-term withdrawal of surplus funds from the money market. The recent introduction of an improved system for tax and loan accounts held by Government with private banks, rules out the extensive use of this instrument for monetary policy purposes. Similarly, arrangements now under negotiation with the Department of Finance to relieve the Reserve Bank of the responsibilities for the primary issue of Government bonds, and for the development of the secondary market in these bonds, will also change the Bank’s position in the capital market. It opens up the way for the Bank to have a more single-minded open market policy approach. The introduction of repurchase transactions in strictly defined acceptable underlying financial assets will also provide an instrument of monetary policy that is more malleable and can be adapted easier to the needs of the new financial environment of which South Africa is now rapidly becoming an integral part. 4. Conclusion There is much room for a continuing debate in South Africa on monetary policy, but not so much on the issue of what the objectives of monetary policy should be, or whether inflation is bad or good for the overriding objective of creating more jobs in the country. The debate should rather concentrate on the effectiveness of the strategy, the operational procedures and the instruments used in the pursuance of a monetary policy objective that has in any case been casted in iron in the Constitution of the Republic of South Africa. | south african reserve bank | 1,997 | 6 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at 'Forex 97': 39th International Congress of the Association Cambiste Internationale held in Toronto on 30/5/97. | Mr. Stals elucidates the opportunities and concerns relating to the South African economy Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at “Forex 97”: 39th International Congress of the Association Cambiste Internationale held in Toronto on 30/5/97. 1. The new South Africa after three years It is now just more than three years since the fully democratic election of a new Government for South Africa took place in April 1994. Mr Nelson Mandela’s Government has now firmly established itself, and has succeeded in allaying many of the fears that existed at that time, both in South Africa and internationally. Not all the developments in South Africa over the past three years were positive and some major challenges still remain for the future. On balance, however, all reasonable South Africans will agree that the reforms in the country succeeded in averting a major disaster and in opening up many new opportunities. One of the most encouraging developments is a growing demonstration of tolerance and comprehension by most South Africans of the changing environment, and an unflagging determination to make the New South Africa succeed. There is a deepening spirit of co-operation amongst the various groups, representing a complex multi-racial community. More and more joint public and private sector projects emerge, providing further support to the integration of all South Africans in a single community. The new Government has established itself as a stable government with the prospect of being in control of the country for a long period of time. Important outstanding constitutional issues were resolved, such as the conversion of the Interim Constitution of 1994 into a final and more permanent version, and the operational relationships between central, regional and local government authorities. The economic growth rate improved, and over the past three years averaged 3.1 per cent, compared with only 0.6 per cent over the nine years from 1985 to 1993. The Government’s initial macroeconomic policy was mainly based on a social and upliftment programme referred to as the Reconstruction and Development Programme (RDP). With its emphasis on providing in the desperate social needs of many disadvantaged South Africans without recognition of the factual constraint of limited overall resources, the RDP met with justifiable scepticism from many economists. Its asymmetrical approach was rectified when the Government in June 1996 supplemented the RDP with a Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR). In terms of the GEAR programme, structural economic adjustment must be implemented to raise the growth potential of the economy gradually to about 6 per cent by the year 2000. The GEAR programme is now again criticised from some quarters as being too restrictive, and is even regarded by some critics as an abortion of the RDP. To be realistic, however, it will not be possible to provide in the demands of the RDP without also implementing the programme of GEAR. Great progress has also been made in re-integrating South Africa in both the political and economic global environment. On the political side, South Africa is now again a full member of the United Nations, has been readmitted as a member of the British Commonwealth and joined the Organisation of African Unity and the United Nations Economic Commission for Africa. On the economic front, South Africa is fully engaged as a respected member in the activities of the World Bank and the International Monetary Fund, has joined the African Development Bank, and has entered into a number of bilateral and regional economic co-operation agreements. The South African financial markets are being opened up for foreign competition; the tariff structure on imports is under major revision; the Government, parastatals and private sector corporations have become major borrowers in the international capital markets, and a market in Eurorand bonds developed outside of South Africa where total borrowings in excess of the equivalent of US $4.1 billion are now outstanding. On the negative side, South Africa has made little progress in addressing the urgent unemployment problem. In fact, over the past seven years, total employment in the formal non-agricultural sectors of the economy declined by 421,395 workers. What growth there was in the economy, was brought about by new technology, capital investments and productivity increases, and not by any additional employment. The best estimates available indicate that at this stage, about 30 per cent of the economic active population of the country is unemployed. Closely linked to the unemployment problem is the rising rate of crime and violence in the country. The need for urgently addressing this problem is now recognised by Government as the major challenge for securing almost all the social, economic and political objectives of the new South Africa in the longer term. Recent steps taken by Government in this regard include the provision for the additional employment of 5,250 policemen, and the appointment of a prominent South African business leader, Mr Meyer Kahn, as Administrative Head of the police force. 2. Major economic developments over the past three years As already indicated, the South African economy was in an upward phase of the business cycle for the past three years, with rates of expansion in real gross domestic product of 2.7 per cent in 1994, 3.4 per cent in 1995, and 3.1 per cent in 1996. During the first quarter of 1997, however, the growth in production lost some momentum when gross domestic product declined by 1 per cent. Gross domestic expenditure showed even more robust growth with increases of 6.5 per cent in 1993, 5.2 per cent in 1995, and 3.0 per cent in 1996. During the second half of 1996, however, there was a clear slow-down in the rate of growth of total gross domestic expenditure and particularly in consumer demand and in gross domestic fixed investment. With total domestic demand outstripping production, the current account of the balance of payments moved into deficit in 1994. The deficit in 1995 increased to $2.8 billion, equal to 2.1 per cent of gross domestic product, but then declined to $1.97 billion in 1996, when the rate of increase in gross domestic expenditure decelerated. One of the most important changes in the South African economy since 1994 has been a dramatic improvement in the capital account of the balance of payments. Over the three years 1991 to 1993, South Africa had to contend with a net capital outflow of US $7.1 billion. Over the next three years, that is from 1994 through 1996, there was a net inflow of $7.4 billion. On balance, the total net capital inflow over the past three years exceeded the accumulated current account deficit of $5.1 billion by $2.3 billion, which enabled the country to replenish its exhausted foreign reserves to a more comfortable but still inadequate level. With the liberalisation of the South African financial markets and the gradual integration of the economy in the global system, South Africa also had its baptism of volatile international capital flows and wide fluctuations of the exchange rate. The average weighted value of the rand against a basket of the currencies of the country’s major trading partners appreciated by 5.9 per cent from May 1995 up to January 1996, then depreciated by 23.8 per cent from February to October 1996. The monetary policy reaction to a sudden sharp decline in the foreign capital inflow after February 1996 was to allow market forces to play an important part in the stabilisation process. The exchange rate was allowed to depreciate, the domestic money market was drained of liquidity, and interest rates were not prevented from rising. Over the past six months, that is from 31 October 1996 up to 30 April 1997, the situation stabilised and the rand appreciated by 10 per cent as more foreign capital started flowing into the country again. Against the background of the expansion in the domestic economy, and particularly the sharp increases in private sector domestic expenditure, pressures developed in the financial sector and total bank credit extended to the private sector increased by about 17 per cent during each of the past three years. This caused the M3 money supply to increase by about 15 per cent per annum, well above guidelines indicated by the Reserve Bank for an acceptable rate of increase in M3. The Reserve Bank was initially very tolerant with the relatively high rates of expansion in the financial aggregates, particularly with a continuous decline in the rate of inflation, which came down from 14 per cent in 1992 to 7½ per cent in 1996. Inflation turned around from 5½ per cent over the twelve months up to April 1996 to almost 10 per cent in April 1997, mainly because of the depreciation of the rand in 1996. This forced the Reserve Bank to switch to a more restrictive monetary policy and to accept a substantial increase in interest rates. At this stage, the prime overdraft rate of banking institutions at 20 per cent is about 10 per cent above the current rate of inflation. The rates of increase in both bank credit extension and in the money supply are also beginning to show signs of a slow-down. A further important development in the South African economy was an almost explosive increase in the volume of activity in all the financial markets. The average daily turnover in the market for foreign exchange is now exceeding $7 billion. Last year, a total turnover of $703.5 billion was registered on the Bond Exchange of South Africa, and of $27.3 billion on the Johannesburg Stock Exchange. Foreign participation played a very important part in the development of the South African financial markets, but also contributed to greater volatility in these markets. It should finally be noted, as far as economic developments over the past three years were concerned, that, contrary to many predictions made at the time of the election of the new Government, three successive Ministers of Finance succeeded in reducing the deficit in the Budget of the central government from 8.5 per cent of gross domestic product in 1993 to 5.6 per cent in 1996/97. In the Budget for the fiscal year 1997/98, the Minister provided for a further decline in the deficit to only 4 per cent of gross domestic product. 3. Opportunities in the South African economy The combination of major political, social and economic reforms and the developments in the business cycle over the past three years opened up many new opportunities and challenges for the South African economy, but also exposed some major macroeconomic deficiencies that still require painful and far-reaching structural adjustment. The South African Government is committed to a policy of further economic liberalisation and the integration of the South African economy in the global markets. As part of this policy, the remaining exchange controls still applicable to certain outward investments of capital by South African residents will be phased out gradually; a programme of reducing excessive tariff protection is now being implemented to liberalise international trade relations; new international trade treaties are being negotiated, for example with the European Union and countries in the Southern Africa Development Community; and a privatisation programme has recently been launched with the sale of a large share of Telkom, the South African telecommunication organisation, to a foreign consortium. Foreign financial institutions are already very active in sharing in the new opportunities for expanding business in South Africa. There are now 17 foreign banks with branches or subsidiaries operating in the country, and 58 other foreign banks competing in the South African financial markets through local representative offices. During the first four months of 1997, foreign participants accounted for about 48 per cent of the total transactions in the market for foreign exchange, about 10 per cent of the turnover on the Bond Market and more than 30 per cent of total activities on the Johannesburg Stock Exchange. South Africa has also become a very attractive destination for foreign tourists. Last year, more than 5 million foreign visitors entered South Africa, of which only about 25 per cent came from destinations outside of Africa. There is a vast potential for the further development of the tourist industry. South Africa attaches great value to the further development of its manufacturing sector, now responsible for 23.8 per cent of total gross domestic product. The growing demand for durable and semi-durable consumer goods in the country, and the vast potential for exports to other countries in the Sub-Saharan African region, provide sufficient justification for the expansion of the production capacity of manufacturing. It is one of the disappointments of the developments over the past few years that only a small percentage of the total capital inflows represented active participation by non-residents in the real economic activities in the country. The Government has recently announced certain tax concessions for approved new investments in industries that must be relatively labour intensive and provide in the needs of economic reconstruction and development. Great value is also attached to the enhancement of economic co-operation in the Southern African region. The Southern African Development Community (SADC) now includes 12 countries with a total population of more than 130 million people, and with a great potential for economic development. Plans are gradually being implemented for economic co-operation to include the harmonisation of policies on financial services, trade development, education and training, fisheries and agriculture, water resource and energy development and other areas of economic activity. These are some of the challenging economic opportunities presented by the new South Africa. There are, however also constraints that must be removed and concerns that must be addressed to enable South Africa to develop its economy to its full potential. 4. Concerns in the South African economy Economic developments over the past three years were encouraging and provided sufficient evidence to prove that, given a supportive environment, there is still enough vitality left in the economy after years of depression, mainly by non-economic factors. The movement through the upward phase of the business cycle, however, also exposed a number of inherent weaknesses in the economic structure. These include: * the insufficient level of saving in the domestic economy which last year was equal to only 16 per cent of gross domestic product. This makes South Africa very dependent on foreign investment capital in support of a durable expansion of the existing production capacity; * a high marginal propensity to import, particularly when substantial new investments in the manufacturing sector are made. The low level of the country’s official foreign exchange reserves makes the country vulnerable to current account deficits in an environment of volatile international capital movements; * inflexible conditions in the labour market. Despite unemployment of about 30 percent of the labour force, workers continue to demand wage increases in excess of the rate of inflation and of productivity gains; * a lack of competitiveness which is exacerbated by inflation in excess of the average rate of inflation in the country’s major trading partners and international competitors. These deficiencies require incisive structural adjustments which will not be possible without some painful reforms, as provided for in the Government’s GEAR programme. In the short-term, it is extremely difficult to find a workable compromise between the legitimate demands of the people for better living conditions, and the need for J-curve structural adjustments that will first inflict more pain before benefiting the total economy. In addition to these deficiencies in the macro-economic structure, a few noneconomic concerns must also be mentioned because of the adverse influence they have on the economic growth potential of the country. These include: * the escalating crime and violence. It has now been identified by Government as a major priority to remedy this serious cancerous problem of South African society; * the need to build and improve the administrative capacity of the public service. Better and more education and training over a wide front is a vital element of the GEAR programme; * the presence of wasteful corruption in many places of public and private sector activity. There is great determination within Government to eradicate all forms of corruption in the public service. It is encouraging to note many cases of quick and decisive action by the new Government against exposed cases of corruption in the public service. The political, social, and economic reforms introduced by the major changes in South Africa in 1993 and in 1994 started a process of transformation which is continuing, and will continue for many years to come. Looking back over the past three years, South Africans are grateful for what has already been achieved, but are at the same time realistically aware of the challenges that must still be met. South Africa is indeed at this stage a country with many opportunities, but also with some urgent concerns. | south african reserve bank | 1,997 | 7 |
Speech by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a conference on Southern Africa: Resources, Investment and Trade, arranged by Forum Southern Africa Limited in London on 10/7/97. | Mr. Stals looks at the future of financial co-operation in Southern Africa Speech by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a conference on Southern Africa: Resources, Investment and Trade, arranged by Forum Southern Africa Limited in London on 10/7/97. 1. The reintegration of South Africa in the world economy Good progress has been made over the past four years with the reintegration of South Africa in the world economy. The political and social changes introduced in South Africa paved the way for the removal of international economic punitive actions that partly isolated the country’s economy from the rest of the world during the ten years preceding the fully democratic election of a Government of National Unity in April 1994. Even before the election took place, the rest of the world gave its support to the moves towards democracy by lifting sanctions, boycotts, disinvestment campaigns and trade restrictions. Since 1994, the following major changes took place in South Africa’s international economic relations: (i) South Africa became a full participating member again in various multinational institutions such as the World Bank, the International Monetary Fund, the United Nations and the African Development Bank. (ii) Agreements were entered into with the World Trade Organisation for a substantial revision over a five year period in the protective import tariff structure, and certain discriminatory export subsidies were removed. (iii) Exchange controls were substantially relaxed to introduce full convertibility for current account transactions, to remove all exchange controls applicable to non-residents and gradually to lift the remaining exchange controls applicable to the outward investment of capital by South African residents. (iv) An extensive liberalisation programme of the South African financial markets included major changes in the capital market, e.g. to allow for foreign and corporate ownership of stock broking members of the Johannesburg Stock Exchange, and the opening up of the South African banking sector for foreign competition. There are now 17 foreign banks with branches and subsidiaries in South Africa, and about 60 foreign banks with representative offices. (v) A number of new bilateral, regional and international economic co-operation agreements were entered into, such as the Southern African Development Community (SADC) and the arrangements with the European Union for closer economic co-operation. These changes have had a material effect on South Africa’s international economic relations and are reflected in a very visible way in the South African balance of payments. Over the three years 1991 to 1993, the current account of the balance of payments showed a surplus of US $5.8 billion, and the capital account a net outflow of $7.1 billion. The official foreign reserves therefore declined by $1.3 billion. When the new Government came into power in April 1994, the country had virtually no official foreign reserves left. Over the past three years, that is from 1994 to 1996, the current account of the balance of payments showed an accumulated deficit of $5.1 billion. During this period, a net capital inflow of $7.4 billion, enabled the Reserve Bank to replenish the exhausted foreign reserves gradually. At the end of June 1997, the Bank held an amount of $4.9 billion in reserves, which was still relatively low (sufficient cover for 7 weeks’ imports), but nevertheless much better than four years ago. The balance of payments developments merely reflected the changes in total gross domestic economic activity. The average rate of change in gross domestic product over the three years 1991 to 1993 showed a decline of 0.6 per cent, compared to an average rate of increase of 3.1 per cent over the next three years. The average rate of change in gross domestic expenditure changed from a decline of 0.3 per cent per annum from 1991 to 1993, to 4.9 per cent growth over the next three years. 2. South Africa’s role in Southern Africa The developments over the past few years enabled South Africa to take on a more active part in the economic development of the Southern African region. Economic co-operation in Southern Africa has been formalised through the Southern African Development Community Treaty of August 1992, which incorporated the following goals: * To achieve development and economic growth, enhance the standard and quality of life of the peoples of Southern Africa, and support the socially disadvantaged through regional integration; * To promote and maximise productive employment and the utilisation of resources of the region; and * To achieve sustainable utilisation of natural resources and effective protection of the environment. To achieve its objectives, SADC shall: * Harmonise political and socio-economic policies and plans of member states; * Mobilise the peoples of the region and their institutions to take initiatives to develop economic, social and cultural ties across the region, and to participate fully in the implementation of the programmes and operations of SADC and its institutions; * Develop policies aimed at the progressive elimination of obstacles to free movement of capital and labour, goods and services, and of the peoples of the region generally among member states; * Promote the development of human resources; * Promote the development, transfer and mastery of technology, and * Improve economic management and performance through regional co-operation. The Treaty provides for other political, social and cultural objectives which are not of direct relevance for the enhancing of financial co-operation in the region. South Africa has been given the task to manage the Finance and Investment Sector of SADC, and the South African Reserve Bank was given the important role to co-ordinate the functions of the central banks of the twelve member states in the promotion of the SADC objectives. For this purpose, a Committee of Governors of Central Banks of SADC was created, with a small secretariat in the South African Reserve Bank, and a research unit to provide assistance to the Governors’ Committee. In drafting its mission statement, the Committee of Governors designed a model for financial co-operation that was described as a “bottom-up” approach. This approach is based on building financial co-operation by first laying an appropriate foundation in the form of an effective institutional framework for the financial system in each country. More ambitious schemes for the harmonisation or integration of macroeconomic monetary policies can be considered at a later stage, i.e., once central banks, competitive private banking sectors and financial markets have been established on a firmer basis, and are functioning effectively in most of the participating countries. In its work programme, the Committee of Governors has made good progress with the following projects: * The development of a monetary and financial statistical data base, captured in the computer of the Reserve Bank in Pretoria, with the intention of providing real-time on-line access to the information to all participating central banks; * The development of an information bank on the policies, structures and functions of the 12 SADC central banks; * The harmonisation of the development of national payment, clearing and settlement systems within each one of the twelve SADC countries, and the eventual provision for a network of cross-border settlements in the region; * The co-ordination of exchange controls, and the gradual removal of exchange controls, in the region. South Africa is now relaxing its exchange controls still applicable to foreign capital investment by South African residents in respect of investments in other SADC countries faster than for the rest of the world; * The co-ordination of training of officials of all SADC central banks. The South African Reserve Bank has introduced a specialised Training Institute for Central Banking, and is now providing specialised courses in central banking and financial management for its own staff and officials of other central banks in the SADC region. * There is also a more ambitious training programme provided through the Macroeconomic and Financial Management Institute (MEFMI), with its headquarters in Harare. The objective of MEFMI is to assist Governments (Treasuries) and central banks to develop internal capacity for macroeconomic management; * The development of the quality of, and capacity for, proper bank regulation and supervision. Some harmonisation is encouraged on policies such as bank licensing, minimum prudential financial requirements, and regular auditing of banking institutions. A joint effort is also being made to take the necessary steps against illegal banking activities in the region, such as money laundering and pyramid schemes. * The forum for closer co-operation amongst the central banks of the region has now been firmly established. The work of the Committee, apart from consolidating the projects so far undertaken, will now be extended to the level of the private banking sector, and of the development of financial and capital markets in the common interest of the region as a whole. 3. Economic challenges for South Africa South Africa now finds itself in the challenging situation that, in one direction, its financial markets are rapidly being integrated in the global financial system, and in the other direction it is becoming more and more part of the difficult process of supporting and stimulating economic development in the Southern African region. At the same time, daunting problems still remain unsolved in the internal economy of the country. The new Government has had remarkable success over the past few years in the implementation of disciplined fiscal and monetary policies, and has gained confidence from investors and business people in its determination to apply sound economic policies in general. Little progress, however, has been made in solving one of the most urgent problems of the South African economy, and that is to create sufficient jobs for the growing population. Total employment in the country is now hardly more than what it was at the beginning of the nineties. South Africa’s economic policies must, at this stage, maintain good balance between the process of globalisation, the satisfaction of the dire basic needs of the domestic population, and the desire to assist in the economic development of the region. In a holistic approach, these various objectives are not in conflict with each other, but are in many respects supplementary. Successful participation in the global financial markets will lead to a larger inflow of foreign investment capital into South Africa, that will enable the country to do more for the upliftment of its own people, and for the development of the region. But this will subject all the macroeconomic initiatives of the country to the disciplines of the global investment community. These disciplines, tested by world-wide experience, amply reward successes, but severely punish failures. With its economic policies of the past few years, South Africa has already proved that it is determined to stand up to this challenge. The process of economic liberalisation and integration into the global markets must continue; economic co-operation in Southern Africa, and with countries further North in Africa, will be extended; the implementation of the Government’s Reconstruction and Development Programme, and the Strategy for Growth, Employment and Redistribution, will be pursued with vigour and determination. The task ahead is not an easy one. South Africa, and Africa, will need all the assistance it can get from the rest of the world. There is growing optimism that, in the early years of the 21st century, Africa will succeed in its concerted efforts to improve the living conditions of all the people of our Continent. | south african reserve bank | 1,997 | 7 |
Speech given by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a luncheon of the Institute of Directors in Southern Africa in Pretoria on 16/7/97. | Mr. Stals considers the issues of the relaxation of exchange controls and raising finance on the foreign bond market Speech given by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a luncheon of the Institute of Directors in Southern Africa in Pretoria on 16/7/97. 1. The relaxation of exchange controls The extension of the relaxation of exchange controls to private individuals as from 1 July 1997, marked a further step in the Government’s committed programme of gradually phasing out all restrictions on the movement of funds between South Africa and the rest of the world. The present system of exchange controls was introduced in South Africa over many years, starting from 1961, and was mainly intended to provide some protection to the domestic economy against the adverse effects of non-economic developments in South Africa, and international reactions that followed internal developments. Since these non-economic factors were removed during 1993 and 1994, following the major social and political reforms in our country, justification for the retention of the exchange controls also disappeared. In the new situation, the retention of exchange controls became counter-productive and, in a more open and freer economic environment, created undesirable distortions in the allocation of resources. There was, therefore, general consensus that South Africa should remove exchange controls as quickly as possible, and some advisers even thought that it should be done in a one-off “big bang” approach. How desirable such an approach might have been, particularly for financial operators in the market, realism forced the Reserve Bank and the Government to opt for a gradual but determined phasing-out programme. The major constraint on the authorities had been the limited amount of foreign exchange reserves available to the country that were required for the conversion of South African rand assets into foreign currencies. Developments over the past few years enabled us to move rather fast with the removal of the exchange controls. Large inflows of foreign funds, mostly in the form of portfolio investments made by non-residents in South African equities and bonds, and inflows of short-, medium- and long-term loan capital made it possible not only to replenish the country’s net foreign reserves from a zero-level in April 1994 to more than R20 billion now, but also to remove more than 50 per cent of the exchange controls that existed three years ago. These relaxations required large amounts of funds, for example to enable South African resident companies to invest about R20 billion in foreign direct investment projects, and to enable institutional investors to diversify about R30 billion of their investments in foreign currency denominated assets. Over the three year period from the beginning of 1994 up to the end of 1996, the total net inflow of capital, that is taking account of non-resident capital inflows and resident capital outflows, showed a net gain for South Africa of almost R30 billion. The substantial capital inflows into South Africa therefore enabled us to achieve our objectives with the replenishment of the official foreign reserves, and the gradual relaxation of the exchange controls. The future programme with the removal of the remaining exchange controls will, as over the past three-and-a-half years, be very dependent on a continuation of net capital inflows from the rest of the world. The capital inflows will, as a matter of fact, not only determine the pace of the removal of the remaining exchange controls, but also the rate of economic growth and development in the country. For South Africa it is of vital importance therefore that we shall continue to make our markets and our economy attractive to foreign investors. We may ask ourselves what foreign investors are looking for before they decide to invest in a country. What prompted them, over the past few years, to make such huge investments in South Africa? They are obviously looking for stable political and social conditions in a country. The ANC Government has certainly established itself as a stable government and has founded a credible track record with the management of the economy. Crime and violence remains a worrying aspect of the social system, and many foreign investors still prefer not to commit themselves for too long a period in making their investments here. On the economic side, the globalisation of the world financial markets is a process that countries such as South Africa cannot stay out of. Operators in these global markets are defining their own economic criteria for the assessment and comparison of countries where they can invest huge amounts of funds administered by them. These criteria may sometimes seem to be rather superficial, but they are basic. For example, the Maastricht criteria require members of the European Union to maintain a deficit on their budgets of not more than 3 per cent of gross domestic product. Total government debt should not be more than 60 per cent of gross domestic product. The rate of inflation in each participating member country should not be too far out of line with the average rate of inflation in all the participating member countries. These criteria are now being applied very generally across the board by many global fund investors when they assess the attractiveness of countries for investment purposes. It is therefore not just a whim of the South African Minister of Finance to reduce the deficit on the Budget of the South African Government to 4 per cent this year. Likewise, it is not just an over-ambitious target of the Reserve Bank to bring inflation in South Africa more in line with the average rate of inflation in the economies of our major trading partners. These are directives and requirements from the international investor community -- those investors that enabled us to achieve the results of the past three years with the exchange control relaxation and the improved economic conditions in general. They will also determine the course of the further relaxation in exchange controls and in the economic development of our country over the next few years. Because of the importance of foreign investment for South Africa, it is essential that foreign investors shall also be well-informed of the South African economy, and its potential to absorb new foreign investment. The recent decline in the gold price created a lot of nervousness in the market for foreign exchange. This is an unfortunate development that can have serious adverse implications for the gold mining industry. Its effect on the balance of payments, however, should be judged against a total level of exports of goods and services that now exceeds R150 billion per annum, with gold contributing less than 18 per cent of the total, and a total capital inflow through the Bond Market and Stock Exchange that was double the value of the gold production in the first six months of 1997. The average gold price last year was equal to US $388 per fine ounce, and South Africa’s total gold exports amounted to 15.75 million ounces. Should the present price of $320 be maintained for a full year, the loss in foreign exchange on the balance of payments will amount to R4.5 billion, or less than 3 per cent of total exports. Relative to the volatility of the net capital movements, the amount should not create any undue pressure on the rand/foreign currency exchange rate. Part of this loss can also be made up with an increase in the volume of production and with increases in other exports. We should also not be too negative for some recovery of the gold price before the end of this year. If anything, the recent decline in the gold price provides further evidence of how important it is for South Africa to continue to attract more foreign investment into the country, particularly in the form of long-term direct investments. 2. Raising finance on the foreign bond market The South African Government recently made two further very successful issues in international capital markets. An issue in the Samurai Yen market raised the equivalent of $357 million for seven years, and an issue in the American Yankee market provided an amount of $500 million for a twenty-year period. Both these loans were raised at relatively attractive interest rates. The international private financial markets have developed very rapidly in recent years, and now provide for the needs of many types of borrowers. Only sovereign borrowers, however, and large multinational corporations will be able to raise funds through public issues in these markets. Many other types of foreign loan facilities are, however, available to other borrowers. It is known that the Reserve Bank is at present busy negotiating for a syndicated loan with a group of foreign banking institutions for $1½ billion. Smaller borrowers can, of course, also negotiate loans on a bilateral basis with one of the many foreign banking institutions that provide their services in the South African markets. It is fairly easy for reputable and established South African organisations at this stage to raise foreign funds. Non-residents are no longer affected by the remaining exchange controls, and accept the credibility of the South African authorities in their determination gradually to remove the remaining controls. One major constraint, however, is provided by the volatility of exchange rates, even amongst the major currencies of the world. It is not only the South African rand that showed great volatility over the past year, but also many other currencies. The exchange rate between the Deutsche Mark and the US dollar, for example, changed from $1=1.54DM at the beginning of January 1997, to $1=1.79DM today, i.e. a change of 16.2 per cent. At this stage, the Malaysian ringgit, the Thai baht, the Indonesian rupiah, the Philippine peso and the Czech koruna are all under pressure from international currency speculators. South African borrowers of foreign funds will therefore most probably prefer to cover foreign borrowings with forward exchange contracts, which will eliminate any cost advantages from lower interest rates in other countries. We nevertheless believe that it is in the interest of the South African economy to make use of foreign finance where available, as this will enable the country to maintain a higher rate of economic development. We are indeed confident that, if carefully managed, the relaxation of exchange controls for residents will not lead to an overall net outflow of capital from the country. New investments by non-residents should continue to exceed the outward investment by residents. | south african reserve bank | 1,997 | 7 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the 77th Ordinary General Meeting of Shareholders of the Bank on 26/8/97. | Mr. Stals reports on major economic developments in South Africa over the past twelve months Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the 77th Ordinary General Meeting of Shareholders of the Bank on 26/8/97. Introduction The turbulences in the South African market for foreign exchange from February 1996, and the subsequent destabilisation of the balance of payments, contributed to a weakening of overall economic growth and to an upturn in inflation. The major task for monetary policy over the past year has accordingly been to restore both external equilibrium and domestic financial stability which are important preconditions for sustained investor confidence and economic growth. The process of restoring external economic equilibrium had to begin at home. Many adverse factors converged to contribute to the sudden exchange rate shock of February 1996. Some were of a non-economic nature while others were rooted in macroeconomic developments over the preceding two years. The problems caused by non-economic factors diminished as concern about the finalisation of the Constitution of the Republic of South Africa, the delay of local authority elections in certain provinces, and the political composition of the Government of National Unity were fortunately allayed during the course of the past year. Equally important has been the fact that the Minister of Finance, newly appointed in April 1996, has stood the test of the markets with acclaim and soon established himself as an effective leader of the country’s overall financial policy. Many of the disturbing economic problems which emerged last year were addressed by appropriate policy responses, while the private sector has on the whole endured the inevitable painful adjustments with much understanding. During both 1994 and 1995, growth in real domestic expenditure by far outpaced growth in real domestic production. This was clearly not a sustainable situation, and growth in domestic demand had to be curtailed to ensure a better balance in the overall economy. The untenable developments in domestic economic activity created a widening deficit in the current account of the balance of payments which was being financed by an inflow of volatile short-term foreign capital. When these short-term capital inflows switched into outflows after February 1996, however, a downward adjustment in the rate of growth in overall domestic expenditure, and therefore in the growing demand for imports, became imperative. The divergent rates of expansion in domestic production and expenditure, respectively, were also being financed to an increasing extent with domestic bank credit, or simply the creation of additional money. With insufficient domestic saving and a sudden decline in the inflow of foreign capital after February 1996, the pressure to accelerate the creation of more money increased even further. Assessed against this background, an untenable macroeconomic disequilibrium was rapidly being perceived to be developing at the then level of the exchange rate of the rand. Large foreign capital inflows in 1995, as well as the early weeks of 1996, exerted upward pressure on the value of the rand. Within a floating exchange rate regime, the rand appreciated in real terms, despite heavy Reserve Bank intervention to absorb part of the excess supply of foreign exchange. The appreciation of the rand at the time was clearly irreconcilable with South Africa’s otherwise weak position in a very competitive world economic environment. A stronger rand could not be sustained in the long term. Also instructive in this regard is that similar experiences by other emerging economies over the past year proved that alternative exchange rate systems, based on fixed or managed floating exchange rates, could also not cope with such divergent economic trends. In some of those countries, even more painful economic adjustments were required to restore financial stability than in the case of South Africa. The monetary policy approach adopted by the Reserve Bank under the circumstances was to let market forces take their course, with some short-term intervention by the Bank only to support an orderly process of adjustment. The exchange rate was therefore allowed to take its market-determined run while liquidity was drained from the domestic money market, interest rates were guided in a gradual upward path, and the resultant adverse consequences of the adjustment in real economic activity were accepted as essential to avoid even greater disruption later on. Domestic financial stability had to be restored first and must now be maintained in order to raise the production capacity of the economy to higher levels on a sustainable basis. These developments over the past year again exposed the urgent need for longer-term structural economic reforms. In June 1996, the Government released a Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR). The full implementation of this programme over the next few years will undoubtedly raise the potential of the economy and enable South Africa to meet the vast basic social and economic needs of the people of the country more adequately. It will also provide the economy with better armour to withstand with more vigour similar adverse macroeconomic developments that may recur in future. In retrospect, the economic policies of the past year contributed significantly towards improving equilibrium when emerging imbalances threatened to frustrate the primary objective of achieving sustainable optimum economic growth and development. Recent improvements in the current account of the balance of payments, the firmer exchange rate of the rand, the increased inflow of foreign capital, and the rise in official foreign exchange reserves, provide sufficient evidence to the effect that the serious danger of a collapse in South Africa’s external economic relations a year ago has been successfully averted. Moreover, there are encouraging, although as yet still only tentative, signs, emanating from both the production and the expenditure sides, that the economy recovered slightly during the second quarter of 1997. This preliminary indication is also confirmed by some hopeful signs that the inflationary pressures which arose from the economic imbalances experienced last year are now subsiding. At the same time, however, the overall financial situation still provides reason for concern, particularly in view of the continued high rates of increase in bank credit extension and in broad money supply. For reasons that will be explained in more detail below, the monetary authorities must persist with their vigil against the threat of overall financial instability that can only lead to stagflation in due course. There are many examples in the world today, both among industrial and emerging economies, where this lesson is again being learnt the hard way after years of reluctance to apply appropriate but unpopular short-term disciplinary monetary policies in a timely fashion. The Reserve Bank is not prepared to consider any short-term expediencies and implement monetary policies that will in the long term lead to serious disruption of financial stability. The country just cannot afford unsound monetary policies for short-term gain. Such policies would gradually undermine the value of the rand and lead to an eventual collapse of the financial system, with serious adverse implications also for the level of real economic activity. Recent economic developments The Reserve Bank’s Annual Economic Report released this morning serves as a background to the following brief summary of major economic developments over the past twelve months: A year of economic consolidation The pattern of developments in real economic activity over the past twelve months can best be described as the outcome of a necessary process of consolidation after three years of positive growth. The rate of expansion in gross domestic product reached a seasonally adjusted and annualised rate of 31½ per cent in the second half of 1996, but then slowed down to only 1 per cent in the first half of 1997, indicating a lower rate of growth for the full calendar year of 1997 compared with that experienced during any one of the past two years. During the first quarter of 1997, total gross domestic product actually declined by 1 per cent, setting off alarm bells of a pending recession. During the second quarter, however, there was a distinct recovery when overall economic activity again turned to positive growth, equal to an annualised rate of 21½ per cent. With a continued decline in agricultural production during the second quarter and only moderate growth in mining production, total value added by the primary sectors declined by a further 1 per cent. Against this poor performance, however, production in the rest of the economy was back on track with an expansion equal to 31½ per cent on an annualised basis. With growth of 7 per cent in manufacturing, 6 per cent in electricity, gas and water, and 41½ per cent in transport and communication, together with positive growth in all the other sub-sectors, the fears of a pending recession must at least for now have been allayed. Gross domestic expenditure, on the other hand, remained fairly depressed. An estimated small decline in total expenditure in the first half of 1997 contributed to the consolidation process of restoring a better balance between total domestic production and effective demand. Further declines in the growth rates of private consumption expenditure and gross domestic fixed investment, coupled with a substantial reduction in total inventories, were partly offset by a continued high level of expansion in general government consumption expenditure, particularly at the level of provincial and local government. During the second quarter of 1997 there was, however, a noticeable recovery in demand when total gross domestic expenditure expanded again by 2 per cent, after having declined by 1 per cent in the first quarter. Small increases from the first to the second quarter in the rates of growth in private consumption expenditure as well as domestic fixed investment were strongly supported by a further rise at an annualised rate of more than 51½ per cent in general government consumption expenditure. Excluding the effect of a substantial reduction in inventories, total domestic expenditure actually increased by 21½ per cent in the second quarter. These disparate movements in real economic aggregates between the first and second quarters of 1997 underline the importance of correctly interpreting short-term indicators of current economic developments. The Reserve Bank will conscientiously analyse all economic information that becomes available over the next few months with the necessary sensitivity to the pressing needs of the country. Better equilibrium in the balance of payments The salutary effects on the balance of payments of slower growth in total domestic expenditure are clearly reflected in the rapid decline in the deficit of the current account. On a seasonally adjusted and annualised basis, this deficit declined from R13 billion in the second quarter of 1996 to only R3.5 billion in the second quarter of 1997. In unadjusted figures, the negative balance declined from R5.5 billion in the first half of 1996 to R3.0 billion in the second half of last year, and R2.4 billion in the first half of 1997. Both imports and exports of merchandise responded to the depreciation of the rand last year. In the second quarter of 1997, the level of merchandise exports at current prices was 25 per cent higher than in the second quarter of 1996, whereas the value of imports increased by only 11 per cent. This was, however, not all due to the price effect of the depreciation of the rand. Growth in the volume of imports also slowed down as a result of the decline in gross domestic expenditure. In the case of the value of exports, an increase of 25 per cent was already experienced in the year prior to the depreciation, partly as a result of the removal of international sanctions, which no doubt continued to affect exports in 1996 and the first half of 1997. The improvement in the current account was supported by a larger net inflow of funds reflected in the capital account of the balance of payments. The pressure on the exchange rate of the rand, which continued from February to October 1996, subsided again after October, almost as suddenly as it had appeared. During the first three quarters of 1996, the net capital inflow amounted to only R585 million, but this was followed by a net inflow of R3.3 billion in the fourth quarter, and by no less than R16.7 billion in the first half of 1997. After the rand had depreciated by as much as 23.5 per cent in nominal terms between 14 February 1996 and the end of October 1996, it appreciated by 10 per cent over the next five months. From the end of March to the end of July 1997, however, the rand depreciated again by 3.6 per cent to give a net increase of 6.0 per cent in the external value of the currency from November 1996 to the end of July 1997. It should be noted, however, that the average level of the exchange rate of the rand over the first seven months of 1997, compared with its average value over the same period in 1996, showed a depreciation in nominal terms of 8.4 per cent. Although the initial appreciation after October 1996 was accepted as a partial correction of an over-reaction, the Reserve Bank nevertheless, already in November 1996, started to intervene again in the market as a net buyer of foreign exchange. The country’s gross foreign reserves held by the consolidated banking sector indeed increased by R17.2 billion over the past three quarters to reach a level of R31.1 billion at the end of June 1997. This was sufficient to cover about 91½ weeks of imports of goods and services. Currency depreciation as a means to achieve greater international competitiveness only has a chance to succeed in countries where inflation is not sensitive to depreciation. The events of the past year proved once again that in South Africa inflation reacts with a time lag of only about six months to major changes in the exchange rate. The quarter-to-quarter increase in the seasonally adjusted and annualised rate of change in the production price index for imported goods escalated from 6.0 per cent in the first quarter of 1996 to no less than 18.1 per cent in the fourth quarter, before it declined again to 12.4 per cent in the first quarter of 1997. In the second quarter of 1997, that is approximately six months after the turnaround in the trend of the exchange rate in November 1996, the production price index for imported goods actually declined by 10.7 per cent. Monetary aggregates slow to respond Over the past two years, the Reserve Bank has on various occasions advanced reasons why changes in the M3 money supply may have lost some of its usefulness as a reliable anchor for monetary policy. At this juncture, the Bank regards changes in M3 only as one among several important financial indicators. It no longer bases its monetary policy decisions automatically on any rigid formula linking actual changes in M3 to the predetermined money supply guidelines issued by the Bank at the beginning of each year. In 1996, for example, monetary policy was aimed more directly towards the restoration of external financial stability. More recently, the Bank has become more concerned about the excessive increase in domestic bank credit extension, not only because of its influence on the money supply, but also for other reasons. There has, for example, been growing anxiety about the over-extension of the private sector’s indebtedness relative to disposable income, and the increasing vulnerability of the banking sector to adverse developments in a possibly less favourable future macroeconomic environment. No central bank can, of course, disregard developments in the money supply or in bank credit extension, even if such developments can be explained as temporary distortions caused by major structural economic reforms. Although changes in M3 and its shorter-term components should be interpreted with circumspection in the present South African environment, they cannot be discarded or ignored. The relationship between the money supply and nominal production, or the velocity of circulation of M3, may be changing, but new relationships are being established in the process of transformation. Over the longer term, it remains true that inflation cannot be sustained indefinitely unless it is fuelled by continuous excessive money creation. Throughout 1996, the annual rate of increase in the M3 money supply fluctuated within a narrow range of between 13.6 and 16.1 per cent. By January 1997 it reached a peak of 16.8 per cent, and then declined gradually to 12.7 per cent in June 1997. As a guideline the Reserve Bank currently regards a rate of increase of not more than 10 per cent per year in the M3 money supply as consistent with the prime objective of reducing inflation gradually to a level that will be more in line with the average rate of inflation in the economies of South Africa’s major trading partners. The increase in M3 has now consistently exceeded the rate of growth in the nominal value of gross domestic product for more than three years, with the result that the ratio of the total amount of money in circulation to gross domestic product has risen to 58 per cent, which is the highest level since 1980. A lack of availability of money can therefore hardly be advanced as a reason for the slowdown in real economic activity over the past eighteen months. The relatively high level of the money supply or, inversely, its low level of velocity of circulation, holds a potential danger for future inflation. Although a substantial part of the excess amount of money in circulation may at this stage be confined to the financial sector, possibly contributing to financial asset inflation, the Reserve Bank will have little control over the situation once holders of financial assets decide again to divert their spending to the acquisition of goods and services. Central bank policy must therefore always be forward-looking and attempt to pre-empt the danger of overspending or rising inflation at some future inopportune stage. Total bank credit extended to the private sector likewise continued to increase at a high rate throughout 1996, and fluctuated between a peak of 18.9 per cent in July and a low of 16.1 per cent in December. During the first six months of 1997, it peaked at 17.4 per cent in April, and then declined only marginally to 16.3 per cent over the twelve months up to June. As in the case of the money supply, the total amount of bank credit outstanding has risen as a percentage of gross domestic product over the past few years. At the end of June 1997, it amounted to 75 per cent of gross domestic product, compared with 67 per cent at the end of 1993. Bank credit is, of course, not only extended for the purpose of financing purchases of goods and services. Indeed, particularly in recent months, a substantial amount of the additional bank credit created may have been linked to the explosive increases in the volume of transactions in the financial markets, particularly in the equity and bond markets. Nevertheless, all forms of bank credit create money, and the initial reason for which money is created is only of limited significance for monetary policy purposes. Once the money has been created, it becomes part of the amorphous pool of the total money supply and, depending on the strength of the multiplier effect, is available to be used a number of times over, and for many purposes other than its first application. Many explanations can be offered for the persistently high rates of increase in bank credit extension and in the money supply, despite the slowdown in real economic activity over the past eighteen months. It could partly be linked to a switching of international trade financing from foreign to domestic sources, or partly to the financing of summer crops in the agricultural sector that are being harvested late this year. It is also known that bank credit extended to local authorities increased by no less than R2.7 billion from 31 December 1996 to 30 June 1997. These explanations, however, do not detract from the need for a curtailment of the excessive rates of increase in these important monetary aggregates at this juncture. In light of the unfavourable experiences of a number of other countries in recent years, ranging from a well-developed country such as Japan to an emerging economy such as Thailand, central bankers elsewhere are increasingly concentrating on restricting the provision of bank credit for investment in financial assets and property. In a bull market, even at high interest rates, borrowers will continue to borrow funds to buy assets that are rapidly appreciating in value; and banks will continue to lend because the value of their collateral is rising. This could easily cause a speculative bubble that, should it burst, can create major difficulties for both lenders and borrowers. In such a situation, it is not unusual for the money supply to continue to rise, in conflict with the objectives of the monetary authorities, and often also in contrast to the slowdown in real economic activity. South Africa is hopefully not yet in such a position. In the implementation of monetary policy more than in anything else, prevention is almost without exception less costly in terms of a possible temporary loss of production and employment that can in any case not be sustained, than the sacrifices that will eventually be required to fight high inflation once it has become entrenched. In the present situation, the Reserve Bank feels that a cautious monetary policy stance remains justified. This has been the approach throughout the past year and undoubtedly has had a major influence on developments in the money market. The shortage of funds in this market, as reflected by the amount of accommodation required by banking institutions from the Reserve Bank, first increased from a daily average of R4.9 billion in January 1996 to R10.6 billion in March 1997, before it declined to R7.3 billion in July 1997. As the recovery in the balance of payments recently gained momentum, the Reserve Bank has been prepared to allow a natural downward adjustment in the money market shortage, paving the way for a gradual decline in money market interest rates. The Reserve Bank raised its lending rate to banking institutions, the Bank rate, from 15 per cent at the end of 1995 to 16 per cent in April 1996, and then to 17 per cent in November 1996. The rate on three-month bankers’ acceptances first increased sharply from 14.6 per cent at the end of December 1995 to 17.0 per cent a year later, but has since declined gradually to 15.0 per cent in the middle of August 1997. As the South African financial markets are being integrated more in the global financial system, the comparison between South African and international interest rates takes on greater significance. Too low a level of interest rates locally will eventually be reflected in a weak currency, and lead to a further depreciation of the rand. Too high a level, on the other hand, will attract speculative short-term capital from abroad, and lead to an undesirable appreciation of the currency, and/or an unhealthy expansion of domestic liquidity. The sharply inverted shape of the yield curve in South Africa makes the comparison of the level of local interest rates with the international markets more difficult. At the long end of the spectrum, the yield on long-term government bonds in South Africa seems to be on the low side in real terms. Short-term interest rates, and particularly bank lending rates at the other end of the yield curve, seem to be high in South Africa, reflecting negative expectations on inflation, high risks involved in more short-term lending to an already overborrowed community, and a relatively high demand for funds. The conservative monetary policy measures applied by the Reserve Bank over the past eighteen months have paid off by containing the increase in inflation to below 10 per cent, despite the pressures arising from the depreciation of the rand last year. Measured over a period of twelve months, the rate of increase in the overall production price index rose from 5.3 per cent in April 1996 to 9.6 per cent in March 1997, but then declined to 7.5 per cent in June 1997. Movements in the consumer price index followed a similar path and the increase in consumer prices, measured over twelve months, rose from 5.5 per cent in April 1996 to 9.9 per cent in April 1997, before declining to 8.8 per cent in June 1997. At the time of the depreciation of the rand in 1996, a much higher rate of inflation was predicted on the basis of previous experience. There is, however, no reason for complacency. As long as the South African rate of inflation remains significantly higher than that in the major countries of the world, the integration of South Africa into the global financial markets will be slow and turbulent. In view of the complex interaction between the level of interest rates, the rate of inflation, and the exchange rate in the process of financial globalisation, disruptive adjustments will be demanded from time to time. This will continue to complicate decisions for investors and cross-border traders. Participation in the process of financial globalisation ultimately requires a high degree of convergence between countries in these basic financial aggregates. The domestic levels for interest and exchange rates can no longer be determined by governments or central banks in isolation. These financial prices will indeed increasingly be driven by international market consensus. At this stage, the international market imperative requires of South Africa to bring its rate of inflation gradually in line with the rest of the world. Alternatively, the country’s drive towards greater participation as an important borrower of funds in the world financial markets will be constrained. Furthermore, what is even more important is that the existing imbalances of income and wealth in the domestic economy will further deteriorate in an inflationary environment. It is relatively easy for those more fortunate members of society to protect themselves against inflation as they have easy access to credit and can spend more in today’s terms, hoping to repay with depreciated money sometime in the future. Less fortunate members of the society find that wage increases do not keep up with inflation, especially run-away rising inflation, and their savings and buying power deteriorate continuously. Financial market reforms pay dividends The major reforms in South Africa’s financial markets over the past few years paid good dividends in the form of substantial increases in the volume of business done through these various markets. Structural improvements introduced by the Johannesburg Stock Exchange, the Bond Exchange of South Africa, and the South African Futures Exchange (SAFEX), were also boosted by the further relaxation of exchange controls. The value of bonds traded in the Bond Exchange of South Africa increased by 51 per cent in 1996 to exceed the R3,000 billion level. In the first half of 1997, the total turnover in this market already exceeded R1,700 billion. These higher values included a substantial increase in transactions effected by non-residents in the market. The value of shares traded in the secondary share market increased from R63 billion in 1995 to R117 billion in 1996, and to R92 billion for the first half of 1997. As in the case of the Bond Exchange, non-residents also made an important contribution to the increase in business transacted through the Johannesburg Stock Exchange. The turnover in options and futures contracts traded through SAFEX performed likewise, showing sharp increases over the past eighteen months. The importance of the formal capital markets for the economic development of South Africa can be clearly illustrated by two basic statistics. Firstly, over the eighteen months from the beginning of 1996 up to the middle of 1997, the amount of new capital raised through issues on the Stock Exchange and net issues of fixed interest-bearing securities in the primary bond market amounted to approximately R50 billion. Secondly, over the same period, net purchases by non-residents of South African securities listed on the exchanges amounted to about R34 billion. Supportive fiscal policies The Minister of Finance applied further disciplines in his Budget proposals for 1997/98 with a commitment to reduce both government dissaving and the deficit before borrowing during the current fiscal year. In the preceding year net dissaving by government was equal to 3.1 per cent, and the budget deficit equal to 5.6 per cent of gross domestic product. The deficit for the current fiscal year is expected to be reduced to 4.0 per cent of gross domestic product. The Government also made an important contribution to the official foreign reserves of the country by way of two bond issues in international capital markets during June 1997. The total proceeds from these two loans amounted to R3.8 billion. A few smaller and one major privatisation transaction – the sale of an equity stake of 30 per cent in Telkom – raised more than R6 billion over the past year. Part of these funds was used to contain total government debt to a level of about 56 per cent of gross domestic product. The better harmonisation of monetary and fiscal policies over the past year made a major contribution to the success achieved with the objective of restoring overall financial stability after the foreign exchange market disruption of February last year. Financial co-operation in Southern Africa The Committee of Governors of the Central Banks of the twelve members of the Southern African Development Community (SADC) met twice during the past twelve months to discuss matters of financial co-operation. The Secretariat of the Committee within the Reserve Bank has made good progress in the compilation of a computerised data base of financial statistics of the region and information on the functions and responsibilities of the twelve participating central banks. Officials from all the central banks participated in a number of courses presented by the Reserve Bank’s Training Institute, and a course was again presented for bank regulators and supervisors in the East and Southern Africa Banking Supervisors Group (ESAF). A special study is being undertaken with the support of the World Bank on the development of national payment and clearing systems with a view to the eventual establishment of a cross-border payment and settlement system for all SADC countries. Over the next year, the co-ordination of financial co-operation in the region will be extended also to include the activities of commercial (private) banks and stock exchanges. A need for more flexible monetary policy operations Developments over the past year revealed a need for greater flexibility in the market for short-term funds. The transformation in the South African financial markets since 1994, and in particular the further integration into the global financial system, will in future require more prompt action and decisive direction for movements in financial asset prices, interest rates and exchange rates. Part of the explanation for the rigidities in the South African money market lies with the present system used by the Reserve Bank to provide accommodation to banking institutions at the discount window. Banking institutions have unlimited access at the Bank rate to overnight loans from the discount window, provided they have at their disposal acceptable collateral. The Bank accepts Treasury bills, Land Bank bills, South African Reserve Bank paper and Government bonds, all with an outstanding maturity of less than 91 days, as security for such overnight loans. A second-tier facility is also available, but at a penalty rate of 75 percentage points above the Bank rate against similar securities as collateral, but with outstanding maturities of between 91 days and three years. The Bank rate is, of course, changed from time to time to adapt to changes in underlying financial market conditions. To make the system work effectively, the market must react with sensitivity to changes in underlying demand and supply conditions, and must also emit clear and comprehensible signals to the authorities. For example, a rise in market interest rates for interbank funds, various maturities of negotiable certificates of deposit, or for bankers’ acceptances to the Bank rate level or above, will provide a clear indication of a need for an increase in the Bank rate. Alternatively, when a Bank rate increase is regarded as undesirable at - 10 - that point in time, the Reserve Bank will have to use other means at its disposal to create more liquidity (money) in order to reduce the pressure on interest rates. Over the past year, major changes took place in South Africa’s underlying money market conditions, but money market interest rates were slow to react to these changes at a time when the Bank was looking for signals from the market, while the market sought guidance from the Bank on the direction of interest rates. It is clearly necessary to find a way out of this uncertain situation and to ensure that greater flexibility will be introduced in the working of the money market. Inflexible markets, be they for goods, services, labour or financing, invariably lead to incorrect pricing, inefficient allocation of resources and, ultimately, unnecessary and costly losses in output and employment. In March 1998, the Reserve Bank will start introducing a new upgraded electronically-driven National Payment System to provide for a daily automated settlement of outstanding interbank positions. The system is planned to be extended by September 1998 to effect intraday settlements on a gross basis for large transactions. The introduction of the new versatile payment and settlement system will also provide a good opportunity for the Reserve Bank to reconsider the existing accommodation arrangements between the Bank and private banking institutions. At this stage, the Bank would like to give notice of the proposed introduction of a new, more flexible accommodation facility, to be created in the form of regular repurchase transactions between the Reserve Bank and its banking sector clients. The private banks will be offered the opportunity to tender on a regular basis for central bank funds through the repurchase facility, and accordingly be given more scope to manage their own liquidity positions better. Furthermore, the purpose of the minimum cash reserve accounts that banks must maintain with the Reserve Bank will be extended to serve also as operational accounts for the regular settlement of clearing account balances. An averaging principle will be introduced, in terms of which each bank will have to ensure that the average daily balance in its account over a monthly period will comply with the prescribed minimum cash reserve requirements. This should enable the banks, during the course of the month, to use their minimum reserve balances for settlement purposes. The present discount window facility will still be retained to provide banks with a further source of funds for the management of their liquidity positions. It is envisaged, however, that the Bank rate for such loans will be at a substantial premium to the fluctuating effective interest rate as established in the regular repurchase transactions. The Department of Finance is planning to implement new arrangements for the primary issue of, and the secondary market-making in, Government bonds through appointed private market securities dealers. The transfer of these functions from the Reserve Bank to securities dealers will strengthen the Reserve Bank’s ability to pursue open-market operations more vigorously for monetary policy purposes. The Bank is now in the process of preparing a discussion document on the proposed new accommodation procedures. This document will be distributed to the banking community and to other interested parties before the end of October for comments and participation in the preparation of the new system. - 11 - It must not be expected, however, that the introduction of the new system will lead to a permanently lower level of interest rates. The Reserve Bank may well in future use interest rates more frequently and extensively to pursue its overriding objective of protecting the value of the currency. The Bank will nevertheless have to ensure that interest rates will be maintained at a level that will be consistent with all the other objectives of monetary policy, and with developments in other economic aggregates. Internal administration of the Bank With the appointment of Mr. James Cross as Deputy Governor from 1 January 1997, all vacancies in the top management of the Bank have now been filled again for the first time since July 1995. The total staff complement of the Bank varied around 1,800 during the year ended 31 March 1997. At the same time, further progress was made with the Bank’s transformation process when more than 70 per cent of the 136 new appointments to the Bank was drawn from previously under-represented groups. The Bank’s international activities were affected to an important extent by the currency turmoils of last year. The International Banking Department, in particular, was frustrated by these developments, which temporarily disrupted the longer-term programme of increasing the country’s foreign reserves and reducing the role of the Bank in the forward foreign exchange market. These programmes are, however, now back on course, and the recent successful conclusion of a syndicated loan facility for a total amount of US$ 1.75 billion served to strengthen the Bank’s foreign liquidity position further. Good progress was made by the Information Technology Department to prepare the way for the introduction of a new real-time gross settlement system within the banking sector. The substructures for this ambitious new programme are now in place, and, as already indicated, the first phase will go live in March next year. Precautions were also taken to ensure that all the Bank’s electronic data processing systems will be able to cope with the technical “Year 2000” problem with the change-over to the next millennium. The Economics Department is likewise involved in guiding the Bank into the fast-expanding, worldwide electronic-communication system. South Africa was one of the first countries to subscribe to the Special Data Dissemination Standard (SDDS) of the International Monetary Fund (IMF) in August 1996, and is now one of only eight countries that provide electronic links (hyperlinks) from the IMF’s SDDS to the more comprehensive sites of important South African economic data and information. In March 1997, the Quarterly Bulletin of the Reserve Bank was released for the first time in its entirety with text, graphs and statistical tables on the Internet. The Exchange Control Department is continuing with the task of gradually phasing out all the remaining exchange controls. The concessions made to private individuals to invest limited amounts abroad as from 1 July 1997, and all the other exchange control relaxations over the past year, were implemented smoothly and efficiently. Subject to the approval of the Minister of Finance, the phasing out of the remaining exchange controls will continue in an orderly manner. During the year, the former Management Services and Administration Departments were merged into a new Corporate Services Department as part of an internal rationalisation programme. A new Organisation Development Department was created to give - 12 - more specialised attention to the Bank’s transformation programme, human resource development, and the co-ordination of strategic planning and development. With the rapid increase in the number of foreign banks operating in South Africa, and with the establishment in many other countries of branches, subsidiaries and representative offices of South African banks, the resources of the Bank Supervision Department came under pressure. The Office of the Registrar nevertheless also gave special attention to specific problem areas such as illegal deposit-taking operations, micro-lending activities, deposit insurance schemes and regional co-operation in Southern Africa. Other administrative functions of the Bank, such as note and coin distribution, protective services and the branch network are being taxed by the ever-increasing need for greater vigilance against fraud, burglaries and violent criminal attacks. The Bank relies heavily on its Internal Audit Department for the early detection of any possible irregular activities, as well as for sound risk management. A major contribution is made in this area by the Audit Subcommittee of the Board, and also by the external auditors. In retrospect, the Bank can be grateful for the quality of its staff, and for their loyalty to the task of the Bank as demonstrated again by the excellence of services rendered during the past year. Concluding remarks In its Macroeconomic Strategy for Growth, Employment and Redistribution, the Government defined the role of monetary policy as follows: “The main objective of monetary policy will continue to be the maintenance of financial stability and the reduction of the inflation rate. Positive real interest rates are a minimum condition for overall financial stability. Low inflation is an important requirement for higher economic growth, the creation of employment opportunities and a more equitable distribution of income.” Looking back, the past year was particularly challenging for macroeconomic management. The Reserve Bank can be satisfied that it has been relatively successful in making its specialised contribution to the attainment of the Government’s overall economic objectives as set out in GEAR. After major disturbances in the market for foreign exchange early in 1996, stability has been restored. The rate of inflation, which accelerated to nearly 10 per cent by April 1997, is now abating. To achieve these results required a consistent restrictive monetary policy with relatively high interest rates. As the monetary policy objectives are being consolidated and other programmes of GEAR, for example to increase total saving in the economy, are being implemented with greater effect, the way will be paved for lower interest rates on a more durable basis. The contribution that monetary policy can make towards the attainment of maximum economic development and the creation of more employment opportunities is, after all, limited to the intermediate goal of maintaining a stable financial environment. Attempts to use monetary policy for wider purposes or, more directly, to solve problems in the real economic sphere are bound to lead to an inflationary dead end. However sincere intentions might be, the inevitable result will eventually be lower growth and even less employment. - 13 - The policy of persisting with essential monetary disciplines in South Africa at this difficult stage of general transformation is understandably being opposed in some circles, due to adjustment fatigue and frustrated expectations. It is imperative, however, for the sake of attaining higher economic growth of a more durable nature, to ensure overall financial stability that will also make access to the world financial markets easier for South African borrowers. This task demands the continuous implementation of monetary policies that will create a financial environment with low inflation, a sound banking system, and well-functioning financial markets. I wish to place on record my appreciation to Minister Trevor Manuel, Deputy Minister Gill Marcus, Ms. Maria Ramos, Director-General of Finance, and also all the officials in the Department of Finance, for their continued support and close co-operation over the past year. I thank my colleagues on the Board of the Bank for their undivided loyalty during difficult times. Finally, thanks are also due to the three Deputy Governors and staff of the Bank for keeping the many activities of the South African Reserve Bank at a level where the Bank has come to be respected as one of the most efficient institutions of its kind in the world today. | south african reserve bank | 1,997 | 9 |
Address by the Governor of the Reserve Bank of South Africa, Dr. Chris Stals, at the Annual Conference of the Bureau for Economic Research, in Cape Town, on 7/11/97. | Mr. Stals considers the role of monetary policy in stabilising the business cycle during the pre- and post-election period Address by the Governor of the Reserve Bank of South Africa, Dr. Chris Stals, at the Annual Conference of the Bureau for Economic Research, in Cape Town, on 7/11/97. 1. Introduction In the implementation of monetary policy the Reserve Bank should not be influenced by the fact that an election will take place in South Africa in May 1999. The reference to the “pre- and post-election period” in the title of this address should therefore be regarded as coincidental. As always, monetary policy should be guided by developments in financial aggregates such as the money supply and bank credit extension, with the obvious objective of protecting the value of the currency. In contemporary monetary policy, central banks are normally also not guided by the objective of “stabilising the business cycle”. It is the task of monetary policy to promote a stable financial environment at all times, irrespective of the current phase of the business cycle. There is, however, a definite relationship between developments in real economic activity (“the business cycle”) and in the financial aggregates relevant for monetary policy. By concentrating on the trends in the financial aggregates, and not in real economic activity, monetary policy, however, has a better chance of maintaining financial stability that will, in the longer term, be conducive for sustainable economic growth at a higher level. A former Governor of the Reserve Bank of Australia once said the following: “There was a recognition that (monetary) policy had to do more than stabilise the cycle: the problem with an exclusive focus on the business cycle was that we may well stabilise the real side of the economy without stabilising the price side of the economy”. (Governor M.J. Phillips, When the Music Stops, Reserve Bank of Australia Bulletin, July 1990). A slowdown in the business cycle will normally also include a slowdown in real gross domestic expenditure, incorporating declines in the growth rates of both consumption and investment expenditure. Such slowdowns, however, may not yet at the time of the decline in expenditure justify the relaxation of monetary policy. The slowdown in real expenditure will after some normal time-lags be followed by a decrease in the demand for bank credit, which will also lead to a decline in the rate of growth in the money supply. Timing monetary policy decisions to coincide rather with changes in the monetary aggregates and not with changes in real economic activity reduces the danger of a premature re-stimulation of the demand for bank credit, and a too early injection of excessive amounts of additional money. A monetary policy linked to changes in the business cycle could easily lead to the re-emergence of the harmful stop-go policies so often pursued by central banks in the 1960s. 2. 1997 - A year of macroeconomic consolidation Developments in the South African economy in the early months of 1996, and particularly the currency crisis of February last year, exposed certain weaknesses that were developing in the South African economy at that time, and that needed early correction. The signs were already there in the first half of 1996 that the calendar year of 1997 would turn out to be a year of macroeconomic consolidation. Now, eighteen months later, we can look back with some satisfaction on the progress that has been made in restoring overall economic equilibrium. Firstly, in the area of real economic activity, equilibrium has been restored not only in the growth rates but also in the absolute levels of total gross -2domestic product and total gross domestic expenditure. After increases of about 6 per cent per year in 1994 and 1995, the growth in gross domestic expenditure slowed down to 3 per cent in 1996, and to almost zero so far in 1997. The rate of growth in total production also slowed down marginally, but was still maintained at a positive level of about 2 per cent in the first nine months of 1997. These developments in real economic activity over the past eighteen months were reflected in an improvement in the overall balance of payments. The seasonally adjusted and annualised rate of the current account deficit declined from R13 billion in the second quarter of 1996 to R3½ billion in the second quarter of 1997. This improvement contributed to the adoption of a more positive attitude by foreign investors and the net capital inflow increased from less than R4 billion in the full year of 1996 to more than R16 billion in the first half of 1997. In light of the surplus that emerged on the overall balance of payments, the total gross gold and foreign exchange reserves held by the banking sector increased by R14 billion from about R17 billion at the end of December 1996 to about R31 billion at the end of June 1997. Thirdly, the excessive rates of increase in the money supply and in bank credit extension in 1995 and 1996 also marginally slowed down in 1997. In the third quarter of 1997, the seasonally adjusted amount of the money supply increased at an annual rate of 12.2 per cent, and that of total domestic credit extension by the banking sector by only 6.3 per cent. Finally, in the consolidation process, South Africa succeeded in absorbing the unavoidable increase in inflation in the aftermath of the depreciation of last year. As was expected, the rate of increase in consumer prices accelerated from 5.5 per cent in April 1996 to 9.9 per cent in April 1997 but then declined again to 8 per cent in September 1997. In the third quarter of 1997, inflation was indeed running at an annualised rate of 6.6 per cent, back on track again towards the medium-term objective of bringing the rate of inflation in South Africa more in line with the average rate of inflation in the economies of our major international trading partners and competitors. The parts played by changes in the exchange rate of the rand, and in interest rates, in bringing about better equilibrium should not be underestimated. The average weighted value of the rand against a basket of currencies first depreciated by about 23 per cent during the first ten months of last year, before it appreciated again by 11 per cent from 31 October 1996 to 13 March 1997. Since then it followed a more steady path and depreciated by about 10 per cent in the next seven months. At the end of October 1997, the average weighted value of the rand was only marginally down from its level of 31 December 1996. Liquidity was initially drained from the money market after the foreign capital inflows subsided in February 1996, and the money market shortage gradually increased to reach a peak of more than R10 billion in March 1997. Since then, the situation eased again to an average daily shortage of only about R5 billion in October 1997. Interest rates obviously followed these trends and increased quite sharply during the course of 1996 but then declined again in 1997. The rate on three months bankers’ acceptances for example reached a peak of almost 17 per cent at the end of November 1996, before declining to 14.9 per cent at the end of October 1997. The macroeconomic consolidation process therefore without any doubt created a sounder and better balanced overall economic basis on which a next phase of more rapid economic expansion can now develop. 3. The role of monetary policy After the exchange rate crash of February 1996, the monetary policy approach was to let market forces work with some intervention by the Reserve Bank in the foreign exchange and in the money markets, but mainly with the intention of supporting an orderly adjustment in market prices. It -3was never the intention to try and fix the exchange rate of the rand at any predetermined artificial level, neither did the Bank try to keep interest rates unrealistically low. It was furthermore accepted that, after the relatively large depreciation in the exchange rate and taking account also of the “openness” of the South African economy, the rate of inflation would rise. The challenge for monetary policy was, however, to constrain the rate of increase in inflation to a first round effect only, and to prevent prices from going into an uncontrollable and perpetuating inflationary spiral. In retrospect, the policy seemed to have worked quite well. The restrictive monetary policy, and particularly the rise in interest rates, were not received with unanimous support by all sectors of the South African community. Interest rates, however, remain one of the main disciplines of the market economy and countries that are not prepared to bear the effects of this discipline from time to time will be punished by the markets. This basic lesson is now being learned again by a number of countries in the East Asia region where interest rates recently soared to a much higher level than ever experienced by South Africa. Now that the overall macroeconomic consolidation process has made good progress, there are some impatient pressures building up on the Reserve Bank to relax monetary policy quickly and decisively. Some of these pressures are still based on the now defunct Phillips curve or an assumed trade-off between inflation and growth -- an argument that was buried in most countries of the world already in the 1980s when macroeconomic policy switched the emphasis from a demand-management approach to a supply-side solution. The rapid expansion of communications and the increase in electronically driven capacity for economic analyses further contributed to the more effective implementation of pre-empting expectations, and reduced the opportunity for central bankers to stimulate economies in the short term by applying over-expansionary monetary policies. The South African Reserve Bank now follows the lead of many other central banks in the world to base monetary policy decisions on developments in financial or monetary aggregates, and not on changes in real economic activity. Indeed, the latest fashion is for central banks, together with governments, to target inflation more directly. Taking account of typical time-lags that exist between the implementation of monetary policies and their eventual effect on prices, monetary policy adjustments are based on the expectation of what the rate of inflation may turn out to be twelve to eighteen months downstream. Reliable forecasting therefore has become as important for the monetary authorities as they are for private sector operators in the markets. For this purpose, the familiar monetary aggregates such as the money supply, bank credit extension, the level of interest rates and the shape of the yield curve and changes in the exchange rate provide the best indicators available in the short term to guide monetary policy decisions. What will be important for the stance of monetary policy over the next year will not be the approaching election in 1999, but rather current developments in these well-known basic financial aggregates. Apart from contending with the after-effects of the depreciation of the rand last year, the major concern for the Reserve Bank recently has been the continuous increase at a high rate in the total amount of bank credit extended to the private sector. Over the past few months there has been a significant slowdown in the annualised rate of increase in bank credit extended to the private sector which amounted to 21.2 per cent in the second quarter of 1997, before declining to 9.5 per cent in the third quarter. After the recent downward adjustment in the financial markets in South Africa, we may find some further slowdown in the rate of increase in bank credit extension, to reflect more truly the slowdown which already occurred in real economic activity. Recent events in the international currency markets proved once again that the forecasting of possible future developments in financial aggregates can be very perilous. As South Africa liberalises its financial markets further and as the South African financial system gets more integrated into an extremely volatile international environment, the hazards of forecasting will increase. For the central bank, this unfortunately reduces the value of strictly defined monetary policy models, and makes -4the task of implementing policies more discretionary. Market participants prefer a monetary policy based on pre-announced rules and want to be in a position where they can pre-empt important changes in monetary policy for their own advantage, and for the sake of giving good advice to their clients. This, however, is not possible in the present environment where unpredictable events in far-away places such as Thailand can have profound influences on monetary developments in South Africa. Forecasting possible developments in the exchange rate of the rand, for example, must not only take account of developments in South Africa, but also of possible changes in the cross exchange rates of major currencies, developments in international capital markets, economic and political developments in a number of emerging economies and a multitude of other possible global developments. As illustrated over the past year, changes in the effective exchange rate of the rand in turn can have many effects on monetary policy decisions in South Africa. In this multi-complex environment it is just unreasonable to expect of any governor of any central bank anywhere in the world to signal to markets in advance what adjustments in interest rates or other monetary policies could be expected over the next year. 4. A greater reliance on markets In the situation, it is advisable to rely more on market forces for the necessary correction of imbalances that may develop from time to time in the macro economy. Markets must therefore be encouraged to become more flexible, more efficient and more responsive to changes in underlying supply and demand conditions. In the case of South Africa, three important changes will be introduced in the structure of financial markets over the next few months: • Firstly, the existing national payment, clearing and settlement system will be upgraded in March 1998 to pave the way for real-time on-line settlement of large transactions on a gross basis, and for the daily settlement on a net basis of other (smaller) transactions between banking institutions. This versatile new system will provide challenging opportunities for the development of a more active interbank funds market. • Secondly, the Reserve Bank will introduce a new system for providing liquidity to banking institutions through daily repurchase transactions that will establish a floating interest rate for central bank accommodation. • Thirdly, the Department of Finance intends to introduce a new system for the primary sale of and secondary market making in government bonds by the appointment of a number of securities dealers from the private banking sector to operate as authorised dealers on behalf of the Treasury. These changes are all intended to serve the needs of more liberalised and free financial markets in South Africa. At the same time, they should open up the way for further exchange control relaxations and encourage greater integration of the South African financial markets in the global financial system. 5. Concluding remarks Next year holds the prospects for being an interesting one for the South African economy. • Firstly, there is the prospect for better economic growth in South Africa, following upon the macroeconomic consolidation of the past year. • Secondly, important structural adjustments, particularly in the financial markets, will introduce interesting new challenges for all participants in the markets. • Thirdly, we shall have to contend with the continuing turmoil in the international currency markets, and possibly also with the adverse effects of the El Nino phenomenon. | south african reserve bank | 1,997 | 11 |
Address by the Governor of the Reserve Bank of South Africa, Dr. Chris Stals, at the Annual Convention of the South African Chamber of Business in Somerset West, on 28/10/97. | Mr. Stals discusses the performance of the South African economy in the light of recent developments in East Asian countries Address by the Governor of the Reserve Bank of South Africa, Dr. Chris Stals, at the Annual Convention of the South African Chamber of Business in Somerset West, on 28/10/97. 1. Recent economic developments in East Asian countries The world economic scene is currently dominated by the collapse of the financial systems in a number of formerly very successful East Asian economies. Turmoil in the financial markets of these countries will not only have a serious adverse effect on real economic development in those countries, but can indeed hold important consequences for the world-wide process of economic globalisation and the international integration of financial markets. The problems started in May this year in Thailand when the Thai currency, the baht, suddenly came under severe pressure. The initial reaction was that it was only a few renowned international currency speculators who were trying to make a quick profit, and that the Thai economy would be strong enough to withstand the pressure. However, only one month later, on 19 June 1997, the Minister of Finance resigned, the exchange rate of the baht was left to float and the onslaught against the economy of the country assumed untenable proportions. Early in July the International Monetary Fund was called in, the currency depreciated by more than 20 per cent, and interest rates went sky-high. Now, four months later, the situation has not yet been salvaged. About sixty banks and financial institutions have been placed under management of government, share prices declined by more than 30 per cent, and the property market has collapsed. A special rescue fund of about US$20 billion was put together by the IMF, Japan and other East Asian countries in an effort to stabilise the Thai economy. In the meantime, a number of other countries in East Asia were similarly affected. The Philippines was the next country to be forced into the painful adjustment process. Then followed Indonesia, Malaysia, Korea and Vietnam, and even the more healthy economies of Hong Kong and Singapore could not escape the contagious effects flowing from the malady of their neighbours. The interesting question that is now being asked is: What went wrong in the East Asian Tigers that were, until recently, regarded as role models for developing countries on sound macroeconomic management? In all these countries, people are hardworking, extremely high national savings ratios are being maintained, and governments spent billions on providing the infrastructure for sustainable economic growth. No better answer can be given to this question than by quoting from an article that appeared in the South China Morning Post of 25 September 1997 under the name of John Greenwood, Chief Economist for Chancellor LGT Asset Management. “The origins of the Asean currency crisis since the devaluation of the Thai baht on 2 July can be boiled down to three essential ingredients: • The primary cause in all cases was the prolonged period of excessive money and credit growth from 1993 onwards. The acceleration of money and credit in turn began with the exceptionally low levels of interest rates. • Managed or quasi-fixed exchange rates in the Asean region combined with financial liberalisation, poor quality management and lax supervision enticed corporates to take on excessive foreign debt. • The third common denominator of the Asean crisis has been the failure on the part of the authorities to ensure that their financial sectors were strong enough to deal with a volatile cycle. There was neither adequate prudential supervision nor adequate financial disclosure by local financial institutions.” Despite all the good macroeconomic management in these countries, they failed in pursuing the basic elements of sound monetary and financial controls. They did not control the growth in the money supply; they did not check excessive growth in bank credit extension; they tried to maintain unrealistic interest and exchange rates, and they allowed the quality of their banking and financial systems to deteriorate. There was a time when countries could get away with this type of easy money and lax financial policies. But that was when countries were more isolated and when national policies different from international norms and standards, could still be pursued within economies shielded from international competition through excessive, protective government controls. But the globalisation of the past decade, and the integration of the world financial markets, created a new situation where even the smaller countries of the world are now subjected to the universal disciplines of integrated financial markets. 2. The South African experience with the international financial markets What happened recently in the East Asian countries is not a new experience. The Mexicans and a number of South American economies were similarly affected late in 1994 and in the first half of 1995. South Africa and a few countries in Central Europe, for example the Czech Republic, were tested in 1996. Some of these countries are only now recovering from the afflictions, others are still going through the process of painful correction. South Africa was not excluded from the new game of global market participation. In February 1996, the international financial markets threw down the gauntlet when the rand came under pressure and painful macro-economic adjustments were forced on the country. At the time, certain political developments in South Africa, supported by unfounded rumours about the health of President Mandela and resignations in the public sector, may have triggered the speculation against the rand. With the advantage of hindsight, it is now clear that various unfavourable developments in the South African economy over the preceding two years justified the forceful action of the international financial markets. Firstly, during 1994 and 1995, real gross domestic expenditure in South Africa grew by about 6 per cent per year, and gross domestic product by about 3 per cent. It stands to reason that this kind of disequilibrium growth could not be sustained for too long. Either production had to be stepped up, or expenditure curtailed. No country can consume more than it produces for ever. The international financial markets brought this message home to South Africa very clearly in 1996. Secondly, the disequilibrium in overall domestic real economic activity affected developments in the current account of the balance of payments over this period. In value terms, total imports of merchandise rose by about 28 per cent during each of 1994 and 1995, whereas exports of merchandise increased by only 3 per cent in 1994 and by 16 per cent in 1995. At the same time, net gold exports declined by 8 per cent per year. The current account of the balance of payments therefore switched from a surplus of R6 billion in 1993 to deficits of R1.2 billion in 1994 and R10.2 billion in 1995. During the second quarter of 1996, the seasonally adjusted annualised rate of the current account deficit increased to R13 billion. With a low level of foreign reserves and a process of gradually removing exchange controls, South Africa became very dependent on a continuous large capital inflow from the rest of the world. When this capital inflow disappeared in the second quarter of 1996, a painful downward adjustment in the economy became inevitable. Thirdly, the increase in real domestic economic activity, and particularly in gross domestic expenditure, was financed to an important extent by large increases in bank credit extension and the creation of additional money. In both 1993 and 1994, total bank credit extended to the private sector increased by more than 17 per cent, and the M3 money supply by more than 15 per cent. This was clearly excessive in an environment of real economic growth of 3 per cent (measured from the production side), or 6 per cent (from the expenditure side). The message signalled by the international financial markets to South Africa in 1996 therefore was to restore macroeconomic equilibrium and to come to live within the means of its own production capacity, or to lift the production potential permanently to a higher level. South Africa took on the challenge both ways. The financial policy reaction was: • to let the exchange rate depreciate to a level that would satisfy the markets in respect of their expectations of future sustainability. The rand depreciated by 23.2 per cent from 15 February 1996 up to 31 October 1996; • to let the outflow of foreign currency payments related to the overall balance of payments deficit drain domestic liquidity from the South African banking sector. In the process, the average daily amount of the money market shortage increased from R4.9 billion in January 1996 to R10.6 billion in March 1997; • to allow interest rates to adjust to underlying conditions and to reflect the shortage of funds that developed in the markets. Interest rates indeed already started moving up during the course of 1994/95 under the pressure of the increasing domestic demand for loanable funds. The rate on three months bankers’ acceptances, for example, rose from 10.15 per cent at the end of 1993 to 12.50 per cent at the end of 1994, 14.60 per cent at the end of 1995 and 17.00 per cent at the end of 1996. In line with these movements, the Reserve Bank raised its Bank rate in five steps from 12 per cent at the end of 1993 to 17 per cent in November 1996; • a rise in the rate of inflation became inevitable after the depreciation of the rand in 1996. The authorities nevertheless adopted a restrictive monetary policy stance to ensure that the adjustment in relative prices of tradable and non-tradable goods would not perpetuate into a long-lasting new era of high inflation. The rate of increase in consumer prices rose from 5.5 per cent over the twelve months up to April 1996, to 9.9 per cent in April 1997. The Government’s response to the other part of the challenge, that is to raise the production capacity of the South African economy permanently to a higher level, was provided with the publication of the Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR). This economic structural adjustment programme will obviously take a longer time to produce results than the shorter-term measures introduced last year to restore business cycle equilibrium by restricting growth in demand. 3. Economic consolidation in 1997 The economic consolidation process forced on South Africa by the events of February 1996 provided satisfying results so far in 1997. The international financial markets already signalled their satisfaction in November 1996, when stability returned to the market in foreign exchange, the outflow of capital through the balance of payments receded, and the exchange rate recovered some of its losses earlier last year. After the middle of 1996, there was a substantial slow-down in the rate of expansion in gross domestic expenditure. In the second half of 1996 and during the first quarter of 1997, total gross domestic expenditure actually declined at an annualised rate of about 2 per cent, before growth was resumed again in the second quarter of 1997. The growth rate in production unfortunately also slowed down marginally but at this stage better equilibrium has now been restored between these two basic macroeconomic activities. The current account of the balance of payments also improved as the rate of growth in imports slowed down. In the second quarter of 1997, the seasonally-adjusted, annualised current account deficit amounted to only R3.4 billion. In addition, although adjusting only very slowly, the rates of increase in both bank credit extension and in the money supply have slowed down since the middle of 1997. Measured over a twelve months’ period, the total amount of bank credit extended to the private sector still rose by 14.6 per cent in August 1997. However, over the three-month period from June to August 1997, the seasonally adjusted annualised rate of growth in the total amount of bank credit extended to the private sector declined to 5.9 per cent. Over the same period, the rate of increase in M3 slowed down to 11.4 per cent on an annualised basis. Finally, inflation, which threatened to run out of control earlier this year, also abated and, after peaking at 9.9 per cent in April 1997, the rate of increase in consumer prices slowed down to 8 per cent over the twelve months that ended in September 1997. The international financial markets confirmed approval for these macroeconomic adjustments that were achieved, not without pain, but with a substantial improvement in the basic fundamentals. Over the first nine months of 1997, non-residents increased their holdings of South African bonds and equities by no less than R39.1 billion which enabled South Africa to continue with the process of removing exchange controls, and also to increase its foreign reserves. The gross amount of gold and foreign exchange reserves held by the Reserve Bank increased by R16.2 billion from 31 December 1996 to R26.5 billion at the end of September 1997. The improved underlying conditions were also reflected in a decline in interest rates. As the overall money market situation eased and the Reserve Bank acquiesced in a gradual decline in the money market shortage to an average daily amount of only R4.5 billion in the first three weeks of October, money market interest rates moved downwards. The rate on three months’ bankers acceptances gradually declined from 17.00 per cent at the end of 1996 to 14.25 per cent last week. The Reserve Bank endorsed these movements in the underlying financial aggregates by reducing the Bank rate from 17 to 16 per cent on 20 October 1997. 4. The role of monetary policy in the adjustment process As the globalisation process progresses, financial markets, and particularly those of the smaller economies, lose some of their independence. In these countries, the task of central banks becomes more difficult. They can no longer follow an independent monetary policy that will please politicians or internal pressure groups, but must learn to understand to respect and to respond to international market pressures. In most of the countries referred to above, international economic disciplines were transmitted to domestic economies through financial markets. Adjustments in exchange rates, interest rates and financial asset prices provided the main transmission mechanism used by the markets to force the disciplines of the international markets on central banks and governments. As with the East Asian countries, excessive increases in bank credit extension and in the money supply, and unrealistic interest and exchange rates, or unacceptable fiscal deficits, were severely punished. South Africa will have to learn to live with, and to adapt to, these market disciplines. This country can not on a permanent basis maintain lower interest rates than those ruling in most of the other emerging markets. Our inflation rate will have to be reduced to come more in line with the average rate of inflation in the economies of our major trading partners and international competitors. There is no magic formula to determine what the level of the exchange rate or interest rates should be on any particular day in South Africa. The world financial markets are too volatile, changes too erratic and unpredictable, and economic models based on past experiences unreliable. Against this background, monetary policy decisions must of necessity often be based more on discretion, and less on pre-established rules. This makes short-term forecasting of financial developments even more difficult, if not impossible. In this environment, it is important to have flexible markets that will emit understandable signals to all the participants in the economy, including the monetary policy authorities. Or even better, to have markets that can be trusted to determine prices with a minimum of government intervention. 5. Prospects for the South African economy Now that the consolidation process in the South African economy has been achieved with some success, the basis has been laid for a new phase of steady and, hopefully, more sustainable growth. In the sphere of real economic activity, some scope has been created for higher growth in both production and expenditure. It will, of course, be good for future development if any increase in expenditure at this juncture could be concentrated in fixed investment rather than in private sector or government consumption expenditure. The South African balance of payments remains vulnerable and dependent upon a sustained inflow of capital from the rest of the world. We must continue to nurture the confidence of all potential foreign investors, and particularly of the long-term investors who are prepared to participate directly in real economic activity. Without foreign capital inflows, any recovery in domestic economic activity will be short-lived. Finally, the short-term consolidation process in the financial sector has not yet reached its final and acceptable destination. International financial markets observe the still relatively high rates of expansion in bank credit extension and in the money supply, the above average-rate of inflation, and the growing indebtedness of particular private individuals with circumspection. Provided we can continue with the process of also improving equilibrium in the financial markets, the prospects are good for a better overall economic performance next year. In the longer term, economic growth at a suitably high level will, however, only become possible once the more fundamental economic reforms envisaged in GEAR have been implemented. The restoration of business cycle stability in the short-term was an important precondition for a revival of economic development, but it also paves the way for a more determined effort by all of us over the next few years to raise the overall production capacity of the economy on a permanent basis to a higher level. | south african reserve bank | 1,997 | 11 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a South African Financial Markets Conference arranged by Standard Bank of South Africa Limited in Cape Town, on 7/11/97. | Mr. Stals discusses monetary policy challenges in South Africa Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a South African Financial Markets Conference arranged by Standard Bank of South Africa Limited in Cape Town, on 7/11/97. 1. Challenge number one - to find consensus on what the objective of monetary policy should be in South Africa In the international community of central bankers, there is widespread consensus that the primary goal of monetary policy must be domestic price stability. Price stability, however, is only a means to an end, and not a final goal of overall macroeconomic policy. The ultimate goal is determined by governments and is normally linked to the objective of maximum economic growth, development and the creation of more employment opportunities. Contemporary economic theory supports the view, however, that financial stability, as measured by a low rate of inflation, is a precondition for the attainment of optimum economic development. Furthermore, monetary policy, being only one of the sub-elements of overall macroeconomic policy, is tasked with the responsibility to create and maintain such a stable financial environment that will be conducive for sustainable economic growth at an optimum rate in the medium and longer term. In South Africa, however, confusion remains on what the task and the functions of the central bank should be. The most important delusion, supported by certain business people, politicians and even some academics, is linked to the now defunct Phillips curve approach in terms of which the assumption is made that a higher inflation rate can produce a sustained lift in growth and employment. World-wide experience, as long back as in the 1970s, provided sufficient evidence that the assumed trade-off of higher inflation for lower unemployment could only be exploited over the limited period in which inflation expectations did not fully adjust to the new higher rate of inflation. With a more effective implementation of the theory of rational expectations within modern communities, this limited period has indeed become very short. Another reason why the conventional theory of demand management through the application of monetary policy is no longer appropriate is the major shift that took place in recent years in macroeconomic management, away from conventional Keynesian demand management to contemporary supply-side economics. The Phillips curve approach is based on the theory of demand-driven inflationary or deflationary conditions. The world-wide situation in the 1970s, when there was a simultaneous rise in inflation and in unemployment in many of the industrial countries, refuted the theory of the trade-off and forced new thinking on particularly the implementation of monetary policy. The present universal approach on monetary policy therefore takes account of the new electronic environment of instant communication leading to a more swift dissection of policy actions and immediate reaction by markets, and of the more general need in most countries to raise production capacity, and not to stimulate demand. In this environment, the appropriate role for monetary policy has been redefined as a responsibility for the creation and maintenance of stable financial conditions that will be reflected in low inflation. This is what central banks can do best to support governmental programmes for overall economic growth and development. In South Africa, considering the many attacks made on Reserve Bank policy during this past year, there is still a major lack of consensus on what the prime objective of monetary policy should be. Unless we can get consensus and support for the almost global approach of contemporary central bank policy, and unless we can agree to pursue these policies also in South Africa, the road to the internationalisation of the South African economy will be rough and difficult. 2. Challenge number two -- deciding on an appropriate framework for monetary policy Given the objective of price stability, each central bank must design a framework or a consistent model within which monetary policy can be implemented, taking account of the structure of the financial system and of the economy of the country. Various models are available to choose from, but whatever model is preferred, the final objective of monetary policy should always be the protection of the value of the currency. In the Bretton Woods system of fixed par values, the main intermediate objective of monetary policy was the protection of exchange rates, or the external value of the currency. By linking global exchange rates through fixed gold parities, there was a convergence of inflation, at a relatively low level, at least for the many countries that succeeded in maintaining fixed exchange rates over relatively long periods of time. Needless to say, the system broke down in the late 1960s and early 1970s when more expansionary monetary policies were followed by some of the major industrial countries, and inflation escalated. Today, some smaller countries still attach their exchange rates to a selected major international currency, and then accept the unavoidable consequence that the rate of inflation in the smaller country must converge with the rate of inflation in the economy of the anchor currency. A good example of this approach is provided by Argentina with its convertibility law of 1 Peso = 1 US dollar. A second widely-used model is the one of monetary targeting where an important monetary aggregate such as the money supply or the amount of bank credit extension is used as an anchor for monetary policy. Within the context of the prime monetary policy objective of maintaining low inflation, a monetary target (or exchange rate target) represents but an intermediate objective of the policy. South Africa is one of the many countries that introduced money supply targeting as an anchor for monetary policy during the course of the 1980s. Initially, the policy served the country well. It made an important contribution to a better understanding of policy decisions, and also made a major contribution towards the successful reduction in the level of the rate of inflation from an average of about 15 per cent over the twenty years from 1973 to 1992, to about 8½ per cent over the past four years. The South African experience with money supply targeting is not very different from those of other comparable countries such as Canada and Australia -- with the difference that the process in South Africa is a slower and lagged one, mainly because of the economic isolation of this country from the rest of the world up to 1993. Australia introduced money supply targets in 1976, and then abandoned them “with reluctance” in February 1985. At the time, Australia tendered two reasons for ending the M3-targeting stage: “The first was the problem of controllability. The fact that targets were often missed was an indication that close control was either not possible, or would have required undesirable movements in the policy instruments. The second was the instability of the relationship between money supply and the ultimate objective of policy such as inflation ...”. (Address by Governor Macfarlane at a Conference of Economists in Hobart, 29 September 1997.) It was Governor Gerald Bouey of Canada at the time who made the famous statement: “In Canada, we did not abandon money supply targets, they abandoned us”. In view of the liberalisation of the South African financial markets in recent years, the integration of the South African economy in the world financial markets and the increasing importance of large and volatile international capital flows, South Africa may have reached the same stage now where the usefulness of the M3-money supply as a target for monetary policy has been diluted to a point where some alternative anchor should be considered. Following the demise of money supply targeting during the mid 1980s, both Canada and Australia went through a transitional period which lasted until the early 1990s. During this transitional period a policy of “monetary pragmatism” was followed. There was indeed no formal or strictly defined framework to guide monetary policy. A “check-list” of an ad hoc mixture of intermediate objectives was introduced and the central bank was allowed a wide degree of discretion in the implementation of monetary policy. After the “rule” of monetary targeting broke down, the policy was “to look at everything”. Although such a pragmatic approach may have some advantages, particularly in an environment of major structural changes and volatile international shocks, it has the major disadvantage of not being transparent. As Charles Goodhart put it: “Supporters would describe it as sensible pragmatism, detractors as a reversion to a muddled discretion which, once again, allows the authorities more rope than is good for them, or us”. (The Conduct of Monetary Policy, Economic Journal 1989.) Both Australia and Canada, and a growing number of other countries, have recently moved to direct targeting of inflation. In all these countries, however, not only central banks but also governments commit themselves jointly with the central banks to a predetermined target for inflation. In the United Kingdom, the Chancellor of the Exchequer indeed sets the target for inflation in his Annual Budget, and then instructs the Bank of England to pursue the goal with its monetary policy instruments. Nowhere does the central bank on its own decide on an inflation target. For an inflation target to be credible, there must be a commitment at least of the central bank and the government, and, if possible, also of the business community and labour, to the achievement of the goal. Furthermore, it will do more harm than good for a country to introduce a formal inflation target that is much out of line with the rest of the world. Of the seven countries reported in the BIS Annual Report for 1996 with formal inflation targets, no one has set a goal for inflation of more than 3 per cent per annum. The central bank must be given sufficient operational autonomy to pursue the inflation target with vigour and without the fear of intimidation by politicians or other pressure groups. And, finally, markets must be free, flexible and responsive to underlying changes. Inflation is often a symptom of malfunctioning markets and the cure lies not with monetary policy, but with a restructuring of the markets. It is a big challenge for South Africa to prepare itself for this new age of direct inflation targeting as an anchor for monetary policy. The proposals made by the Reserve Bank last week for the introduction in March next year of a more flexible system of providing accommodation to banking institutions, represents an important further step on this road towards a more effective monetary policy system that will be compatible with global policies. 3. Challenge number three - establishing an effective institutional framework for monetary policy There is a lot of misunderstanding in South Africa about what is meant with the independence of the Reserve Bank. The Bank can never be made responsible for determining the overall macroeconomic policy objectives of the country. This is a prerogative of government. The central bank must, however, be given a clear mandate from government on what its policy objective should be, but should then be given the necessary autonomy to pursue and achieve this objective. Taking account of the powers and influences of central banks, the obvious directive by government to the monetary authority should be to protect the value of the currency in the interest of sustainable optimum economic growth and development in the longer term. To achieve this objective, a central bank must at times apply financial disciplines that are unpopular, will be opposed by pressure groups and are perceived to be against the interests of private sector profiteers, and political popularity. It is inter alia for this reason, and only in respect of the implementation of measures that may at times prove to be unpopular, that central banks should be given “independence” from governments. To quote once more from what a former Governor of the Reserve Bank of Australia once said: “The Reserve Bank must be given all the freedom of the prison exercise yard”. (R.A. Johnston - “Comments on Professor Schedvin - Economic Papers - 1992.) Although this autonomy has been given to the South African Reserve Bank in terms of the Constitution of the Republic of South Africa, the disciplinary actions applied by the Bank in the pursuance of its mandate are often challenged by economists, business people and politicians whenever they believe their vested interests are impeded by the actions. Many South Africans must still learn to be more tolerable towards the need of painful financial disciplines, when justified by adverse macroeconomic situations. These may often be forced on us by international developments over which we have no control. Apart from an effective institutional framework for the Reserve Bank, South Africa also needs well-managed private sector banking institutions, well-functioning financial markets and an effective clearing, settlement and payment arrangement for inter-bank transactions. The challenge is therefore not only to liberalise the South African financial sector further, but also to ensure good and prudent financial regulation, and to provide the country with a modern electronically-based national payment system. The new system to be introduced by the Reserve Bank in March 1998 for an improved clearing and settlement system will provide a further step on the road of preparing for an effective integration of the South African financial system in the global economy. The challenge for South Africa is not to isolate itself from the adverse effects of the globalisation process, but to continue to participate in the programme of gradual international integration. 4. The overriding challenge for monetary policy is to keep inflation low Financial stability in South Africa is threatened from time to time by new and more intensive inflationary pressures. We have not yet succeeded in suppressing the prevailing inflation psychosis in this country. Expectations at this juncture may have settled around the 8 per cent per annum level, which is about half of what it used to be at the beginning of this decade. But this is still about three times the amount of actual inflation in the economies of our major trading partners. The process of globalisation unavoidably leads to a convergence of the major financial aggregates such as inflation, real rates of interest and budget deficits. South Africa will either continue to be part of the globalisation process, together with its inevitable convergence effects, or will be marginalised and excluded from the advantages of being part of the world-wide process. In this period of transition from monetary policy targeting to the introduction of a national inflation objective, monetary policy must continue to maintain overall financial stability. This is essential in order to buy time while other policies (as proposed in GEAR) are put in place to handle the more deep-seated structural deficiencies that must be corrected before South Africa will be able to experience optimum economic growth with financial stability. 5. Conclusion and summary The challenges facing monetary policy in South Africa at this stage can be summarised as follows: • We must convince more South Africans that the one and only task for monetary policy must be to protect the value of the currency. • We must adapt monetary policy to the changing environment in which we now have to operate. This may require of us to move away from money supply targeting and to adopt a more direct focus on inflation developments. • We must guard against growing pressures in our country for the curtailment of the autonomy of the central bank. • The Reserve Bank must continue to guide the South African financial markets into the world financial system. This will require further progress in the gradual elimination of exchange control, the modernisation of the payments system, the encouragement of the development of more efficient markets and, in the context of Africa, support for co-operation and integration of financial markets within the Southern Africa Development Community. The overriding challenge remains to bring inflation in South Africa to a lower level that will be more in line with the average rate of inflation of our major trading partners. This will require a sound monetary policy approach, based on realistic (but not necessarily low) interest rates; a stable (but not necessarily fixed) exchange rate; a sound (but not necessarily protected) banking sector, and effective and well-functioning financial markets. | south african reserve bank | 1,997 | 11 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at an investment conference arranged by Huysamer Stals in Johannesburg on 18/11/97. | Mr. Stals discusses the current monetary situation in South Africa and the implications for 1998 Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at an investment conference arranged by Huysamer Stals in Johannesburg on 18/11/97. 1. The task and function of monetary policy Monetary policy is about money. Governments give central banks the special right to issue money, and also a mandate to manage the money system in the interest of economic development. In the final situation, monetary policy is about the quantity of money, the price of money and the value of money. In the broad context of macroeconomic policy, the central bank is normally tasked with the function of protecting the value of money. This is but an immediate objective, making an important contribution to the achievement of the ultimate goal of economic policy, which is to sustain optimum economic development that will create more jobs and lead to an improvement in the standard of living of all the people of the country. Monetary policy cannot be used to solve all the macroeconomic problems of a country. However, a stable financial environment with a low rate of inflation is regarded as an important precondition for the solution of many of the existing macroeconomic problems in any country. By focusing on the maintenance of low inflation, central banks do not distance themselves from the broader macroeconomic problems such as excessive budget shortages, untenable balance-of-payments deficits, short-term business cycle developments or uncompetitive international trade positions. It is indeed only in conditions of a stable financial environment, that is low inflation, that the real nature of the more fundamental macroeconomic deficiencies will be exposed, diagnosed, understood and rectified. In most cases, remedial action for structural economic ails will also not produce the required corrections in an inflationary environment. Pressure is often put on central banks to harness the power of money creation for purposes other than pure monetary policy objectives, for example to facilitate the financing of public sector budget deficits, or to stimulate real demand for goods and services, or to help small businesses. Pursuing all kinds of non-monetary objectives with monetary policy will, however, normally lead the country inevitably on the dead-end road of higher inflation. 2. Recent monetary developments in South Africa The main objective of monetary policy therefore is and should be to keep inflation low. In the absence of a national commitment to a predetermined and quantified target for inflation, the Reserve Bank’s approach is that the rate of inflation in South Africa should be maintained more or less in line with the average rate of inflation in the economies of our major trading partners and competitors. Measured against this benchmark, South Africa did not do well in recent years. It is true that the average rate of inflation stayed around a level of about 14 per cent for more than twenty years from 1972 to 1992 and has now been kept below 10 per cent per annum for almost 5 years. At the level of 8 per cent established over the twelve months up to September 1997, the most recent available statistic, the South African rate of inflation is, however, still about three times as high as the current rates of inflation in our major international trading partners. After the depreciation of the rand last year, consumer price inflation increased from 5.5 per cent in April 1996 to 9.9 per cent in April 1997. Since then, it declined again to 8 per cent in September. Calculated at a seasonally adjusted annualised rate, consumer prices increased by only 6.6 per cent in the third quarter of 1997. Increases in the production price index followed a similar trend and declined from a peak of 9.6 per cent in March 1997 to 6.1 per cent in September. In the third quarter of 1997, the seasonally adjusted annualised rate of production price inflation indeed declined to a very low level of 2.1 per cent. The rate of increase in the total amount of domestic bank credit extension to the public and private sectors together similarly showed an encouraging slowdown in recent months. The rate of growth in total bank credit extension reached a peak of 21.6 per cent in February 1997, before declining to 15.3 per cent over the twelve months up to September 1997. The growth from quarter to quarter in the average total domestic credit extension fell from 23.6 per cent in the first quarter of 1997 to 6.2 per cent in the third quarter. The growth in total bank credit extended to the private sector also declined to a level of less than 10 per cent in the third quarter. Developments in the M3-money supply were less satisfactory. The growth rate in M3 measured over twelve months declined from 16.5 per cent in March 1997 to 12.7 per cent in June, but then accelerated again to 16.3 per cent in September 1997. On a quarterly basis, however, the rate of increase in M3 also slowed down from 18.1 per cent in the first quarter of 1997 to 12.2 per cent in the third quarter. Another monetary aggregate which is of great importance for the Reserve Bank is the amount of liquidity available in the banking sector as reflected in the amount of loans banking institutions seek from the Reserve Bank’s discount window every day. This amount declined from a daily average level of R10.6 billion in March 1997 to R5.3 billion in October, indicating that the lower rate of increase in the demand for credit was no longer absorbing the increases in liquidity arising from the large net capital inflows from abroad. The banks no longer needed large amounts of Reserve Bank assistance for most of the time. These trends in monetary conditions were also reflected in interest rates which first rose quite substantially last year but then declined since the beginning of 1997. The rate on bankers’ acceptances with a maturity of three months declined from 16.2 per cent at the end of January 1997 to 14.2 per cent on 25 October. Satisfactory developments also occurred in the international financial aggregates over the past twelve months. The net inflow of foreign capital gained momentum again towards the end of 1996. During the first three quarters of this year, the total net capital inflow amounted to almost R20 billion. Net purchases of bonds and equities by non-residents amounted to about R34 billion, which enabled South African residents, mainly institutional investors, to switch a further R17 billion of their South African portfolios into foreign currency denominated assets. The relatively large net capital inflows during the first three quarters of 1997 exceeded a smaller deficit on the current account of the balance of payments and enabled the Reserve Bank and the private banking sector to increase their holdings of short-term foreign assets. At the end of September 1997, the total gross gold and other foreign exchange reserves held by the combined banking sector amounted to an estimated R33.6 billion, or the equivalent of about 10 weeks’ imports. These favourable overall balance of payments developments contributed to a more stable exchange rate for the rand. After depreciating by almost 22 per cent in 1996, the nominal effective exchange rate of the rand, measured against a basket of the currencies of South Africa’s major trading partners, depreciated by less than one per cent from 31 December 1996 to 31 October 1997. Larger depreciations against the US dollar and the British pound were neutralised by appreciations against most of the European currencies and the Japanese yen. The average value of the rand against foreign currencies for the first ten months of the year is about 6 per cent lower compared with the average value for the first ten months of 1996. 3. Implications for monetary policy Monetary policy decisions in South Africa are guided mainly by developments in financial aggregates such as the money supply, bank credit extension, money market liquidity, market interest rates, the official foreign reserves and the exchange rate. There is, over time, obviously a relationship between developments in the financial aggregates and in real economic activity. The growth rates of most of the financial aggregates over the past few months showed a marked slowdown, particularly the rates of growth in the components of gross domestic expenditure, which already started to decline in the second half of 1996. Critics of the Reserve Bank are often of the opinion that monetary policy should be linked more directly to changes in real economic activity, and not to changes in the financial aggregates. The experience of the 1960s and 1970s, when monetary policy was still guided by Keynesian demand management principles, proved that premature relaxations of monetary policy could easily lead to “stop-go” or “boom-bust” economies, and to a persistent rise of inflation to a higher level after the completion of each successive business cycle. In the modern approach of supply side economies, monetary authorities in most countries now link policy changes with great success rather to changes in the financial aggregates. There is therefore a different and more effective timing of changes in monetary policy. Taking account of developments in real economic activity in South Africa over the past year, in the overall balance of payments and in the financial markets, the Reserve Bank adopted an easier monetary policy stance already in the middle of 1997. The Bank acquiesced in gradual increases in money market liquidity, and also in the declines of market interest rates such as the yield on long-term government bonds and Treasury bills, and on bankers’ acceptances and negotiable certificates of deposit. The Reserve Bank endorsed the easier monetary conditions by reducing the Bank rate from 17 to 16 per cent on 20 October 1997. 4. Recent developments in the monetary situation Since the last week of October, turmoil in the currency and capital markets overflowed the cauldron of certain overheated East Asian economies and disrupted also the South African financial tranquillity. These developments led to some substantial selling of South African bonds and equities by non-residents, sharp declines in equity prices, volatile conditions in the foreign exchange markets, an increase in the money market shortage and upward pressure on interest rates. Understandably, the new situation created great uncertainty in the financial markets and initiated an ongoing debate on what the consequences of these developments would be for South Africa. There is no doubt that major adjustments will be necessary to restore equilibrium in the economies of the affected East Asian countries. Some of the countries, for example Thailand, are already biting the bullet and are now implementing IMF austerity programmes for painful macroeconomic adjustments that cannot be avoided. It will take time to restore confidence and to put a new tiger in the tanks of those countries that are perhaps now suffering from growth fatigue. It remains to be seen to what extent the unavoidable slow-down in real economic activity of the East Asian region will affect global economic developments over the next year. The South African economic conditions will obviously also be influenced by these developments, although our direct trade with the affected economies is relatively small. We have perhaps a greater interest in the early recovery of the ailing Japanese economy, which can now also be delayed because of adverse influences of conditions in the economies of the tired tigers of the region. South Africa has also recently been affected by the decline in the gold price, a development which is of course not completely unrelated to the developments in the foreign exchange and capital markets. There may be some disappointment that on this occasion international investors looking for value in a flight from securities opted for the US dollar, and not for gold. Once again, the possible adverse effects of the decline in the gold price on the South African balance of payments or the exchange rate of the rand should not be exaggerated. It holds a much greater social problem if one or two gold mines should be forced to close and many mine workers should be retrenched because of the low gold price. Monetary policy must obviously even in the short term be adapted to major changes in underlying conditions, and must take account of the recent dramatic movements in the foreign exchange and financial markets. The basic fundamentals in South Africa, however, remain sound and well-balanced. Should these external disruptions settle down soon, and should the events of the past few months in East Asia not have too much of a ripple effect on the overall global economic growth prospects for 1998, South Africa can look forward to a period of steady and sound economic recovery next year. 5. Implications for 1998 The macroeconomic consolidation process in the South African business cycle has been completed to an important extent: There is better equilibrium now between real total domestic production and real total demand; The overall balance of payments is in surplus and the capital inflows up to the third • quarter exceeded a relatively small current account deficit; In the financial sector, both money supply and bank credit extension still increased at • relatively high rates over the past year, but slowed down significantly over the past few months; The total gold and foreign exchange reserves is now at a more comfortable level than at • any stage last year; • • The rate of inflation has declined since the first quarter of this year and the rates of increase in both consumer and producer prices will hopefully continue on a downward path; the average nominal effective exchange rate of the rand stabilised over the past year. Not everyting is, however, favourable for an expected economic recovery in South Africa next year. In our forward planning we must take account of: the possible adverse effects on the global economy of the present problems of certain East Asian countries and Japan; the adverse effects of the lower gold price, particularly for the official objective of • increasing total formal sector employment in South Africa; and the threatening danger of adverse climatic conditions because of the El Nino effect. • On balance, South Africa can with justification look forward to a better economic performance in 1998 after the successful consolidation period of 1997. | south african reserve bank | 1,998 | 1 |
Address by the Governor of the South African Reserve Bank, Mr. C. Stals, at the 21st Annual Investment Conference of Société Générale Frankel Pollak (Pty) Ltd. in Johannesburg, on 24/2/98. | Mr. Stals discusses the independence of the central bank and monetary policy in South Africa Address by the Governor of the South African Reserve Bank, Mr. C. Stals, at the 21st Annual Investment Conference of Société Générale Frankel Pollak (Pty) Ltd. in Johannesburg, on 24/2/98. 1. Introduction The debate on the independence of central banks is, fortunately for both governors of central banks and Ministers of Finance, gradually losing its momentum. The discussions were often misguided and created the misleading impression that central bankers had a desire to be completely isolated from their political masters, and that monetary policy objectives could and should be pursued in complete isolation from fiscal and other macroeconomic policies. This is, of course, not realistic. Monetary policy is but part of the overall macroeconomic strategy pursued by governments. Monetary policy must, after all, support the overall macroeconomic goals of governments, and must be applied in a consistent framework of overall macroeconomic strategy. The independence of the central bank therefore applies not to the setting of the final destination, but to the choice of the route it prefers to take to reach that predetermined destination. In the context of the South African macroeconomic policy framework, Government has decided, by means of the Constitution of the Republic of South Africa, that the task of the South African Reserve Bank shall be to protect the value of the currency. Without giving an explicit definition of what “protection of the currency” precisely means, it is clearly the intention that the Reserve Bank shall pursue a policy that will keep inflation under control. The pursuance of this objective, however, often requires unpopular measures that politicians may find difficult to force on their voters, particularly in times of pending elections. For this reason, and to ensure consistent and persistent implementation of the required financial disciplines, central banks are given independent discretionary powers on the operational procedures they regard as necessary to discharge of their responsibilities. The South African Government therefore wisely wrote into the Constitution that the South African Reserve Bank will be allowed to pursue the objective of financial stability independently and without fear of interference by pressure groups, be they from government or the private sector. In the final instance, success will be measured not by the degree of independence of the central bank, but by the results it will achieve. After the turmoil in the South African financial markets in 1996, the South African Reserve Bank had no alternative last year but to follow a restrictive monetary policy, intended to restore overall financial stability and confidence. The Bank was often criticised for not resisting the market pressures for higher interest rates, and for not providing more liquidity by using its unlimited powers to create more money. Private business people, many home-owners and heavily indebted individuals, economists with vested interests in speculative financial operations, labour unions and some politicians, criticised the Bank for its stance, and blamed monetary policy for all the ills of the economy. Seasoned central bankers, however, know that the opposition to unpopular monetary policy measures gets more intense in situations when constraints are needed most, and when the catalyst of painful monetary adjustment is indeed producing the desired results. In this game, there is no gain without pain. Wise governments know that this is the time for them to stand aloof of independent and often stubborn central bankers. South Africans can be grateful for the country’s political leadership last year when the Reserve Bank was allowed to pursue unpopular policies in an unfriendly environment. The beneficial effects of the policies are now being reflected in recent encouraging developments in a number of the more important financial aggregates. 2. 1997: Year of financial consolidation At the beginning of 1997, the Reserve Bank predicted that the year ahead would be one of consolidation. Time was needed to recover from the shocks of 1996 when foreign capital inflows suddenly subsided and left the overall balance of payments with a R5 billion deficit. In the process, the country’s official foreign reserves declined to the extremely low level of less than R14 billion (in September 1996), and the average effective exchange rate of the rand depreciated by 23.2 per cent from February to October 1996. Monetary policy, which was tightened considerably during the course of 1996, had to remain restrictive throughout the major part of 1997. The Reserve Bank’s lending rate to banking institutions, which was raised to 17 per cent in November 1996, was retained at this level until late in October 1997. Those market interest rates, such as the prime overdraft and mortgage lending rates of banking institutions that are closely linked to the Bank rate, therefore also remained relatively high. The high level of interest rates reflected a continuing high demand for credit, against the background of a further marginal decline in overall domestic saving. Total bank credit extended to the public and private sectors together increased by 16 per cent over the year. There was, however, some slowdown in the rate of increase in bank credit extension to the private sector from 17 per cent in 1996 to 14 per cent in 1997. This figure, however, still includes credit extended to local authorities. A refined version of the definition of bank credit extension to the private sector, excluding local authorities, indicates a growth of only 12.4 per cent over the twelve months up to December 1997. Be that as it may, the Reserve Bank remains concerned about the high level of bank credit extension in South Africa over the past three years. Bank credit extension is the main source of money creation, and the increase of 17 per cent in the M3 money supply last year raised the level of the total money supply to gross domestic product to 60.2 per cent in the fourth quarter of 1997, compared to 56 per cent a year earlier. With a low income velocity of circulation at this stage, there is always the danger that idle money can easily be activated in spending on real goods and services. It is accepted, however, that a number of structural changes affected the developments in the major financial aggregates over the past few years which require discreet interpretation of the meaning of the observed changes. The almost explosive increases in the volume of transactions in the financial markets, for example, may have contributed significant amounts to both bank credit extension and the money supply. Total turnover in the secondary bond market increased by 41 per cent in 1997 to an aggregate amount of R4,269 billion. The number of shares traded on the Johannesburg Stock Exchange almost doubled from 1996 to 1997, whereas the total value of transactions increased by 77 per cent to R207 billion. Less spectacular, but also significant, increases were registered in the markets for derivatives and for foreign exchange. Financial market operators obviously needed more cash (money) against the inflated turnovers. However, no central banker should ever become complacent about excessive increases in bank credit extension and in the money supply. Even if such increases do not have any visible or proximate effect on real spending or inflation, the excessive amount of money, once it has been created, can easily be redirected, at some inopportune future time, into spending on goods and services. What is of even more importance, is that excessive growth in the banking sector, relative to real economic growth, can lead to a systematic decay in the health and soundness of the financial system. Ample evidence of the dangers of persistent excessive expansion in the financial aggregates can be found in the recent frustrating experiences of many countries in South-East Asia. It is, however, true that the excessive increases in bank credit extension and in the money supply last year, did not prevent the restrictive monetary policy pursued from supporting meaningful restoration of overall financial stability. Firstly, equilibrium was restored in real economic activity because of a significant slowdown in the rate of growth in gross domestic expenditure. After increases of about 6 per cent in 1994 and 1995, total demand increased by 2½ per cent in 1996 and 1½ per cent in 1997. Secondly, with growth in total domestic demand more or less in line with but modest increases in total production, the current account of the balance of payments returned to a more sustainable deficit during the last six months of 1996 and the first nine months of 1997. Preliminary indications are that the deficit widened again in the fourth quarter of 1997, although the deficit for the year as a whole remained well below the R10 billion level. A third very encouraging development last year was the return of foreign investor confidence and a substantial increase in the net inflow of capital from the rest of the world. After slumping from R19.2 billion in 1995 to only R3.9 billion in 1996, the total net inflow of capital through the balance of payments recovered again to R20.2 billion in 1997. The net inflow of long-term capital indeed amounted to about R30 billion, which was partly neutralised by a net outflow of R10 billion in short-term funds. The surplus on the overall balance of payments enabled the country to increase its net gold and other foreign reserves by R11½ billion from the end of December 1996 to the end of December 1997. The total gross foreign reserves held by the Reserve Bank and the rest of the banking sector amounted to R36.6 billion at the end of 1997, the equivalent of about 10 weeks’ imports of goods and services. 3. Results of macroeconomic financial consolidation Two important beneficial macroeconomic results flowed from the frustrating consolidation process of last year. Firstly, because of the improvement in the overall balance of payments situation, the exchange rate of the rand became much more stable. As a matter of fact, were it not for the substantial net purchases of foreign exchange by the Reserve Bank, the rand could have appreciated quite strongly last year. The average weighted value of the rand against a basket of the currencies of South Africa’s major trading partners declined by 0.3 per cent from 31 December 1996 to 31 December 1997. The average level of the effective exchange rate of the rand throughout the year 1997, compared with the average level in 1996, showed a depreciation more or less equal to the inflation differential between South Africa and its major trading partners. The more stable exchange rate also reduced the demand for forward cover in respect of outstanding foreign exchange commitments of South African residents. The net oversold forward book of the Reserve Bank, about which there is much misunderstanding in financial markets, declined from US $22 billion at the end of 1996 to less than $15 billion at this stage. The second gratifying development was that South Africa succeeded in 1997 to arrest the inflationary pressures created by the 1996 depreciation of the rand. The rate of increase in consumer prices, measured over a twelve months’ period, accelerated from 5.5 per cent in April 1996 to 9.9 per cent in April 1997. During the rest of last year, however, the rate of increase in consumer prices gradually drifted down to 6.1 per cent in December 1997. On a seasonally adjusted annualised basis, the rate of inflation declined to 4.1 per cent in the fourth quarter of 1997. Against the background of the relatively successful financial consolidation process of 1997 and the progress made during the course of the year towards reaching overall financial stability, it is understandable why the turmoil in the international currency markets after the East Asian crisis only had a limited effect on the South African situation. It hit the South African markets just at a time when the country had more or less completed painful adjustments to restore equilibrium after its own crisis of 1996. Apart from the downward adjustment of prices in the equity market, the contagion on South Africa from the currency problems in East Asia appeared to have been limited. 4. Prospects for 1998 At the beginning of 1998, South Africa therefore finds itself in a much more comfortable situation than a year ago, at least as far as the overall financial situation is concerned. The improved conditions were already recognised by a gradual easing of monetary policy in recent months. Bank rate was reduced from 17 to 16 per cent on 20 October 1997, and the money market shortage allowed to decline from R11.1 billion at the end of November 1997 to R7.6 billion at the end of January 1998 (and R7.2 billion last Friday). The more flexible interest rates in the money and capital markets drifted downwards. The monthly average yield on long-term government bonds declined from 14.5 per cent in November 1997 to 13.6 per cent in January 1998, and to 13.3 per cent at the end of last week. The rate on bankers’ acceptances with a maturity of three months gradually drifted lower from 15.0 per cent at the end of November 1997 to 14.45 per cent at the end of January 1998, and 14.05 per cent at this stage. There is a general expectation in the markets that the level of interest rates in South Africa will decline further during the course of 1998. This expectation can be justified in terms of recent developments in most of the underlying domestic financial conditions, except that the Reserve Bank must remain on its guard for any further acceleration in the growth rates of total bank credit extension and the money supply. Prudence requires lower rates of growth in these aggregates in 1998. The continuing East Asian crisis, which placed many of the emerging market economies under pressure, also calls for caution. It should be pointed out that, even at the current high levels, real interest rates in South Africa fall more or less in the middle of comparable rates in the economies of the thirty or so countries that have become known as the emerging economies of the world. The prospects for inflation in 1998 are also very encouraging. With production price inflation at 4.0 per cent and consumer price inflation at 6.1 per cent in December 1998, and both still on a downward trend, South Africa finds itself now more in line with inflation in the rest of the world. In the longer term, as the South African financial markets get more integrated into the world financial markets, the level of inflation in this country will be determined more by international inflation levels, and not so much by domestic policies. In a fully liberalised economy, the initial impact of excess nominal demand or other inflationary pressures will fall on the balance of payments, and not in the first instance on domestic prices. The current more stable overall financial situation in the country provides a good opportunity for the introduction of further structural adjustments aimed at improving the efficiency of the South African financial markets. Next month, the Reserve Bank will introduce two important new initiatives in this regard: Firstly, on 9 March 1998, the South African Multiple Option Settlement System (SAMOS) will be activated to pave the way for the introduction later this year of an on-line real-time inter-bank settlement system. This will reduce risk exposures in respect of open inter-bank positions and lead to a more efficient financial system in general. Secondly, also on 9 March 1998, the Reserve Bank will change its present operational procedures of supplying accommodation to banking institutions through overnight loans at the discount window. A new system for repurchase transactions (Repo’s) between the Reserve Bank and banking institutions will be introduced, and the banks will tender on a daily basis for an amount of central bank liquidity that will be determined by the Reserve Bank. The new system will bring more flexibility into money market interest rates and will place South Africa on a basis of central bank/private bank relationships that is being followed by many other countries in the world. The Department of Finance will also switch to a new system for the primary issues and secondary dealings in government bonds as from 1 April 1998. Eleven banks have already been appointed by the Department of Finance as authorised Securities Dealers for this purpose. With the continuing further removal of the remaining exchange controls, the South African financial markets will provide some exciting new challenges over the rest of this year. We hope that foreign investors, so well represented at this Conference today, will continue to participate in these challenges. The better overall financial environment provides a more supportive background for improved real economic conditions. Monetary policy should never be used to stimulate total nominal demand artificially when the stimulation will only be reflected in higher inflation. Monetary policy should also not unduly restrict aggregate nominal demand once the objective of stable overall financial conditions has been accomplished. The present financial situation in South Africa must be seen as conducive for an improvement in real economic activity over the next year. If last year was a year of consolidation, 1998 can easily turn out to be the year of recovery. | south african reserve bank | 1,998 | 3 |
Opening address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Twentieth Mint Director's Conference in Sun City on 23/3/98. | Mr. Stals looks at the role of central banks in the twenty-first century Opening address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Twentieth Mint Director’s Conference in Sun City on 23/3/98. 1. The history of money reflects the history of the world The history of money by far outdates the history of central banking. The Riksbank of Sweden and the Bank of England are recognised as the oldest central banks in the world. And yet, they were only established during the seventeenth century. The use of various instruments as money dates back at least 5,000 years. In antiquity, money took the form of ornaments and household utensils and tools. In Egypt, circa 2000 BC, rings, anklets, necklaces and bracelets were used extensively as common means of exchange. As you as Mintmasters know very well, the legendary King Croesus of Lydia in Asia Minor is generally credited with the honour of first introducing a formal and sovereign coinage system, when official silver and gold coins were struck in his kingdom between the years 560 to 546 BC. It became common practice to mint sovereign coins in the subsequent Persian, Greek and Roman empires. Perhaps even before this time, official coins were also struck in China. Thus, coinage, mintage and the issue of money became part of the history of the world. It is recorded in history that the Greeks managed their financial responsibilities quite well. They consolidated the coin issues of the various city states into the drachma, a unit for the Greek currency that is still used today. The Romans, however, were more profuse. One of the first things they did after they conquered Greece in 146 BC was to debase the drachma by reducing its silver content from 67 to 65 grammes. As a matter of fact, the Romans often wiped out state obligations by devaluation or coin debasement. In the end, this profligacy contributed to the downfall of the Roman Empire. 2. The history of coinage in South Africa In South Africa, likewise, the history of coins was always interwoven with the history of the country. The Portuguese, with Bartholomew Dias reaching the Cape in 1487, and Vasco da Gama, who sailed around the Cape in 1497, are credited for discovering the sea route around Africa to the spices of the East. Later discoveries, however, of Phoenician and Chinese coins on the east coast of Southern Africa, raised the question of who the first real non-African explorers of Southern Africa could have been? With Portuguese, Dutch, British, Spanish, French and even eastern interests in the sea route around the Cape, many coins of foreign origin came into circulation in Southern Africa. The Dutch riksdaalder and the British guinea and pound perhaps played the major role for many years in the early history of South Africa. It was during the time of the second British occupation of the Cape after 1806 that a British Governor found it necessary to fix “ exchange” rates between the various currencies that circulated in the Cape at that time. It is interesting what currencies were included in this list: Spanish daalders, Venetian sequins, a ducat, a gold ropy (rupee), an English shilling, and the Dutch riksdaalder and half-guilder. ˝ During a long period of British rule, British money circulated freely in South Africa, which included the farthing, ha’penny, thruppence (tickey), sixpence, shilling, florin, half-crown, and crown (5 shillings). The situation changed again with the establishment of the independent Republics of the Orange Free State and the Transvaal (ZAR). The Free State reverted to the riksdaalder (= 1 shilling and sixpence). In the ZAR, riksdaalder notes were also issued to serve as currency, although the riksdaalder was supplemented by periodic issues of ZAR pound notes in various denominations. In 1874, the ZAR issued its first coins, the Burgers pounds. As not many of these coins were issued, they became very valuable collectors’ pieces. It was only in 1890, however, that final legislation was passed for the establishment of a State Mint, and for the minting of ZAR coins in pennies, shillings, and pound denominations. These coins, commonly referred to as Kruger coins, were first minted in 1892 in a building situated on Church Square in Pretoria. After the Anglo Boer War, British money was again used predominantly in the new British South Africa (to become the Union of South Africa in 1910). The history of South African coinage took a last major step when a branch of the British Royal Mint was established in Pretoria and started to issue South African minted (sterling) coins in 1923. This association with the Royal Mint came to an end on 1 July 1941, when its Pretoria branch became the South African Mint. Today, the South African Mint belongs to the South African Reserve Bank, and is minting coins of a world standard. 3. The future: Electronic money The world, including South Africa, is now moving into the future with the gradual introduction of electronic money. It is still an interesting question to what extent the introduction of e-money will indeed have an impact on the use of coins and bank notes. There are big differences in the payments systems of different countries, and in the habits of people using different means of payment. In South Africa, for example, the total amount of bank notes and coin in circulation is less than 15 per cent of total demand, or transferable deposits, compared with most of the countries in Eastern Europe (former Union of Socialist Soviet Republics), where it exceeds 100 per cent of the short-term bank deposits, or Greece, where it is equal to 104 per cent. In these latter countries, the introduction of e-money will most probably have a much bigger effect on the demand for coins and bank notes than in South Africa. I believe the subject of electronic money will be discussed in more detail in one of the sessions of this Conference today and tomorrow. It will also, of course, have important implications for central banks, and for monetary policy in the next century. As already said, money, and particularly the use of coins as money, goes much further back in history than central banks. Most central banks in the world today were only established during the course of the present twentieth century. But central banks now have the responsibility to protect the value of money, including, of course, the value of coins and bank notes. To be able to fulfil this function, central banks must have some power to control the issue ˝ of money, and must have some influence on the total amount of money in circulation in the economy. In countries where notes and coin form a substantial part of the total money supply, and where the central bank has the sole right to issue notes and coin, the task may seem to be easier. It is, however, also in these countries where it is often easier for governments to exploit the money-creating powers of the central bank, and where an excessive amount of money is often created to finance government expenditure. Such policies, of course, invariably lead to higher inflation. In the more sophisticated economies, such as we have in South Africa, money is created by banking institutions through their lending and investment operations. The control over the money supply therefore becomes more difficult, and the central bank can only indirectly influence money creation with instruments such as interest rate variations, overall liquidity management, open market operations, and money market interventions. With the current liberalisation of financial markets and the tendency for an integration of financial services in gigantic multi-functional and multi-national financial conglomerates, the task to protect the value of the currency, that is, to keep inflation low, has become more difficult. The debate in the world of central banking about the introduction of e-money at this stage is therefore not only about the effects it might have on the use of, and the demand for, bank notes and coin, but also how it will change the role of monetary policy. Will it still be possible, for example, to maintain control over the creation of money and the total money supply? How will it affect the spending habits of people? How will it influence cross-border trade and the balances of payments between countries? How will it change the velocity of circulation of money, and the savings of the community? 4. Central banking in the 21st century With changes in the concept of money and the use of coins and bank notes, and with the introduction of electronic money, satellite communication and financial globalisation, central banks and the modus operandi of monetary policy will also have to change to adapt to the new environment. It will no longer be sufficient to define money-creating institutions (banks), and to manage the defined monetary liabilities of these institutions in our efforts to protect the value of the currency. The effective definition of money as a means of payment changed over the centuries from objects of value (gold and silver), to fiduciary issues (bank notes and coin), and then to deposit-money created by banking institutions. To this will now be added e-money and payments made through electronically operated global systems (the Internet). Central banks will have to adjust their monetary policies to affect, most probably through indirect market-based measures, these new methods of payment and the creation of additional purchasing power. Central banks will have to operate more on a universal basis, as the banks and the suppliers of conventional and new money instruments will operate globally and beyond the borders of any individual nation-state. Central bankers of the world will be forced by circumstances to work more closely together, not only in the control over banking and other financial institutions, but also in ˝ the implementation of monetary policy. Developments now taking place in Europe for the establishment of a European Central Bank may be followed in other future regional compilations. Perhaps one day in the next century, the world will have only one central bank! As central bankers, we share with you, the Mintmasters of the world, in the excitement of the challenges and the prospects of the 21st century. ˝ | south african reserve bank | 1,998 | 4 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Fifteenth Payment Systems International Conference, Sun City, 1/4/98. | Mr. Stals discusses the transformation of the national payment and interbank settlement systems Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Fifteenth Payment Systems International Conference, Sun City, 1/4/98. 1. Background The political reforms in South Africa over the past five years opened up the way for major changes in the South African financial sector. With the removal of sanctions, boycotts, disinvestment campaigns and the withdrawal of foreign loan funds from South Africa, the challenge was extended to reintroduce the South African financial markets in the world environment. This reintegration took place at a time when the international markets also changed drastically, and when the trend towards financial globalisation gained momentum. During the past four years, many international financial institutions established themselves in South Africa to participate in the expansion of the South African markets. Today, there are about 25 foreign banks with established branches or subsidiaries, and about 60 with representative offices operating in South Africa, competing with and supplementing the activities of about 40 local banks. Many other international fund managers and financial brokers also entered the South African market. Many South African banks and other financial institutions, on the other hand, established themselves in other African countries and in the rest of the world. Explosive increases occurred in the volume of transactions in the South African financial markets. Total turnover in the secondary bond market increased from R2,300 billion in 1995 to R4,600 billion in 1997. The total value of shares traded on the Johannesburg Stock Exchange increased from R63 billion in 1995 to R207 billion last year. The average daily turnover in the South African market for foreign exchange last year exceeded US $10 billion. During the first three months of 1998, non-residents increased their holdings of South African securities (shares and bonds) by about R17 billion. These greater volumes brought with them greater risk exposures, and therefore a need for more sophisticated and modern risk management procedures. Financial regulation and supervision in South Africa had to introduce internationally recognised principles and procedures, e.g. the Basle Committee directives for bank regulation. Modern electronic data processing and communication systems had to be introduced. It also became necessary to review the national payment, settlement and clearing system. Against this background, the South African Reserve Bank took the initiative in April 1994, together with the banking industry, to reform the South African National Payment System. The problem was approached on an all-inclusive national level and a strategy was formulated to upgrade the existing South African payment system to comply with world-best standards. In May 1994, a strategy-formulation team, consisting of representatives of the Reserve Bank and the banking community, was established. A collaborative consensus building approach was adopted. The Reserve Bank acted as facilitator, and it took the task force approximately 14 months to produce a first draft of a proposed strategy for the upgrading of the NPS. This document was intensely discussed amongst the many stakeholders before it was finally presented to the South African Council of Banks (COSAB), for approval. The document, entitled the South African National Payment System: Framework and Strategy, which has become known as the blue book, is widely recognised as a product of the South African banking industry and its recommendations are accepted as the basis for the official strategy for the reform of the payment system. The National Payment System Framework and Strategy identified the lack of a sophisticated electronic settlement process as a major shortcoming in the South African payment system. To this end a strategy was formulated to introduce an online central bank settlement system that would enable banks to effect interbank fund transfers electronically and in real time, when required. 2. Development of a new electronic interbank settlement system The project to implement a new electronic interbank settlement system was identified as the cornerstone for the introduction of a new national payment-processing infrastructure. The South African Multiple Option Settlement (SAMOS) system, introduced on 9 March 1998, was developed over a period of two years as a collaborative venture between the Reserve Bank, private banking institutions, and the technology suppliers. The system ushered in a new era in electronic payment and settlement in South Africa and will have a major impact on the future development of the national payment system. Furthermore, the new system has already enabled the Reserve Bank to introduce new operational procedures for the execution of monetary policy. Under these new arrangements, banks now participate in a daily tendering system, based on repurchase agreements (repos), to obtain funds from or repay funds to the Reserve Bank. To this end, the settlement system became a convenient vehicle to establish market liquidity needs and to facilitate payment flows, resulting from repo transactions, between the Reserve Bank and the banks. 2.1 Features of the new settlement system The introduction of the new interbank settlement system represents a major reengineering of the way in which banks exchange value amongst themselves. It provides participating banks with a range of additional functions and business opportunities, including: • Online real-time link between participating banks All banks participating in the new system are linked to an online real-time network provided by the Reserve Bank. These banks are able to link to the Reserve Bank service either directly or via Swift, the highly secure international funds transfer mechanism. The system enables banks to exchange payment messages with the Reserve Bank and, through the Reserve Bank, between themselves. • Secure high value fund transfers between participating banks The SAMOS system processes all fund transfer messages received by the Reserve Bank. SAMOS will eventually enable banks to effect their payments in real time through a fully auditable and robust system. The system will provide a highly secure vehicle for interbank payment flows and ensure the authenticity and non-repudiation of all transactions. All fund transfers will be final and irrevocable and processed successfully by the system. This will be accomplished by effecting payment transactions directly on the settlement accounts of banks held in the Reserve Bank. • Settlement risk reduced by prefunding The risk of settlement failure by any individual participating bank is avoided through application of the principle of prefunding. A request to the system to transfer funds will therefore be carried out only if the bank issuing the fund transfer instruction has sufficient funds in its settlement account; otherwise, the instruction will be rejected. This implies that banks cannot build up exposures to one another within the system. All funds transferred are irrevocable, and the underlying transactions can thus be finalised during the course of the business day, as and when the bank and the customer require. • Collateral managed dynamically The system operates on the principle of full collateralisation of all intraday loans. Banks can reserve financial instruments to be used as collateral should they require additional funding during the day. These instruments have to be in electronic form, that is immobilised at either the Central Depository (CD) or in the Financial Instrument Register (FIR) of the Reserve Bank. Should a bank not have sufficient funds in its settlement account to carry out a fund-transfer request, the system will automatically determine whether the bank has any financial instruments available to be pledged as collateral for a Reserve Bank loan. If this is the case, the system will automatically raise a loan of the required amount against this collateral and transfer the funds necessary to process the fund-transfer instruction from the bank’s loan account (or marginal lending facility) into its settlement account. The SAMOS system will now be able to effect the transfer of funds to the receiving bank’s settlement account. This process will be completed without any manual intervention. The borrowing bank can revert to the next repo tender opportunity to redeem the out-standing amount on its marginal lending facility. The introduction of the new system will have a significant impact on payment, clearing and settlement transactions in South Africa. Numerous changes have already been made to existing practices, processes, arrangements and agreements and many will be made during the further implementation phases of the system. Banks, clearing houses, other payment system intermediaries and corporate customers of banks will need to modify and enhance their systems if they wish to obtain maximum benefits from the new payment processing architecture. 2.2 The implementation schedule The system will be implemented in a number of phases. The following dates have been set for the implementation of major milestones: Date Phase 9/3/98 Introduction of electronic end-of-day settlement through SAMOS The SAMOS system and the interbank settlement network SARBLINK to facilitate the end-of-day settlement process were activated as from 9 March 1998. Although the system is now fully functional and the banks are able to transfer funds during the day, settlement finality as at this stage is only achieved at the end of each day. For the time being, end-of-day positions will still be settled in the morning of the next day. 9/3/98 to 3/10/98 Determining the liquidity impact of real time gross settlement The banks will use the system during this interim period to monitor their liquidity requirements for a trial period prior to the introduction of intraday finality. Banks will also be able to bring their back-office systems in line with SAMOS in order to enable them to capitalise on the opportunities provided by the new settlement options. 5/10/98 Introduction of immediate intraday finality The switch to intraday finality will mean that all settlement instructions received by the SAMOS system will become final and irrevocable as and when they are received, if processed successfully. The main implication of this step will be that banks would need to monitor their positions in the SAMOS system carefully and ensure at all times that they have sufficient funds or financial instruments available to process their settlement instructions. To be decided Move of the end-of-day settlement process to same day To bring the South African settlement practices in line with international best practice the final endof-day settlement process needs to be effected on a same day basis. The date of this change will be negotiated with the banks taking due consideration of the impact this would have on their customers and operations. 2.3 Impact on the financial system The new settlement arrangements and the SAMOS system have placed the South African settlement practices on par with international best practice and presented many new challenges and opportunities to the banking and non-banking sector. Major changes include: • Increased participation In line with the philosophy of the new NPS, the interbank settlement system has been opened to enable more participation. All registered South African banks are eligible to participate in SAMOS. The number of participating banks in the settlement process has already increased from 11 banks in the old system to 21 banks in the new system. The number of participants will most probably increase significantly over the next few months. • Exposures monitored in real time A participating bank can monitor its balances in the SAMOS system in real time. In other words, the effect of any payments made or received by a participant will immediately be reflected on the banks’ position monitor. The bank will thus be fully informed at all times of the position in its settlement account, intraday-loan account and the utilisation of collateral provided. The Reserve Bank will be able to monitor the positions of all participating banks and the system as a whole. • Early warning signals of potential systemic crisis Various system indicators will enable the Reserve Bank to ascertain whether any particular bank is experiencing difficulty in meeting its payments commitments. This will enable the Reserve Bank to take pro-active steps to address a potential systemic crisis before it destabilises the payment system. • Synchronisation of payment and delivery The fact that the SAMOS system will eventually provide intraday finality of settlement between banks will enable the financial markets to intro-duce the practice of delivery against payment. The finality of payment achieved through SAMOS can be synchronised with the delivery of immobilised scrip, thereby providing safe and secure financial market transactions. • Customer-to-customer funds transfers in real time Finally, the implementation of the SAMOS system and the interbank settlement network provides a key building block in the enhancement of the payment services and products available to business and the general public. The new technological architecture introduced provides a vital link which could enable the interlinking of payment networks and services on a national basis in future, thereby creating endless permutations of payment services and products. The opportunity for banks and non-banks to co-operate and collaborate in order to exploit the potential of SAMOS introduces a new era in the provision of payment products and services in South Africa. 3. Payment system of the future The key to establishing the envisaged architecture was to create a highly secure and efficient settlement network between the Reserve Bank and banks. The settlement network as introduced enables banks to transfer funds to one another, through their accounts at the Reserve Bank, in real time. It can also be used to expand the national payments infrastructure by interlinking the payment networks of banking institutions to the settlement network. This could enable corporate customers of banks, for example, retailers, to link their networks to the national payment infrastructure. Other institutions such as the Post Office or any other entity wishing to provide payment services to the public could, through the intermediation of a bank, link their technological infrastructure to the national network. This could theoretically allow a member of the public frequenting a point-of-sale device of a payment-service provider to transfer funds and make payments to any other authorised participant who has access to the infrastructure. The introduction at a later stage of such an integrated payments network would represent a major step towards safe and secure payments for the broad public and would enable the further modernisation of the financial system in South Africa. | south african reserve bank | 1,998 | 4 |
Address by the Governor of the Reserve Bank of South Africa, Mr. C. Stals, at a breakfast meeting organised by Life Line West Rand in Krugersdorp on 29/4/98. | Mr. Stals asks whether the East Asian financial crisis can be repeated in South Africa Address by the Governor of the Reserve Bank of South Africa, Mr. C. Stals, at a breakfast meeting organised by Life Line West Rand in Krugersdorp on 29/4/98. 1. Background to the East Asian crisis It is now history that the economies of a number of East Asian countries collapsed in the second half of 1997 and created disruptive turmoil in financial markets around the world. The countries most affected were Indonesia, the Republic of Korea, Malaysia, the Philippines and Thailand. A number of reasons were provided for this collapse which shocked the world economy, particularly because it occurred in those countries that were the most successful in achieving their economic development objectives during the past thirty years. The main reasons included: • a substantial build-up of foreign liabilities -- particularly of a short-term nature -took place over the protracted period of rapid economic growth; • the financial sectors were not properly supervised and regulated, with the result that banking institutions accumulated large amounts of non-performing loans, not provided for in capital and reserves; • there were unjustified governmental interventions in the normal working of the financial markets. Financial institutions were, for example, instructed to make loans to preferred clients at low interest rates; • governance within private sector institutions, public corporations and government departments was of low quality and, in the case of some countries, undermined by corruption; macroeconomic policies did not adjust to the changing environment; markets were liberalised without concurrent adjustment in internal economic structures; money supply and bank credit extension increased almost unchecked; interest rates were kept artificially low, and exchange rates were not allowed to adjust in accordance with changes in the overall balance of payments situation. • The final collapse was triggered first in Thailand, when foreign investors lost confidence in the economy and started to withdraw part of their more liquid investments from the country. The authorities were very slow to react to the threatening crisis. As became evident at a later stage, important information on the deteriorating economic situation was withheld from the markets and vital statistics were, in some cases, deliberately not released. In the end, the International Monetary Fund, the World Bank, a number of the governments of industrial countries, and the international investment community, had to provide a massive amount of financial support -- more than US $120 billion -- to assist these countries. The countries themselves also had to implement painful corrective measures that will, over time, restore equilibrium in their economies. These programmes inter alia provide for: • relatively restrictive monetary policies that must prevent further depreciation of the currencies to protect domestic institutions with outstanding foreign liabilities from further losses, and must eventually reduce inflation; • the restructuring of the financial sectors through predetermined reform agendas in each country. Public sector rescue operations must be supported by cost sharing sacrifices from the private sector, and prudential regulations for financial institutions must be tightened; • improvements in public and corporate governance and a strengthening of transparency and accountability; • a reduction in the dependence of public sector budgets on external funds, and fiscal provision for the costs of restructuring and recapitalising banking systems. The devastating effects of the crises can be illustrated by a few statistics from some of the affected countries. According to a recent World Bank report, prices of key commodities, such as rice, increased by 25 per cent or more in Indonesia, leading to food riots and major demonstrations against the Government. Unemployment is rising sharply and will increase the number of people living below the poverty line from 23 million to 40 million during the course of 1998. In Korea, bankruptcies and unemployment are on the rise. Eight of the thirty biggest conglomerates (chaebol) have filed for liquidation. Unemployment is expected to increase from 500,000 last year to 1.2 million workers soon. In Thailand, the slump in industry is severe. Monthly sales of motor vehicles, steel, consumer electronic goods and durable consumer goods are now running at levels of 35 to 75 per cent down on last year. Industrial output growth is expected to decline by about 50 per cent. In terms of the latest World Economic Outlook of the International Monetary Fund, the global economic growth rate for 1998 will be reduced by the East Asian crisis from a previous forecast of 3½ per cent to not more than 3 per cent in 1998. This will have an adverse effect on world trade, and also on the export prospects for countries such as South Africa. It further deteriorates the outlook for an early economic recovery in Japan, and also holds adverse effects for many emerging market economies. 2. The South African situation The South African economy was so far relatively little affected by the East Asian crisis. The foreign exchange market, and particularly the exchange rate of the rand, came under pressure for only a few weeks in October last year. Prices on the Johannesburg Stock Exchange were more directly affected, although the declines registered at that time were wiped out by a strong bull run over the past three months. Some other emerging markets, for example Brazil, were affected much more severely than South Africa. The question is often asked why was South Africa left almost unimpaired by the East Asian crisis? There are a number of reasons for this: Firstly, it must be remembered that South Africa had its own mini-crisis in 1996 when sudden capital outflows from the country forced a depreciation of the rand of more than 20 per cent, and the introduction of restrictive fiscal and monetary policies that reduced the growth rate in total domestic expenditure from 5.0 per cent in 1995 to 2.7 per cent in 1996, and 1.4 per cent in 1997. At the time of the East Asian crisis, South Africa had just gone through a very painful downward economic adjustment period that satisfied foreign investors of our resolve to apply acceptable macroeconomic disciplines. Secondly, the South African problems of 1996 were created by a cyclical disequilibrium, following from excessive rates of growth in total domestic expenditure, and this situation could be corrected fairly easily with the right kind of monetary and fiscal policies. In most of the East Asian countries, the fundamental problems are more of a structural nature and will require longer and more painful adjustments to restore growth to previous levels. There are, nevertheless, a number of lessons to be learned by South Africa from the East Asian crisis. Our country is also being integrated more and more into the global markets of the world and, as in the case of those countries, developments in South Africa are also subject to the very critical surveillance of the international investors’ community. At this stage, their critical monitors are being focused on: • • • • • • • the health and soundness of the domestic financial sector; the openness and efficiency of the money and capital markets, and the market in foreign exchange; the transparency, both of policies and of macroeconomic data made available by the authorities; the quality of governance in both the public and the private sectors of the economy; the macroeconomic policies followed in the country by the monetary and fiscal authorities, and in respect of labour and commodity markets; the overall balance of payments situation, including developments in the current and in the capital accounts; and the total outstanding foreign liabilities, with special reference to the vulnerability of the country for sudden outflows of capital. In recent months, foreign investors showed their satisfaction with the South African situation by continuing to increase their investments in South Africa. Over the first four months of this year, non-residents increased their holdings of South African equities and bonds by no less than R34 billion. This enabled South Africa to continue with the programme of gradually relaxing exchange controls, and also helped the Reserve Bank to increase its net foreign reserves by R4.9 billion during the first quarter of this year. South Africa can continue to hold the confidence of foreign investors, provided we are also prepared to continue to apply the sound monetary and fiscal policies of the past year. If not, foreign market sentiment towards the country can change very quickly, and we can easily be forced into a new financial market crisis of our own. With his latest Budget, the Minister of Finance reconfirmed the Government’s determination to maintain the necessary disciplines in fiscal policy. The Reserve Bank is known for its conservative approach towards monetary policy, and is equally determined to maintain strict disciplines in the management of the money and banking systems of the country. In this way, South Africa will continue to benefit from being part of the global financial system, and to make use of the savings of other countries to help finance growth and development. In summary, it depends on us and on the economic policies we apply, whether an East Asian crisis will also develop in South Africa. Foreign investors nodded their approval of the policies of the past year. We should therefore not deviate unnecessarily from the course of the existing policies. | south african reserve bank | 1,998 | 5 |
Speech by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Tenth Annual 'Beeld' Economist of the Year Banquet, held in Johannesburg on 8/5/98. | Mr. Stals addresses the topic “Implications for the South African financial sector of the process of financial globalisation” Speech by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Tenth Annual “Beeld” Economist of the Year Banquet, held in Johannesburg on 8/5/98. 1. Lessons from the East Asian crisis Recent developments in certain East Asian countries focused attention on the many pitfalls for the smaller economies of the world on the road to financial globalisation. The reasons for the collapse of financial markets in East Asia may differ from country to country, but a few common shortcomings in the economies of the afflicted countries were identified: Firstly, in many countries, inappropriate macroeconomic policies were applied to defend artificial exchange rates, and/or to maintain interest rates at untenable low levels. These countries were highly successful for many years and they achieved remarkably high average economic growth rates over an extended period of time. Based mainly on an industrious and frugal labour force, they were able to remain competitive, despite the emergence of underlying weaknesses in the economic fundamentals. Secondly, the financial systems did not keep pace with the changing macroeconomic environment. Banking institutions were not properly regulated and monitored, and financial markets were distorted by undue governmental intervention. In some cases, there were insufficient disclosure of basic information that could have enabled investors to make a better assessment of the deteriorating situation at an earlier stage. Thirdly, the countries became overly exposed to foreign capital flows, and vulnerable balance of payments positions developed that could not be managed once confidence faded. Large current account deficits were no longer covered by total capital inflows, and the withdrawal of short-term funds from some countries exacerbated the situation. Fourthly, bad governance in public and private sector institutions did not realise the seriousness of the underlying adverse developments, and did not take timely corrective action. When the bubble finally burst, the situation had already advanced to a stage where only costly and painful macroeconomic restructuring could salvage these economies. The experience of the afflicted East Asian countries provides ample evidence of the vulnerability of the smaller, emerging market economies in the environment of financial globalisation. Other countries, including South Africa, can also be subjected by the global financial markets to similar painful corrections, although it might be for completely different reasons. The lesson for South Africa from the East Asian crisis is therefore to be alert, to be cautious, and to be aware of the harsh but not unreasonable disciplines of the global markets. 2. South Africa and financial globalisation Over the past few years, the South African financial sector has moved quite fast on the road of globalisation. In the Annual Report for 1997 of the Bank Supervision Department of the Reserve Bank, interesting information has been made available about developments in the South African banking sector in 1997. There are now more than 20 foreign banks operating in South Africa through locally-established branches or subsidiaries, and more than 60 foreign banks with representative offices in South Africa. South African banks are also extending their activities to the rest of the ˝ -2˝ world and during 1997 obtained permission from the Registrar’s Office to establish more than 45 branches, subsidiaries, and representative offices in other countries around the world. At the end of 1997, the total South African banking sector utilised more than R35 billion in foreign funding, and carried loans extended by them in foreign currencies of about R17½ billion. The foreign liabilities and foreign assets of the South African banking sector, respectively, represented but small percentages of the total assets (or total liabilities) of the banking sector, estimated at about R440 billion as at 31st December 1997. Foreign funds as a source of financing of the activities of South African banking institutions are, however, still increasing. It is well-known that non-resident investors have become very important participants in the South African financial markets. Over the past 16 months, that is since the beginning of 1997, non-resident investors increased their holdings of South African equities by R45.6 billion, and their holdings of South African bonds by R31.1 billion. The South African Government raised a total amount of approximately R11.3 billion in seven public loan issues made in international capital markets since December 1994. At the same time, many South African public and private sector borrowers also made use of the foreign financial markets to fund the expansion of their activities in South Africa, and in the rest of the world. The gradual relaxation of exchange controls has indeed enabled South African residents to acquire large foreign assets abroad. The following estimates provide some indication of the extent of these investments since the beginning of 1994: Direct foreign investment by South African corporates Portfolio foreign investment by South African institutional investors Portfolio foreign investment by South African private individuals R44.3 billion R37.4 billion R1.1 billion Volumes in the South African foreign exchange market increased substantially in recent times. At this juncture, it is not unusual to have a daily turnover in excess of US$ 10 billion in this market. One further indication of the extent to which South Africa has already become part of the global financial markets can be found in the expansion of the Euro-rand market. The total amount outstanding in this market, where non-resident borrowers raise funds in rand-denominated loan issues made to non-resident (mainly European) investors, now exceeds R37 billion. 3. Consequences for the South African economy This process of the globalisation of the South African markets has important consequences for the South African economy. The major advantage for South Africa is, of course, that the scarce sources of finance for economic development can be supplemented with increasing amounts of foreign funds. Savings of more developed countries are therefore transferred to South Africa to supplement domestic saving. The large inflow of funds over the past four years enabled the Reserve Bank to increase the country’s official foreign reserves from a small to a more acceptable amount of R33 billion, which is sufficient to cover about three month’s imports of goods. This increase also made it possible to substantially relax exchange controls in order to create a more free market, which should eventually contribute to a higher economic growth rate. It is necessary that foreign investments make a more purposeful direct contribution to real economic development in South Africa, and not only to the restructuring of the financial system. ˝ To achieve this, South Africa must ensure that attractive and competitive investment projects are available for this purpose. The globalisation of South Africa’s financial markets, however, have important consequences for the analysis of South African financial conditions, and in particular for the forecasting of possible future developments in South African financial aggregates. The exchange rate of the rand is consequently more subject to the inclinations and whims of foreign investors, as well as to developments in the foreign exchange markets of nearly all the other parts of the world. How well the South African financial authorities may plan and manage, developments over which they have no control can change the exchange rate of the rand, especially against individual currencies, in a direction which was not expected or could not be forecasted. These kinds of changes can be very disruptive over the short term. This also applies to South African interest rates. A sudden inflow of funds from the rest of the world can lead to a decline of South African interest rates against the run of events in the South African economy or the objectives of the monetary authorities. Similarly, an outflow of funds arising from developments in a distant country, such as for example Indonesia, can very easily lead to an increase in South African interest rates when we would have liked to have seen a decline. South African share prices are also affected by the views of foreign investors and do not always truly reflect the actual potential of South African companies. Developments in the prices in London, New York, Paris and Tokyo often have a greater influence on these prices than developments in South Africa. Even the South African inflation rate tends to move to lower levels in accordance with the inflation rates in the rest of the world. Inflationary errors that are made with domestic macroeconomic policy under these circumstances, will often have a detrimental effect on the South African balance of payments, or aggregate domestic economic activity, before leading to an increase in prices. 4. Economic forecasting: a difficult task Against the background of the international integration of financial markets it becomes much more difficult to predict developments in financial aggregates, such as interest rates, exchange rates and the inflation rate. It does not only depend on what happens in the better known own national economy, but requires a broader cosmopolitan knowledge. Mr. Alan Greenspan’s decisions often can have a greater influence on the developments of these aggregates in South Africa than decisions of the Governor of the South African Reserve Bank. Unfortunately, businessmen, investors and economic policy makers often have to take a view about possible future developments in these financial aggregates. The decisions they have to take are mainly concerned about the future, and not about the past or present situation. It is therefore essential that forecasts be made, even if it is done in a framework of greater uncertainty and unforeseeable future developments. With all the modern electronic technology which is available to facilitate forecasts, the world of the actual economy remains too uncertain to be always correct. There are a few basic principles which must be kept in mind when making forecasts of financial aggregates: 1. Do not believe too much in your own forecasts. There are good reasons why you will often be wrong. ˝ -4˝ 2. Do not accuse someone else - for example, the Governor of the Reserve Bank - if your forecasts are wrong. He also has only little control over developments in these macroeconomic aggregates. 3. Make regular forecasts. The data on which forecasts are usually based change often and therefore justify regular revisions of forecasts. 4. Be willing to acknowledge a wrong forecast and produce a new one. Most people who take note of your forecasts have in any case already forgotten the last one that you made. 5. Remember the assumptions which form the basis of every forecast. They are often so unrealistic that the forecast is also nearly worthless. 6. Make forecasts on the basis of objective analyses, and not on what suits your book or the book of your clients. It doesn’t help to be popular but wrong. 7. Be grateful if you are sometimes right in this difficult game of trial and error - it may not happen again. 5. Concluding remarks The integration of South Africa in the world financial markets is an on-going process that is linking developments in the major financial aggregates in this country more and more to developments in the rest of the world. Because of this process, economic forecasting has become much more complex. Not only changes in the South African situation influence developments in important financial aggregates, such as interest and exchange rates, but also events in remote places such as Indonesia. Economic forecasters have great responsibility, not only to provide consistent and sensible forecasts, but also to understand and explain the shortcomings of even their best efforts - and to remember that even bad forecasts can sometimes become self-fulfilling. ˝ | south african reserve bank | 1,998 | 5 |
Address by the Governor of the Reserve Bank of South Africa, Mr. C. Stals, at the Monthly Meeting of the Bank for International Settlements in Basle on 11/5/98. | Mr. Stals elucidates monetary policy objectives in South Africa in the environment of financial globalisation Address by the Governor of the Reserve Bank of South Africa, Mr. C. Stals, at the Monthly Meeting of the Bank for International Settlements in Basle on 11/5/98. 1. Background Major political and social reforms in South Africa in recent years created new expectations, and many demands are being made on the Government for the social upliftment of the people. In defining its macroeconomic strategy, the South African Government first produced a Reconstruction and Development Programme (RDP) in 1994 in which legitimate needs were identified. The total cost of implementation of the RDP, however, as could have been expected, by far exceeded what was affordable. This was confirmed by the publication in mid-1996 of a Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR), which concentrated more on the supply-side of the economy. GEAR provided a programme for macro-economic restructuring that is intended to raise the growth potential of the country over a five-year period from 3 to 4 per cent to 6 per cent per annum. In the Government’s macroeconomic strategy, monetary policy was tasked with the responsibility of maintaining overall financial stability, or of protecting the value of the currency. It was assumed that the objectives of neither the RDP nor GEAR would be attainable unless overall financial stability is maintained. The instruction to the Reserve Bank to secure financial stability also appears in the South African Reserve Bank Act, and was recently written into the new Constitution of the Republic of South Africa. In terms of Section 224(1) of the Constitution: “The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic”. The Constitution also provides for the protection of the independence of the Reserve Bank: “224(2) The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters”. The macroeconomic strategy of the Government, and particularly the GEAR part of it, is often criticised and there are strong pressures, emanating mainly from labour organisations, for the total rejection of this programme. The disciplined monetary policies applied in terms of the above mandates from the Government are also often denounced by these pressure groups. The Reserve Bank is from time to time castigated for not following a policy that will provide more money at lower interest rates for the purpose of financing the social upliftment programmes of the country. 2. The main objective of monetary policy The mandate from Parliament to the Reserve Bank is not explicit on what “protection of the value of the currency” really means. This obviously opens up the way for malignant attacks on the Bank, whatever objectives might be pursued. The main objective of the Bank, however, is to bring inflation down. Over the twenty years from 1972 until 1992, inflation in South Africa fluctuated between 10 and 20 per cent per annum, with an average of about 15 per cent. This was obviously too high, and there was general public support for determined efforts by the Bank since 1990 to reduce inflation to a single digit level. Since 1992, the rate of inflation has been contained within the single digit level, fluctuating between 5 and 10 per cent. Over the twelve months up to March 1998, the consumer price inflation equalled 5.4 per cent, and at the production level, prices rose on average by 2.3 per cent. In the absence of a formal quantified guideline from the Government, the Reserve Bank defined its goal for inflation as a rate that will be more or less in line with the average rate of inflation in the economies of South Africa’s major trading partners and competitors. In the present world environment, this will require a rate of inflation of even lower than 5 per cent. The Reserve Bank is often criticised for being obsessed with inflation, and for unnecessarily depressing the domestic economy, in its efforts to reduce inflation. Studies like those recently produced by Michael Sarel, an economist at the International Monetary Fund, are thrown against the Bank. 3. The monetary policy model of the Reserve Bank In 1986, South Africa introduced the M3 money supply as an anchor for monetary policy. Annual targets, or guidelines, for an acceptable rate of growth in M3 were announced by the Bank, and decisions to influence overall liquidity in the banking sector, or to change the Bank rate, were triggered by substantial deviations in actual money supply growth from the predetermined guidelines. To control the money supply, the Reserve Bank obviously had to manage the amount of liquidity available within the banking sector, and had to accept realistic interest rates. With fairly stable relationships between the money supply and aggregate demand, the model served South Africa well for a relatively long period of time. In 1987/88, for example, the rate of growth in M3 was close to 30 per cent, and the rate of inflation 20 per cent. In 1992, growth in M3 was reduced to 8 per cent, and inflation declined to a single digit figure for the first time in 1993. In recent years, however, with the major changes particularly in South Africa’s international financial relationships, the money supply model lost some of its usefulness. Over the past four years, the rate of increase in the money supply has persistently stayed around the level of about 15 per cent, being about 5 full percentage points above the annual guidelines of the Reserve Bank. Over the same period, total bank credit extension increased by about 16 per cent per annum, a rate of growth that is also regarded as excessive by the Reserve Bank. And yet, gross domestic expenditure declined from 5 per cent growth in 1995 to 1½ per cent last year, and inflation remained well under control. After a depreciation of the rand of 22 per cent in 1996, inflation rose correspondingly from 5 per cent to almost 10 per cent a year later. Over the past twelve months, however, inflation has come down again to the level of about 5 per cent per annum. These developments forced the Reserve Bank to reconsider its monetary policy model and to follow a more eclectic approach in which a strict financial (monetary) package is used as a basis for monetary policy decisions. This financial package includes: n n n n n movements in the money supply and its components M1, M2 and M3; changes in total bank credit extension, both to the Government and the private sector; the level of interest rates and the structure of the yield curve; changes in the gold and foreign exchange reserves; and movements in the exchange rate of the rand. In terms of Reserve Bank analyses, the main reasons for the breakdown in the money supply model in recent years have been: n n n n the almost explosive increases in volumes on the various financial markets; the reintermediation in the banking sector of certain financial transactions, such as direct lending by foreign banks to South African non-bank private sector institutions; the absorption of many new workers from the subsistence sector in the market economy; and the effects of large and volatile international capital flows on bank liquidity, interest rates and the money supply. The debate in South Africa at this stage about the monetary policy model is whether South Africa should not, at this juncture, follow the example of many other countries and introduce a formal inflation target as an anchor for its monetary policy. 4. Other objectives of monetary policy Effective monetary policy is, for obvious reasons, not only dependent on sound principles applied by the central bank, but also on the infrastructure or the architecture within which we operate. In summary, over the past few years, we had to restructure our banking sector, our financial markets, and the national payment, clearing and settlement system to support the process of gradually introducing the South African financial system in the global markets. Bank regulation and supervision are, at this stage, a responsibility of the Reserve Bank, but there are serious proposals for following the recent examples of the United Kingdom and Australia to remove these functions from the central bank. The present regulatory system is very much based on the risk management approach as prescribed by the Basle Committee, and on the Core Principles. The major change in the South African banking sector in recent years was the introduction of more than 20 new foreign banks and additional foreign competition by the opening of more than 60 representative offices of foreign banks in South Africa. The financial markets were also encouraged to modernise. The Johannesburg Stock Exchange (JSE) introduced major reforms to provide for corporate ownership, foreign ownership (of stockbrokers), dual capacity trading, negotiated commissions, and electronic screen trading. It is continuing to improve its facilities by providing for the immobilisation and dematerialisation of stock, and for improved clearing and settlement arrangements. The total turnover on the JSE last year amounted to about US $45 billion. Major changes were also introduced in bond trading, and the total turnover in the Bond Exchange of South Africa last year amounted to the equivalent of US $927 billion. Non-residents accounted for $257 billion. The daily turnover in the market for foreign exchange in South Africa now exceeds $10 billion. A Euro-rand market developed in Europe where the total amount of outstanding Euro-rand bonds now exceeds R37 billion. To stay in step with the financial globalisation process, the Reserve Bank recently also upgraded the national payment, clearing and settlement system. The new system now provides for: n n n n n an electronic on-line real-time link between participating banks; secure fund transfers between banks through Reserve Bank settlement accounts; a better management on a continuous basis of the liquidity positions of banks; electronically managed end-of-day settlement of interbank transactions; and from the beginning of October, settlement of large transactions on a gross basis as and when instructions are received by the system. 5. The financial globalisation process The implementation of sound monetary policies and the establishment of a sound and well-managed banking sector, effective financial markets, and an efficient national payment, clearing and settlement system, were regarded as important preconditions for the extension of South Africa’s participation in the process of financial globalisation. As a further important element of the process, South Africa is also removing exchange controls on a gradual and structured basis. There are, at this stage, no more exchange controls on any current account transactions; all controls were removed on non-residents who are now free to bring funds into South Africa and to repatriate funds for any purpose; restrictions on residents to make investments outside of the country have been eased for corporates, institutional investors and private individuals, who may make foreign investments within fairly generous prescribed limits. These limits are being raised gradually until they will become ineffective. The South African approach on financial globalisation is that it is in the interest of the country to have access to foreign funds, and that we must therefore apply domestic financial and other macroeconomic policies that will make the country attractive to the foreign investor. Furthermore, policies in South Africa must be flexible enough to adjust quickly and decisively to changes in foreign investor sentiment. When capital inflows subside, or switch into outflows, as a minimum: n n n n the exchange rate must be allowed to absorb part of the shock; an outflow of capital must reduce liquidity in the banking sector; interest rates must be allowed to rise; and some inflationary pressures will develop that will require, almost immediately, more restrictive monetary and fiscal policies. These adjustments will obviously not be painless, but will provide a basis for re-establishing confidence in the shortest possible time. | south african reserve bank | 1,998 | 5 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Annual Australia/Southern Africa Business Council Meeting held in Sydney on 23/7/98. | The changing face of exchange control and its impact on cross-border investment opportunities in South Africa Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Annual Australia/Southern Africa Business Council Meeting held in Sydney on 23/7/98. 1. The history of exchange control in South Africa The beginning of exchange control dates back to 1939 when South Africa, as a member of the now defunct British Sterling Area, was asked, together with other members of the Sterling Area, to introduce restrictions on the outflow of funds to non-Sterling Area countries. This ensured the free movement of funds, emanating mainly from the United Kingdom, within the Sterling Area. After World War II, the Sterling Area exchange controls were gradually phased out, but in South Africa in 1961 the controls were extended and given a specific South African function. This followed upon disrupting internal political clashes (the Sharpeville incident), and South Africa’s withdrawal from the British Commonwealth. Exchange control in South Africa was now intended to provide some protection to the domestic economy from the adverse effects of large-scale outflows of capital. For the first time, exchange control also restricted the repatriation of non-resident investment funds from the country. During the period 1961 to 1993, exchange control was extended from time to time, mostly in reaction to a worsening of South Africa’s internal political situation, and increasing external pressures in general. For example, in 1976, after the uprising of school children in Soweto, proceeds of the sale of non-resident owned securities in South Africa were blocked and eventually converted into securities rand, tradable only at a substantial discount at a second tier (lower value) exchange rate. After the United Nations introduced world-wide economic and financial sanctions against South Africa in 1986, a standstill on the repayment of a major part of South Africa’s foreign indebtedness was introduced, providing for an extended negotiated redemption of the outstanding amount. By the time that the major social and political reforms were introduced in South Africa in the early nineties, there existed a very comprehensive system of exchange control that covered certain current account transactions and the inflows and outflows of both resident and non-resident investment funds. 2. The phasing out of exchange control There was general consensus that exchange controls created many distortions in the South African economy. Interest rates, the exchange rate, financial asset and property prices, and even production costs in the domestic economy were affected by the comprehensive exchange controls. The system prevented the important price mechanism of the market economy from functioning properly. This led to the maldistribution of scarce resources and the functioning of the economy at levels below its optimum capacity. After the democratic election for a new Government of National Unity took place in April 1994, and international punitive actions against the South African economy were removed, there was general consensus within the new Government that exchange controls should also be removed. There was, however, major disagreement on how fast the controls should disappear. At the one extreme were supporters, mostly in the private financial sector, of a “big bang” approach. They pleaded for the immediate removal of all the controls. On the other hand, there was substantial support for a more gradualist approach and for the dismantling of the exchange controls over an extended period of time. The Reserve Bank supported the latter approach, mainly for the following reasons: • Years of economic sanctions, boycotts, disinvestment campaigns and the withdrawal of foreign loan funds from South Africa depleted the country’s foreign reserves. At the time of the elections of April 1994, the Reserve Bank owned, on a net basis, zero foreign reserves. • During the long extended period of exchange controls, backlogs developed, and a huge pent-up demand for an outflow of capital emerged. Overdue loans had to be repaid to non-residents, and no South African residents were allowed to accumulate foreign assets of any significance over a period of more than thirty years. • Distortions were by that time so much embedded in the South African financial structure that the sudden removal of exchange control would not only have exerted pressure on the country’s low level of official foreign exchange reserves, but could also have forced painful immediate structural changes that would have unduly disrupted the domestic economy in the short term. The South African authorities therefore decided on a gradual phasing-out of the existing exchange controls. Beginning already in 1993, the following relaxations were accordingly introduced over the past five years: • As a first priority, all exchange controls applicable to current account transactions were removed. South Africa now fully complies with the requirements of Article VIII of the International Monetary Fund. • Secondly, controls on non-residents were removed. The debt standstill arrangements of 1985 were finally rescheduled towards the end of 1993, and the financial rand system (two-tier exchange rate) was terminated in March 1995. Non-residents are now completely free to introduce funds for any purpose into South Africa, to repatriate such funds and to transfer out of the country current and capital gains earned on their investments without restriction. • Resident corporates (companies) were gradually enabled to make direct investments in foreign subsidiaries, branches or joint ventures by transferring limited amounts of funds from South Africa, and by raising funds abroad through equity and loan issues. In the process, direct investments of about R50 billion (US $10.7 billion) were acquired by the South African corporate sector over the past four years. • Resident institutional investors were given permission in June 1995 to diversify part of their total assets into foreign currency denominated investments. At this stage, they may hold up to 15 per cent of their total assets outside of South Africa. In total, the financial sector has now acquired about R55 billion (US $11.8 billion) in the form of portfolio foreign investments. • Last year, in June 1997, private individuals were given permission to make limited investments in their own names outside of South Africa. At this stage, individual taxpayers in good standing with the tax authorities may invest up to R400 000 per individual outside of South Africa. A modest amount of foreign exchange equal to less than R2 billion has since then been absorbed under this concession • Many other smaller exchange control restrictions were either eased or removed, for example on short-term trade financing, inter-bank financing arrangements and the transfer of legacies, donations and emigrants’ funds. Administrative procedures were simplified and banks (authorised dealers in foreign exchange) were mandated to approve many transactions without prior reference to the Reserve Bank. There remains but one major area for relaxation, and that is in respect of the restrictions still applicable to the so-called “blocked” funds of former residents of South Africa. Apart from settling-in allowances, the remainder of the assets of emigrants is blocked in South Africa and becomes non-transferable. Income earned on blocked funds, however, is not subject to the restrictions. South Africa has therefore now reached a stage where there are no effective exchange controls any more on current account transactions and on the movement of funds of non-residents. Resident corporates, financial institutions and private individuals all have limited scope to make some investments outside of the country and have, on a combined basis, now accumulated more than R100 billion of foreign assets. Backlogs that existed in 1994 for the outflow of non-resident funds have been accommodated in full, and those that existed for the outward investment of resident funds are gradually being absorbed. On balance, South Africa has now removed more than seventy per cent of all the exchange controls of the past. 3. The inflow of capital into South Africa The macroeconomic argument for the removal of exchange control is based on the assumption that, on balance, in a liberalised economy, over time capital inflows will exceed outflows. Despite the need to accommodate large accumulated backlogs, this philosophy was vindicated by developments in the capital account of the South African balance of payments over the past four years. Non-resident investors increased their holdings of South African equities by about R63 billion (US $13.5 billion) from 1 January 1995 up to the end of June 1998, and also invested a net amount of about R30 billion (US $6.5 billion) in South African bonds. The total portfolio investment capital inflow of more than R90 billion was mainly used for financing the acquisition of foreign assets by South African residents, as already mentioned above. Taking account of the relatively large net inflows of portfolio foreign capital, outflows to finance foreign investment by residents, and all other capital movements, the capital account of the South African balance of payments still showed a net inflow of funds from abroad of R53 billion over the period from the beginning of 1995 up to March 1998. The inflows were more than sufficient to cover modest current account deficits and to raise the total gross foreign exchange reserves of the country to a level of R45 billion (US $9.0 billion) at the end of March 1998. At this level, the total foreign reserves were sufficient to cover about three months’ imports of goods and services. In terms of international standards, the level of the foreign reserves is still relatively low, but at least much more comfortable than at the end of March 1994, when the gross foreign reserves of the country amounted to only R10.3 billion (US $3.0 billion). One of the disappointing aspects of the capital inflows into South Africa over the past four years has been the relatively small amount of direct foreign investment made in the country. Not more than 25 per cent of the total inflows represented direct foreign investment, and the rest came in as portfolio investment in securities, loan capital and short-term financing facilities. 4. Restructuring of the financial sector The gradual removal of exchange controls was accompanied by some major restructuring of the financial sector in South Africa. To encourage competition in the market, more foreign banks were allowed to establish themselves in the country. More than 20 foreign banks opened up branches or subsidiaries in South Africa, and more than 60 foreign banks now do business in the country through representative offices. Together with about 35 domestic banking institutions, the South African banking industry is now providing, on a competitive basis, excellent and modern financial services to the country. The industry is healthy, well-managed and subject to financial regulation and supervision based on the principles of the Basle Committee guidelines and core principles. While the gradual phasing-out of exchange control continued, the financial markets were also restructured, liberalised and made more flexible to accommodate almost explosive increases in volumes. In the capital market, three separate specialised institutions were created to provide, respectively, for equity trading on the Johannesburg Stock Exchange (JSE), bond trading on the Bond Exchange of South Africa, and trading in derivatives on the South African Futures Exchange. Two years ago, the JSE introduced major reforms to provide for corporate ownership, foreign ownership (of stock brokers), dual capacity trading, negotiated commissions and electronic screen trading. The JSE is continuing to improve its facilities by providing for the immobilisation and dematerialisation of stock, and for improved clearing and settlement arrangements. With a listing of about 700 different securities, a total market capitalisation of about US $275 billion and a turnover of about US $45 billion last year, the JSE is now classified as one of the major stock exchanges of the world. The most spectacular increase in the total volume of transactions over the past few years took place in the Bond Exchange of South Africa. Total turnover in this market increased from the equivalent of US $553 billion in 1995, to US $927 billion in 1997, that is an increase of 67.6 per cent over just two years. The relaxation of the exchange controls made an important contribution to the development of the Bond Exchange. Total gross transactions by non-residents in this market last year exceeded the equivalent of US $257 billion, or almost 30 per cent of total turnover. Interest is also growing in the South African Futures Exchange. The total number of contracts traded in this market increased from 3½ billion in 1995 to more than 5 billion in 1997. A further important development that flowed from the globalisation process is the emergence of a Euro-rand market where the outstanding amount of rand-denominated loans raised by non-South African borrowers from non-South African investors now amounts to about R36 billion. A substantial part of the proceeds obtained from these loan issues was reinvested in South African bonds. The market in foreign exchange in South Africa is also growing rapidly. The average daily turnover in this market now exceeds US $10 billion. Of particular importance is the expansion in forward cover operations in this market, where South African banks now carry a fully covered forward sales (or purchases) book of about US $180 billion. The Reserve Bank recently introduced steps to encourage a more active development of the domestic inter-bank market for funds. It is the objective to ensure that short-term interest rates should be flexible, and should fluctuate to reflect changes in underlying market conditions. The effective rate at which central bank funds are made available to banking institutions is now determined on a daily basis through a tender system for repurchase transactions, entered into between the Reserve Bank and banking institutions. This greater flexibility in short-term interest rates is of particular importance in light of the growing volume of, and greater volatility in, short-term international capital movements. As a further step in the development of the financial system, the Reserve Bank at the beginning of this year also upgraded the national payment, clearing and settlement system. The new system provides for an electronic on-line real-time link between participating banks, and for secure fund transfers between these banks. It enables the banks to monitor and manage their liquidity positions continuously, and provides for electronically managed end-of-day settlement of interbank transactions. As from the beginning of October, it will become possible to settle transactions on an intra-day basis as and when instructions are received within the system. The gradual phasing-out of the exchange controls was therefore accompanied by a simultaneous process of liberalising, modernising and upgrading of the domestic financial system. In the process, the removal of the exchange controls did not create any major disruption in the domestic markets, and the health and soundness of the South African financial institutions were protected. Both processes, however, should be seen as part of the wider movement of international financial globalisation. Without introducing these changes, it would not have been possible for South Africa to participate in the process of world-wide integration of financial markets. The removal of exchange controls and the simultaneous upgrading of the domestic financial system, opened up the way for South Africa’s participation in this process. 5. The Southern African Development Community A further consequence of the socio/political/economic reforms in South Africa over the past few years was a natural greater involvement for the country in the economic development process of the African continent. Apart from a more active participation in continental initiatives working through the Organisation of African Unity, the United Nations Economic Commission for Africa, and the African Development Bank, South Africa is taking an active part in the activities of the Southern African Development Community (SADC). Fourteen countries of the Southern African region now belong to this formal agreement for economic co-operation, with the long-term goal of eventual economic integration. South Africa plays a leading role in the development of financial and investment co-operation amongst the participants in SADC. Within the structured institutional framework of SADC, a Committee of Governors of all the central banks of the region was established. This Committee introduced a number of co-operation projects intended to develop the financial systems and markets of the region. The approach of the Governors Committee at this stage is first to develop the financial infrastructures in each of the countries, before venturing into the more challenging task of macroeconomic co-ordination or integration. One of the important projects in the work of the SADC Governors Committee is to remove remaining exchange controls within the region. Where practicable, countries are encouraged to do this even faster than what has been programmed for the overall phasing out of the controls. It is envisaged that there will eventually be a relatively free movement of goods, services and capital in this vast area with a total population of more than 180 million people. 6. The financial globalisation process The phasing out of exchange control and the restructuring of the financial system are important preconditions for South Africa’s greater participation in the financial globalisation process. As can be deducted from some of the statistics quoted in this address, South Africa is now firmly on the road of greater participation in the expanding international financial markets. Recent events in the wake of the East Asian financial crisis proved once again, however, that the globalisation process is not without risk. The easy movement of large amounts of funds into and out of countries with relatively small economies can at times be very disrupting. During the four months January to April 1998, non-residents increased their holdings of South African bonds, acquired through the Bond Exchange, by more than R16 billion. Over the next ten weeks, that is during May, June and the first half of July 1998, they reduced their holdings again by R12 billion. Both the inflows and the outflows of capital on this occasion disrupted the South African financial markets and complicated the implementation of monetary policy centred on the medium-term objective of maintaining financial stability in the interest of optimum economic growth. In the situation and against the background of a rather depressed domestic economy, the yield on long-term government bonds increased from 12.7 per cent on 30 April 1998, to 16.4 per cent on 6 July, before it declined again to 15.5 per cent last week. The Reserve Bank’s fluctuating repo rate similarly showed wide fluctuations and increased from 14.8 per cent in early May to a peak of 24.0 per cent on 22 June, before settling down at a level of about 21 per cent. All banking institutions in the country were forced to raise their deposit and lending rates by about 6 percentage points since the end of April. The prime overdraft rate of the major commercial banks now stands at 24 per cent. With the latest measure of inflation at only 5 per cent per annum, real interest rates are at an extremely high level. The exchange rate of the rand also came under a lot of pressure. After being relatively stable for a period of about 18 months from October 1996 up to the end of April 1998, the rand depreciated from R5.05 against the US dollar in the middle of May to R6.62 = $1 on 6 July 1998. Since then, the exchange rate appreciated again to fluctuate around the R6.00 = $1 level for the last few days. At this level, the rand, measured against a basket of currencies, is still about 18 per cent down from where it was at the beginning of this year. Some critics do believe that the removal of the exchange controls is partly to be blamed for this greater volatility in financial conditions. They advise South Africa, therefore, to reintroduce some of the controls, for example, the two-tier exchange rate system. This view is not shared by the monetary authorities in South Africa. Despite the gyrations of recent weeks, we still believe that the advantages of participation in the financial globalisation process will, over time, bring more advantages to the South African economy than disadvantages. 7. Concluding remarks The policies of the phasing out of exchange control, the restructuring and liberalisation of the financial system and the promotion of active participation in the process of financial globalisation, have created many opportunities for cross-border investment in South Africa. Foreign banks, fund managers, institutional investors and manufacturing concerns are extending their financial business with South Africa in the form of: • conventional short-term trade financing; • short-term inter-bank financing facilities; • loans extended for medium and longer-term periods to South African borrowers in both the private and public sectors; • portfolio investment in equities, bonds and financial derivatives, acquired through the various capital market exchanges; and • direct investment in the form of subsidiaries, branches, or joint ventures with South African undertakings. Developments in recent years also led to the creation of an active Euro-rand market outside of South Africa, and to a greater involvement of South Africa in the economic development process of the Southern African region. These exciting developments have already created opportunities, also for the expansion of financial relations between South Africa and Australia. I believe many more opportunities exist and are waiting for the financial and other economic entrepreneurs in South Africa and in Australia to be exploited. Our two countries should not always be regarded as major export competitors in the world markets for base minerals and other commodities. There are also many areas where our economies are complementary and where our policies can be supportive in the global environment. This applies particularly when it comes to our efforts of integrating our financial markets into the world environment. | south african reserve bank | 1,998 | 8 |
Address by Governor of the South African Reserve Bank, Dr. Chris Stals, at a Breakfast Meeting of the Insurance Brokers Council of South Africa, on 2/9/98. | Mr. Stals discusses “The many facets of interest rates” Address by Governor of the South African Reserve Bank, Dr. Chris Stals, at a Breakfast Meeting of the Insurance Brokers Council of South Africa, on 2/9/98. 1. Introduction Nobody will deny it that South Africa has extremely high interest rates at this stage. In the context of South Africa’s own historical record and measured against a current rate of inflation of about 6½ per cent, nominal interest rates are extremely high. In the context of the world environment, and particularly within the group of emerging market economies, the level of South African interest rates lies in the upper quartile, but is still beaten by a number of other comparable countries. Six of the 24 emerging markets listed in the weekly publication of the Economist, for example, have higher short-term interest rates than South Africa at this stage. Nobody will deny it that the high level of interest rates is bad for the South African economy, particularly at the current stage of the business cycle and a rather depressed domestic economic situation. It is only the few savers we still have in the country, and the old-aged people who live off their interest income, who may benefit from these high interest rates. On the other hand, the high interest rates will most probably reduce consumption financed with borrowed funds, and also investment in fixed capital, equipment and inventories. The future production capacity of the economy is therefore constrained by the present adverse financial conditions. In terms of domestic needs, South Africa now requires a stimulation of the economy, and would prefer lower interest rates to encourage economic development. There is also a fairly general consensus of opinion that the present high interest rates were recently forced on South Africa by the international financial situation. The so-called East Asian crisis that started to surface in Thailand more than a year ago spilled over into the economies of many other countries. Even countries with more stable economies such as Australia, New Zealand and Canada were adversely affected by these developments. Emerging countries far away from the East Asian epicentre such as Mexico, Colombia, Brazil and Venezuela have been infected by the problem. Countries with economies in transformation such as the Czech Republic and Poland also suffered and the recent catastrophic developments in Russia cannot be completely divorced from the East Asian crisis. In the end, South Africa also could not escape from the turmoil. There are major differences of opinion among economists inside and outside of South Africa on what the reaction of the official macroeconomic policymakers in South Africa should be to soften the blows for the economy. At the one extreme there is the International Monetary Fund that believes that much more restrictive monetary and fiscal policies should have been applied in South Africa in recent months to fend off the attacks of international speculators and short-term profiteers. At the other extreme we find economists in South Africa with major private sector interests who believe that the Reserve Bank should have kept interest rates artificially low with a complete disregard of the consequences this would have had for the exchange rate of the rand and subsequent inflation. There are those who believe that the Reserve Bank should have done more to keep the exchange rate stable, even if it should have required the reintroduction or tightening of exchange controls. There are many naive critics in South Africa who believe that the Reserve Bank is fully responsible for the high interest rates and that the Reserve Bank indeed used its mythical powers to force interest rates to these destructively high levels. In their ignorance they believe that the Reserve Bank can even at this stage pull the rabbit from the hat and instantaneously bring interest rates down again. Unfortunately, in the real world such miracles are just not possible. 2. What caused interest rates to go up To avoid confusion in this debate, the real causes for the recent sharp rise in interest rates should be revisited. It will be recalled that in the first quarter of this year there was wide-spread optimism that interest rates in South Africa could decline further during the course of 1998. The Reserve Bank had already reduced its Bank rate from 17 to 16 per cent in October 1997, and to 15 per cent on 9 March 1998. Inflation was declining, foreign portfolio investments flowed into the country, the foreign reserves were rising and the exchange rate of the rand was under pressure to appreciate. However, the situation changed dramatically in May 1998 when non-residents reviewed their investment strategy and started to withdraw some of the funds they had previously invested in South African bonds. During the four months January to April 1998, non-resident investors increased their holdings of South African bonds by approximately R16 billion. Over the next four months, that is from May to August 1998, they reduced their holdings of South African bonds by about R19 billion. This dramatic change of strategy had an almost immediate negative effect on the overall demand and supply conditions in the South African financial markets. The yield on long-term government bonds rose from just below 13 per cent at the beginning of May to a peak of over 21 per cent last week. Other interest rates followed the upward trend and established the extremely high levels we now have for the Reserve Bank’s rate for repurchase transactions, the prime overdraft rate, and the mortgage lending rate of banking institutions. In this process, triggered by a decline of investors confidence in the emerging markets of the world, little concern was shown for the depressed conditions in the South African economy. No consideration was given to the needs, desires or expectations of the people of South Africa. Neither the Minister of Finance nor the Governor of the Reserve Bank was consulted by the markets before interest rates were forced to higher levels. The whole process was driven by external factors that swept across many of the smaller economies of the world like a huge tidal wave. The switch from a R16 billion inflow of capital for investment in South African bonds in the first four months of 1998 to an outflow of an almost similar amount in the next four months dramatically changed the demand versus supply conditions in the South African financial markets. In the situation, it would have required a massive creation of money by the Reserve Bank to prevent interest rates from rising to the extent they did. Such a creation of money in turn would have added fuel to the inflationary pressures that were already stimulated by the depreciation of the rand. 3. What can now be done to bring interest rates down? It is amazing to read in the financial press in South Africa almost every day the accusation that the high interest rates in South Africa at this stage are a reflection of the Reserve Bank’s deliberate “high-interest-rate-policy”. The present level of interest rates is often described as being “artificially” high because of Reserve Bank intervention in the market. These critics overlook the fact that the Reserve Bank indeed raised the amount of accommodation made available to banking institutions at the daily repurchase tender for central bank funds from R4.1 billion early in May to R9.8 billion at this stage. This action by the Reserve Bank obviously prevented interest rates from rising even further and, if anything, created an artificially low level of interest rates in the country. Perhaps with some justification, this policy of the Bank was recently criticised by the International Monetary Fund. The Reserve Bank also made a huge amount of forward cover available to South African residents with outstanding commitments in foreign currency, and to non-resident investors with open rand positions in South Africa with the objective of discouraging them from sending more funds out of the country. This policy undoubtedly contributed towards maintaining interest rates at a lower level as the IMF quite correctly pointed out. In South Africa, the Bank is widely criticised for having provided this forward cover, but at the same time also blamed for the “high” interest rates. After four months of heavy pummelling by the markets, South Africa now finds itself in a situation where: • • • the exchange rate of the rand has depreciated by about 25 per cent; the banking sector has lost a lot of liquidity; interest rates have risen to a level where borrowing from the banking sector for the financing of additional economic activity has become almost prohibitive. There is therefore an understandable pressure on the Reserve Bank to do something that will bring interest rates down immediately and effectively for all borrowers in the South African market. Can the Reserve bank do anything to salvage this situation? A simplistic view is that the Bank should reduce the rate for its repurchase transactions and therefore provide accommodation to banking institutions at a lower cost. This view overlooks the fact that the repo rate of the Reserve Bank is determined on a daily basis through a tender system, and is no longer fixed by the Bank. Should the Reserve Bank therefore want to reduce the repo rate, it will have to offer more central bank funds (“high-powered” money) to the banking institutions. In deciding on its policy, the Reserve Bank must, however, take into account: • the recent large outflows of funds through the Bond Exchange. An expansion of domestic liquidity in this situation could facilitate the outflow of funds; • existing relationships between interest rate margins, spot exchange rates and forward rates. A disruption of these relationships can easily lead to new speculative transactions against the rand; • the continuing high rates of growth in bank credit extension and in the money supply; and • the need to keep inflation in check in the aftermath of a depreciation of the rand of more than 20 per cent since May this year. In this situation, it will be irresponsible for the Bank to create more money in an effort to force interest rates down. Advantages, if any, to be gained from such a policy will be very short-lived. A solution in the short-term for the South African dilemma can only come from the original source of the problem, that is, from the international financial markets. Confidence must return to the many international fund managers who have decided in recent months to withdraw substantial amounts of portfolio investments from the bond markets of the smaller economies around the world. These fund withdrawals not only forced interest rates to higher levels, but also created turmoil in the foreign exchange markets. A return of stability to these markets will pave the way for lower interest rates in South Africa, and in many other affected countries of the world. For any individual country such as South Africa to try to break out of these shackles at this stage will be almost impossible, unless impenetrable brick walls will be constructed around the South African economy to isolate it from the rest of the world. 4. Can South Africa survive with these high interest rates? As already mentioned, the high level of interest rates at this stage is not consistent with the current needs of the South African economy. There is, however, very little we can do to get ourselves out of the dilemma in the very short-term. The present unsatisfactory situation emphasises the long identified need for South Africans to save a greater percentage of our income or, to put it in more sensible economic language, to consume less. We must remember that, in terms of the macro-economy, consumption financed with borrowed funds counts as negative saving. By borrowing from banks to finance current expenditure, we actually use up tomorrow’s income today. The situation also emphasises once again that the South African total production machinery must become more competitive. We must make ourselves not only more self-sufficient in the provision of finance for our own economic development, but also in the production of the goods and services we need for domestic consumption and real investment. In other words, we must reduce our dependence on the rest of the world and eliminate our vulnerability for recurrent balance of payments crises. As long as these high interest rates are forced on us by the international situation over which we have no control, a slow-down in total economic activity will be unavoidable. Sensible adjustment to the realities of the situation will, however, avoid a major recession that is already predicted in some quarters, and feared by many. To delay a spending decision today, does not mean a permanent abolition of a justifiable need, but realistic deference to the economic disciplines and constraints of an adverse global situation, until international conditions improve again. In the meantime, we should not lose confidence in the resilience of the South African economy, and in its ability to weather the current storm. Looking around the world today, we still have, even in the present adverse climate, many reasons for remaining optimistic about the medium and longer-term prospects for the South African economy. Our banking system remains sound, our financial markets operate with great efficiency, and a huge pent-up demand for goods and services needs but little encouragement to re-stimulate the economy. | south african reserve bank | 1,998 | 9 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Fifth Annual General Meeting of the South Africa - Canada Chamber of Business in Johannesburg on 22/10/98. | Mr. Stals reviews the position of South Africa against the background of the global financial crisis Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at the Fifth Annual General Meeting of the South Africa - Canada Chamber of Business in Johannesburg on 22/10/98. 1. Background As could have been expected, this year’s Annual Meetings of the International Monetary Fund and the World Bank held in Washington D.C. during the first week of October, were dominated by a discussion of the global financial crisis. What started off more than a year ago as an East Asian crisis gradually extended to other emerging market countries and eventually also affected a number of smaller well-developed economies. The most recent extension was an infliction on the financial systems of some of the industrial countries, such as the United States of America. What started off as a more regional problem of the countries surrounding the depressed economy of Japan, indeed became a global problem that is now demanding the serious attention of the entire international community. This may be a depressing thought, but it is nevertheless one of the more encouraging outcomes of this year’s annual meetings of the IMF and the World Bank. Now that so many countries, and also major industrial countries, are more directly involved in the financial crisis, there is a greater urgency for finding a solution. 2. The causes of the problem Many reasons have been advanced for the world financial debacle. Apart from the adverse effects of a protracted recession in the Japanese economy, East Asian countries were blamed for lax macroeconomic financial policies, for insufficient disclosure of information on foreign capital movements and debt positions, for bad governance at government and private sector levels and for crony capitalism. Private international investors were blamed for irresponsible speculative attacks on the foreign exchange rates of countries, destabilizing activity in the financial markets and a reluctance to share in the burden of eventual collapse and adjustment. The International Monetary Fund has been criticized and is still under attack from many quarters for not diagnosing the problem at an earlier stage, and for the way the Fund eventually handled the crisis situation in individual countries. The medicine prescribed by the Fund (the Fund’s “conditionalities”) is blamed for killing the patient, rather than curing the illness. Recent developments added a further dimension and exposed a possibly more important basic cause for the global financial dilemma, and that is the excessive leverage positions that certain financial institutions were allowed to create in funding international capital flows, including speculative investments in emerging markets. The near-collapse of the hedge fund Long-Term Capital Management (LTCM) in the United States of America in September exposed an astonishing balance sheet position for an important operator in the world financial markets - a balance sheet for a non-bank financial intermediary that used more than $50 of borrowed funds (mostly bank funds) for every one dollar of own capital! Finally, the nature and functioning of the present international financial system of floating exchange rates, unrestricted capital movements and liberalised financial markets is also now being questioned. This system, which gradually developed through an evolutionary process over the past two decades after the final demise of the system of fixed par values in the 1970s, has some builtin elements that encourage periodic occurrences of international financial instability. Particularly the smaller economies of the world find it increasingly difficult to maintain orderly domestic financial conditions in an environment of financial globalisation, financial market integration and exchange control liberalisation. The truth is perhaps that no solitary cause can be singled out as the only reason for the development of the present international financial crisis. The erosion in the quality of the system took place over a long period of time and the possible causes identified above most probably all contributed to the weakening and eventual foundering of the system. The restoration of greater stability in the international financial markets is therefore a cumbersome and complex process that will take some time to achieve. The seriousness of the problem, however, demands a worldwide concerted effort that can best be accomplished by working through the available existing infrastructure of the IMF and the World Bank. 3. Implications of more recent developments in the crisis Three important events over the past few months contributed to a deepening of the crisis, but at the same time also to a better understanding of the situation. Firstly, the decision of Malaysia to reintroduce rather restrictive and comprehensive exchange controls on international capital movements focused attention on the real danger of a new movement towards national protectionist and economic isolation policies. It is true that Malaysia is traditionally a country with a high domestic savings rate and is therefore less dependant on foreign investment for the financing of its own internal economic development. It is also true that the presence of serious internal political division in Malaysia to some extent discredited Mr Mahathir’s recent economic policy measures. International investors, however, could not ignore the signals of the danger of a wider and more general recourse to direct governmental controls over international capital movements, particularly over the more volatile short-term capital flows that recently disrupted the economies of so many of the emerging and developing countries of the world. Secondly, the default by Russia in respect of the redemption of its short-term domestic and foreign sovereign debt caught many investors by surprise. A huge overnight decline in the discounted value of Russian government bonds that was previously regarded as secure collateral for large banking loans extended to Russian borrowers forced massive losses on investors, and led to large provisions for bad debts from international banking institutions. The Russian debacle more than anything else exposed the vulnerability of the world’s banking system in the current situation of global financial turmoil. It also partly exposed the role of hedge funds and short-term speculators in this evolving global drama. More than one short-term non-banking financial intermediary and quite a few banks were caught with their pants down in the Russian debacle, and were forced to absorb huge losses. The clear warning was for greater caution in the games they play in this high-risk environment of the global financial markets. Thirdly, the near collapse of Long-Term Capital Management and the decision of the American Federal Reserve Bank System to get involved in the subsequent rescue operation of this non-bank financial institution, exposed a new dimension of the emerging world financial crisis. It remains a highly debatable issue of why the Federal Reserve was prepared to attach its name, albeit not its funds, to the rescue of LTCM. The only reason can be that the Fed was gravely concerned about possible adverse implications for the American banking system of a liquidation of LTCM. As it turned out to be, LTCM managed about $5 billion of selected clients funds, but had invested in the financial markets more than $250 billion of borrowed funds, mostly raised on a short-term basis from American banking institutions. Both the American authorities and representatives of the hedge fund movement recently went out of their way to explain that LTCM was not representative of the industry and that most other hedge funds maintained much more reasonable leverage positions on their balance sheets. The vulnerability of the world’s financial system, and of many reputable multinational banking institutions, was nevertheless rudely exposed by the LTCM affair. The real explanation that should at this stage be demanded from the American financial supervisory authorities is therefore not why the Fed got involved in the rescue operation of LTCM, but rather why such excessive gearing was permitted by a financial institution that in the end turned out to hold a major systemic threat for the American banking system, and indeed for the emerging global financial system as a whole. The moment that the Fed decided to support the rescue operation for LTCM, the whole ball game changed as far as the future role of hedge funds is concerned. The fact that it has become necessary for the monetary authorities of the most important financial structure in the world to lend their support to the rescue of an institution such as LTCM, surely recognises the importance of this type of institution for monetary policy in general, and for the protection of overall financial stability in particular. But then it also demands financial disciplines and the adherence to minimum requirements of financial prudency, capital adequacy and risk-aversion policies from such institutions. The epicentre of risk exposure in the present global financial crisis has therefore partly shifted from the East Asian or emerging and smaller developed economies of the world to some of the world’s major financial centres. Important international banking institutions have become so involved in the problem of excessive leverage and speculative investments in the global financial markets that they now also have to implement major and painful internal restructuring programmes. A few examples of such forced financial reform programmes already surfaced in recent weeks and more will most probably follow. Maybe we are now much closer to finding a solution for the international financial crisis of the past year, which can surely no longer be blamed only on macroeconomic mismanagement in the smaller economies of the world. LTCM exposed one of the major sources of global financial instability. 4. In search of a solution The causes of the current world financial crisis are complex and widespread. The solution therefore is not a simple one. In particular no quick solution is available. It must firstly, be taken into account that the adverse developments in the financial markets will continue to have secondary effects that will, for some time to come, exert a negative influence on global real economic activity. Forecasts for world economic growth in 1998 have systematically been scaled down from a rather ambitious 4 per cent made towards the end of last year to only about 2 per cent at this stage. In a number of East Asian economies, growth will indeed be negative this year. Secondly, the restructuring of the banking systems in a number of the affected countries will take some time before normality will be restored. As is known, the Japanese Government has just recently provided an amount of more than Yen 60 trillion to recapitalise the Japanese banking system. In the meantime only modest amounts of new bank loans will be available for the financing of consumption and investment. Thirdly, the deleveraging process to reduce the absurd excessive gearing ratios of some mega-sized financial institutions can only be accomplished by a reduction in world liquidity. Taking account of the magnitude of the problem of over-leveraging as evidenced by the balance sheet information recently released for LTCM, this can become a major constraint on the availability of new funds in the global financial market over the next year. Against this background, the world can only extricate itself from this complex problem by a coordinated effort applied from three different levels: Firstly, many macroeconomic deficiencies were exposed in a number of countries that in the end suffered most from the global financial crisis. It is dangerous to generalise the shortcomings as they would obviously differ from country to country and would therefore also require specialised treatment suitable to the underlying situation in each one of the affected economies. A number of countries such as Thailand, Korea and the Philippines have already addressed their problems with appropriate adjustment programmes, and are beginning to reap benefits from often painful corrective measures. These adjustments provide for more disclosure and transparency, enhanced financial regulation and supervision, recapitalising of banking institutions, more restrictive monetary and fiscal policies, exchange rate adjustments and improved governance in macroeconomic management in general. Secondly , all the criticism against the multinational institutions, and particularly against the IMF, is not without foundation. These institutions did not keep up with the accelerating process of financial globalisation in recent years, and with the rapid integration of world financial markets. Economic policy models that may have been appropriate in the old system where central banks and governments could still exert strong influences on the direction of major financial aggregates such as interest and exchange rates and could effectively control changes in the money supply and in bank credit extension cannot be applied without adjustment in the new world where market forces now dominate the scene. Some changes in the global financial system have become necessary and urgent. These institutions are now concentrating on increasing their resources, e.g. IMF quotas, on improving their surveillance functions and on revising the “architecture” of their existing infrastructural frameworks. Thirdly , after the LTCM affair, there is an urgent need for multinational banking and other financial institutions to revise their own internal risk control models. The action taken by Malaysia recently to reintroduce exchange controls on international capital movements and the de facto default by Russia in its inability to redeem its public debt eroded almost overnight the value of what was regarded as secure collateral in terms of normal banking practices. The development of more suitable risk management models cannot be left entirely to the official financial supervisors of the world - private sector financial institutions should on their own initiative improve their internal financial disciplines and controls. 5. South Africa’s position in the international financial crisis The South African economy was also badly affected over the past six months by the deteriorating international financial situation. As non-resident investors reduced their holdings of South African bonds, we had to ride with the storms. Although the authorities “leaned against the wind”, South Africa ended up with: • • • • a decline in the value of the rand. Changes in the exchange rate of the rand after some turbulent fluctuations resulted in a currency that is now about 18 per cent weaker than at the beginning of this year; higher interest rates. The level of interest rates also moved up and down but now stands at about 7 full percentage points above the level of six months ago; some decline in overall liquidity in the banking sector which, however, eased again in recent weeks; a depressed real domestic economy. Growth in real gross domestic product slowed down already last year and was further restrained by the recent adverse developments in the financial markets. During this testing period, some structural weaknesses in the South African economy were once again exposed, but also some inherent strengths for which we should be grateful. These include a sound and well-managed domestic banking sector and financial markets that provided the liquidity, the mechanisms and the resilience to adapt to the rapidly changing international environment. South Africa’s approach to this worldwide financial market problem is to remain part of the system and to lend our support for a global initiative to solve the problem. Action at the level of national governments, the multinational financial institutions and private sector financial market operators is necessary to restore stability in the global financial system: • • • Governments must recognise, analyze and define deficiencies in their macroeconomic policies and identify weaknesses in their financial structures, and must take the necessary steps on a case by case basis to strengthen the system at the national level. Problems are different from country to country and no standard macroeconomic module can be prescribed on a global basis for universal application. The multinational institutions should concentrate on the obvious shortcomings of the present infrastructure for international payments, international capital flows and the determination of exchange rates. The process of financial globalisation, worldwide financial market integration and liberalisation of financial institutions moved faster than the global authorities themselves did with their control and surveillance systems. The approach now should not be for the markets to be stopped in their progress, but rather for the authorities to catch up. Private sector financial market operators, including multinational banking institutions, hedge funds and institutional fund managers, must in their own interest reconsider and review their modus operandi in the markets. In particular, risk management models must provide for the volatile global financial environment in which they now operate. Many encouraging signs emerged from the discussion in Washington D.C. to indicate that progress is now being made at all three levels, and that greater stability is gradually returning to the world financial system. South Africa, like many other countries in a similar situation, is watching these signs of hope with great interest. | south african reserve bank | 1,998 | 11 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a Breakfast Meeting of the Institute of Credit Management in Johannesburg on 29/10/98. | Mr. Stals discusses the importance of credit extension for macroeconomic financial stability Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at a Breakfast Meeting of the Institute of Credit Management in Johannesburg on 29/10/98. 1. A “credit” economy Modern economies are often described as “credit-based” economies. This is a true reflection of the functioning of modern, sophisticated economies in which money plays the important part as a means of exchange, as an instrument of payments and as a store of value. The availability and the use of credit facilitates the exchange of goods and services, the production processes and the growing importance in all modern economies of financial services. One can hardly visualize a modern economy that works without credit. The normal characteristic of credit is that one participant in the economy, be it an individual, a corporate body or a governmental institution, denies himself the immediate use of purchasing power already in his possession, and makes this purchasing power on a temporary basis available to another participant in the economy who has an immediate need for the use of the purchasing power. This kind of transfer of purchasing power from savers (the lenders) to users (borrowers) will never create macroeconomic distortions in the economy. On the contrary, as already mentioned, it supports maximum economic growth and development in the country. This basic form of credit extension encouraged the development over many years of financial savings institutions, financial intermediaries, institutional investors, fund managers, etc. that serve as useful conduits for transferring purchasing power from savers to users, either for consumption or for real or financial investment purposes. The financial authorities in all countries have a responsibility to oversee these financial institutions, mainly with the intention of protecting the general public, be they lenders or borrowers, against exploitation that may lead to an unreasonably low remuneration for savers, exorbitantly high costs for borrowers and/or financial losses for both. Together with the development of these specialised financial intermediaries financial markets emerged where the transfer of savings from lenders to borrowers can take place in a more competitive environment with greater transparency and more general participation. These markets, such as the stock exchanges, bond markets, markets for derivatives and short-term money markets play a very important part in the optimum allocation of scarce resources in modern economies. Financial authorities also have a vested interest in overseeing these financial markets to ensure orderly conditions, the effective and efficient transfer of funds from borrowers to lenders and the maintenance of orderly and stable conditions in the markets. A further development in this process of the transfer of purchasing power from savers to users of funds, took place with the development of cross-border or international transfers of purchasing power. Savers in the more mature economies of the world where the demand for purchasing power is relatively low, found it increasingly attractive to make loans to the less-developed economies where they could earn much higher interest rates. These cross-border movement of funds introduced a new dimension in the credit extension process, in the form of exchange rates for foreign currency transfers. The financial authorities of individual countries now obtained more than just an overseeing function in the credit extension process. Rightly or wrongly, governments were in the past seen to be responsible for the fixing of the exchange rate, and for ensuring that convertibility of national currencies into other currencies will at all times be possible. There is one further form of credit extension that has become of vital importance for macroeconomic financial management, and that is the extension of bank credit that simultaneously also creates money. Banks are not normal financial intermediaries that accept funds from savers and then make loans out of these funds to borrowers. Banks can create money to make loans, and in the process can increase the total purchasing power in the economy. In summary, therefore, the presence of credit facilities, financed out of normal savings, is an essential and necessary element of all modern economies. The financial authorities should have no more than an overseeing function in the management, organisation and internal administration of the whole process of credit extension. As far as both financial intermediaries and financial markets are concerned, the authorities should restrict their intervention to the creation of a protective and transparent legal and accounting framework within which institutions and markets can function effectively. However, the financial authorities have more than just an overseeing function when it comes to international credit extension activities, and to the creation of money by banking institutions. 2. Bank credit extension Excessive bank credit extension lay behind many of the global financial problems of recent times. In a number of the East Asian countries, controls on banking institutions were rather lax and enabled them to increase their total credit to governments and private sector borrowers by substantial amounts over a protracted period of time. In the process, interest rates were kept artificially low and banks on an increasing scale relied on foreign borrowings to supplement their liquidity base for the continuing expansion of total credit. In the end, when foreign investors became reluctant to continue to provide the liquidity base for the credit extension by the banks, the financial systems crumbled. In summary, the final collapse was forced by: • • • • • A withdrawal of foreign deposits from banks and of foreign portfolio investments from the capital markets of the affected countries. Foreign credit previously extended to the East Asian countries was therefore withdrawn. A reduction in the amount of liquidity available within banking institutions as they lost foreign deposits and had to fund the withdrawal of other investments from the capital markets. Forced reductions in the amount of credit banking institutions could make available to their clients, many of whom were overborrowed and could not meet the demand for the repayment of loans. An unavoidable depreciation of exchange rates and sharp rises in interest rates which forced losses on borrowers of foreign and domestic funds. Overborrowed institutions were forced into liquidation, and in the process transferred their losses to their lenders. The consequences of this credit crunch are now well-known. In many of the East Asian countries, negative real economic growth rates are now experienced as painful consolidations and reforms of banking and financial structures are taking place. The East Asian financial crisis, which quickly spread to other emerging markets, to the smaller more stable developed economies of the world and recently also to major financial centres such as New York provided a stark reminder of how important sound credit management is for the protection of macroeconomic financial stability in individual countries, and in the world at large. No country can procure permanent and sustainable economic growth at a high level if this growth is dependent on the creation of an increasing amount of credit, extended by banking institutions. Not only lenders (banking institutions) and borrowers (private sector institutions and individuals) can be destroyed in the process, but also total financial systems and even total economies can break down under the burden of too much credit. Central banks have the unenviable task of judging at all times what amount of additional bank credit will in prevailing circumstances be reconcilable with the objective of maintaining overall financial stability. Economies normally provide early warning signals of excessive credit extension, such as rising inflation or unaffordable increases in imports, or the withdrawal of foreign funds from the country. It is important not to ignore such signals. 3. Other lessons from the global financial crisis The recent turmoil in world financial markets provided important lessons, not only for central bankers, but also for credit managers in private sector financial institutions. The following three lessons must have come to the notice of many a private sector financial institution: (i) Risk management models based on past experience or on rigid computer programmes do not necessarily provide adequate protection against potential losses in the new environment of financial globalisation. Experience and discretion cannot be replaced by models and machines. (ii) The value of collateral against credit extension can disappear overnight (vide the Russian example). (iii) Excessive leveraging must be avoided at all times, and particularly in the present environment of volatile global changes (vide the example of the Long-Term Capital Management Fund). Governments, central banks, market managers, private sector institutions and private individuals all have learned once again from this experience that the excessive use of credit sooner or later leads to disaster. At this juncture, the world economy is paying a high price in the form of depressed growth for being reminded of these basic truths. 4. Credit extension and the South African economy Although the South African economy was also severely affected by the current world financial crisis, a sound banking system, well-managed financial institutions and effective financial markets protected the country against the almost total collapse of the economy, as happened in a few other countries. The Reserve Bank has some concern, nevertheless, for the increasing use of bank credit to maintain expenditure levels. The recent financial crisis forced exorbitantly high interest rates on the South African economy and borrowers of funds could not avoid sharp rises in the cost of servicing existing debts. The world financial crisis therefore hopefully also served as a grim warning to all South African borrowers and lenders that excessive debt positions should be avoided. Neither the Reserve Bank nor the Government can guarantee low interest rates or overall financial protection in the new environment of a worldwide integration of financial markets. It will also be foolish for South Africa now to try to revive the domestic economy by creating an excessive amount of additional credit extended by banking institutions in a fragile global financial environment. Such a policy could easily lead South Africa also on the path of overall economic disaster, as more than one country in the rest of the world experienced over the past year. 5. Conclusion I believe that members of this Institute of Credit Management are aware of the potent danger of excessive debt positions, be it for countries, governments or private sector borrowers. The discipline of controlling this dangerous element of modern, sophisticated market economies, is not a responsibility only of the central bank. It is not only a problem of macroeconomic policy, but also one for institutions operating at the micro-level. We can all make a contribution towards protecting our country from falling in the debt trap of excessive borrowing by applying sound principles in the management of our debt positions. | south african reserve bank | 1,998 | 11 |
Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at an International Conference arranged by ABN AMRO Bank and Kagiso Financial Services, held in Johannesburg, on 3/11/98. | Mr. Stals discusses the current economic situation and factors influencing monetary policy in South Africa in 1999 Address by the Governor of the South African Reserve Bank, Dr. C. Stals, at an International Conference arranged by ABN AMRO Bank and Kagiso Financial Services, held in Johannesburg, on 3/11/98. 1. Domestic economy dominated by international developments During the past six months the South African economic scene was dominated by developments in the international financial markets. The East Asian financial market crisis, which already started with pressures in Thailand’s foreign exchange market in June 1997, took some time before it spread to other emerging markets outside of the East Asian region, and also to the smaller industrial countries of the world. More recently, financial markets in major industrial countries also became contaminated. In the case of South Africa, the contamination took place through the disinvestment of foreign funds from the South African Bond Exchange. During the first four months of 1998, non-residents increased their holdings of South African bonds by R16.3 billion. During the next five months, from May to September 1998, they reduced their holdings of South African bonds by R22.4 billion. This major switch was directly linked to a reassessment made by foreign investors during April/May 1998 of their investment positions, and the decision to reduce their exposure in fixed-interest bonds of the emerging market economies. It is interesting to note that non-residents continued to increase their investment in South African equities. After increasing their investment in South African shares acquired through the Johannesburg Stock Exchange by R19.4 billion in the first four months of 1998, they added a further R17.3 billion during the following five months. The reversal in the investment trend on the Bond Exchange was, however, sufficient to change drastically the outlook for the South African economy, and some promising economic developments in the first quarter of this year were promptly aborted. 2. Adverse financial developments lead the downward trend in the economy The sudden switch of foreign investors’ sentiments had far-reaching effects in the South African financial markets: • • • The immediate effect of the withdrawal of investment funds from the Bond Exchange was a sudden and sharp increase in the yield on long-term bonds. The average monthly yield on long-term government bonds rose from 12.9 per cent in April 1998 to 18.3 per cent in September. The withdrawal of foreign investments created pressure in the foreign exchange market and the average effective exchange rate of the rand against a basket of currencies depreciated by 21.4 per cent from 22 May 1998 to 31 August 1998, to bring the cumulative decline in the external value of the rand from the end of last year to 24.6 per cent. The depreciation of the exchange rate encouraged further capital outflows in the form of negative “leads and lags”, and also led to speculative positions taken against a further depreciation of the rand. In the end, a net outflow of more than R13 billion in the form of private sector short-term capital exerted additional pressure in the foreign exchange market. • • • • The outflow of capital reduced liquidity in the banking sector and forced the banks to borrow more from the Reserve Bank on a day-to-day basis. The estimated daily liquidity needs of the banks increased from about R2 billion at the beginning of May to more than R13 billion in early June 1998. Other interest rates followed the yield on long-term government bonds on its strong upward surge. The rate for repurchase transactions from the Reserve Bank increased from 14.78 per cent on 12 May 1998 to 24 per cent on 22 June 1998, before it settled early in July at a level just above 21 per cent. Banking institutions raised their prime overdraft rate from 18.25 per cent at the end of April 1998 to 25.5 per cent on 28 August 1998. In order to provide liquidity to the drained foreign exchange market, the Reserve Bank drew about R8 billion on foreign loan facilities and increased its outstanding hedge facilities in respect of future international balance of payments commitments from US$ 17.5 billion at the end of April 1998 to US$ 25.3 billion at the end of June 1998. Having risen by 32.3 per cent from December 1997 to an all-time high in May 1998, the average monthly level of share prices listed on the Johannesburg Stock Exchange declined by 38.7 per cent between May to September 1998. Although the financial conditions started to stabilise again in early July 1998, the situation remained extremely sensitive throughout the next three months, up to September 1998. Exchange rates, yields and interest rates and share prices reacted to rumours, speculative transactions and adverse international developments, and most of the financial aggregates showed great volatility. 3. Adverse financial conditions brought negative developments in real economic activity The adverse developments in the financial markets had a negative effect on an already fragile real domestic economy. The GDP growth rate remained subdued at a level of ½ per cent in the first two quarters of this year. All indications are that it became more subdued in the third quarter, and there may even have been some decline in the level of total production. A much smaller decline in inventories during the second quarter of this year caused some improvement in the level of gross domestic expenditure from the first quarter. Total domestic final demand, however, declined marginally to a rate of expansion of 3 per cent in the second quarter. Indications are that the expansion in demand may have been maintained at this level throughout the third quarter. The current account of the balance of payments recently also showed the strains of the adverse international conditions. The main reason for a substantial weakening in the current account balance from the first two quarters of 1998 into the third quarter lay with an unexpectedly sharp rise in total imports whereas total exports, at least in volume terms, declined from the second to the third quarter. As could have been expected after the depreciation of the rand, inflation moved upwards. The rate of increase in consumer prices measured over a twelve-month period increased from 5.0 per cent in April 1998 to 9.1 per cent in September, and the rate of increase in the overall producer price index rose from 2.3 per cent in March 1998 to 4.3 per cent in September. In this environment, the rates of increase in bank credit extension and in the money supply remained on a high level. Together with the external strains, the situation forced a very restrictive monetary policy approach on the Reserve Bank in order to restore overall financial stability to the South African financial markets. The overall South African economy is now going through a cycle that is led very strongly by developments in the financial markets. The recent decline in real economic activity was directly caused by the adverse developments in global financial conditions. The East Asian crisis had started already in the middle of 1997, but had a delayed effect on the South African financial markets, which deteriorated badly, particularly during the second quarter of this year. Trends in the real economy followed the downward trend in the financial markets with but a short time lag. 4. More stable conditions return to financial markets Although the underlying conditions in the South African financial markets had already become more stable in early July, conditions started to improve noticeably only in late September and early October. Just as the initial negative impact on South Africa was closely linked to adverse developments in the international financial markets, the recent recovery also followed an improvement in international financial conditions that gained momentum during and after the 1998 Annual Meetings of the International Monetary Fund and the World Bank. The improvement in the South African financial market conditions was reflected in: • • • • • A decline in the net sales of South African bonds by non-residents. The net outflow in October declined to less than R1 billion and was the smallest for the past six months. An easing in the overall liquidity position of banking institutions. The total liquidity requirement at month-ends declined from R12.2 billion in June to R7.2 billion in September and R5.9 billion in October. A decline in long and short-term interest rates. The yield on long-term government bonds declined from 20.09 per cent on 28 August 1998 to below 16 per cent at this stage. The rate on repurchase transactions from the Reserve Bank declined from 21.85 per cent on 13 October to 20.45 per cent today. Banking institutions reduced their prime overdraft and mortgage lending rates by 1 full percentage point during the past few weeks. An appreciation of the rand from the very low level reached in July. During the month of October the average effective exchange rate of the rand appreciated by 3.9 per cent to reduce the cumulative depreciation since the beginning of the year to about 17½ per cent. A significant slowdown during September 1998 in the rates of growth of both the M3 money supply and bank credit extended to the private sector. Conditions in the financial market will hopefully continue to improve further and to lead real economic activity into recovery in the course of the current business cycle. The recent improvements in the South African financial market conditions should therefore hopefully lead to an improvement in real economic activity, and particularly in gross domestic production, during the course of next year. 5. What monetary policy must take into account for 1999 The tight monetary conditions, high interest rates and restrictive monetary policy in 1998 were forced on South Africa by adverse developments in the international financial markets. In the situation, monetary policy had to carry a heavy burden in restoring financial stability to the South African financial markets. Unpopular measures, such as a reduction in bank liquidity and high interest rates, had to be embraced in order to avoid more serious problems, such as a foreign reserves crisis, or a breakdown in the banking system. Provided the encouraging recent trends towards greater stability in the international financial markets continues, monetary conditions in South Africa should also gradually become easier. From the point of view of real economic activity this is, of course, a most desirable development at this stage. There are a number of reasons why any deliberate actions taken by the monetary authorities to relax monetary policy should be implemented with caution. Firstly, not all problems in the international markets have been resolved. The world is still holding its breath on the vulnerable situation of the Japanese banking and financial systems; Brazil is still lingering on the edge of a dangerous cliff with its international financial relations; weaknesses recently surfaced in the financial markets of a few industrial centres; and the secondary effects of the financial market crisis are only gradually filtering through in the form of a decline in global real economic growth. Secondly, the recent financial turmoil left the South African scene with a few additional scars that need time to heal. The depreciation of the rand forced inflation to a higher level and even more out of line with the rest of the world; the weakening of the current account of the balance of payments in the third quarter provides a further warning for caution; a monetary stimulation may easily increase demand without increasing production; and the continuing low level of the country’s official foreign reserves do not provide much scope for manoeuvring unless large foreign capital inflows will again supplement the supply of foreign exchange. Structural deficiencies in the South African economy that restrict the country’s economic growth potential to a relatively low level place an almost permanent obligation on monetary policy to remain relatively restrictive. A relaxation of monetary policy would normally stimulate demand and, unless production responds flexibly and quickly to increases in expenditure, monetary stimulation is inclined to lead either to an unsustainable overall balance of payments deficit and/or an unacceptably high rate of inflation. The monetary policy targets in the Government’s Strategy for Growth, Employment and Redistribution (GEAR) cannot be achieved unless all the other goals for structural adjustment are also achieved at the same time. In view of the depressed real economic situation in the country at this stage, there is, however, some room for a responsible relaxation of monetary policy, provided the international and domestic financial conditions continue to improve further. The Reserve Bank will move cautiously with and not against any improvement in the underlying conditions, and will allow market forces to exert normal pressures on important prices such as the exchange rate and domestic interest rates. | south african reserve bank | 1,998 | 11 |
Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Annual Dinner of the Institute of Bankers in Cape Town on 5/11/98. | Mr. Stals comments on the need for greater financial flexibility in a volatile global financial environment Address by the Governor of the South African Reserve Bank, Dr. Chris Stals, at the Annual Dinner of the Institute of Bankers in Cape Town on 5/11/98. 1. Increasing volatility in financial markets Developments in the global financial markets over the past year focused the attention on the ability of countries to adapt to rapidly changing conditions in an extremely volatile global environment. With a strong trend towards globalisation and the worldwide integration of financial markets that swept through the world economy over the past decade, most countries of the world, big and small, have now become more exposed to volatile capital inflows and outflows. The cross-border (and therefore cross-currency) transfers of huge amounts of investment funds disrupt domestic and foreign currency markets in many countries almost on a regular basis. From the experience of the past year, it is clear that many of the smaller countries with rapidly expanding domestic economies and emerging financial markets find it increasingly more difficult to maintain domestic financial stability and remain within the unstable environment of an integrated global financial market. The amounts involved in volatile capital transfers are too large for the smaller economies to absorb. Countries find it difficult to adapt internal situations to sudden and unpredictable turnarounds in the flow of funds that may take place from time to time. A second major problem that surfaced during this year of financial turmoil centred around the diverse economic needs of many countries that find themselves at different stages of economic development, different phases of the business cycle, and pursuing different objectives with their overall economic strategies. The integrated global financial markets set high standards, based on the needs and norms of the more developed economies, being the main source of the supply of funds. Ambitious fund managers, seeking to maximise the yield on investments managed on behalf of demanding clients, have little loyalty to the needs or the circumstances of the countries where they make their investments. There is, indeed, little diversification in their thinking or in their computer programs when they invest in the global markets -- all emerging markets are, for example, treated as just one group of countries. Given the environment of volatile capital movements, a third deficiency of the present system has been identified, and that is the lack of a global “lender of last resort” or “discount window facility” that can serve to provide temporary assistance in times of sudden outflows of capital from a country. The resources of the International Monetary Fund turned out to be completely inadequate in the present volatile environment. Even after the completion of the current round of increases in the quotas of the Fund, the IMF will not be in a position to supply the needs of its member countries in times of serious global financial crises. Many recipients over the past year of IMF assistance are also of the opinion that the conditionalities attached to IMF loans are no longer appropriate for the present world environment. Disruptions in international financial markets are no longer created by structural or temporary imbalances in international trade, but rather by volatile international capital inflows and outflows. The IMF’s conditionalities are still directed, however, to the restoration of equilibrium in the current account of the balance of payments. A fourth conclusion from the developments of the past year is that the present international financial system of floating exchange rates and free capital movements provides increasing incentives for speculators and short-term profit explorers to exploit weaknesses of individual countries, often at the cost of the impoverished and the poor people of the world. 2. A Hobson’s choice for the emerging markets Smaller countries such as South Africa can do little to change the world financial system, but may still be able to isolate themselves from the volatility of the world environment. This will, however, require comprehensive restrictive exchange controls on both residents and non-residents in respect of all international capital transactions. In the process, a country that moves in this direction will most probably be excluded from the ongoing process of financial globalisation, and will be barred from access to international capital markets. A few countries recently nevertheless opted for this alternative and rather preferred the route of isolation to the continued exposure of their economies to fickle foreign fund managers and international currency speculators. In the case of Malaysia, it was judged that the country’s high domestic savings rate will generate sufficient funds to provide for its needs for future economic development. In the case of Russia, the government had no other choice but to close its financial markets after a major collapse in the public and private sector financial systems. South Africa, with its low level of domestic saving and massive needs for future economic development, has no choice. Unless this country can rely on some regular substantial inflow of capital from the rest of the world, its economic growth rate will not create sufficient jobs for the already large number of unemployed and the annual addition to the labour force, or provide the resources needed for the social upliftment of the population. South Africa must therefore remain part of the global financial markets, and must pursue macroeconomic policies and introduce structural adjustments regarded as necessary to make the country attractive for foreign investors. It is not precluded that some important changes may be introduced to the world financial system over the next few years. South Africa will, to the extent that it participates in this debate in various international fora, press for the introduction of measures that will reduce the volatility of the markets. We know from experience, however, that proposals for change to the global financial architecture can take a long time to find consensus, and changes will most probably only be introduced gradually. In the meantime, South Africa will be exposed from time to time to volatile capital movements, and the domestic economy will remain vulnerable to external disturbances that may in the short term force macroeconomic policies inconsistent with domestic economic objectives. The question remains, what can, or should, South Africa do to make sure that the domestic economy will, over the medium and longer term, be better protected against the disadvantages of international financial market volatility and still gain maximum advantage from international capital inflows? 3. The need for financial flexibility Globalisation is about markets. It is markets that are being integrated in a worldwide system of unrestricted capital movements, and markets that are being opened up for participation by investors from all around the world. Acceptance of any country in the global financial markets therefore requires a recognition of the principles of the market economy, and an adherence to the rules of the game. One of the basic rules of the game in a market economy is that governments must allow market forces of demand and supply to determine prices. Intervention by governments in the markets for whatever purpose, if necessary, must always work through the markets, without suspending or restricting the forces of demand and supply. The price mechanism indeed provides the core discipline of the market economy, and through price changes, markets signal messages and activate automatic adjustment processes intended to hold demand and supply in equilibrium. In the context of international capital flows, the exchange rate is, of course, the most important price. It is important for the smaller countries therefore to ensure flexible adjustment processes for exchange rate changes in the environment of a volatile global financial environment. It is almost impossible to maintain a fixed exchange rate for any currency once large amounts of capital start flowing out of or into a country. Efforts to maintain a fixed and unrealistic exchange rate in such circumstances will only entice speculative transactions that will eventually exacerbate the problem. This does not mean, however, that the authorities may never intervene in the foreign exchange market, for example to maintain orderly conditions, to smooth out short-term fluctuations, or to provide liquidity to the market. Such interventions, which must preferably always be conducted through the market system, are often confused with a policy of fixing the exchange rate through more direct means of control. In South Africa, there is a misguided perception that the Reserve Bank must intervene in the foreign exchange market to prevent any appreciation of the rand, but must refrain from intervention whenever the rand comes under pressure for depreciation. Such a policy will, of course, create a one-way bet for speculators and will encourage short-term investors to take positions against the rand and then force the exchange rate down to generate capital profits for themselves. The Reserve Bank prefers to intervene in the market on a discretionary basis, to work discreetly through the market forces of demand and supply, and to keep speculators guessing on what the Bank’s next step will be. South Africa adheres to a policy of a floating exchange rate system. As long as we still maintain exchange control restrictions on the foreign assets that South African residents may hold, the Reserve Bank will have to continue to intervene in the foreign exchange market from time to time, both as a buyer and as a seller of foreign exchange. As in the past, the Bank will exercise cautious discretion, will respect the underlying forces of demand and supply, and will accept the need at times for a depreciation and, in different circumstances, also for an appreciation of the rand. In other words, we believe the present South African exchange rate policy has sufficient flexibility built into the system to accommodate the vicissitudes of a globalised financial market system. Another very important price that must be flexible and adjustable in this new world financial environment is the interest rate. Interest rates are prices: the prices of loanable funds with different maturities and different risk exposures. As is the case with all other prices in a market economy, interest rates are determined by forces of demand and supply. If the authorities do not want to accept interest rates as determined by market forces, they should preferably work through the markets to either reduce the demand for funds (for example by reducing government expenditure), or increase the supply of funds (by creating more money through the central bank). This latter course may reduce interest rates in the short term, but holds the danger of higher inflation, and therefore also higher interest rates, in the longer term. In March this year, the Reserve Bank moved away from the conventional fixed Bank rate for its loans to banking institutions and introduced the more flexible daily tender system for repurchase transactions, where the effective lending rate of the Reserve Bank is determined on a day-to-day basis through a process of the interaction of demand and supply. The repo rate is now more closely linked to movements in short-term market interest rates as determined by overall demand and supply conditions in the money market. Short-term interest rates can adjust very quickly to changes in underlying conditions. The repo rate can be influenced by the Reserve Bank by changing the amount of central bank funds supplied to the market. In the process, the basic principle of the market mechanism is adhered to. Here once again there is a misguided perception in South Africa that the Reserve Bank should intervene more actively in the markets to prevent interest rates from rising, even when there is a fundamental shortage of funds, but should not prevent interest rates from declining in times of increases in the supply of funds. Such an asymmetrical approach will, unfortunately, not be tolerated by the disciplines of the global market economy. In the recent turmoil in the international financial markets, a number of smaller countries experienced the vengeance of the international market forces when they tried to keep exchange rates or interest rates fixed at artificial levels not associated with the underlying market fundamentals. A third area where greater flexibility in the price-fixing process has become of more importance in the situation of global financial integration is in the determination of the prices of financial assets such as share and bond prices. A decision by the Hong Kong Monetary Authority recently to buy shares in the stock exchange when sales by non-residents pushed prices down was exploited by speculators, but nevertheless contributed to some stabilisation as the authorities operated mainly through the market mechanism of demand and supply. As with all other interventions by the authorities in the financial markets, buying or selling of paper in the financial markets should be done with discretion, and should not prevent normal market forces from continuing to function effectively. For a country such as South Africa, it is therefore important to encourage well-functioning, efficient and flexible financial markets where prices can adjust quickly to changes in the underlying demand and supply conditions. Many other examples of a need for greater flexibility in the process of price determination can be conjectured, for example, prices of commodities, of financial services, and of labour. Without flexible prices in all markets, smaller countries will find it increasingly difficult to survive in an integrated worldwide economy. 4. South Africa’s experience with global financial volatility Over the past six months, South Africa has experienced the full force of the uncontrollable volatility of the international financial markets. A few statistics will illustrate the impact these forces had on the South African economy: • During the first four months of 1998, non-residents increased their holdings of South African bonds by R16.3 billion. During the next five months, that is from May to September, non-residents reduced their holdings of South African bonds by R22.4 billion. • The exchange rate of the rand, which was relatively stable throughout 1997 and the first four months of 1998, depreciated by 21.4 per cent from 22 May 1998 to 31 August 1998. Since then, the rand has appreciated slightly but is still, at this stage, on average about 16 per cent down from the beginning of the year. • The yield on long-term government bonds rose from below 13 per cent in April 1998 to 20.09 per cent on 28 August 1998, and then declined again to below 16 per cent at this stage. • The prime overdraft rate of banking institutions was raised from 18.25 per cent at the end of April 1998 to 25.5 per cent on 28 August 1998. During the past few weeks, the major banks have reduced their prime overdraft rates again to 23.5 per cent. • The average prices of all shares listed on the Johannesburg Stock Exchange increased by 32.3 per cent from December 1997 to an all-time high in May 1998, but then declined by 38.7 per cent to the end of September 1998. Since the end of September, the all-shares price index of the Johannesburg Stock Exchange has increased again by about 19 per cent. These erratic movements in major financial aggregates created many problems for the authorities, financial institutions, businesses, private individuals, and indeed for the total economy. And yet, nobody can be blamed for it. It is part of the globalisation of financial markets, and of South Africa’s participation in this process. South Africa went through a similar experience in 1996. On both occasions, that is in 1996 and so far in 1998, we succeeded in restoring financial stability in a relatively short period of time, but not without painful adjustment and a high social cost in terms of low economic growth. There is no guarantee that somewhere down the road our economy will not be tested again by the increasing volatility of an integrated world financial market system. It is therefore important that we shall all learn from the two experiences of the past three years, and shall prepare our economy to prosper even within the environment of volatile international capital movements. We have learnt that sound macroeconomic policies at all times make it easier to absorb the fluctuations in the financial markets. Countries that do not apply sound macroeconomic policies are punished more severely during times of international currency turmoil. We have learnt that flexibility in domestic financial and other markets makes it easier to absorb the shocks of the periodic global financial market disturbances. In particular, we have learnt that prices as determined by market forces must be allowed to respond quickly and decisively to changes in underlying market conditions. We have learnt that government policies are important, but that government actions alone cannot solve the problem once it has infiltrated into our markets. The disciplines of the market economy must be allowed to function in a flexible way. We have learnt above all that sound, well-managed, and healthy banking institutions can form a major bastion against total economic collapse in a situation of large capital outflows. In a number of East Asian countries, the economies collapsed completely because weak banking systems could not survive in the adverse climate of sudden large outflows of capital. South Africa must be grateful for the strength of our banking system, and must protect it to make sure that we shall also be able to withstand the future storms of a volatile global financial market environment. Weak banking systems lead to weak economies. | south african reserve bank | 1,998 | 11 |
Opening remarks by the Governor of the South African Reserve Bank, Dr Chris Stals, at the Regional Year 2000 Meeting of Financial Regulators from Africa organised by the Joint Year 2000 Council and the South African Reserve Bank in Pretoria on 21/1/99. | Mr Stals discusses the importance of the Y2K problem and the responsibility of central banks Opening remarks by the Governor of the South African Reserve Bank, Dr Chris Stals, at the Regional Year 2000 Meeting of Financial Regulators from Africa organised by the Joint Year 2000 Council and the South African Reserve Bank in Pretoria on 21/1/99. 1. Introduction Fairly early in the second millennium, some time in the course of the eleventh century, the renowned Persian philosopher and poet Omar Khayyám, also known as the tentmaker of Naishapur, wrote the following verse: “The Bird of Time has but a little way To fly -- and Lo! the Bird is on the Wing” (from The Rubáiyát) Now, nine hundred years later and in the closing months of the same millennium, these words of wisdom become very appropriate once again, referring of course at this juncture to the Y2K problem of our modern electronic age. We can with all justification quote Khayyám and say: “The Bird of Time has but a little way To fly -- and Lo! the Bird is on the Wing” I believe that this Conference will serve to bring this message more clearly to all parties concerned, and particularly to the financial regulators and supervisors of the Southern Africa region. Time to prepare our financial institutions and systems for this major event of the switchover to the new millennium is indeed running out. It is too late now to blame the designers and suppliers of electronic equipment for not having incorporated in the tools we use today four-digit date facilities. This will be tantamount to blaming Henry Ford for not having provided facilities for a CD player in his Model T Ford of about a hundred years ago. The distance already covered by our Bird of Time took us beyond what the experts in this Y2K exercise will describe as the sensitisation, awareness, or risk identification phase. Those of us who have not gone through these preliminaries may have missed the boat already. Looking through the programme for this Conference, there is a strong focus on the second and third phases, referred to as actions of remediation and of testing. I hope that most of our participants in this Conference find themselves, together with the Reserve Bank, already well advanced into these secondary stages of preparation for the switch-over date. Tomorrow’s meetings will proceed into a discussion of the final phases of risk assessment and contingency planning. I believe in this game the best advice for contingency planning is to provide for worst case scenarios, and eventually to enjoy the pleasure of having been wrong and unnecessarily pessimistic. I must congratulate the organisers of this Conference for putting together a very well-structured and detailed programme. All the aspects and phases of this challenging exercise will be covered in the discussions of today and tomorrow at this Conference. –2– 2. The importance of the Y2K problem for the global financial market It is not necessary to elaborate on the importance of electronic data processing and communication systems for financial institutions and markets. It is, therefore, understandable why there is great concern that financial systems will be severely disrupted when the year 2000 arrives and computer systems have not been corrected to be able to process dates into the next century. Taking account of the extensive globalisation of financial markets, the exploding volume of worldwide cross-border transactions and the integrated inter-relationships of financial institutions and markets throughout the world, disruptions, if they do occur on any large scale, will not remain localised. Just as the East Asian financial crisis of last year had a contagion effect and spread throughout the rest of the world in a matter of months, a breakdown in computer systems as a result of a Y2K-bug infection in any important financial centre will spread to other places. The only difference will be that in case of a Y2K problem, the transmission mechanism is open, uncontrollable and instantaneous. The potential for severe disruption of the global financial system is enormous and could have dire consequences. Because of possible “knock-on” effects or “chain” reactions, it is imperative that all countries in the world take the necessary actions to remove the Year 2000 threat. These actions can best be initiated and monitored by governments and financial regulators. There will be a temptation for countries that do comply timeously with the problem to restrict trade with, and reduce investment in, countries that are not seen to be making sufficient efforts to become compliant or are unable to satisfactorily prove compliance. In the present volatile world financial markets, the smaller economies with emerging financial markets, such as South Africa, cannot afford to add this additional burden to the perceived high risk exposures already linked to doing business with them. 3. The importance of the Y2K problem for financial regulators The main purpose of this Conference is to assist financial regulators of the Southern Africa region to bring themselves and their constituencies, that is the financial institutions in the region, on board in this exercise of preparation for the Year 2000 electronic switch-over. The financial systems of the world are today in most countries entirely based on electronic data processing technology, and any major hitch in these systems will obviously have serious implications for financial markets, and therefore for total economic activity. I referred to possible knock-on or chain effects in the global financial system, and the danger of global contagion from one or more infected centre. This danger of contagion is of course, equally important in the case of any domestic financial system. Because of the inter-dependence of financial institutions in any closed system, care must be taken that all the financial institutions in each country will be compliant by the end of this year. The programme that must be followed in this process of preparation provides no room for competition amongst individual institutions, but surely requires a high degree of co-operation. This provides a further reason why financial regulators have a major part to play. Problems must be overcome, not only by institutions within the financial system, but also by all the major clients of the financial institutions, such as government departments, public authorities, and major non-financial private sector corporations. 4. The responsibility of central banks in the Y2K problem Central banks hold a pivotal position in domestic and international financial markets. They must obviously take a leading role in preparing their financial systems for this major event. –3– The South African Reserve Bank started at a very early stage in identifying all problem areas in its own information technology and communication systems. In terms of our programme, all electronic technology in use in the Bank must be in full compliance by 31 March 1999. Some parts of the internal system have already been tested. The crucially important Samos system for clearing and settlement transactions is to be tested and must be certified as fully compliant by all participants by mid-April 1999. The Bank has also established a Financial System Risk Evaluation Committee which is tasked with identifying indirect exposures to the central bank and the financial system, and with developing contingency measures. The Committee is, for example, providing for additional stocks of bank notes to be available at all centres for an expected increase in demand around the dates of the switch-over, and is looking at a possible need from banking institutions for additional financial liquidity over this short transition period. The South African Government last year also established the National Year 2000 Decision Support Centre to co-ordinate and provide advice on a national scale for the programme of preparing for the switch-over to the new millennium. Finally, the Year 2000 problem has been on the agenda of discussions of the Committee of Governors of the countries of the Southern Africa Development Community (SADC) for the past eighteen months. All member countries will be requested to report back on the progress made in their country systems at the next meeting of this Committee in April. 5. Concluding remarks I must thank the organisers of this Conference, and particularly the Joint Year 2000 Council, for arranging this seminar. It is timely, it is very much needed in our region, and it will hopefully contribute further to the awakening of a full awareness of the urgency of the problem. I am impressed by the list of participants, and the high quality of speakers who have made themselves available to share with us their experiences, and provide further guidance and assistance in our efforts to make sure that South Africa and the countries of the Southern Africa region will be compliant before the end of this year with the Y2K problem. Representatives from a number of the multinational financial institutions of the world, and a number of central banks and regulatory authorities from other countries and from South African institutions, will introduce, lead and guide the discussions at this Conference today and tomorrow. We thank all our speakers and facilitators for the sacrifices you are making to ensure a successful, stimulating and productive discussion at this seminar. I welcome and thank all other participants in this Conference for accepting the invitation to be here today. We particularly welcome a number of participants from other African countries. Looking at the programme, I have no doubt that you will be amply rewarded. In conclusion, I would like to thank my colleagues in the Reserve Bank, and also those staff members of the Bank for International Settlements in Basle, who were responsible for making all the arrangements for this Conference. *** | south african reserve bank | 1,999 | 1 |
Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at conferences organised by Omega Investment Research (Pty) Ltd held in Frankfurt on 25/1/99 and Zurich on 27/1/99. | Mr Stals looks at South Africa’s financial and economic prospects for the next five years Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at conferences organised by Omega Investment Research (Pty) Ltd held in Frankfurt on 25/1/99 and Zurich on 27/1/99. This overview of the South African economy is presented in three parts. Firstly, recent developments in the economy and the current situation are summarised to provide a background for possible future developments. Secondly, the more important structural economic adjustments that are now in progress and that will have an important influence on the course of future developments are referred to. Thirdly, a longer-term view is taken of developments over the most recent past two five-year periods, supplemented with a forecast for the next five years. 1. Recent developments and the current situation The year 1998 turned out to be a very frustrating one for the South African economy. During the first quarter, encouraging signals of an imminent improvement in underlying conditions emerged. Substantial amounts of foreign capital flowed into the country, mainly in the form of portfolio investments in South African bonds and equities. The country’s foreign reserves increased sharply; there was upward pressure on the exchange rate of the rand; domestic liquidity increased; and interest rates declined. At that stage, there was some optimism that the fairly depressed conditions in real economic activity since the second half of 1997 would be turned into a new upswing during the course of 1998. Growth in real gross domestic product, which had declined from a level of about 3½ per cent per year in 1995 and 1996 to below 2 per cent in 1997, was predicted to rise again in 1998. However, the South African economy was severely shocked when the large inflows of foreign funds in the form of portfolio investment in South African bonds were suddenly reversed in May 1998. Non-residents increased their holdings of South African bonds by R16 billion during the first four months, but then became net sellers, and reduced their holdings of South African bonds by R26 billion over the next eight months. It is interesting to note that, throughout last year, nonresidents remained more positive about investment in South African equities and increased their holdings of shares acquired through the Johannesburg Stock Exchange by R42 billion over the year as a whole. Despite the large disinvestment in bonds, non-residents still increased their overall holdings of South African securities by R32 billion. The abrupt change that took place in May in the Bond Exchange nevertheless had far-reaching effects for the South African financial situation. The yield on long-term government bonds, for example, rose from a monthly average of 12.9 per cent in April to over 18 per cent in September, and fluctuated widely on a daily basis to peak at over 21 per cent at one stage. The adverse effects of the net selling of bonds by non-residents quickly spilled over into the market for foreign exchange. Pressures in this market led to an eventual devaluation in the nominal effective exchange rate of the rand of 16.4 per cent from the end of April 1998 to 31 December 1998. The country’s net gold and foreign exchange reserves, which increased by almost R19 billion over the fifteen months that ended in March 1998, then declined again by R12½ billion over the last three quarters of last year. At the end of 1998, the total official reserves of the country amounted to about R31.6 billion, the equivalent of about two months’ imports. These changes in the capital account of the balance of payments, which were obviously directly linked to the worldwide dispersion of the East Asian crisis, forced the Reserve Bank to switch to –2– a more restrictive monetary policy. The interest rate on the Reserve Bank’s daily repurchase transactions with banking institutions increased from below 15 per cent in early April 1998 to almost 22 per cent in August. In light of the declining amount of liquidity in the banking sector, and the rising rate for Reserve Bank accommodation, banking institutions raised their prime lending rate from 18 per cent in April 1998 to over 25 per cent in August. With these adverse developments in the financial markets, the outlook for an early improvement in real economic activity faded. On the contrary, overall economic activity slowed down further. In the third quarter, total real gross domestic product indeed showed an annualised rate of decline of 2½ per cent. It is estimated that, on balance, total gross domestic product in 1998 was not much different from that of 1997. The negative developments in the global financial and commodity markets had some adverse effects also on the current account of the balance of payments. The deficit indeed increased from a level of about R7 billion in the first half of the year to a level of about R18 billion in the second half. Special imports, however, contributed to this increase in the negative balance, and indications are that the growth in imports is now slowing down in line with the more depressed domestic demand, whereas certain exports are beginning to react positively to the depreciation of the rand last year. Short-term developments in the South African economy were therefore very much affected by the turmoil of the past year in the global financial markets, and by negative developments in international commodity markets. The current situation creates frustration for the monetary authorities, who have an understanding of the need for some stimulation of domestic demand, but also an obligation to protect overall financial stability in an unfriendly and volatile international financial environment. The strong link between internal economic developments in South Africa and changes in the international situation was illustrated clearly when global financial markets became more stable towards the end of last year and in the early weeks of 1999. The strained South African financial situation simultaneously eased to such an extent that the exchange rate of the rand appreciated from about R6.30 to the United States dollar in August 1998 to R5.70 early in January 1999. Domestic interest rates declined by about 3 full percentage points from the extremely high levels reached last year. In the past ten days, however, negative developments in the Brazilian situation once again created new pressures in the South African market for foreign exchange, and put some brakes on the declining trend in interest rates. In the short term, the fate of the South African economy is now to an important extent determined outside of the country. Should the international situation stabilise and improve during the course of 1999, the South African economy will be sure to follow. 2. Structural economic adjustment As already explained, cyclical developments in the South African economy turned negative in 1997 and remained depressed throughout 1998. The business cycle will hopefully swing more positive again as the international financial situation becomes more stable (in the second half of this year?). There are, however, a number of fundamental or more basic deficiencies in the economy which were identified by Government in its Macroeconomic Strategy for Growth, Employment and Redistribution (GEAR), published in June 1996, and which also needs attention. –3– In the GEAR document, Government recognised that the most important economic problem facing South Africa at this juncture is the large and growing unemployment in the country. This problem not only provides a serious economic challenge for macroeconomic policy, but also contributes to adverse socio-political developments. For example, the seriously disrupting crime and violence situation in the country can be linked directly to growing unemployment. In its turn, the crime and violence makes economic recovery more difficult. The country is therefore trapped in a vicious circle of growing unemployment, more crime and violence, lower economic growth, and, therefore, more unemployment. The Government’s GEAR programme supports its earlier Reconstruction and Development Programme (RDP), providing for the social upliftment of the South African community, particularly of the disadvantaged groups of the past. The RDP focused the attention on the demand side of the economy, that is on the huge and legitimate needs of millions of South Africans that still live in poverty. It is understood by Government, however, that the means to provide for RDP can only come from increases in the production of goods and services. The disappointing past performances of the supply side of the economy must therefore be addressed in order to make it possible to meet the accumulated pent-up demand by producing more goods and services in the country. The main strategies in the GEAR programme provide for the following: • a fiscal deficit reduction programme to contain debt service obligations, counter inflation and free resources for investment; • a reduction in tariffs to contain input prices and facilitate industrial restructuring; • a commitment to moderate wage demands, supported by an appropriately structured flexibility within the collective bargaining system; • an exchange rate policy to keep the real effective rate stable at a competitive level; • a consistent monetary policy to prevent a resurgence of inflation; • the gradual relaxation of exchange controls; • the restructuring of state assets (privatisation); • tax incentives to stimulate new investment in competitive and labour-absorbing projects; and • a strengthened levy system to fund training on a scale commensurate with needs. South Africa is in a process of gradually implementing the GEAR strategy, although Government is often criticised for moving too slowly, particularly with the privatisation programme, and with the introduction of more flexibility in the labour market. The adverse cyclical developments of the past eighteen months, and the dismal performance of the economy in the short term, encouraged the critics of GEAR to condemn it as a failure. There are therefore strong pressures within the country for Government to relinquish the strategy and to replace it with a more populist approach. Government, however, remains committed to the gradual restructuring of the economy with the objective of raising the economic growth potential to at least 5 per cent over a six-year period. It –4– is admitted that some of the strategies provided for in the 1996 GEAR document may need some revision in light of recent economic developments, but the essence of the strategy must be retained and must be pursued and implemented with determination. In a recent study of the South African economy, economists from Goldman Sachs of New York concluded as follows: “The GNU (Government of National Unity) successfully led the country through the first phase of the transition (1994-98) from the apartheid era. The GNU completed a program of structural reforms, including progressive current and capital account liberalization, committed to respect the independence of the SARB (South African Reserve Bank), and announced a development strategy emphasizing gradual fiscal consolidation. However, a second round of structural reforms to address structural rigidities on the supply-side of the economy are required if real GDP growth and employment are to be boosted in a significant and sustainable way. These reforms include liberalization of labor markets, completion of the trade reforms, completion of capital account liberalization, and further public sector reform -- including an aggressive privatization program”. 3. Longer-term developments in the South African economy Turning to the longer-term developments in the South African economy, it is interesting to note that some remarkable improvements did take place in parts of the economy over the past five years. An analysis of a few selected key economic indicators of developments over the past ten years (see Table 1 attached to this document) reveals the following: • The rate of growth in real economic activity as reflected in changes in gross domestic product increased from a yearly average of 0 per cent in the first period (1989 to 1993) to 2 per cent in the second period (1994 to 1998). Similarly, the rate of growth in real gross domestic expenditure changed from minus ½ per cent to positive growth of 3 per cent per annum. Greater confidence was also reflected in a substantial improvement in gross domestic fixed investment, which declined by 2½ per cent per year from 1989 to 1993, but then increased by 7 per cent per year from 1994 to 1998. One of the emerging weaknesses in the economy is reflected in the decline over these two periods in gross domestic saving as a percentage of gross domestic product, from an annual average of 19 per cent in the first, to 16 per cent in the second period. • Where the economy failed most was in the creation of jobs. Total employment indeed declined by an average annual rate of 2 per cent from 1994 to 1998, which was even worse than the average decline of 1.3 per cent in the preceding period of five years. Despite the further increase in unemployment, the annual rate of increase in average real wages and salaries more than doubled, from 1.7 per cent in the first, to 3.9 per cent in the second period. • A further positive development was a dramatic switch-around in the net capital flows from abroad -- from persistent outflows before 1994 to a cumulative net inflow of more than R50 billion over the next five years. The relatively large capital inflows made it possible to tolerate a deterioration in the current account of the balance of payments -- from forced surpluses in the first, to continuous deficits in the second period, reflecting a substantial increase in total domestic expenditure at a rate that outpaced the rate of growth in gross domestic product. It should also be noted that, with the removal of international boycotts and sanctions against South Africa after 1993, both merchandise imports and exports started expanding at a much higher rate. –5– • A further important improvement in the economy is reflected in the decline in the average annual rate of inflation, which was still in double digit territory during the first period, but stayed comfortably below the 10 per cent level in the second. It is obvious from an analysis of the macroeconomic statistics that, in the process of structural adjustment, South Africa must, over the next five years, succeed in its stated objective to turn around the trend of the past ten years for total employment to decline consistently. This remains the most daunting challenge for the South African economy. The forecast for possible developments over the next five years provided in Table 1 is, like all economic forecasts, based on past trends, and on discretionary assumptions about possible future developments. For the purpose of this forecast, it was assumed that Government will continue to implement the GEAR strategy and will retain disciplined fiscal and monetary policies. It was also assumed that South Africa will be able to attract a fairly substantial amount of foreign investment funds over the next five years -- an amount at least equal to the total net inflows of the past five years, with hopefully a greater part of it in direct instead of portfolio investment. A further requirement for the strategy to succeed is that monetary policy will remain fairly restrictive, and interest rates will be retained at a relatively high level. It also requires some further reduction in the deficit on the Budget of central government from about 4½ per cent of gross domestic product this year to 2½ per cent in the near future. It should, furthermore, be remembered that, apart from the shortcomings of the economy referred to above, South Africa also offers many advantages that provide a strong basis for future economic development. These include a well-developed infrastructure, sound and well-managed financial institutions, sophisticated and modern financial markets, and highly-developed skills and experience in areas such as engineering, architecture, the legal professions, medical care, and business management. Add to this the possibilities that are being opened up for an expansion of South Africa’s economic relations with the rest of Africa, and there are many reasons for being optimistic about the economic potential of the country. On the assumptions made about the implementation of macroeconomic policy, and on condition that the existing advantages present in the South African economy will be protected and further expanded, the following forecast for possible developments in the South African economy over the next five years does not seem to be unrealistic. • The capacity of the economy to produce goods and services will be raised gradually to reach a level of 5 per cent by the year 2004. This will give an average annual rate of growth in gross domestic product of about 3 per cent over the next five years. • Net capital inflows into the country at a rate of more than R10 billion per annum will make it possible to maintain growth of at least 3 per cent per annum in gross domestic expenditure, also rising gradually to about 6 per cent per year by 2004. • This will include a continuous growth in gross domestic fixed investment at an average rate of 4 per cent per annum. • The current account of the balance of payments will remain under pressure, and a rising deficit will require more capital inflows. Positive steps will have to be taken (in line with the GEAR strategy) to attract more direct foreign investment into the country. –6– • Inflation will decline gradually and will come in line with the level of inflation in the major industrial countries of the world. • The process of gradually removing exchange controls will be completed, and South Africa will become even more integrated in the world economy. • South Africa’s leading economic role in Southern Africa will be firmly established through SADC, and will gradually expand beyond the Southern Africa region. It must be expected that the path of economic development in South Africa over the next five years will not be a smooth one. The structural economic reforms, further integration in the world economy, and the continuing socio-political reforms in the country will all at times have a destabilising effect on the domestic economy. It will be extremely difficult at this stage to provide any sensible year-to-year forecast of possible developments in the economy. The attempt to take a longer-term perspective covering the next five years, therefore, makes more sense. The forecast also indicates that total employment in the country should soon start rising, although it will still require a major effort to make up for existing backlogs. 4. Conclusion Based on a short-term analysis, the South African economy is rather depressed at this stage, and is very dependent on some improvement in the international economic environment for sustainable recovery. An analysis of developments in a few important macroeconomic aggregates reveals significant improvements in the performance of the overall economy over the past five years, but also exposes a few structural weaknesses that must be addressed urgently in order to raise the total production capacity. Finally, if well-managed, the South African economy has the potential of making further steady progress over the next five years to reach the objective of at least 5 per cent growth per annum, and of creating more jobs. Should the country want to achieve more ambitious targets in the next five years, and I believe even that would be possible, we shall, in the words of the Goldman Sachs economists, have to apply the same strategies, but with less timidity, and more aggression. –7– Table l: Selected Key Economic Indicators (Average annual percentage changes, unless otherwise indicated) 1. Real gross domestic product 2. Real gross domestic expenditure 3. Real gross domestic fixed investment 4. Ratio of gross domestic saving to gdp 5. Employment 6. Real salaries and wages per worker 7. Balance of payments (R billions) * Current account (average) * Capital account (cumulative total) 8. Merchandise 1989 to -½ 1994 to +2 +3 1999 to 2003* +3 +3 -2½ +7 +4 -1.3 +1.7 -2.0 +3.9 +1 1.5 +R 5.2b -R26.6b -R 7.9b +R50.9b -R 9b ... +2.2 +2.9 +13.6 19.2% +9.2 +6.4 +8.1 18.9% +7 +5 5.5 15.5 4.9 5.1 2.5 * Imports * Exports (including gold) 9. Consumer prices 10. Prime overdraft rate of banks (level) 11. Central Government Budget deficit as % of gdp ... *Forecast *** –8– | south african reserve bank | 1,999 | 2 |
Presentation by the Govenor of the South African Reserve Bank, Mr Chris Stals, to the Portfolio Committee on Finance in Cape Town, South Africa on 04/02/99 | Mr Stals reviews the 1998 IMF and World Bank annual meetings Presentation by the Govenor of the South African Resrve Bank, Mr Chris Stals, to the Portfolio Committee on Finance in Cape Town, South Africa on 04/02/99 South Africa’s position in the Fund South Africa is one of the more than 180 member countries of the IMF and the World Bank Group. At this stage, South Africa holds a quota in the IMF equal to SDR 1,365 million (R9.3 billion). The Fund is now in the process of raising all quotas by approximately 45 per cent. South Africa’s quota will increase to SDR 1,868 million (R12.7 billion). The total new quotas for all members add up to SDR 212 billion. South Africa therefore holds about 0.87 per cent of the total voting rights in the Fund. Under certain conditions, South Africa can borrow its total quota (R12.7 billion) from the Fund under normal Fund policies, but, of course, subject to the implementation of certain prescribed macroeconomic policies. The Fund also provides a number of other specific credit facilities, e.g. the Supplemental Reserve Facility, the Compensatory Financing Facility, and the Enhanced Structural Adjustment Facility, that members can make use of under certain conditions. At this stage, South Africa has no borrowings outstanding from the Fund. The size of a country’s quota also determines its participation in the Special Drawing Rights Scheme. Up to now, South Africa has been allocated a total of SDR 220 million. Under the terms of a decision of last year, there will be a further allocation of SDRs later this year, when South Africa will receive a further amount of SDR 180 million (R1.2 billion). As a member of the IMF, South Africa has the right to be represented on the Executive Board of the Fund (24 Executive Directors represent all members). South Africa joined the English Speaking Group of African countries for this purpose (20 countries), and is given an opportunity on a rotation basis amongst the members of this Group to appoint an Executive Director to the Fund. (This Group is now represented by Mr Jose Pedro de Morais of Angola, with Mr C.D.R. Rustomjee from South Africa as the Alternative Executive Director for the Group. Two years from now, i.e. in September 2000, South Africa will provide the Executive Director for the Group for a two-year period.) The main controlling body of the IMF is the Board of Governors (Ministers of Finance and Governors of Central Banks of all participating countries). The Board meets once a year (the Annual General Meeting). The Interim Committee of the Board of Governors is an advisory board and has 24 members (one for each constituency). This Committee meets twice a year and advises the Board of Governors on major policy issues. South Africa’s Minister of Finance was elected in October 1998 to represent the English Speaking Group of African countries on the Interim Committee for the next two years. There is also a Development Committee, constituted on the same basis as the Interim Committee, but with the task of advising the Fund and the World Bank on developmental issues. South Africa is also a contributing member to the capital of the World Bank and its affiliates. The World Bank has a similar institutional structure to the IMF. Our constituency is at this stage represented on the Board of Executive Directors of the World Bank by Namibia. Loans from the World Bank are, however, granted to countries on a completely different basis and are normally project linked. The Annual Meetings of the Board of Governors of the World Bank and of the IMF take place at the same time (Joint Annual General Meetings). At the Annual Meetings, the South African delegation participates actively in: –2– • the plenary sessions (three days); • the Interim Committee Meeting; • the Africa Constituency Meeting; • many bilaterally arranged private meetings, and • a series of social functions and receptions. Other meetings at the time of the Annual Meetings The confusion for any new participant in this annual event is substantially increased by numerous other conferences and meetings that take place at the same time. Of great importance are meetings of: • the Group of Seven, and • the Group of Ten. South Africa obviously does not participate in these meetings. In addition, there is also a Group of Twenty-four, representing mainly developing countries from Africa, South America and Asia. This group is officially known as The Intergovernmental Group of Twenty-four on International Monetary Affairs. South Africa is not a member of this Group, but has been given observer status with an open invitation to participate in the activities of the Group. Many other (regional) groups also make use of the occasion to hold meetings in Washington. Last year, the South African Minister of Finance invited all the SADC countries for a short discussion in Washington. A new grouping that is now in the making is the so-called Willard Group, called together earlier last year by the American Secretary of the Treasury and the Chairman of the Board of Governors of the Federal Reserve System, for a special discussion on the world financial crisis. The Group originally included 22 countries, being the major industrial countries and leading emerging market countries, including South Africa. At a meeting in Washington on 5 October 1998, three more countries from Europe were also invited to participate. This Group, working through sub-committees in which South Africa also participates, produced three interesting documents with proposals for improving the international financial system in respect of: • Transparency and Accountability; • Strengthening of Financial Systems (Regulation and Supervision), and • Managing International Financial Crises. The nature of the current debate Last year’s Annual Meetings took place against the background of: • the East Asian crisis and its contagion effect, first on other emerging markets, and later on the world economy; • the serious eco-political situation in Russia; • the collapse of a major hedge fund in New York – Long Term Capital Management; –3– • the growing threat of a collapse of the Brazilian economy; and • growing concern about a slow-down in world economic growth. At the Washington meetings, these economic problems were dissected from all angles; the causes of the problems were linked to: bad macroeconomic management; ineffective financial regulation and supervision; the current non-system of international exchange rates; excessive gearing within financial institutions; etc. Steps taken by countries and by the multinational institutions to manage the problem and to find solutions were criticised, sometimes for good reason, but often also on the basis of illusory perceptions. The search for measures to prevent the recurrence of a similar situation in future started in all earnest. It is not possible to summarise all the discussions in this short presentation of today. I am therefore taking a cue from summaries published by the IMF itself (after the meetings) of some consensus reached in the discussions (from IMF Survey of 19 October 1998). Apart from stressing the need for sound macroeconomic policies at the national level, a programme was agreed to for further studies on the strengthening of the international financial system (the “architecture”). These further studies would be undertaken within the Executive Board of the Fund and would cover: • a possibility of strengthening or transforming the Interim Committee; • a code of conduct for fiscal policy, as well as the ongoing work on the code of monetary and financial policies (standards); • the need for greater transparency at all levels, beginning with the IMF itself. The IMF’s Special Data Dissemination Standard should be expanded; systems for reporting external debt should be improved; the operations of international investors should be disclosed in more detail; the Fund’s surveillance operations should be expanded; • plans for an increase in private sector involvement in preventing and resolving financial crises; • introducing or tightening capital controls is not regarded as appropriate in dealing with fundamental economic imbalances. The IMF’s Executive Board was nevertheless asked to review experience with the use of controls and the circumstances under which they may be appropriate; • the Interim Committee expressed its serious concern over the IMF’s tight liquidity position. It stressed the critical importance of augmenting IMF resources; and • there was general support for expanding the Enhanced Structural Adjustment Facility (ESAF) and the Highly Indebted Poor Countries (HIPC) Initiative. South Africa does not qualify for any one of these facilities, although we have a vested interest in the proposal because of our sympathy for other countries in our constituency. It will be noted that none of these proposals are very revolutionary and are intended to work mostly through the existing framework of institutions and systems. More radical proposals are nevertheless also being thrown around in the global debate, e.g.: • for a major revision of the present floating exchange rate system and a return to a more stable system for the global structure; • for a merger of the IMF and the World Bank in one organisation (a merger of the Interim Committee and the Development Committee); –4– • for the conversion of the IMF into a world central bank with a lender-of-last-resort facility; and even • for a close-down and termination of the role of the IMF. South Africa’s role in the debate Over the past year the South African economy was severely affected by the adverse world financial conditions. Our approach has been to manage our economy as best as we could in this adverse environment, and to work with the international community to seek for a global solution. As one of the leading emerging market economies, South Africa has many opportunities to make a constructive contribution to the ongoing debate on the reform of the international financial system. Unfortunately, we do not have the resources to participate more actively in all the discussions that are now taking place. * * * | south african reserve bank | 1,999 | 2 |
Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a breakfast meeting of the Johannesburg Branch of the Institute of Bankers in South Africa on 17 March 1999. | Mr Stals addresses the subject of inflation targeting as an anchor for monetary policy in South Africa Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a breakfast meeting of the Johannesburg Branch of the Institute of Bankers in South Africa on 17 March 1999. 1. Introduction The debate on whether South Africa should formally introduce an inflation target as an anchor for monetary policy recently revived again. Such targets were introduced by a number of other countries over the past twenty years, in most cases with relatively good results. Amongst these countries can be mentioned New Zealand, Canada, Australia, Israel, Sweden, the Czech Republic, Turkey and the United Kingdom. The new European Central Bank recently decided to follow a more eclectic approach in which both the money supply and inflation will be targeted, with due recognition of an important role for a number of other monetary/financial aggregates in the process of inflation creation. In the case of South Africa, formal targeting of the M3 money supply was introduced in the mid-1980’s to serve as an anchor for monetary policy. Like in many other countries, this base for monetary policy served South Africa well for some years and made an important contribution towards the gradual reduction in the level of the rate of inflation from a wellembedded double-digit figure of between 12 and 20 per cent over a twenty-year period from 1972 to 1993 to an average of well below 10 per cent over the past five years. The use of the money supply as an anchor for monetary policy is based on the assumption that there is some stable relationship over time between changes in the money supply and total spending on goods and services and prices, that is inflation. Monetary policy is therefore directed towards controlling the rate of expansion in the total money supply as an intermediate objective, with the ultimate goal of protecting the value of the currency. To achieve the intermediate objective, the central bank uses various operational instruments such as open market operations, variable minimum cash reserve requirements and changes in the conditions of discount window facilities to influence the amount of liquidity in the banking sector (supply of money) and the level of short-term interest rates (demand for money). In this monetary policy model, the central bank therefore has an ultimate objective (to protect the value of the currency), an intermediate objective (to control the money supply), a supportive objective (to influence the amount of bank credit extension) and a number of operational instruments that can be used to achieve the goals of monetary policy. It must be pointed out that, apart from the fairly generally accepted ultimate goal of protecting the value of the currency, central banks can choose any one of the more important elements of the model as an intermediate target for guiding their shorter-term decisions on monetary policy. Some central banks may prefer a target for total domestic bank credit extension (DCE); others may prefer more direct controls over the amount of liquidity in the banking sector; others may set a more direct objective for the level of interest rates. Be that as it may, the monetary policy model as described above is a consistent model in which fairly stable relationships exist between the various components of the model. Whatever element may be chosen as an anchor for monetary policy, the other components of the model cannot and should not be ignored. 2. Moving from an intermediate objective to the ultimate objective of monetary policy In South Africa, like in many other countries with a comparable experience of economic development, changes in the money supply in recent years lost some of their usefulness as an anchor for monetary policy, and as an intermediate objective for achieving the ultimate goal of protecting the value of the currency. This has happened, as in many other countries, mainly because of a major liberalisation of the financial markets, a huge increase in the volume of transactions in the money and capital markets, and an opening-up of the country for international participation, not only in respect of trade, but also for the inward and the outward movement of capital across international borders. In the process, huge increases in the money supply occurred that were not related directly (or indirectly) to total spending on real goods and services. In technical terms, the additional money supply remained in financial circulation and was reflected in a large decline in the income velocity of circulation of the money supply. More money became available for every one unit of goods and services produced in the country. And yet, these increases in the money supply did not lead to increases in the rate of inflation. On the contrary, inflation in South Africa remained on a steady downward path, interrupted only by the adverse effects of the exchange rate depreciations of 1996 and 1998. Reserve Bank guidelines for an acceptable rate of increase in the money supply, based on the objective of a gradual reduction in the rate of inflation and providing for a desirable but realistic rate of growth in real economic activity, were overshot by a substantial margin during each of the past four years. Taking account of developments in the financial markets, and the acknowledgement of a growing need for more money to service the growing volumes of financial market transactions, the Reserve Bank remained indulgent about these “excessive” increases in the money supply, as long as inflation continued to decline gradually. These developments, however, impinged on the credibility of the continued use of M3 as the intermediate target of monetary policy in South Africa, and opened up the way for unreasonable criticism of monetary policy decisions taken by the Reserve Bank. After more than four years of a persistent “excessive” growth in M3, with a clear downward trend in inflation at the same time, the question has arisen whether the time has not come for South Africa to follow the example set by many other countries and to switch from a money supply anchor for monetary policy to a more direct targeting of the ultimate goal, that is, inflation in its own right. In many statements made since 1997, the Reserve Bank has expressed its support for gradually moving towards this new approach. In the annual monetary policy statements issued by the Bank in March 1998 and again in March 1999, the Bank indeed distinctly moved towards what it referred to as “informal” inflation targets. The view was expressed that this new approach was indeed more clearly linked to the directive contained in the Constitution of the Republic of South Africa in terms of which the Reserve Bank has been tasked with the responsibility of protecting the South African rand in the interest of economic development in the country. The Bank has always held the view that, in the case of South Africa, it is essential that the Government through the Minister of Finance should endorse Reserve Bank targets or alternatively set quantitative inflation targets together with the Reserve Bank for the Bank to pursue. Inflation expectations play a major part in the ongoing inflation process, and a commitment by not only the Reserve Bank but also Government to lower inflation will add credibility to a resolute and collective objective of bringing inflation in South Africa in line with the relatively low levels that now apply in most other countries of the world. A recent view expressed by the Minister of Finance that South Africa should consider the possibility of introducing inflation targeting, fuelled renewed speculation on the possibility of such a move in the near future. The ignorance revealed about inflation targeting in the subsequent public debate exposed once again the need for a better understanding of the intricate process of inflation in a modern economy. It is often overlooked, for example, that inflationary pressures can be created in many sectors of the economy and, if not depressed at source, can require draconian monetary policy measures to avoid monetary accommodation, with a continuing process of vicious inflationary circles that can harm the country for a long time. It is also a fallacy to believe that a switch from money supply to inflation targeting will enable South Africa to have lower interest rates almost instantaneously. Taking account once again of the intimate relationships that exist between the various components of the monetary policy model, there is but little difference between inflation targeting and money supply guidelines (or for that matter a DCE, liquidity or interest rate anchor for monetary policy). Interest rates will only decline to a lower level once inflation has been reduced on a sustainable basis to a lower level, and expectations about higher inflation in future have been eliminated with success from the minds of the majority of economic agents. 3. Introducing inflation targets The introduction of inflation targeting is no easy task. Apart from the question of who should be responsible for the establishment of the target, the following questions must also be answered: How should inflation be measured? Although it is widely accepted that some form of a cost-of-living index or a consumer price index should be used for this purpose, there is no consensus on how exactly inflation should be measured ideally for the purpose of implementing monetary policy. One of the major deficiencies of any kind of price index for this purpose is that the statistics are based on past consumption expenditure, and do not take account of possible future purchases – a deficiency that does not apply to money supply targeting, where accumulated money balances form part of the base aggregate. At what level or range should the target be set? “The purpose of an inflation target is to provide the central bank with a rule for making monetary policy decisions. For that purpose, a target band is not necessary: a single point target is sufficient” (William A. Allen: Inflation Targeting: The British Experience, a Bank of England publication). A fixed point, however, is much more difficult to hit than staying within a range. Moving within a band also leaves some discretion to the central bank and can also provide more flexibility in the case of unforeseeable future price shocks. What models should be used for forecasting inflation? It must be understood that inflation targeting is about the future. Any monetary policy decision implemented today, for example a decision to raise interest rates, will normally only affect actual measured inflation with a time lag of, say, twelve to eighteen months (or even longer in some countries). Inflation targets can therefore only be set in a forward-looking model that takes account of long-delayed effects. A reliable system for forecasting future inflation therefore becomes an essential precondition for any monetary policy model based on inflation targeting. To what extent should inflation targeting be concerned with asset price inflation? It is well-known that the Board of Governors of the Federal Reserve System in the United States of America is always concerned about the dangers of financial and property asset price inflation, and of the risk of a “bursting bubble”. The experience of Japan in the late 1980’s can be quoted, where measured consumer price inflation never exceeded 4 per cent per annum, and yet excessive increases in bank credit extension and the money supply created unrealistic asset prices. Eventually, when the bubble burst, the total Japanese economy collapsed. 4. Conclusion It is mainly for these reasons that many countries still prefer to stick to a more controllable intermediate target such as M3 or DCE, rather than the more complex and difficult inflation targets. South Africa’s expressed intentions to move towards inflation targeting therefore need careful preparation. The Reserve Bank is in the process of improving its techniques of forecasting inflation, and continues to analyse the changing relationships that are now emerging in the new situation between the various components of the monetary policy model. Reference should, in conclusion, be made to a third alternative in addition to intermediate targets, such as the money supply and inflation targeting, that can also be considered by countries as an anchor for monetary policy, and that is explicit targeting of the exchange rate of the currency. Countries such as Argentina, Hong Kong and the People’s Republic of China have opted for this alternative with a reasonable measure of success. There are, however, many reasons why this option is not regarded as appropriate for the present South African situation. Suffice it to say that, in the macroeconomic monetary policy model used by the Reserve Bank, the exchange rate is included as an important element in the comprehensive model, but it comes out as a result of the policy process, and not as an independent objective. | south african reserve bank | 1,999 | 3 |
Statement by the Governor of the South African Reserve Bank, Mr Chris Stals, at the Annual Dinner of Ethos Private Equity in Stellenbosch on 29 March 1999. | Mr Stals’ statement on South Africa as an emerging market Statement by the Govenor of the South African Reserve Bank, Mr Chris Stals, at the Annual Dinner of Ethos Private Equity in Stellenbosch on 29 March 1999. The emerging financial markets of South Africa South Africa is well-known in the international financial community for the sophistication of its financial markets. Founded on a good legal and accounting infrastructure, on a long experience of more than one hundred years which started with the need for the financing of the early gold mines of the Witwatersrand, on a good education system, and on transparent and universally recognised macroeconomic fiscal and monetary policies, the country is well placed to be one of the leaders, albeit of the second league of world financial market structures, i.e. after the more established and super-financial markets of the major industrial countries. For some years, the development of the South African financial markets was shackled by the constraints of the socio-political problems of the country. In the economic field, the restrictive measures of boycotts, sanctions, disinvestment campaigns and isolation placed severe restrictions on the development of the South African financial markets. The socio-political reforms of the early 1990’s removed most of these constraints, and new challenges have emerged since 1994 to reintroduce the South African financial markets into the global system, just at a time when the global system underwent one of the most revolutionary changes in its total history, a process which has become known as “the globalisation of financial markets”. South Africans took up these challenges with enthusiasm and the results achieved with, firstly, restoring normal relations with the international markets and, secondly, adapting to the major changes in the global system are often underrated. Progress made in the South African markets is, perhaps, best illustrated by the almost explosive increases in turnovers in the major financial markets: • • • • Secondary trading in shares on the Johannesburg Stock Exchange increased, in terms of number of shares traded, from 5.1 billion in 1995 to 9 billion in 1996, 17.9 billion in 1997 and 34.4 billion in 1998. The total value of shares traded increased from R63 billion in 1995 to R117 billion in 1996, R207 billion in 1997 and R319 billion in 1998. The increase in total turnover in the secondary market for bonds was equally spectacular. The total value of transactions in secondary trading on the Bond Exchange of South Africa increased from just over R2 trillion in 1995 to R4.3 trillion in 1997 and to R8.5 trillion in 1998. Activity in the market for derivatives likewise increased quite significantly over the past few years. The number of contracts traded in both futures and options on futures transactions more than doubled from 1995 to 1998. The South African market in foreign exchange made its contribution to the development of the overall financial markets. The average daily turnover in this market increased from US $2.7 billion in 1995 to $8.0 billion in 1998. At one stage, in the middle of 1998, the average daily amount exceeded $10 billion. These developments in the South African financial markets obviously dictated major changes in the official policy approach and in regulatory requirements for the various financial institutions. The “big bang“ changes introduced by the Johannesburg Stock Exchange, the changes introduced by the Department of Finance in the primary marketing of government bonds, the switch from a fixed bank rate to a fluctuating rate for repurchase transactions by the Reserve Bank, and the upgrading of the national payment, clearing and settlement system are just a few examples of the flexibility in official policy that supported the developments of the past few years. The expansion of total activity in the financial markets for obvious reasons also attracted more foreign participation. A great number of foreign banking institutions, for example, established themselves in South Africa. At this stage, almost thirty foreign banks now operate in the South African market through branches or subsidiaries established here, and more than sixty foreign banks have established representative offices in South Africa. Foreign investors have taken active participation in a number of the member stockbroking firms of the Johannesburg Stock Exchange, and participate as authorised dealers for the Department of Finance in primary issues of, and secondary trading in, government bonds. Last year, non-residents accounted for 28.5 per cent of the total value of transactions in shares on the Johannesburg Stock Exchange, and for 16.2 per cent of the total value of transactions in bonds traded on the South African Bond Exchange. The development of the South African financial markets in recent years was therefore supported to an important extent by the active participation of non-residents. In the process, South Africa not only succeeded in rejoining the world financial markets, but also in keeping abreast of the major developments in the process of globalisation of financial markets. The phasing-out of exchange controls as a contributing factor An important precondition for the incorporation of the South African financial markets in the global economy was the lifting of exchange controls. South Africa had to face this daunting challenge in 1994 with the knowledge that the country had no foreign reserves at its disposal at that stage to finance any net outflow of capital. It had to rely, therefore, on inflows of capital to generate the foreign exchange reserves that would be needed for the financing of any outflows, following upon the removal of the controls. In the beginning, the South African monetary authorities were often criticised for not being more bold, and for following a policy of gradualism instead of a “big bang” approach for the removal of exchange controls. In retrospect, and taking account of the magnitude of the gross flows into and out of South Africa over the past five years, the path followed by the authorities was undoubtedly the correct one. On balance, and on a gross basis, non-residents increased their claims on South African residents by more than R200 billion over the past five years. This enabled South Africa to finance an accumulated current account deficit of about R40 billion, to increase the net foreign reserves by about R35 billion, and to allow private South African residents to accumulate about R130 billion in foreign assets. This included about R60 billion of foreign direct investment by South African corporates, about R65 billion held by institutional investors in foreign assets, and about R4 billion invested by private individuals outside of the country. The process of the gradual removal of exchange controls resulted in the effective withdrawal of about 70 per cent, [or even more], of the exchange controls that existed at the beginning of 1994. At this stage, South Africa has no effective exchange controls any more on: • • current account transactions of the balance of payments; or the inward or outward transfer of funds owned by non-residents. In the case of residents, limits were introduced for amounts that can now be invested outside of the country by corporates, institutional investors and private individuals. The further phasing-out of exchange controls requires the gradual raising of these ceilings until they are no longer restrictive. The only area in which no concessions of any significance were made so far refers to the blocked funds of emigrants or former residents of South Africa. The Government must still take a decision on the implementation of a programme for what will most probably be a gradual release of the blocked funds of former residents. The globalisation process The liberalisation of the South African financial sector and concurrent developments in the structure of and volumes in the capital, money and foreign exchange markets supported the absorption of the South African markets in the process of globalisation. Last week, Mr Andrew Crockett, General Manager and chief executive officer of the Bank for International Settlements in Basle, delivered the annual Gerhard de Kock Memorial Lecture in Pretoria. He gave the following definition of globalisation: “Globalisation is a term that is widely used, but defies precise definition. I take it to mean a process in which geographic and market barriers are being rapidly eroded. Economic agents are now able to make financial transactions with little hindrance in all major markets of the world. Not only this, they can switch with increasing ease between different types of intermediation, each of which is in increasingly close competition with the others”. Globalisation holds many advantages for a country such as South Africa. It gives developing countries or emerging markets easier access to the surplus saving of the more mature industrial countries of the world. The advantages in globalisation for South Africa are clearly illustrated by the figures on gross cross-border capital flows over the past five years quoted above. The volatility in these capital flows, however, can also cause many macroeconomic problems for participating countries, particularly in the short-term, when international investment sentiments may change very quickly and often unpredictably. Last year, South Africa felt the full impact of adverse developments in the global financial markets when large amounts of portfolio funds previously invested in the country were suddenly withdrawn. To illustrate the severeness of this problem, the flows of non-resident portfolio investments into and out of the South African Bond Exchange last year can be quoted. In the first four months of 1998, non-residents increased their holdings of South African bonds by R16 billion. In the subsequent eight months, that is from May to December 1998, they reduced their investments in these bonds by R26 billion, to become net disinvestors of R10 billion for the year as a whole. These volatile capital flows had serious implications for the South African financial markets. The exchange rate of the rand depreciated by about 20 per cent; liquidity was drained from the domestic banking sector; interest rates rose to extremely high levels, and the rate of inflation increased from 5 per cent in April 1998 to 9.4 per cent in December 1998. These adverse developments in the financial markets had a serious depressing effect on growth in the South African economy. South Africa was, of course, not the only country that was so hard hit by the adverse developments in the global financial markets that began as a more localised East Asian crisis in the second half of 1997. In the end, emerging markets in Latin America, Central and Eastern Europe and in Africa all suffered from the contagion effect of the East Asian crisis. Even financial markets in the industrial countries were affected, as evidenced by the near-collapse in September 1998 of the Long-Term Capital Management fund in New York. There are at this stage numerous initiatives in progress at the international level to improve the international financial architecture in an effort to create greater stability in the global financial markets. It is widely accepted, however, that the developments of the past decade cannot be rolled back. In the words of Professor Klaus Schwab of the World Economic Forum: “The financial globalisation is no longer a process – it is now a situation. We should therefore no longer talk of globalisation, but rather of globality”. The outlook for South Africa as an emerging market The question can now be asked what the outlook for South Africa is as an emerging market in this unfolding brave new world? Firstly, what are the prospects for the further expansion of the South African financial markets? It is unlikely that the rate of expansion in the volumes in the various markets experienced over the past few years will be maintained. There are, however, a number of further important structural reforms now in progress that will provide further stimulus, further expansion and more growth in the markets. A few can be mentioned: • • • • The implementation of the STRATE (Share Transactions Totally Electronic) system of the Johannesburg Stock Exchange to provide a secure electronic settlement environment for share transactions; The immobilisation, dematerialisation and concentration in a fully electronic Central Securities Depository of paper scrip and certificates to facilitate immediate payment against delivery of financial asset transactions; The further extension of the National Payment, Clearing and Settlement System (SAMOS) to provide for real-time on-line settlement on a gross basis for all large transactions, and sameday settlement for all transactions with and within the banking sector; The further extension of international participation at all levels in the South African financial markets. Secondly, will the remaining exchange controls be removed to provide a further stimulus to the development of the South African financial markets? Here again, the answer must be in the positive. The removal of exchange controls is a one-way process that should not be reversed, not even when international capital flows go against the country, as happened in the past year. The continued integration of South Africa in the world financial markets will force a greater use of the versatile major driving force of globalisation, and that is electronic communication. The emergence of a global electronic network for trade (e-commerce), financial transactions (epayments) and money transactions (e-money) makes the retention of exchange controls on current account or capital transactions virtually impossible. Thirdly, will the process of financial globalisation continue, and will it provide further stimulus to the expansion of financial markets? It is true that globalisation played havoc with the world financial markets last year and created many macroeconomic hardships, particularly in the emerging markets of the world. It is also true that there is some backtracking by certain countries from the process of globalisation. It is also true that the integration of the world financial markets is a process that is irreversible. South Africa’s attitude is therefore not to withdraw from globalisation, but rather to learn from the lessons of the past, and to adapt more effectively to the vicissitudes of this new world financial environment. In the final situation, South Africa with its low domestic savings rate and urgent requirement for the expansion of its production capacity, needs foreign investment to finance economic development in the interest of all the people of this country. The process of globalisation brings with it growing competition amongst the approximately thirty countries that have now been grouped together as the emerging markets of the world. Investors, mainly from the industrial countries, have many options on where they can invest their funds. South Africa came through the financial turmoil of the past eighteen months relatively well. The banking sector stood up to the strains without any major mishap, the financial markets continued to function effectively, and the macroeconomic adjustments were painful but nevertheless less severe than in most of the other affected countries. Perhaps our fiscal and monetary policies were not as bad as local critics perceived them to be. The final assessment is now being made in the global markets. Some foreign investments are beginning to flow back into South Africa. Since the beginning of this year, non-residents have again increased their holdings of South African bonds by almost R4 billion. The world financial markets are returning to a situation of more stability. Serious efforts are now being made at the multinational level to improve the architecture of the world financial system. After the turmoil of the past eighteen months, a period of sobering consolidation will at this stage have a salutary effect on this exciting process of the worldwide integration of financial markets. In the longer-term, the process will continue. And South Africa will hopefully continue to be an active participant in the process, and will come out as one of the winners in this very competitive environment. | south african reserve bank | 1,999 | 4 |
Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at the Convention of the Institute of Life and Pension Advisers (ILPA) in Johannesburg on April 12, 1999. | Mr Stals talks about the international economic environment Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at the Convention of the Institute of Life and Pension Advisers (ILPA) in Johannesburg on April 12, 1999. 1. The international financial crises of 1997/98 The past eighteen months witnessed disrupting turbulences in world financial markets that led to the collapse in financial structures in many countries, and to a serious decline in economic growth in the world at large. A chronic weakness in the Japanese economy over a prolonged period of time should perhaps be regarded as the major cause of the financial crisis, which is generally linked to the collapse of the economies of a number of countries in East Asia. These included Thailand, Korea, the Philippines, Indonesia and Malaysia -- countries that managed their economies with great success for many years. What went wrong in these countries is now part of history, and some consensus has been found on an ex post basis of the reasons for the collapse in the economies of what used to be referred to as the East Asian Tigers. In general, the following can be offered as a summary of mistakes that were made in the economic management of the afflicted countries: * Governments failed to react timeously to overheating economies. This was manifested in unsustainable high levels of economic growth, inflated property and share prices, as well as large deficits on the current account of the balance of payments. * Prolonged pegging of currencies to the United States dollar at unsustainable levels, making monetary policy less effective and making the exchange value of domestic currency appear to be guaranteed. This encouraged huge external borrowing, leading to excessive exposure to foreign exchange risks for borrowers in the public and in the private sectors. * Insufficient supervision of financial institutions and poor enforcement of prudential rules, reinforced by cronyism. * Lack of sufficient and accurate data to enable market players to make a correct assessment of economic fundamentals. * In the situation, international investors under-estimated risks as they searched for higher income yields. In particular, investors failed to grasp inevitable links between market (liquidity) risks and credit risks. * The expanding world financial market and lax controls over multi-national financial institutions encouraged excessive leveraging based on a relatively small capital base for hedge funds and certain banking institutions. * A herd-like reaction by international investors, once the bubble burst, that led to an almost panic-withdrawal of funds from economies that could not in a short period of time absorb the shock of the turnaround in the sentiment of international investors. The adverse developments in East Asia almost immediately affected emerging markets all around the world. Initially, that is from the middle of 1997 up to the second quarter of 1998, most of the other emerging markets succeeded in keeping afloat and there was still a chance to keep the crisis restricted to the East Asian region. The situation was exacerbated, however, by the complete collapse of the situation in Indonesia, and by the early signs of an emerging second crisis in Russia. The effective devaluation of the rouble and unilateral restructuring announced by Russia in August 1998, triggered a further series of sharp market corrections, indicating a generalised increase in perceived risk or risk aversion. A third threat to a major collapse of the global financial system came towards the end of last year with the deterioration of the financial situation in Brazil, mainly because of chronic fiscal imbalances and large-scale speculative attacks on what markets perceived to be an overvalued currency. In general, the immediate effect of a loss of confidence of investors in any specific economy was reflected in a decline in the inflow of foreign capital or, in many cases, a large withdrawal by nonresidents of previously invested funds from the country. The widespread flight to quality and liquidity gave rise to a severe tightening of credit conditions in the affected countries: equity prices fell sharply; yields on bonds rose to extremely high levels, followed by soaring interest rates in general, and exchange market pressures intensified as exchange rates went in an uncontrollable tumble. As a by-product of these developments, many international investors and banks suffered substantial losses, especially on highly leveraged investment positions. Gradually, the worsening conditions in the financial markets also affected real economic activity. The International Monetary Fund (IMF) revised its outlook for world economic growth in 1998, first from 3 to 2½ per cent (in August 1998), and then to 2 per cent (in October 1998). For 1999, the projection was similarly reduced from 3¾ per cent to 2¼ per cent at this stage. 2. The contagion effect of the financial crisis A special feature of the financial crisis of the past two years has been the contagion effect, or the spill-over of the economic problems of a few important emerging market economies to other countries, and eventually to the world economy. The transmission mechanism, or the conduit followed in the contagion process, was not the same for all countries. Initially, with countries in East Asia, perceptions played an important part in the process. Once the Thai baht came under pressure in the middle of 1997, it did not take long before international investors discovered many similarities in the economies of Korea, the Philippines, Indonesia and Malaysia. The serious collapse of the Russian financial system, and particularly the action taken by the Russian Government in the unilateral restructuring of its sovereign debt, gave rise to an indiscriminatory withdrawal of funds previously invested in sovereign debt of other emerging market governments. It was also noted at the time that the IMF, the World Bank, and Governments of other countries were rather reluctant to provide the massive amount of assistance needed for propping up the Russian balance of payments problem. The following quotation from a recent IMF publication summarises the Russian events of mid-1998: “More important was the role of Russia’s default as a defining event that challenged widely held views about the default risks associated with all emerging market investments, and the willingness and ability of the international community to provide assistance to countries in difficulty.” (World Economic Outlook and International Capital Markets, December 1998) The flight to high quality assets and, at a later stage, a major “de-leveraging” process of multinational investment institutions, reduced international capital flows in general, and therefore provided a second conduit for contagion. It is estimated at this stage that net private capital flows from the industrial countries to the developing and emerging markets, including countries in central and Eastern Europe “in transition”, declined from US $118 billion in 1997 to $70 billion in 1998. In the case of the Asian countries, it changed from an $100 billion net inflow in 1996 to an $18 billion outflow in 1998. A third obvious conduit for the transfer of the economic ills of the East Asian economies to other countries, and particularly countries with vulnerable balance of payments positions, is the deterioration of current account positions caused by the generally depressed world economic environment. The negative effects of this development are only now beginning to filter through to some of the poorer, developing countries in the world that do not have developed financial markets but are nevertheless dependent on the exports of basic commodities, metals and minerals. Examples in Southern Africa can be found in Botswana (diamonds), and Zambia (copper). Finally, the weakening or full collapse of the banking systems in a number of the afflicted economies has had a major impact on the global banking sector. Not even financial institutions in the major industrial countries have been immune to this problem. The near-collapse of the Long Term Capital Management Fund in New York towards the end of September 1998, provided a stern warning to the world that the East Asian crisis had indeed become a worldwide financial problem. Quick action by the American Federal Reserve and the major New York banks prevented serious problems for other financial institutions, including many multinational banking institutions with similar over-leveraged positions. 3. Policy reactions to the global financial crisis The initial “fire-fighting” reactions of countries in the midst of the crisis obviously differed from country to country. Led by initiatives from the IMF, however, a relatively standard policy procedure was adopted that required of countries, firstly, to adjust important macroeconomic fundamentals to new levels as dictated by market forces; secondly, to restore some stability to financial markets, and thirdly, to introduce structural and other remedial adjustments that will regain the confidence of international investors. In the process, the countries directly afflicted by the crisis had to accept: * a sharp depreciation in the external value of their currencies; * a substantial tightening of liquidity conditions in domestic financial markets; * a tightening in fiscal policy, mainly through significant reductions in government expenditure. In some countries, inflation also increased to higher levels and necessitated even more restrictive monetary policies. These developments obviously depressed real economic growth, and led to increased unemployment in the affected economies. It is estimated, for example, that the rate of economic growth in the ASEAN Countries (Indonesia, Malaysia, Philippines and Thailand) changed from positive growth of more than 7 per cent in 1996, to negative “growth” of more than 10 per cent in 1998. In the case of two important countries also afflicted by the crisis, a different approach was followed with macroeconomic policies to address the problem. In the case of Malaysia, the Government preferred a route of self-protection by the reintroduction of exchange controls on international capital flows. The wisdom of this policy was severely criticised at the time, but history will eventually provide a final verdict on the issue. There is general belief, however, that international investors will in future be much more reluctant to invest again in Malaysia than, for example, in the other East Asian countries that were more prepared to bite the bullet with extremely painful and costly macroeconomic adjustment processes. The second country to follow a different route, Russia, perhaps had no alternative but to introduce an almost complete moratorium on the repayment of its foreign debt. Private market investors have more or less written off their Russian exposures as a complete loss. It will take major adjustments before these bitten investors will ever return to Russia. 4. Promising signs of a reversal in the financial markets It would seem as if the global financial crisis reached a lower turning point in about October last year and, although still very fragile, there are encouraging signs of a return of greater stability in the global financial markets. In retrospect, the demise of the Long Term Capital Management Fund of New York at that time may have triggered the required concerted international action, also from the major industrial countries, to help restoring a measure of calm to financial markets. Actions taken since October 1998 included: * The easing of interest rates by central banks in most industrial countries, including the United States, United Kingdom, and the newly-established European Central Bank. * In Japan, new policy measures to address banking sector problems and announcements of further fiscal actions to stimulate demand. The Japanese Government indeed provided ¥60 trillion (about US $500 billion) to restructure the banking sector. * Commitments and actions by Brazil to address its chronic fiscal imbalances, and the largescale support of the international community, agreed in mid-November, for a strong programme of assistance that would forestall a financial crisis in that country. * Continued progress with stabilisation and reform in the Asian crisis countries implementing policy programmes supported by the IMF. With current account balances having moved into surplus and financial market confidence having begun to recover, the strengthening of exchange rates has allowed monetary policy to be eased, which in turn has helped to boost equity markets. * Recent increases in IMF quotas and other measures taken to replenish the funds of the IMF improved the international community’s ability to assist countries in the resolution of financial crises. It would seem as if the first objective of macro-economic policy has therefore been achieved in the major crisis centres (with the exception of Russia). Some stability has now been restored in the financial markets. The attention of the world debate has now been shifted, firstly, to what is needed and prudent to re-stimulate the world economy and, secondly, what structural adjustments to national and global economic structures will be necessary to avoid a recurrence of the East Asian crisis and its contagion effects in future. 5. The lessons learned from the experience of the past two years The analyses of the reasons for the financial markets’ disaster of 1997/98 are still continuing and the dissection of the major casualties is continuing. Some consensus may be developing, however, that both at the macroeconomic and at the microeconomic level, important adjustments are necessary to strengthen the fibre of financial systems and markets in order to meet the challenges of the irreversible process of globalisation. These structural adjustments must include: * An improvement and standardisation of accepted institutional arrangements covering aspects of property protection, bankruptcy procedures and accounting standards. * Bank and other financial institution supervision and regulation must be upgraded, and new standards of adequate risk management must be introduced. * The architecture, role and policies of the multilateral institutions such as the World Bank and the IMF, not only on an ex post basis but also in the prevention of a crisis, must be reviewed. * Policy makers must follow sound and credible economic and financial policies. The experience in a number of countries, for example, warned against a policy of excessive short-term borrowing by governments and by countries to finance chronic fiscal or balance of payments deficits. Credibility comes from monetary policies aimed at achieving price stability. Macro-economic policies that are judged by investors to be responsible are those that allow free markets to work with undue intervention from governmental authorities. * The international exchange rate regime of floating exchange rates and its contribution to the increasing volatility of the global financial markets has come under the spotlight. * The need for greater transparency at the level of multinational institutions, governments and public sector institutions and, very importantly, also from private sector participants in global markets has been identified. * The ability of countries to attract long-term foreign capital, e.g. direct foreign investment, should be improved. This once again leads to the conclusion that exchange controls and/or excessive protectionist policies should be avoided by developing and emerging market countries that want to remain competitive in the global market environment. 6. Prospects for the world economy Although there are still a number of downside risks in the global economy, there is growing optimism that some recovery will take place in most of the more seriously affected economies of the East Asian crisis. The main priorities in these countries are now to end the decline of economic activity, limit the adverse impact of the crisis on the welfare of the most vulnerable members of the community, promote the resumption of sustainable growth, and accelerating the restructuring of financial and corporate sectors. In Korea, Thailand, and more recently, Indonesia and the Philippines, the tightening of monetary policies that occurred in the wake of the crises has achieved considerable success in re-establishing financial stability. A strengthening of exchange rates has indeed allowed interest rates to be lowered significantly. In Brazil, a determined and sustained implementation of a front-loaded fiscal adjustment effort, accompanied by appropriately tight monetary policies and wide-ranging structural reforms is making an essential contribution to sustaining the improvement in global financial market sentiment. Russia continues to lack macroeconomic policies that would help to restore the confidence of investors and establish the preconditions for sustainable growth. Once again, however, the financial markets of the world have marginalised the Russian situation, and seems to have discounted it as, for the time being, a lost cause. In Japan, the critical challenge for the authorities remains to find a quick and forceful restructuring, including a recapitalisation, that will restore the financial health and profitability of the banking system. It remains a problem to re-stimulate demand in the highly saving-conscious community of Japan. For the other industrial countries, although there have been widespread downward revisions to growth projections for 1999, the outlook in most cases is still fairly good. Continuing low inflation provides scope for monetary easing, if warranted, to support demand and out-put growth, and also to help stabilise financial markets. There is, therefore, cautious optimism in general that the painful macroeconomic adjustments of the past year have succeeded in restoring financial stability in most parts of the world, and that a basis has been laid now for some recovery in real economic activity in the depressed economies that suffered most from the East Asian crisis of the past two years. Note: Information used in this presentation has been taken mainly from: World Economic Outlook and International Capital Markets - Interim Assessment, December 1998; published by the International Monetary Fund. | south african reserve bank | 1,999 | 4 |
Speech by the Governor of the South African Reserve Bank, Dr Chris Stals, at the 52nd Congress of the South African Nurserymen's Association in Johannesburg on 17 May 1999. | null | south african reserve bank | 1,999 | 5 |
Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a conference on "The South African Economy in a World of Volatile Financial Markets", arranged by the Bureau for Economic Research of the University of Stellenbosch in Johannesburg on 25 May 1999. | Mr Stals discusses the challenges to monetary policy in increasingly volatile international markets Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a conference on ‘The South African Economy in a World of Volatile Financial Markets’, arranged by the Bureau for Economic Research of the University of Stellenbosch in Johannesburg on 25 May 1999. The contagion effect The globalisation or international integration of the world’s financial markets brought with it new challenges for monetary and other macroeconomic policies. The volatile conditions in world financial markets over the past two years created new problems for macroeconomic management in a number of countries. It was particularly smaller economies with partly developed financial markets – the emerging markets – that were more seriously affected by these adverse developments. Ex post analyses of the financial crisis of 1997/98 focused attention on purported deficiencies of macroeconomic policies, and of economic structures in many of the afflicted countries. From these lessons, programmes for a major reform of existing structures, particularly financial structures, and of essential adjustment in macroeconomic policies, are now emerging. At the same time, attention is given to the need for some restructuring of the global financial architecture with the objective to avoid a repetition of the 1997/98 crisis. Crisis prevention, after all, is better than crisis resolution. Without going into the details of the many proposals now being discussed at the global and national level for reforming macroeconomic structures and policies, pragmatism leads to the conclusion that the present globalised financial market structure is by its nature unstable, unpredictable and, with all its virtues and advantages, at times very disrupting for domestic national economic policy objectives. Easy communication through a worldwide network, the instant transfer of information on a real-time basis to all destinations, economic liberalisation and the transfer of resources such as surplus saving from more developed to developing countries have changed the environment in which macroeconomic policies must now be framed. Recent developments exposed an important aspect of this new global environment and that is the so-called contagion effect, or the ease with which economic problems that may develop in one country, region or functional group of countries can be transmitted to others. The conduit for the transfer of the problem is not in all cases the same. Referring to the East Asian crisis of 1997/98, at least three distinct transmission mechanisms can be distinguished in the contagion process: • First, there was the group of countries in East Asia, with many similarities and fairly intimate economic relationships, where individual countries were affected almost immediately after the Thai baht collapsed in mid-1997, partly because of perceptions and the herd-like reactions of international investors. In the case of this group of countries, contagion worked mainly through the withdrawal of short-term foreign financing to banking institutions, trade financing, and all forms of foreign loan facilities. • Second, there was a further group of countries that were affected only gradually through a decline in the flows of portfolio investments from industrial to developing countries. Emerging market economies with fledgling capital markets were mainly affected with some time lags by the change in the attitude of the managers of major institutional investment funds who at some stage decided to convert high-yielding, high-risk assets into low-yielding, high-quality assets. South Africa is a good example of such a country that suffered in the wake of the East Asian crisis, mainly as a result of a large-scale withdrawal by nonresidents of portfolio investments previously made in the country. • Third, another group of countries representing mainly exporters of primary products, metals and minerals were affected with an even longer time lag by depressed world economic conditions created by the East Asian cum global financial market crisis of 1997/98. Not all countries have therefore been affected in the same way by the global financial crisis of the past two years, and not all countries can therefore rely on the same protective measures to prevent the same disastrous effects in future. There are, nevertheless, many commonalties in the challenge for monetary policy, despite the differences in conduits followed in the transmission of contagion to the various countries. Whether a balance of payments deterioration takes place through an outflow of short-term finance and the withdrawal of loan funds, or through the repatriation of previously invested portfolio funds, or through a decline in exports, the proximate monetary effects are more or less the same: • First, the overall supply and demand conditions in the market for foreign exchange will change and a short supply in foreign currency may develop. Some pressure for depreciation will therefore be exerted on the exchange rate. • Second, liquidity conditions in the domestic money and capital markets will tighten, and upward pressure will be exerted on interest rates and yields on financial assets. • Third, banking institutions will lose liquidity and their capacity to provide loans to their domestic clients will be reduced. • Fourth, inflationary pressures will emerge within the economy, particularly in a relatively open economy where import inputs play an important part in the overall economic process. • Fifth, if not reversed fairly quickly, these adverse developments in the financial markets will disperse throughout the economy and will eventually also depress real economic activity. It should be noted once again that, as happened last year in the case of South Africa, the adverse developments were transmitted into the South African economy as part of an international contagion process, without any special reason or obvious explanation for it in the domestic environment. It is true that, like a real virus, the international transmission process seeks weaknesses in the world environment and exploits structural deficiencies in the economies of globalised markets. Weaker economies are therefore affected more severely in the process, and unacceptable macroeconomic policies are punished with greater venom. The contagion effect and the South African economy It is history now that South Africa was also struck by the global financial crisis of 1997/98 when nonresident investors in May 1998 suddenly started to withdraw large sums of portfolio investments previously made in South African bonds, mainly government bonds of longer maturity. In the first four months of 1998, nonresidents increased their holdings of South African bonds by R16 billion; in the subsequent eight months, from May to December 1998, they reduced their holdings of South African bonds by R26 billion. This sudden switch from a large net inflow to an even larger net outflow of portfolio foreign investment in South Africa exposed the country to the East Asian financial crisis and triggered all the predictable adverse developments in the financial markets referred to above. The predicament for the South African macroeconomic policymakers in the situation was that the adverse developments took place at a very inconvenient time if account is taken of prevailing conditions in the domestic economy in the first half of 1998. These adverse financial developments indeed forced an early abortion of an economic recovery that was in its infancy during the first quarter of 1998. During the rest of last year, the economy lost its momentum and is only now beginning to show tentative signs of a resumed recovery. South Africa and other emerging market countries learned a lot from the experience of the past two years. For those countries, such as South Africa, that are committed to continued and enhanced participation in the process of financial globalisation, there is no escape from volatile international capital flows. These countries, including South Africa, are now working together in the multinational forums of the International Monetary Fund (IMF), the World Bank, the Bank for International Settlements and many groupings such as the Willard Group and the Basel Committee for Banking Supervision to create a more stable global financial environment. For the time being, however, they have to accept greater volatility in the financial markets as a fait accompli. Challenges for monetary policy The market economy provides its own disciplines and its own mechanism for adjustment when disequilibrium develops in the system. The foregoing analysis of financial developments in countries afflicted by the turbulence in world financial markets last year provides a brief description of the market mechanism of self-adjustment. The outflows of capital forced a depreciation of the currency, higher interest rates and inflationary pressures in those countries from where foreign investments were repatriated. The challenge for monetary policy is to accommodate these adjustments, however unpopular they might be at the time, and even if they come in direct conflict with the contemporary needs of the domestic economy at that stage. Despite the depressed conditions in the South African economy at the beginning of 1998, we had to accept a depreciation of the rand of almost 20% last year; we had to adjust to a sharp rise of about 7 full percentage points in the level of the cost of money; banking institutions were forced to reduce the rate of lending to their clients, and the rate of inflation increased from 5% in April 1998 to 9.3% in October 1998. Painful adjustments in real economic activity were unavoidable. Monetary policy had to flow with the flood. Reserve Bank intervention in the financial markets became necessary to smooth adjustments, prevent a crisis situation from developing in the foreign exchange market (still subject to many exchange controls) and facilitate the adjustment process by partly redistributing the cost of adjustment between private and public sector participants. Monetary policy, however, could not avoid, and should not have tried to prevent, the painful but essential market adjustment process. With hindsight, South Africa came out of the global financial crisis of 1997/98 relatively well, but not without some scars. In three areas, the South African economy showed its strength and resilience: • Unlike in many other countries, South Africa’s financial system managed to survive the turbulences of 1997/98 without any major failure. • South Africa became an exception to the emerging market world by not approaching the IMF for any special financial assistance. At this stage, South Africa has zero loans outstanding by the IMF. • Financial stability returned to South Africa relatively quickly after the major disruptions in the second and third quarters of 1998. The negative flow of portfolio investments turned positive again towards the end of last year; liquidity conditions in the banking sector eased; interest rates declined and are almost back to levels that applied at the beginning of last year; inflation peaked at 9.3% and is now gradually declining again; and the country’s foreign exchange reserves are on a rising path. In the heat of the situation, monetary policy, which in the case of South Africa had to carry a heavy burden in the adjustment process, was criticised a lot and was even blamed by armchair economists for causing the problems. With hindsight, the policy of letting the markets work with only smoothing-out intervention operations may not have worked as badly as the critics of the policy predicted. Exchange rate policy One of the elements of the restabilisation programme used by the South African monetary authorities over the past 30 years again elicited a lot of criticism recently, and that is the Reserve Bank’s so-called forward book. There is a lot of misunderstanding about this facility, perhaps because ‘forward books’ were used by many other central banks for completely different purposes. In many cases, misuse of the forward book contributed to the eventual downfall of financial markets. In the case of the Reserve Bank, a hedge facility is made available, mainly to South African residents, to protect them against exchange rate changes over which they have no control. These hedge transactions may only be entered into in respect of ‘firm, ascertained and documented’ commitments to make allowable balance of payments transfers within a 12month period. The Reserve Bank’s forward book is perhaps a misnomer, and should rather be referred to as an ‘insurance policy’ available to South African residents with foreign exchange exposures, either because they have to make payments in foreign currency or because they will receive payments in foreign currency within the next 12 months. The Reserve Bank’s forward book the therefore at any time represents a duplication of part of the stream of balance of payments transactions that will take place over the next 12 months. Analysts often make the mistake of adding a net oversold position in the Reserve Bank’s forward book to their estimates of future balance of payments streams as an additional commitment of the country to make foreign payments. This is obviously wrong and must lead to a distorted assessment of the country’s overall foreign exchange position. By making use of this hedge facility, South African residents can transfer their exchange rate risk exposures to the Reserve Bank for account of the government (that is, the taxpayers). The concerns we have in the Reserve Bank and in the Treasury on the forward book are not linked to the availability of foreign exchange for the country – that will be determined by the overall balance of payments position. Our concerns are more about the transfer of the exchange rate risk from certain sectors of the private sector (importers, exporters, borrowers of foreign funds) to taxpayers in general (the Budget). What we must ask ourselves is whether this transfer of risk brings on a net basis a macroeconomic social advantage to the overall community, or whether the final net cost in the form of losses on the forward book will exceed the overall social advantages of the insurance scheme. The decision to provide the hedge facility through the Reserve Bank dates back to the early 1960s, when South Africa introduced exchange controls. These controls prevented private sector users of foreign exchange from protecting themselves through the market mechanism for possible exchange rate changes. As long as South Africa still has exchange controls, albeit substantially relaxed in the meantime, there is some justification for the continued provision of a government-backed insurance policy for the protection of exchange rate risks. There are many disadvantages to the scheme, most important of which must be the distorted perception in world financial markets of the use of the Reserve Bank’s forward book. In a crisis situation, such as was experienced last year, there are also indisputable advantages in the provision of a government-sponsored hedge facility for exchange rate changes. The availability of this facility last year, for example: • enabled South African importers and exporters and other borrowers of short-term foreign exchange funds, to continue to make use of these facilities (note: South Africa did not experience large outflows of short-term funds as many other countries did); • prevented the exchange rate of the rand from depreciating more, and interest rates from rising to even much higher levels; • protected the private sector, including financial institutions, from huge losses on outstanding foreign commitments (part of the explanation, perhaps, why our banking institutions survived the crisis so much easier than their counterparts in many other countries). There is, however, a price to be paid for this protection, and that is huge losses on the forward book that are now being carried by the Reserve Bank for account of the Treasury. Future premiums on the insurance policy will, hopefully, go some way towards the recovery of part of these losses. The cost of financial stabilisation in the case of South Africa has been concentrated in the Reserve Bank’s forward book. In the case of many of the other afflicted countries, it remained vested in the private sector but eventually also came to book in national budgets, that is after private sector institutions collapsed under the burden of huge exchange rate losses. Is the forward book of the Reserve Bank/Treasury really such a bad thing after all? How can it be phased out from future stabilisation programmes, that is after exchange controls have disappeared? We South Africans should approach this challenge in a more positive and constructive way, and should not only concentrate on the obvious disadvantages of a scheme that also provides very valuable protection to private sector users of foreign currencies. | south african reserve bank | 1,999 | 5 |
Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a meeting for business people arranged by the Reserve Bank of Zimbabwe in Harare, Zimbabwe on 18 June 1999. | Mr Stals discusses regional trade and financial integration in the Southern African Development Community Address by the Governor of the South African Reserve Bank, Dr Chris Stals, at a meeting for business people arranged by the Reserve Bank of Zimbabwe in Harare, Zimbabwe on18 June 1999. Reasons why international financial cooperation is important There is a worldwide trend towards an integration of financial markets. This process of globalisation is no longer restricted to the industrial countries of the world, but emerging markets, countries in transformation and the developing countries of the world are all being drawn into this process. In many parts of the world, this process of globalisation goes through an intermediate phase, and that is one of regional economic cooperation or integration. The European Union, which has been developing over the past thirty years, has now reached the advanced stage of almost full financial integration. There are many other examples, such as Mercosur in South America, NAFTA in North America, and ASEAN in East Asia, where similar initiatives for economic integration are in progress. The smaller countries of the world can easily be marginalised in this process of global financial integration, unless they form part of some regional cooperation arrangement to guide them into this highly competitive global system of integrated financial markets. The Southern African Development Community (SADC) provides the opportunity for the countries of Southern Africa to approach the process of global financial integration through first combining forces in a regional cooperation arrangement that will, in a second phase, facilitate the real worldwide integration process. There are, of course, a number of other more localised reasons why financial integration within the Southern Africa region will hold advantages for all participating countries. These can be summarised as follows: • The expansion of trade between Southern African states will be supported by a simultaneous integration of the financial sector. Payment and settlements will be facilitated by the removal of unnecessary financial obstructions and constraints. • The extension of services across borders will be made easier. Such services can include insurance, business, legal advice and assistance, engineering, architectural, medical, and other professional services. • The movement of people within the region will become easier in support of activities such as tourism, inter-governmental services, exchange of skills, and the mobility of labour. • It is of vital importance for the Southern Africa region that maximum use shall be made of scarce resources. The coordination and sharing of limited resources such as skills, technological infrastructure and financial systems will contribute to a higher rate of economic development for the region as a whole. What has been achieved so far? The Southern Africa Development Community is a political association of the Governments (Heads of State) of fourteen countries in Sub-Sahara Africa (including Mauritius and Seychelles). It has, of course, much wider objectives than just financial cooperation in the region. The Governors of the central banks of the 14 member states of SADC made use of the opportunity to create within the SADC structure an independent Committee of Governors of SADC with the objective of promoting financial cooperation within the region. The South African Reserve Bank set up a small Secretariat and Research Unit for SADC within the Economics Department of the Reserve Bank to assist the Governors’ Committee with its programme. A number of working groups and subcommittees were created within the structure to give attention to specialised projects. The work done by the Governors’ Committee over the past 3½ years can be summarised under a few headings: (i) Enhanced cooperation amongst central banks: It was important for the central bankers of the region to know each other better. Meetings were therefore arranged, not only between Governors and Managers, but also between staff members at all levels. Specialised groups, such as economic research staff, bank regulators and supervisors, information technologists, computer operators, money and financial market dealers and traders, and security officials, met from time to time to exchange views on their functions. A database was established for each central bank on its structure, functions, internal administration, relations with government, statistics and legal aspects. This mass of information is now available in book form, and also on a special website provided on the Internet for the distribution of SADC information. Discussions took place within the Governors Committee on the exchange controls and exchange rate policies, interest rate policies and accommodation facilities provided by each central bank to its national banking institutions. Assessments were also made of the implications of last year’s East Asian crisis for the countries of our region. The independence of central banks is a topic which is often discussed in this forum. There are many reasons why central banks should be given some autonomy for the implementation of monetary policy. It is accepted that governments (Parliament) established central banks and gave them the special power to create money. Because of this special power, central banks have a great responsibility, and that is to protect the value of the currency (that is, to keep inflation low). The monetary policies needed to keep inflation low, are often very unpopular, and politicians normally do not like to take responsibility for such unpopular measures. Furthermore, the power to create money can easily be abused for short-term gains, but any excessive creation of money in the short-term will eventually lead to higher inflation (and therefore higher interest rates). It is also understood that, because Parliament has vested the power to create money within the central bank, this institution must remain accountable to Parliament for its policies. (ii) Cooperation amongst bank regulators and supervisors The Governors’ Committee has encouraged bank regulators and supervisors in the region to work together in order to standardise and coordinate policies followed to control the banking system. Special attention has been given to: • the implementation of the Basel Committee’s recommendations for capital adequacy; • the implementation of the BIS Core Principles for Banking Supervision; • training of bank regulators and supervisors in the region; and • identifying and eliminating money laundering and illegal banking transactions. (iii) The expansion of training facilities for central bankers in the region The South African Reserve Bank expanded its Training Institute to accommodate participants from the other central banks of SADC. We also coordinated our training programmes with those provided by other central banks (for example, Bank of Tanzania) and institutes (Macroeconomic and Financial Management Institute of Eastern and Southern Africa [MEFMI]) in the region. Our training efforts within SADC are now getting recognition from the International Monetary Fund and other central banks, such as the Bank of England, and can make an important contribution to the improvement of central banking skills in the region. (iv) Development of the payment, clearing and settlement systems in the region An analysis was made of the existing facilities for inter-bank clearing, payment and settlement systems in each one of the original 12 members of SADC. The sophisticated SAMOS system of South Africa, which provides for real-time on-line settlement for large transactions and full daily settlement for smaller transactions, can eventually be expanded to other countries, and can provide a system for cross-border settlement of intra-regional transactions. (v) Cooperation amongst (private sector) banking institutions in the region The Committee of Governors formed a sub-committee, consisting of the private sector banking institutions in the region, to encourage cooperation at this level. (vi) Cooperation amongst stock exchanges The Association of Stock Exchanges of the SADC region is making a useful contribution to the development of financial integration in the region. This sub-committee has been instrumental in providing for: • dual listing procedures; • the reduction of exchange control restrictions; and • sharing of information technology. (vii) Harmonisation of exchange controls The existing exchange controls in the region were analysed by a sub-committee of the Governors’ Committee with a view to gradual harmonisation. Participating countries are being encouraged to remove remaining exchange controls for transactions within the region as quickly as possible. Arrangements were made for the repatriation of banknotes amongst participating countries, and for an easing of private sector investments across borders in the region. Three countries, i.e. Botswana, Mauritius and Zambia, have removed all exchange controls and some others are making steady progress in the implementation of this programme. A vision for the future As already mentioned, the SADC organisation is a political association that covers a much wider objective than just financial cooperation within the region. This wider objective, however, has more potential for disputes and friction, and will also at times be constrained by the red-tape of a long drawn-out inter-governmental decision-making process. I believe that the Committee of Governors of the Central Banks of SADC provides a unique body that should be able to proceed with a programme of financial cooperation in the region, without being unduly constrained by the more complex political decision-making processes. At this stage, I believe work should continue to proceed on the accepted road of focusing on identified projects that can be developed on a regional basis without full economic integration of the 14 countries now forming part of SADC. Most of these programmes will also not require any formal inter-governmental agreements. In the process, we shall provide a basis for gradual but effective cooperation and integration of the financial systems and markets of Southern Africa. In the longer term, the vision should be: • to make it possible for residents of the whole SADC region to move funds around within the region without formal exchange control restrictions or border controls; • to make it possible for residents of the region to invest in the shares of companies in every country of the region without restriction, to buy and sell on any one of a series of closely-linked stock exchanges, and to arrange for settlement anywhere in the region; and • to make it possible for business people to do their business, whatever kind of business it might be, anywhere in the region without any undue financial restriction. To reach these objectives, however, I believe that the central banks of the region should, for the time being, continue to work on an almost informal way to establish a sound basis for the more ambitious plan of eventual full economic integration of the region. The momentum built up over the past few years amongst the central banks, with the attention focused on the building of a compatible financial infrastructure in the region, must be maintained. We must first establish: • independent central banks with strictly defined monetary policy objectives; • well-managed and sound private sector banking institutions; • well-functioning and well-coordinated financial markets, including foreign exchange markets; and • effective clearing and settlement arrangements within and amongst countries, before we can proceed to the more ambitious plans for macroeconomic integration. Only after the basic financial structures have been established in our countries can we harmonise interest rate, exchange rate, money supply and inflation policies. Cooperation on this basis will strengthen the position of the SADC region in the on-going process of financial globalisation. As part of the strategy, SADC countries should indeed now begin to give more attention to the development of a common economic strategy vis-à-vis the outside world for the eventual integration of the SADC region in the global financial markets. | south african reserve bank | 1,999 | 6 |
Remarks by Dr Chris Stals, retiring Governor at a Gala Dinner of the South African Reserve Bank, on 7 August 1999. | Mr Stals gives a summary of his views on central banking Remarks by Dr Chris Stals, retiring Governor at a Gala Dinner of the South African Reserve Bank, on 7 August 1999. * 1. * * Introduction I have listened to many speeches about central banking over the past forty years. Some of my international colleagues present here this evening will recognise titles such as “The Agony of Central Banking” “The Triumph of Central Banking” or “The Art of Central Banking” I can obviously make long speeches about each one of these subjects, or many others on central banking. Out of respect for this occasion and taking account of the late hour of night, I am going to be brief and give you, at the end of my long career in this wonderful profession, in summary form my views on what I would regard as: 2. The Twelve Commandments of Central Banking 2.1 A true central banker will always be against inflation. 2.2 The need for independence of the central bank must be recognised and appreciated by the public and by governments but, after all is said and done, a central bank can only be as independent as the government of the day wants it to be. From my experience I have learned that, without regular contact and close co-operation with the Minister of Finance the life of a central banker can become very lonely. 2.3 In many countries of the world the powers of the central bank should be reduced in order to increase the effectiveness of monetary policy. Joined with the potent power to create money, the power also to make loans and spend money has the potential to create a malignant superpower whose actions can easily lead to financial destruction. 2.4 Wealth cannot be created by the creation of more money; poverty cannot be relieved by increasing the money supply. If this would have been possible there would have been no poverty in the world any more. 2.5 By successfully restricting growth in the total domestic assets of the central bank, monetary policy will bring about positive growth in the total foreign assets of the country. 2.6 A central banker is often very unpopular in his own country. As a matter of fact, if the governor does become popular in his own country, it may be time for him to retire. Monetary policy is about financial discipline, about restricting expenditure, about forcing the country to live within its means. Measures to achieve these objectives can never be popular. You cannot ask the turkeys of the world to vote for Christmas. You also cannot ask the borrowers of money what the level of interest rates should be. 2.7 Where anybody stands on monetary policy is determined by where he sits. When I was criticised for the policies of the Bank, I always asked who the critic was and where he worked. The answer invariably made me apathetic to the criticism. 2.8 A country may be able to keep politicians out of interest rates, but you can never take interest rates out of politics. When politicians therefore make statements about interest rates, tolerable central bankers should accept that politicians talk to their voters, and not to central bankers. 2.9 There is no such thing as central banking by rules. Discretion remains indispensable in the daily implementation of monetary policy. Economics, after all, is not an exact science. In the world of macroeconomic policy two plus two may sometimes add up to five. The central banker must, however, never try to stretch it to six. 2.10 A central banker must learn to ignore any praise bestowed on him, particularly through or by the public media. This will justify his right also to brush aside the unfair criticism that will be launched at him next time from the same source. 2.11 In our present world of a rapidly changing global financial environment, a central banker must be a student for ever. Always remember the old Chinese saying that a man must study as if he will live forever, but live as if he will die tomorrow. 2.12 I have left the most important commandment for the last – a good central banker is always against inflation. These twelve commandments represent for me a final conclusion of my experience as a central banker over many years. 3. The people in central banking I cannot let this occasion go by without saying a few words about the people I worked with over many years as a central banker. Firstly, there are the people in government. I wish to thank the Presidents of our country who appointed me in 1975 as Deputy Governor, in 1980 as Senior Deputy Governor and then on two occasions in 1989 and again in 1994 as Governor of the South African Reserve Bank. It was a great privilege for me to serve our country and all of its people for more than twenty years in these senior positions in the Bank. I thank the five Ministers of Finance with whom I worked very closely over this extended period of time. And I add to their names the Directors General and the staff of the Government Departments such as Finance, State Expenditure, the S.A. Revenue Services and Trade and Industries for their co-operation. It is still true as Walter Bagehot observed in the previous century that monetary policy begins at the Treasury. Without co-operation between the central bank and the ministry of finance both monetary and fiscal policies will be weaker. I enjoyed the loyal support of all the people who served with me on the Board of Directors of the Reserve Bank. In particular, I would like to thank those Board members who supported me with dedication and devotion over the past ten years when I was also Chairman of the Board. No words can express my appreciation to the staff of the Bank, all my colleagues past and present who worked with me with great commitment to achieve our objective of protecting the value of the rand in the interest of all the people of South Africa. Many times I said to you, and to the many people in South Africa and abroad who praised me for the achievements of the Bank, that we must always remind ourselves that the world is run by people second in charge. You made the South African Reserve Bank the outstanding institution of excellence that it is known to be today. You shall also protect this laudable reputation of our proud institution in the future. I am grateful for this opportunity to direct a few words of appreciation also to the many foreign visitors we have with us this evening, firstly, to the Governors and representatives of central banks, the International Monetary Fund and the Bank for International Settlements. What a wonderful experience it was for me to have been a member of the exclusive club of central bankers in an expanding global financial environment. I have learned more from you in conferences, in meetings and in numerous discussions than from all the textbooks I struggled with to obtain my university degrees. It is a great privilege for us to have the governors of more than ten central banks from Africa here this evening, and also senior staff members to represent others. I wish I could spend another ten years working with you in meeting the great challenges we face together to develop the financial structures of our continent, and to establish in Southern Africa an intimate forum for effective central bank co-operation. We have a number of private foreign bankers present here, representing institutions that battled with me in the days of South Africa’s isolation and debt rescheduling arrangements, but also lend great support to me and the Reserve Bank, particularly over the past five years when we had to reintegrate our country in a rapidly changing global financial market environment. I pay tribute to the South African bankers who do not always agree with the Reserve Bank’s hard line approach on financial disciplines, but who always remain loyal to their central bank. It did not go unnoticed in the world financial markets over this past year, with major global financial market disruption, that the South African banking sector remained stable and sound. I give the credit for this to you, the managers of sound and well-disciplined private sector institutions. Finally, talking about the people of central banking, I must thank my wife, my four children together with their spouses for their support over many years. I like to refer to the husband and wives of my children as my children who became my children because of the decisions of my children. My wife seldom had a normal husband, my children must on many an occasion have missed a normal father in the house because they had to contend with a husband and a father addicted to central banking. My peers as central bank governors will know what these words mean. 4. The future of central banking Looking ahead, I can only express my regrets that I were not as of today ten years younger. Exciting times lie ahead for the central bankers of the world as the process of the integration of financial markets around the globe will continue. However, I leave the South African Reserve Bank in great peace of mind because I am confident that Mr Tito Mboweni and the team with him in the Bank have the ability, the determination and the will to steer South Africa successfully into this brave new world. Tito, I admire the way in which you approached the past year of induction with us in the Reserve Bank. You succeeded in getting the staff of the Bank on your side. You grasped very quickly what many outsiders will always regard as the mystique of central banking. You have truly become one of the members of the exclusive club of central bankers of the world. I leave the Bank with great confidence that you will be the Governor that will finally destroy the African jackal of inflation in our country. I wish you well. 5. Conclusion One day, shortly after lunch, as I was sitting in the Governor’s office on the 32nd floor of the Reserve Bank Head Quarters building in Pretoria, the sliding door to the balcony in front of the office was standing open. I heard a noise and there came a bird almost falling out of the air as if it was shot. I walked out and found a beautiful homing pigeon lying on the floor of the balcony as if it was dead. I carried on with my duties behind my desk. After about half-an-hour, I noticed the pigeon was recovering. On weak legs and with watery red eyes it started observing the environment. And then, to my surprise, with unexpected dignity and confidence, it walked straight into the Governor’s office. The pigeon settled itself down on the carpet against the couch. I realised this bird must have come from somewhere far and it must be thirsty and hungry. In an ashtray, I gave it some water. My secretary produced a few breadcrumbs from somewhere. The pigeon drank and ate with a grateful look in its beautiful yellow-ringed red eyes, and then nestled down for a good sleep-in. I asked my Secretary not to let anybody into the office and to walk on tip-toe as long as the special guest stayed with me. After about two hours with the sun already setting in the west, my visitor woke up, looked around and then, with even greater dignity and self-composure, walked out of the office. On the balcony, it stretched its legs, shook its wings and looked around to determine direction. And then it took off and flew away. The bird obviously came a long way and was now destined for the comforts of its home, and for a good rest after a long journey. I could not help but to think of this homing pigeon when I left the office of the Governor on the 32nd floor of the Reserve Bank building for the last time this morning. | south african reserve bank | 1,999 | 8 |
Statement by Mr Tito Mboweni on the occasion of the retirement of Governor Chris Stals as Governor of the South African Reserve Bank and his inauguration as new Governor, held in Midrand on 7 August 1999. | Statement by Mr Mboweni at his inauguration as new Governor of the Reserve Bank of South Africa Statement by Mr Tito Mboweni on the occasion of the retirement of Governor Chris Stals as Governor of the South African Reserve Bank and his inauguration as new Governor, held in Midrand on 7 August 1999. * * * … Esteemed guests Ladies and gentlemen, It is a privilege and an honour to have you all here as guests of the South African Reserve Bank as we say goodbye to Dr Chris Stals, who was Governor of the Reserve Bank for ten years, and as we also mark the start of my term as Governor. I am particularly pleased that all of you people with busy schedules have come from near and far to be with us on this occasion. A special note of thanks to the President of the Republic, Professor Stanley Fischer from the International Monetary Fund, Mr Bill McDonough, President of the Federal Reserve Bank of New York, Mr Urban Bäckström, Governor of the Central Bank of Sweden and also President of the Bank for International Settlements, Mr Adriano Maleiane, Governor of the Bank of Mozambique and other central bank governors who are here tonight. Thank you to those of you who battled to rearrange your diaries to be with us tonight. Thank you once again. Tonight we say farewell to Dr Chris Stals, with whom I have worked closely over the past year but whom I have known since 1988. I have come to know Dr Stals as a committed central banker of international stature, a truly new Voortrekker who did not shy away from contributing his best to the new South Africa. Thank you, Dr Stals, for your lasting contribution and for showing such commitment during this smooth transition. We are also bidding a fond farewell to Dr Chris de Swardt, an Afrikaner gentleman par excellence who was Deputy Governor, and whose career at the Bank also spanned some 44 years. This man is an example of how one should relate to and treat other human beings. Although our association was brief, I will treasure our association for a long time to come. We wish both of you well in your retirement. It is a most interesting and demanding time to be Governor of the South African Reserve Bank. It is a time when the costs and benefits of globalisation are under scrutiny, not just by policymakers, but also by ordinary citizens. Emerging markets globally have experienced financial turmoil which plunged many into deep recession. South Africa, though resilient, has not emerged from this turmoil unscathed. At only 0.5%, the rate of growth in gross domestic product last year fell woefully short of the levels needed in a country where poverty and joblessness remain widespread and where tackling these issues remain priorities for all of us. Against this background, it is hardly surprising that people sometimes hope that the Reserve Bank will take action to stimulate economic growth by printing money. Some people think that, as a former Cabinet Minister, my appointment heralds the start of a cheap money era in the Bank. I must say it here, loud and clear, they are wrong. Our view has been, and will continue to be, that it is not our role to provide an artificial stimulus for the economy. The role of the Bank is to create a climate of financial stability in which sustainable economic growth and wealth creation can be achieved; an environment in which an economic boom will not be followed by an inevitable bust. We are not Icarus; there is no need to fear that we will fly too close to the sun. Tonight is not the appropriate occasion to spell out our detailed approach to monetary policy or its role in the South African economy. However, we are not going to try to rewrite the monetary policy textbooks or reinvent the wheel. The principles of sound and prudent central banking are the same the world over and will not be fundamentally changed by any central bank governor, no matter how energetic or enthusiastic, let alone how young. The details of our approach will be spelt out in the Governor’s Address at the Annual General Meeting of the Bank on the 24th of August. However, whatever we say then will be in accordance with the principles of sound and prudent monetary policy frameworks that have been tested in a global context. Central banks follow different approaches to their monetary policy frameworks. Some central banks have adopted currency boards to fix their exchange rates, while others follow exchange rate targeting or inflation targeting. We will design our approach bearing in mind our particular experiences and history, as well as taking into account international best practice which has delivered financial stability and acceptable levels of inflation. South Africa has been exposed to the recent turmoil in financial markets but has emerged, whilst a little bruised, both stronger and wiser. We, like other countries, have learnt important lessons and will put our experience to good use. We know that if we want to benefit from globalisation in the form of sustained foreign capital inflows, we should constantly think of ourselves as citizens of the global village. The strength of the United States economy and trends in financial markets in New York, London, Tokyo and elsewhere will be significant factors in influencing whether or not South Africa realises its economic potential. But we must not underestimate our own responsibility as South Africans to develop our own potential and to run our economy responsibly and efficiently. As citizens of the global village, we must continue to participate actively in the debate on improving the international financial architecture in the hope that a way can be found to minimise the intensity of financial shocks to emerging and developed markets alike. After a long, stimulating and challenging year which I have spent navigating the transition from Cabinet Minister to central banker and getting to know my colleagues in South Africa and other parts of the world, I am looking forward to starting officially next week with enthusiasm and confidence, inspired in no small part by many of you present here tonight. We are fortunate that the South African Reserve Bank is staffed by well qualified, committed and loyal people. To the President, the members of the Board of Directors of the Bank, my colleagues the Deputy Governors, management and staff, and esteemed guests: sweswi hi ngene eka nkari wa mahlambandlopfu (we are now entering the time of the day when the elephants go washing; that is, the crack of dawn). | south african reserve bank | 1,999 | 8 |
Address of Mr T T Mboweni, Governor, at the South African Reserve Bank's seventy-ninth ordinary general meeting of shareholders on 24 August 1999. | Mr Mboweni’s address on the occasion of the seventy-ninth ordinary general meeting of shareholders of the South African Reserve Bank Address of Mr T T Mboweni, Governor, at the South African Reserve Bank’s seventy-ninth ordinary general meeting of shareholders on 24 August 1999. * * * Introduction The South African economy has recovered remarkably from the contagion effect of the financial turbulence in Asia and Russia. After being seriously affected by the volatility in global financial markets during the four months from May to August, tentative signs of a return to financial stability already began to appear during the last few months of 1998. The recovery of the financial sector was, however, attained at the cost of lower economic growth because of the restrictive measures that the authorities were forced to apply, the impact of a slowdown in international economic activity in many parts of the world and a slump in international commodity prices. Currently the economy seems to be poised for higher growth in production, provided that it is not again affected by setbacks in other countries. At the beginning of the financial turmoil the thinking was that it would only have a limited impact on domestic economic conditions through a lower demand for South African exports from the Asian region. Later it became apparent that the crisis would not only be restricted to certain countries in Asia, but would affect many countries around the world. The international financial system was dealt a further blow when Russia de facto devalued the rouble, imposed a moratorium on foreign credit repayments and unilaterally restructured public debt in August 1998. As a result of these circumstances, international investors lost confidence in emerging markets and withdrew investments from developing countries to higher quality, but lower yielding, financial assets of industrialised countries. Interest rates rose to high levels, equity and bond prices fell sharply and the currencies of many economies depreciated considerably. Many banks and other financial institutions suffered losses, especially on highly leveraged investment positions, which induced systemic risks in the financial sectors of some emerging-market economies. The financial turmoil spilled over to real economic activity, with serious consequences for growth in world production and trade. All these developments once again demonstrated that in a globalised financial system the mobility of capital has serious consequences for financial stability. In a closely integrated financial world it has become even more important for monetary policy to be focused primarily on financial stability. The lack of a credible commitment to that objective by the monetary authorities could intensify the risk of market overreaction and systemic instability. Such a policy approach does not, of course, provide unconditional protection against speculative capital outflows. Decisions by international investors to withdraw capital from a country, based on developments in other emerging-market economies, are beyond the control of any central bank. The best approach that the South African Reserve Bank can follow is to pursue financial stability in a transparent way so that it can forestall uncertainties. Monetary policy will be more successful in avoiding imbalances and disruptive capital flows if measures are in place to address structural weaknesses in the economy. Crisis prevention requires close coordination between the various spheres of macroeconomic management to ensure market confidence. In addition, domestic financial systems should be closely monitored and made more transparent and thus more robust. While it is essential for South Africa to maintain these disciplines, the recent crisis has illustrated the need to adapt the international financial system to the realities of global markets to reduce the frequency and size of crisis situations. International organisations have made considerable progress with the improvement of the financial architecture. Standards or codes of good practice have been or are being developed in many financial disciplines to allow market participants to compare the practices of countries with internationally agreed benchmarks. The Reserve Bank regards this work as essential for the creation of more stable conditions and is accordingly willing, wherever possible, to participate in these endeavours. If a financial crisis does occur despite the efforts of the monetary authorities to prevent it, monetary policy has to accommodate the market. Intervention in financial markets can assist in smoothing the adjustment process, but should not oppose market trends. The authorities have to allow interest rates and the exchange rate of the currency to move to new levels. Such adjustments increase the cost of speculation, reduce inflationary pressures and contribute to an improvement in the balance of payments position of a country. Unfortunately, the adjustments required in a crisis also adversely affect real economic activity. However, experience in many of the emerging-market economies during the recent financial crisis has shown that where monetary policy had not been tightened quickly and sufficiently, instability persisted with an even greater negative impact on those economies. Pursuing a tighter monetary policy led to a quicker return to currency stability and market confidence. This, in turn, provided room for a lowering of interest rates which helped to mitigate the negative results of the earlier tighter measures. The efforts of individual governments and the international financial community to re-establish financial stability are proving successful. The implementation of flexible exchange rate regimes and other structural adjustments in emerging-market economies seemed to have stabilised financial markets during the first seven months of 1999, and are also improving the prospect of a gradual economic recovery. Interest rate cuts by central banks in virtually all major industrialised countries are helping to improve liquidity and to rebuild investor confidence. Although there are still risks and uncertainties in the world economy, conditions are far better now than they were during 1998. The contagion effects of the international financial crisis on South Africa The effects of the international financial crisis spilled over into the South African economy in May 1998 when foreign fund managers began withdrawing portfolio investments. The well-developed capital markets and the relatively free convertibility of capital in the country provided an easy source of liquidity for fund managers who wished to reduce their exposures to emerging markets. From May to December 1998 non-residents reduced their holdings of South African bonds by R26 billion. In the first four months of the year they were net buyers on the South African Bond Exchange to the amount of R16 billion. This reversal of portfolio investments in bonds by non-residents was difficult for the South African economy to absorb because it occurred at a time when South Africans were also making direct and portfolio investments in other countries following a relaxation of exchange controls. Moreover, the reversal created leads and lags in other foreign payments and receipts related to an expected depreciation of the rand. However, non-residents continued to invest large sums in the equity capital of South African enterprises, with the result that the net outflow of capital not related to reserves amounted only to R0.4 billion in the second half of 1998, compared with an inflow of R8.3 billion in the first half of the year. The international developments also affected the current account of South Africa’s balance of payments because they brought about a substantial drop in international commodity prices and depressed world trade. The volume of merchandise exports declined in the second half of 1998, while higher rand proceeds for exports mainly reflected a depreciation of the currency. In addition, the gold price in terms of United States dollars declined further and the value of imports rose steeply because of infrastructural investments by public corporations. These developments led to an increase in the deficit on the current account of the balance of payments and a marked decrease in the gold and foreign exchange reserves of the country. As could be expected under these circumstances, the exchange rate of the rand depreciated to a level at the end of 1998 that was nearly 20% lower than its weighted value at the end of 1997. The volatility in international financial markets generated substantial increases in the turnovers of financial markets in South Africa, including the markets in foreign exchange, shares, bonds and derivatives. The large outflow of foreign funds on the Bond Exchange contributed to an increase in the daily average yield on long-term government bonds from a low of 12.67% on 17 April 1998 – its lowest level since May 1994 – to 20.09% on 28 August 1998. So much liquidity was drained from the South African banking sector that the banks had to borrow large amounts from the Reserve Bank on a daily basis. The liquidity shortage in the market pushed up short-term interest rates by about 7 percentage points, forcing the banks to raise their prime overdraft and mortgage lending rates to more or less the same extent. These higher lending rates had a dampening effect on real-estate transactions. Share prices also dropped sharply, even though the market was supported by a strong demand from foreign investors. The high turnovers in the financial markets and a desire for precautionary money balances resulted in an exceptionally strong growth in the money supply. The growth over twelve months in the broadly defined money supply (M3) reached 19.4% in June 1998 and declined only fractionally to 18.9% in August 1998. These high rates of increase were recorded despite a slowdown in the growth of nominal gross domestic product and apparently formed part of the rise in the nominal value of financial asset portfolios. This latter factor, together with an increased demand for working capital by the corporate sector and some borrowing by companies to tide them over a period of slack demand in the economy, were prominent forces behind a continued steep rise in total bank credit extension. The increase in the demand for bank credit was reinforced by speculative opportunities in a period of heightened volatility in the securities markets. The international financial turmoil halted the downward movement in the rate of increase in both production and consumer prices from the beginning of 1997. Over the six months to September 1998, growth in production prices accelerated considerably as the rand depreciated. The consumer price index, in turn, was strongly influenced by a sharp rise in the prices of consumer services, notably the rise in mortgage lending rates. Core inflation, which excludes certain food prices, interest costs, valueadded tax and municipal rates, was far more subdued, rising from 6.9% in March 1998 to only 7.7% in September 1998. In comparison to other emerging-market economies, the South African banking sector proved remarkably resilient during the global financial turmoil. Banks were able to weather this storm better than some of their counterparts in other countries because of good management, strict legislative requirements, low international credit exposures and diligent risk management. The level of the net external liabilities of banks is low, in other words their exposures to exchange rate risks are minimal. In addition, our banks eased the increased burden of high interest rates on borrowers by extending the repayment period. The non-performing loans of banks nevertheless increased by more than R8.2 billion over one year to R27.4 billion at the end of June 1999, but the gross overdues of banks as a percentage of total loans and advances amounted to only 4.7% on this date; a level which is still low enough not to be of concern. Many of the banks have in any case also increased their provisions for bad and doubtful debts, which amounted to 2.7% of loans and advances at the end of June 1999. The banks in South Africa are well capitalised. The average risk-weighted capital-adequacy ratio for the system as a whole reached 11.6% at the end of June 1999, compared with the required minimum ratio of 8% stipulated by the Basel core principles. Moreover, more than half of the banks had a capital-adequacy ratio of 15% or better. The disruptions internationally did not materially affect the profitability of banks, and their return on equity reached approximately 15% at the end of June 1999. Cost control and an expansion of the business of banks into new areas helped to sustain profit levels. Banks have successfully developed alternative non-interest-bearing sources of income, and transaction-based fee income and investment income now represent nearly half of their net revenues. The return to financial stability The way in which the banking sector coped with the international financial crisis, together with a prudent monetary policy approach, were important factors that contributed to a relatively quick return to financial stability in South Africa. By the fourth quarter of 1998 there were signs that the storm was abating. The strain on the South African situation slackened so much in the last part of 1998 that the exchange rate of the rand against the United States dollar eased from about R6.66 on 28 August 1998 to R5.70 early in January 1999. Domestic interest rates declined by about 3 percentage points over the same period. Although problems in Brazil temporarily created new pressures in the South African market for foreign exchange in January 1999 and interrupted the decline in interest rates, the nervousness in the financial markets gradually evaporated when it became apparent that the contagion effects of Brazil’s problems would be limited. Non-residents again became net buyers of South African bonds, while they continued to invest large amounts in shares listed on the Johannesburg Stock Exchange. In the first seven months of 1999 the portfolio investments of non-residents in South Africa amounted to no less than R33.8 billion, compared with disinvestments of R3.2 billion in the last eight months of 1998. Direct investment by foreigners in domestic enterprises came to R3.7 billion in the first half of 1999. These investments were neutralised to some extent by South African investments in other countries, with the result that the net inflow of capital not related to reserves, or the surplus on financial transactions with the rest of the world, totalled R7.4 billion. At the same time, a lower level of final demand, significant further reductions in inventories and an increase in the cost of imported goods, depressed the value of imports. By contrast, exports rose strongly as the Asian economies began to recover, the decline in international commodity prices levelled out and domestic producers began expanding into other markets. Expressed in terms of seasonally adjusted and annualised rates, the current account of the balance of payments accordingly turned around from a deficit of R19.1 billion in the last half of 1998 to a surplus of R0.6 billion in the first half of 1999. The improvement in South Africa’s overall transactions with the rest of the world led to a sizable increase in the international reserves of the country. The total gross gold and other foreign reserves improved steadily from a lower turning point of R40.9 billion at the end of November 1998 to R47.2 billion at the end of June 1999. The nominal effective exchange rate of the rand nevertheless decreased somewhat in the first seven months of 1999. At the end of July 1999 the weighted average level of the exchange rate of the rand was no less than 38.4% below its level at the end of 1995, clearly indicating a marked strengthening of the international price competitiveness of domestic producers. The greater stability in the exchange rate of the rand and the containment of domestic cost increases relieved inflationary pressures. As a consequence, a slowdown in inflation in consumer prices was observed from the end of 1998. However, higher oil prices contributed to a rise in production prices from the very low levels reached in the first half of 1998, while core inflation increased from 7.1% in April 1998 to 8.2% in July 1999. The surplus balance on South Africa’s transactions with the rest of the world eased the total liquidity requirement of banking institutions and prompted a steady decline in money market rates in the first seven months of 1999. Sentiment in the market for fixed-interest securities became more positive in view of the slowdown in the inflation of consumer prices, an easing in money market conditions and declining short-term interest rates, a conservative fiscal policy which reduced government’s funding requirement for the fiscal year ending 31 March 2000 and positive credit assessments by international rating agencies. Consequently, the yield on long-term government bonds declined from 20.09% on 28 August 1998 to 15.18% at the end of July 1999. As normality returned to financial markets and the turnovers on these markets came down from the exceptionally high levels that they had reached during the international financial turbulence, growth in the monetary aggregates finally started to decline after four years of high rates. The general downturn in economic activity, lower inflation and a decline in liquidity preference, were other factors that caused the growth in M3 to move within the guideline growth range of between 6% and 10% from February 1999. The growth in total domestic credit extension by banks also slowed down significantly in the first half of 1999. Despite these favourable developments, it is important that monetary policy takes into account that the ratio of the money supply to gross domestic product was still very high at 53.5% in the second quarter of 1999. All in all, the financial markets have rallied remarkably during 1999. Internationally, the turbulence prevailing during 1997 and 1998 seems to have calmed down. Provided that there are no serious setbacks in the international economy, we are confident that real economic activity in South Africa should begin to recover. Adverse financial conditions depressed economic growth and employment At the beginning of 1998 it was expected that the downswing in economic activity experienced during the preceding year would come to an end and that the economy would turn around before moving into a recession. However, the measures that the authorities were forced to take to stabilise financial conditions led to sharp declines in the components of domestic demand that are sensitive to interestrate costs, such as inventories, consumption expenditure on durable goods and private-sector fixed investment. Domestic production was also harmed by a lower demand for exports, with the result that real gross domestic product contracted sharply in the third quarter of 1998. Fortunately, this setback was short-lived and aggregate output began to increase again, albeit at low rates. The downturn during the middle of 1998 spread to most of the economic sectors, with the notable exception of financial services which benefited from price volatility and high turnovers in financial markets. From the fourth quarter of 1998 the secondary sectors and some of the other tertiary sectors started to record small positive growth, but the value added by agriculture and mining continued to contract. Gold production, in particular, decreased sharply in reaction to the effect that increased gold sales by some central banks had on the price of gold. The gold mines have had to contend with rising costs of production and a generally depressed market price since the mid-1980s. This has not only had serious consequences for the domestic economy, but also affected developments in neighbouring countries through the loss of employment opportunities. From the beginning of the 1980s the number of people employed on the gold mines has been reduced by almost 250,000 because of mine closures and the introduction of cost-saving production methods. The substitution of capital for labour in other sectors of the economy further contributed to high unemployment in South Africa and other negative social effects. The low production growth in the past year aggravated this problem as employment was slashed further. The decline in employment was accompanied by a marked increase in labour productivity. At first the growth in output per worker could not contain an acceleration in the rate of increase in nominal unit labour costs. From the beginning of 1999 the growth in unit labour costs has slowed down significantly, which could help to curtail inflation because labour is still the single most important component of overall production cost in the economy. Unlike the decline in production, the domestic demand for goods and services continued to expand in 1998, but the rate of increase in aggregate expenditure slowed down. The main reason for the expansion in final demand was the solid growth in fixed capital formation, largely owing to investment expenditure in telecommunication and transport activities by public corporations. Contrary to these developments, the rates of increase in the consumption expenditure of both the public sector and households slowed down considerably during 1998, while private-sector real fixed investment declined sharply. Inventory levels were reduced significantly in response to the slowdown in domestic economic activity and the high costs of carrying stock. In the first half of 1999 the real domestic final demand for goods and services declined markedly when the capital spending of public corporations contracted. In addition, a decline in interest-rate sensitive household expenditure on durable goods and the strict discipline applied to government expenditure resulted in a decrease in consumption expenditure, while private-sector fixed investment continued to move to lower levels. Real gross domestic expenditure contracted even more sharply than final demand, due to a reduction in inventory levels as businesses economised further on inventory holdings. The reduction in consumption expenditure and efforts of households to bring down high debt levels led to a marginal improvement in the savings ratio of households in the first half of 1999. Moreover, the resolve by government to adhere to sound fiscal policies was reflected in a decline in the net dissaving by general government as a ratio of gross domestic product from 5% in 1997 to 3% in the first half of 1999. The corporate sector succeeded in lifting retained earnings by more than the growth in production over the same period. As a consequence, the ratio of gross saving to gross domestic product rose somewhat from a low of 13% in the fourth quarter of 1998 to 15% in the first half of 1999. Although this is a welcome change in the declining trend of the savings ratio, it is still well below the levels needed for sustained higher economic growth. Serious attention will have to be given in economic policy deliberations to promoting saving and inward direct investments in order to create job opportunities. Prudent public finance The government persisted with a well-managed conservative fiscal policy stance. The public-sector borrowing requirement, i.e. the deficit before borrowing of the central government, provincial governments, local authorities, non-financial public enterprises and public corporations, has been brought down systematically from an upper turning point of 9.3% of gross domestic product in the fiscal year 1993/94 to a ratio of 3.4% in the fiscal year 1998/99. In the past fiscal year there was a decline in the absolute value of the public-sector borrowing requirement. What made this an even more remarkable achievement was the fact that the revenue of the government increased at a lower rate than in the preceding year. Total expenditure by general government, however, rose at a rate of only 5.3% in the fiscal year 1998/99, i.e. significantly below the inflation rate. General government successfully contained growth in expenditure mainly through a decisive slowdown in current spending on goods and services. The financial turbulence and monetary policy The conservative fiscal policy stance assisted in countering the contagion effect of the international financial turbulence during 1998. However, the brunt of the adjustment process fell on monetary policy, as it takes a long time to make changes in fiscal and other policy measures. The strains that developed in the foreign exchange market in 1998 caused the exchange rate of the rand and domestic interest rates to adjust automatically to the changed supply of and demand for foreign exchange and the impact of these developments on bank liquidity. In these volatile and uncertain circumstances, the monetary authorities could only influence the speed of the adjustments required by the market. The Reserve Bank’s response was to underprovide in the liquidity requirement of the banks and to intervene in the foreign exchange market so that financial stability could be restored at the least cost in terms of inflation and economic growth. As a result, the repo rate moved sharply upwards by about 7 percentage points from the beginning of May to 21.85% on 28 August 1998. The accommodation system was made more effective to cope with the crisis by phasing in a wider spread from 1 to 20 percentage points between the repo rate and the marginal lending rate. These measures led to corresponding steep increases in other short-term interest rates, which eased the adjustment in the exchange rate of the rand. In tandem with the rise in interest rates, the Reserve Bank at first intervened heavily in the foreign exchange market in May and June 1998 in an attempt to create some order in a market that had become extremely sensitive to any negative news or rumours. The intervention consisted mainly of swaps in the forward market, which increased the Bank’s net open foreign currency position from US$ 12.8 billion at the end of March 1998 to US$ 23.2 billion at the end of September 1998. The Bank returned this foreign exchange liquidity to the market which had been obtained previously from large inflows of portfolio investments. In view of the large risks and potential costs associated with a net open exposure, the Reserve Bank stopped using this intervention technique when it became apparent that the contagion impact of the emerging-markets’ crisis would be more severe and longer lasting than originally expected and when the purchases of foreign exchange preceding the crisis had been fully reversed. This decision was validated when it became known that highly leveraged funds had built up speculative positions against the rand through forward foreign exchange transactions. Later, when these leveraged funds incurred losses in emerging markets and were forced to buy back their short rand positions, these transactions contributed to the retracing of some of the rand’s earlier losses. As indicated, financial conditions became more stable from the fourth quarter of 1998. General nervousness continued to prevail among international investors, and they withdrew funds from emerging-market economies whenever there were signs of any pressure on exchange rates. In these circumstances, the Reserve Bank deemed it prudent to guide the repo and other money market interest rates gradually down to lower levels. With brief interruptions, the repo rate then moved lower from its upper turning point of 21.85% on 28 August 1998 to 13.65% on 31 July 1999. Over the same period, the net open foreign currency position of the Reserve Bank was reduced by US$ 5.6 billion to US$ 17.5 billion at the end of July 1999. Despite the initial wide fluctuations in the repo rate, the repo-based accommodation system that the Reserve Bank had introduced in March 1998 is proving of considerable value in general and during periods of instability in financial markets in particular. Most of the difficulties encountered shortly after the implementation of the system were due to general nervousness in the market and teething problems. The system was flexible enough to be adjusted easily to solve these problems. Changes to enhance the efficiency of the repo system included the shortening of maturities, the introduction of “square-off auctions” at the end of the daily settlement period, administrative adjustments to the management of cash reserves and a refinement of the signalling procedures of the Reserve Bank. After these changes had been made, short-term interest rates became more flexible without being too volatile or too slow in reacting to signals. The way forward The liberalisation and international integration of financial services make it imperative for South Africa to bring domestic inflation in step with that of the rest of the world and to maintain sound and efficient financial institutions and markets. If these goals are not achieved, the economy could be subjected to sudden reversals in international capital flows, exchange rate instability and volatile interest rates. The thrust of monetary policy in these circumstances should therefore be to establish and maintain financial stability, i.e. stability of prices, financial institutions and financial markets. This does not mean that monetary policy ignores other objectives of economic policy, such as economic growth, employment creation and improved social conditions in the country. On the contrary, we regard financial stability as a precondition for balanced and sustainable economic growth and improved living conditions, because it improves the efficiency of the pricing system and economic decision-making; enhances the efficiency of financial intermediation; minimises the inflation risk premium in long-term interest rates; reduces the incentive to hedge against inflation; promotes a more equitable distribution of wealth and income; and facilitates investment decision-making. A monetary policy that maintains financial stability in a credible and lasting way will accordingly make the best overall contribution to improving economic growth, employment and living standards. A market-oriented strategy will be followed to achieve this overriding goal of monetary policy because financial institutions and markets function best in the national interest if they are competitive, active and liquid, and if interest rates and exchange rates are flexible. The Reserve Bank will accordingly continue to discuss with government the relaxation of exchange controls when underlying conditions are conducive to taking such steps. The eventual removal of exchange control restrictions should contribute towards dismantling the oversold forward book and reducing the net open foreign currency position. Once residents have accumulated large amounts of foreign assets, they could use these assets to counterbalance short-term currency volatility if they perceive this to be an opportunity to profit from a temporary undervaluation of the exchange rate. In pursuit of the primary objective of price stability it is essential, as stated in the Constitution, that the Reserve Bank performs its functions independently and without fear, favour or prejudice. The Bank will maintain an attitude of economic-professional objectivity, but will, of course, at the same time be accountable to Parliament and the general public for its actions. Transparency in the interpretation of economic data and the monetary policy stance will be promoted further. Regular reporting on economic conditions and Reserve Bank operations to Parliament and the general public will receive high priority. Although the Bank will strive to achieve closer cooperation and coordination with the authorities responsible for policy decisions in other macroeconomic and microeconomic fields, the autonomy of the Bank will be preserved. There are structural deficiencies in the economy which impair saving, investment, production growth and employment creation and increase the level of real interest rates. A number of initiatives announced by the President at the opening of Parliament are aimed at easing these supply-side constraints. The implementation of these structural changes could create further scope for lower nominal and real interest rates. Closer cooperation and coordination between the Reserve Bank and other national official bodies may expedite this process. The Southern African Development Community (SADC) provides an opportunity for member states to face jointly the challenges of global financial integration. Considerable progress has been made over almost four years in promoting interaction in Southern Africa through the Committee of Central Bank Governors of the SADC. This committee has enhanced cooperation among central banks; forged close ties between bank regulators and supervisors in member countries, promoted the expansion of training facilities for employees of central banks, enhanced the payment, clearing and settlement systems of member countries, established closer consultation between private banking institutions and stock exchanges operating in the region, analysed exchange control restrictions in Southern African countries with the aim of gradually removing or harmonising these restrictions and collected and disseminated macroeconomic statistics. The South African Reserve Bank will continue to promote the effective cooperation and integration of the financial systems and markets of Southern Africa. Where needed, banking institutions and financial markets should be established in conjunction with effective payment, clearing and settlement arrangements within and between countries in the region. For the time being this will be done informally before attempting to achieve officially sanctioned harmonisation and integration of financial arrangements. In applying monetary policy in South Africa it is advisable to move away from the “eclectic” or informal inflation-targeting framework to formal inflation targeting. The eclectic monetary policy approach has been a useful framework for containing inflation, but at times it created uncertainties about Reserve Bank decisions and actions which were perceived as being in conflict with intermediate objectives. The guidelines on the growth in money supply and bank credit extension have constantly been breached in recent years as a result of financial deepening. To the extent that a formal or explicit inflation-targeting framework would be more transparent than the previous framework, it ought to allay some of these uncertainties. With the adoption of inflation targeting, it will become clear that the containment of inflation is not solely a Reserve Bank responsibility. Inflation targets should be set jointly by the Reserve Bank and government. Inflation targeting will be more effective when economic policies are well coordinated. Before inflation targeting is introduced, this coordination should be clearly spelled out and all stakeholders must be consulted, including business and the trade union movement. We are convinced that the government will ensure that the policy measures are properly coordinated. Our considered view is that a policy target agreement should be drawn up that would be signed by the Minister of Finance and the Governor of the Reserve Bank to define precisely the coordinated effort needed to contain inflation in pursuit of the broader economic objectives of sustainable high economic growth and employment creation. In this agreement the instrumental independence of the Reserve Bank must be guaranteed. This stipulation and the rest of the agreement will, of course, have to be ratified by Parliament. Inflation targeting is a complicated monetary policy framework that requires careful preparations before an announcement is made to apply it in practice. To facilitate the implementation of inflation targeting, the Bank is currently revising and reorganising the functions of the Economics Department, now renamed the Research Department. As the new name implies, the activities of the department will concentrate on research, i.e. analysing monetary issues and coordinating research in the Bank. Although an important part of the Research Department’s work will still be devoted to the compilation of economic statistics that can be used in economic analysis, greater attention will henceforth be given to monetary policy assessment, econometric modelling, international economic developments, international relations and labour and social research. The Research Department is developing the technical support systems that are essential for the implementation of an inflation-targeting framework, namely the development of additional and more sophisticated inflation-forecasting models, the investigation of the transmission mechanism between changes in policy instruments and inflation and the design and implementation of a survey-based assessment of inflation expectations. Although these steps are necessary for the implementation of inflation targeting, this new framework should not in any significant way affect the conduct of monetary policy. Policy actions will still be guided by a medium-term inflation outlook, albeit in a more transparent manner. In order to arrive at an inflation outlook, the Bank will continue to monitor a wide range of economic indicators, including developments in money supply and bank credit extension. In this new framework the Bank’s main operational instrument will continue to be the repo mechanism. The same fine-tuning and structural operational instruments will be used to influence interest rates and the level of the exchange rate of the rand will be determined primarily by the impact of these actions on the supply of and demand for foreign exchange. Price stability depends not only on monetary operational procedures, but also on stability in the financial sector or the degree of confidence in the ability of financial institutions and markets to meet contractual obligations without interruption or outside assistance. Any signs of weakness in the financial system could disrupt price stability. Conversely, stability in the financial sector could be seriously disturbed by sharply rising inflation and interest rates, and a resultant increase in nonperforming loans and a fall in asset prices and collateral values. An appropriate balance between risk and reward in the financial system is a major challenge to any central bank. In view of these considerations, the Reserve Bank will continue to monitor financial conditions carefully as part of its objective to maintain financial stability. Where unavoidable pressures do arise in the financial system, the Bank may have to carefully contain them directly as “lender of last resort”. The lender-of-last-resort facility will not, however, automatically be made available to all banks in distress, but only in cases where the failure of a bank would pose a serious threat to the financial system as a whole. Criteria will be established to specify the exit strategy of the Reserve Bank. A deposit-insurance scheme is being developed to cover retail depositors. This scheme could provide more latitude in deciding whether to close an ailing bank, without the concern that depositors in financially healthy banks may lose confidence in the banking system as a whole. Sound financial supervision is a prerequisite for financial stability and warranted the debate during the past year on the feasibility of establishing a single financial regulatory authority in South Africa. Most countries have securities commissions responsible for the regulation of investment services and in many countries there is still a separation of banking and insurance supervision. Current opinion in South Africa is influenced strongly by recent developments in the United Kingdom and Australia where banking supervision has been moved out of the central bank into a single financial regulator. There are convincing arguments both for and against a single financial regulator. Arguments for such a single regulator include issues such as the blurring of functional dividing lines between different institutions, the development of financial conglomerates, the exploitation of gaps in financial regulation and the achievement of economies of scale and a uniform style of regulation. Arguments for the retention of bank supervision as a Reserve Bank function are based on the characteristics of banking, the special relationships between the Bank and the banking sector, the high systemic risks in banking, the importance of a healthy banking system for effective monetary policy and the Bank’s ability to compete for scarce human resources. It is important that all these arguments be carefully considered by government to find an appropriate approach to this issue that can continue to assist in the execution of monetary policy. A well-organised decision-making process is another important factor in the conduct of monetary policy. All monetary policy decisions are currently made by the Governors’ Committee (consisting of the Governor and deputy governors), while the Monetary Policy Implementation Committee (MPIC) is responsible for carrying out monetary policy. Although this decision-making process works well, monetary policy issues demand more attention. It has therefore been decided to create a Monetary Policy Committee (MPC) for the formulation of monetary policy. The MPC will consist of the Governor and deputy governors as voting members and senior officials of the Bank as non-voting members. The MPC will consider and evaluate the state of the economy, the current stance of monetary policy and the operational procedures in the conduct of monetary policy and formulate the changes deemed necessary in monetary policy and operational procedures. The final decision-making power on monetary policy matters will nevertheless still vest in the Governors’ Committee. In order to provide opportunities for public involvement in the monetary policy decision-making process, it has also been decided to create a Monetary Policy Forum (MPF). The Governor of the Reserve Bank will chair the MPF, and representatives of private business enterprises, labour and other interested institutions and organisations will be invited to participate in the meetings of the MPF. The MPF will meet twice a year to discuss macroeconomic developments and monetary policy issues. Internal administration of the Bank The internal decision-making process of the Reserve Bank will be changed in the coming year. In addition to the existing Currency, Payment and Financial Systems Committee and the Management Committee, a Budget Committee will be formed. The Budget Committee will have the authority to compile and monitor the implementation of the Bank’s annual budget. Through a Subcommittee on Procurement, the Budget Committee will also be responsible for the procurement, management and control of supplies, services and assets of the Bank. In a further attempt to achieve greater transparency, the Bank has decided to establish a fully fledged Media Office. This office will be primarily responsible for focusing external communication, thus assisting the media, national and provincial legislative structures and the general public to gain a better understanding of the Bank’s policies, decisions and activities. During the past year, considerable progress has been made with a number of other administrative projects in the Reserve Bank. These projects included the certification of year 2000 compliance of the banking system’s information technology infrastructure and applications, as well as the South African Multiple Options Settlement (SAMOS) system. Operational contingency plans have been prepared to handle any problems that may arise over the year-end, including plans for the provision of additional cash, the management of liquidity and for continued clearing, payment and settlement through the SAMOS system. Simulations of the clearing arrangements were conducted on the public holiday on 9 August 1999 and the results were successful. Moreover, the Registrar of Banks has issued a number of regulations to ensure that the banking sector is year 2000 compliant and, in collaboration with the Financial Services Board, has prepared a booklet to inform the public of the preparations to overcome the year 2000 problem. Further progress was made in enhancing various national payment system principles, practices and arrangements in preparation for same-day settlement by June 2000. These enhancements included the introduction of settlement risk-reduction measures, the adoption of a legal framework and the development of a risk and research database. The Reserve Bank and the banking industry have also agreed to collaborate in improving the national notes and coin management system. The wholesale cash processing services performed by SBV Services (Pty) Ltd. will revert to the Reserve Bank. A study is currently being done on ways of improving the infrastructure of the branches of the Bank to cater for these changes. The Bank completed comprehensive recalculations of national accounts and balance of payments statistics during the past year. The estimates follow the conventions and guidelines of the latest System of National Accounts 1993 and the Balance of Payments Manual, prescribed by the United Nations Organisation and the International Monetary Fund (IMF), thus complying with the IMF’s requirements for the Special Data Dissemination Standard. Human resource development is regarded as an important element of the Reserve Bank’s responsibilities because the Bank’s staff is its major asset. Considerable effort has accordingly been made in the past financial year to develop the skills of the Bank’s staff. In addition, several courses were presented to trainees from other African central banks at the Reserve Bank’s Training Institute. The Institute, and the Bank of Tanzania Training Institute also jointly compiled a report on the coordination of training and development in the SADC region. In a further attempt to promote training, the Reserve Bank established a task force to review the training currently provided to staff and to make recommendations on ways of optimising the existing training facilities. In the past financial year, a beginning has been made in drawing up a human resources plan which will deal with progressive employment equity in the workplace by promoting equal opportunities and fair treatment. The plan will propose the implementation of affirmative action measures to redress the disadvantages of designated groups to ensure their equitable representation in all occupational categories and levels of the workforce. A renewed focus will be placed on recruiting from the target group and enhancing the skills profile through development and monitoring. This plan will, however, be put into effect in a manner that will ensure that the institutional memory does not drop below the critical level required for national and international excellence. To achieve these goals, a Subcommittee on Human Resources will be established under the auspices of the Management Committee to oversee the execution of the human resources plan. Concluding remarks Events over the past year illustrate that the thrust of monetary policy in an integrated financial world should clearly be to pursue financial stability. Although such a policy stance does not provide unconditional protection against volatile international capital movements, it improves the country’s ability to withstand international financial turbulence. When international financial disruptions affect the South African economy, adjustments will inevitably have to be made to the exchange rate of the rand, domestic liquidity and interest rates. The objective of the monetary authorities should not be to resist such changes, but rather to ease the adjustment process by pursuing consistent and transparent policy measures. Financial stability is a precondition for sustained economic growth and employment creation. The changes to the monetary policy framework and the monetary policy decision-making process that are proposed in this address should assist the authorities in this difficult task. Inflation targeting is no panacea, but it should help to anchor inflation expectations and minimise the inevitable, but shortterm, social and economic cost of achieving price stability. A more transparent decision-making process will further assist in reaching this goal. The financial crisis over the past two years showed that globalised financial markets and volatile capital movements create new challenges for supervisors to maintain stability in the financial sector. Various incidents revealed the extent to which participants took advantage of a wide variety of leverage methods to enhance returns on investments in emerging-market economies. The extensive use of derivatives and short sales of securities compounded losses and increased the need for liquidity when asset prices declined. In view of such developments, credit risk management becomes extremely important because of the dangers of default and large bad debts in the banking sector. In the recent crisis South Africa was fortunate to have had efficient and well-run banking institutions. Continued attention will have to be given in the coming years to sound risk management and to devoting even more resources to the maintenance of stability in the financial sector. In conclusion, I wish to thank the President and Deputy President of the Republic for their support and appreciation with regard to the functions of the South African Reserve Bank and its governors. I further wish to thank Mr Trevor Manuel, Minister of Finance, Ms Maria Ramos, the Director-General of Finance and the staff of the Department of Finance for their support of the Reserve Bank over the past year. I should like to thank the directors of the Reserve Bank, including the deputy governors, for their undivided loyalty to the Bank. On this occasion, it is also fitting to pay further tribute to Dr Chris Stals for his term of ten years as Governor, and just more than 44 years in the service of the Bank. Dr Stals made numerous valuable contributions to the work of the Bank and for the benefit of South Africa during his career, for which we are deeply grateful. Dr Chris de Swardt, Deputy Governor for almost ten years, also retired recently after a distinguished career of nearly 44½ years in the Bank. We wish both Dr Stals and Dr de Swardt, as well as their wives, a happy retirement and fulfilling years ahead. Finally, I wish to thank the staff of the Reserve Bank for the professional manner in which they performed their duties in the past year. I am confident that with their continued loyal support, the Bank will meet the challenges that lie ahead. | south african reserve bank | 1,999 | 8 |
Speech given by Mr Tito Mboweni, Governor of the South African Reserve Bank at the Western Cape Exporter of the year awards dinner on 1 September 1999. | Mr Mboweni speaks on the role of the South African Reserve Bank in developing the economy Speech given by Mr Tito Mboweni, Governor of the South African Reserve Bank at the Western Cape Exporter of the year awards dinner on 1 September 1999. * * * Many central bank governors fight a constant battle against public misconceptions about the central bank’s role in the economy. After only a short period in the job, I have realised that I, too, will have my work cut out for me in explaining the South African Reserve Bank’s responsibilities. As I discovered last week when I took part in a phone-in programme on SABC radio, there are people who mistakenly believe the Bank can provide them with personal loans, or loans for their businesses. I had to explain that I am not a personal banker with a limitless cheque book. I was also worried to find that some of the callers did not have a good understanding of the relationship between interest rates and inflation. Once again, I realised the need for education and for continued emphasis on the Bank’s main task – the achievement and maintenance of financial stability. There might be people who are getting bored with my message. But I think it is well worth repeating, as even people with a good understanding of the economy sometimes expect us to be miracle-workers who will bring new life to the economy. When I was invited to speak here tonight, my hosts asked me to talk about the role of the central bank in developing the economy, with a particular focus on exports. As was highlighted in the Governor’s Address last week, the central bank’s main contribution to economic development and export growth is to achieve price stability. That must come as a disappointment to those exporters here tonight who hoped I would say something about the rand’s exchange rate against the currencies of SA’s major trading partners. The best that I can do on the topic of the exchange rate is to recount a story about the euro, which has recovered somewhat from its weakness against the dollar. Please bear in mind that I tell the story with my tongue firmly in my cheek. Research published last week by 4Cast, a London-based economic consultancy, suggests that an inverse relationship has developed between the performance of the euro and the frequency of statements by European Central Bank officials about the currency. The periods during which central bank officials kept quiet about the euro coincided with relative stability or appreciation of the euro against the dollar. The researchers were worried that when the ECB officials return from their summer holidays and start talking again, the currency could resume its slide to parity with the dollar. I know there are people who might try to read some deeper meaning into that story. I tell this story simply to illustrate that I believe “less is more” when it comes to comments on the rand. The only comment I will make is to reaffirm that we will not set targets, formal or informal, for the exchange rate. As you know, we have started making preparations for implementing inflation targeting as our monetary policy framework. We believe the inflation targeting route is incompatible with trying to force the currency into a straightjacket. And, in any case, fixed exchange rates are globally becoming a thing of the past as more and more countries move towards flexible exchange rate systems. In the Governor’s Address last week, we outlined our approach to inflation targeting and we reported on the organisational changes being made to the monetary policy decision-making process. We also noted that the South African economy had recovered remarkably well from the effects of financial turbulence in Asia and Russia. Many tentative signs of a return to financial stability had appeared in the economy. This was again confirmed by July’s money supply and bank credit figures which became available yesterday. These figures show that for the first time since 1993, total bank credit extension increased at a rate of below 10%. This is good news indeed. The markets have by now digested last week’s Address. We have noted that analysts and commentators welcomed the decision to formalise monetary policy decisions by establishing a Monetary Policy Committee, or MPC, which will comprise the governor, the deputy governors and senior bank officials. However, market participants are apparently disappointed by our decision not to publish the minutes of the MPC meetings. There are costs and benefits for the Reserve Bank to publish the minutes of internal meetings. In the interests of greater policy transparency, we will issue brief statements to the public at regular intervals to provide information on overall economic conditions and the monetary policy stance. These statements will usually follow MPC meetings, which will take place every six weeks. Frequent and predictable communication with the financial markets is not the only way in which we hope to achieve better public understanding of monetary policy. Regular reporting to Parliament’s finance portfolio committee meetings, which are open to the media and the public, is another important component of getting our message across. That is why I was pleased to accept the portfolio committee’s invitation to brief its members in Parliament and take questions on the Governor’s Address later this month. The release last week of the Governor’s Address and the Annual Economic Report was a good opportunity to take stock of the economy after a particularly difficult time. As exporters, you will know that global demand for South Africa’s exports suffered a severe setback in the second half of last year as a result of the turmoil in international financial markets. As a result of the crisis in Asia, the share of South African exports destined for Asian countries, including Japan, declined from more than 21% of total exports in the third quarter of 1997 to about 15% in the fourth quarter of last year. African economies were also experiencing hard times, and the contribution of exports to Africa fell slightly to below 14% of total exports over the same period. South African exporters did, to some extent, offset the effects of the recession in these economies by redirecting trade flows to markets less affected by the crisis. Exports to the United States, for example, increased by about 30% in rand terms between 1997 and 1998. But the effects of the global crisis and continued buoyancy in imports were such that the annualised current account deficit swelled to 2.6% of gross domestic product in the second half of last year. Although the deficit was not large by international standards, it nevertheless raised concerns that the level of spending, especially on public sector capital formation, could not be sustained. Last year’s tightening in monetary policy, and the improvement in international economic conditions as the turmoil in financial markets subsided, caused a marked recovery in the current account this year. The improvement in the current account reflected a revival in international demand for South African exports and a significant contraction in local demand for imports. Export volumes rebounded satisfactorily in the first quarter of this year, but lost some momentum in the second quarter, when the current account slipped into deficit again. It seems that the current account may remain in deficit for the remainder of the year, although exports should still benefit from the lagged effects of the rand’s depreciation, the resurgence of foreign demand and an increase in international commodity prices. As the lagged effects of interest rate cuts continue feeding through to economic activity and the recovery gains momentum, the demand for imports can be expected to strengthen. The turnaround in the inventory cycle, which appears to have begun in the second quarter of this year, will heighten local demand for imports. The deficit on the current account should be financed comfortably by net capital inflows. Barring any unforeseen shocks on the international front, the South African economy has entered a period of more rapid growth coupled with a fairly comfortable balance of payments situation. But the expected increase in the economic growth rate from last year’s paltry half-a-percent will fall far short of the levels needed to make inroads into South Africa’s high unemployment rate. Many of our people remain poverty-stricken, living below the breadline in makeshift shacks that do little to keep out the winter cold. To them, the concept of financial stability might be remote, but the only way in which their lot can be improved on a sustainable basis is if the Reserve Bank does not deviate from its course. Globalisation of financial markets means that countries that are out of step with the rest of the world will be punished swiftly and severely. For our part, we must continue policies and programmes to contain inflation. We must also maintain sound and efficient financial institutions and markets. In other words, the main thrust of monetary policy has to be the maintenance of financial stability – that is, stability of prices, financial institutions and financial markets. Ladies and gentlemen, every time you invite me to occasions such as these, expect to hear the same thing. Thank you. | south african reserve bank | 1,999 | 9 |
Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the biennial Congress of the Economic Society of South Africa, Pretoria, on 6 September 1999. | Mr Mboweni explains the position taken by the Reserve Bank of South Africa on inflation targeting Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the biennial Congress of the Economic Society of South Africa, Pretoria, on 6 September 1999. * * * Introduction In my Governor’s Address at the Ordinary General Meeting of Shareholders of the Reserve Bank on 24 August 1999, I stated that it is advisable to move away from the “eclectic” or informal inflation targeting monetary policy framework to formal inflation targeting. This change is necessary because the eclectic framework has at times created uncertainties about Reserve Bank decisions and actions which were perceived as being in conflict with the stated guidelines for the growth in money supply and bank credit extension. The question may be asked whether the adoption of inflation targeting will lead to a more effective monetary policy? I believe that this will be the case and that inflation targeting should minimise the social and economic cost of achieving price stability. In my address this evening I want to explain this position that has been taken by the Reserve Bank by elaborating on the following aspects of inflation targeting, namely: • What are the main characteristics of inflation targeting? • What are the advantages of inflation targeting? • Are there any disadvantages in shifting to an inflation targeting framework? • What are the preconditions that have to be met before implementing inflation targeting? • What factors should be taken into consideration with the implementation of inflation targeting? Characteristics of inflation targeting A number of industrial countries, such as New Zealand, Canada, the United Kingdom, Sweden, Finland, Australia and Spain have adopted an inflation targeting framework during the 1990s. More recently some of the developing countries have also opted for this monetary policy framework. The Czech Republic has operated a fully fledged inflation targeting regime since December 1997. Israel, Chile and Mexico are countries that have one-year inflation targets, while Poland, Hungary and recently Brazil have multi-year inflation targets. The motives for the adoption of inflation targeting have varied considerably from country to country. In some countries, such as the United Kingdom and Sweden, the collapse of their exchange rates led to inflation targeting in order to assure the public that monetary policy would remain disciplined. Other countries, such as Canada, introduced inflation targeting because of problems experienced with the targeting of monetary aggregates. Whatever the motives of the countries were, the adoption of an inflation targeting strategy in all cases reduced the role of formal intermediate targets or guidelines, such as the exchange rate or the growth rate in money supply. Commitment to an intermediate target would be inconsistent with inflation targeting except if it is the only determining factor of inflation. Obviously this is unlikely. Although growth in money supply is a precondition for a general rise in prices, it is not the only factor that causes inflation. In an inflation targeting framework the central bank has to adopt a strategy of determining directly what the likely path of inflation will be. In inflation targeting close attention is typically given to changes in indicators which in the past have affected inflation. This has led to sophisticated models for the prediction of inflation and detailed assessments of factors that could affect it. The prediction of inflation is of the utmost importance in the implementation of monetary policy because changes in policy measures are based on likely future price developments. The fact that inflation targeting has to rely on forecasting has led to the criticism that this is a weakness of the technique because forecasts are inherently unreliable. Although it is true that an inflation targeting framework is based on forecasts, it is also true that any other monetary policy framework has to take account of the fact that policy changes will only affect inflation some time in the future. If the objective of the central bank is the attainment of financial stability, it will always have to take a view on how its current policy stance will effect future price developments, whatever monetary policy framework it decides to pursue. The difference between inflation targeting and other monetary policy frameworks is that inflation targeting makes forecasting explicit and transparent. The adoption of inflation targeting by a central bank does not mean that the central bank must apply definite rules and is not left with any discretion. Exclusive emphasis on inflation goals over the short-term could lead to a highly unstable real economy in the case of serious supply shocks. If a severe supply shock hits the economy, keeping inflation close to the long-run target could be very costly in terms of lost output. In such cases, some discretion must be applied. Many of the central banks opt for escape clauses in these circumstances. Others have defined the inflation target in such a way that changes in food prices, the price of oil or the effects of value added tax are excluded from the index that they target. The degree to which the central bank is held formally accountable for inflation outcomes varies considerably. In New Zealand the tenure of the Governor of the central bank is linked directly to the achievement of the inflation targets. In most other countries there are no explicit sanctions on central banks if they miss the target. However, missing the target by a very wide margin and consistently would, of course, lead to lost reputation or prestige and eventually perhaps to a request for the resignation of the officials involved in targeting. In most countries applying this framework it is still too early to determine what prospective penalties will be applied. The achievement of the target is, however, also important because it affects the credibility of the central bank. An inflation targeting framework can only be successful if the public is convinced that the central bank is serious about containing inflation. This means that the government and the central bank cannot simply change to inflation targeting without reference to anyone else. It must ensure that the ordinary people in the street are in favour of price stability. Any misconception that the central bank is not concerned about economic growth and employment creation must be removed. It is important that the public does not get the impression that the central bank is dogmatic about the containment of inflation and does not care about other critical issues of importance to the economy. It is also important that the public is ensured that there are no hidden agendas, in other words that the objectives stated will be the ones actually pursued. Bill Allen, an official of the Bank of England, at the beginning of this year in a speech at the Reserve Bank indicated that this was a major issue in the United Kingdom when they adopted inflation targeting in 1992. This was partly due to their mixed historical record at that time in achieving monetary policy objectives and partly because monetary policy had traditionally been conducted in an environment of considerable mystery and secrecy. Fortunately, we have progressed somewhat on both these fronts in South Africa and there should not be any difficulties in switching to inflation targeting. Advantages of inflation targeting What are the advantages of inflation targeting for South Africa? Firstly, inflation targeting can improve the coordination between monetary policy and other macroeconomic policies depending on the way the target is set and whether the target is consistent with other policy objectives. The setting of inflation targets should preferably (but not compulsorily) be a joint effort between the government and the central bank. Inflation targeting will be most effective when economic policies are well coordinated. This coordination must be clearly spelled out and all stakeholders should be consulted, including business and the trade union movement. A formalised coordinated approach will probably lead to the best results. The Reserve Bank is therefore of the opinion that with the adoption of inflation targets a policy target agreement should be drawn up that would be signed by the Minister of Finance on behalf of Cabinet and the Governor of the Reserve Bank to define precisely the coordinated effort needed to contain inflation in pursuit of the broader economic objectives of sustainable high economic growth and employment creation. While this agreement should define the practical implication of the Reserve Bank’s goal of price stability, it should also guarantee the instrumental independence of the Reserve Bank. Secondly, the announcement of inflation targets clarifies the central bank’s intentions and reduces uncertainty about the future course of monetary policy. Inflation targets make policy transparent. They make the central bank’s intentions explicit in a way that should improve the planning of the private sector. Thirdly, inflation targeting helps to discipline monetary policy and strengthens the central bank’s accountability. If targets are not met, the central bank has to explain what went wrong. This leads to a better understanding on the part of the public on what basis monetary policy decisions were made. Disadvantages of inflation targeting Although inflation targeting has certain definite advantages when compared with other monetary policy frameworks, it could also have certain disadvantages. One of the limitations of inflation targeting is that it is a complicated approach to implement. Although all monetary policy frameworks should be forward looking, inflation targeting relies heavily on forecasts. Where inaccurate forecasts are made public it can obscure the central bank’s objectives and reduce its credibility. Compared with other monetary policy frameworks there is also the risk that inflation targeting could lead to inefficient output stabilisation. This can occur particularly in the event of significant supply shocks, such as sharp changes in the price of oil. Preconditions for inflation targeting In view of these potential disadvantages of inflation targeting, it is important that certain preconditions are met before a decision is taken to implement this framework. In this regard it is important that a central bank is free to pursue financial stability. The inflation target may be jointly set by the government and the central bank. However, once the target has been determined the central bank should be free to use any instrument to achieve the ultimate objective. In the application of inflation targeting it is further important that there is a commitment by all authorities to the objective of price stability. Preferably there should be close cooperation between monetary policy and other policies, and in this coordinated effort the inflation objective should be an inherent part of overall policy. To implement inflation targeting it is important that well-developed financial markets exist in a country. The policy instruments generally used by monetary authorities require effective money, capital and foreign exchange markets. If financial markets do not react quickly to the instruments applied, it obviously reduces the effectiveness of monetary policy and leads to a delay in impacting on inflation. For the implementation of inflation targeting the central bank must have the necessary resources, i.e. human, technological, etc. Inflation targeting requires sophisticated forecasting models which need advanced computer hardware and software. In developing economies in particular, this could be an important constraint on the implementation of inflation targeting. Fortunately, the Reserve Bank’s staff should be able to refine and strengthen the Bank’s forecasting framework, especially with the help of international experts in this field. The Bank has enough experience in information technology for the implementation of inflation targeting and the other preconditions are generally met in the case of South Africa. The implementation of inflation targeting Before inflation targeting is implemented, it is important that: • a decision is taken on the inflation target that will be set; • a satisfactory forecasting framework is developed; and • a high degree of transparency is ensured. In all inflation targeting countries the practice has been to specify the target in terms of the consumer price index, or some variant thereof. There is, however, no consensus on how inflation should be measured. Preferably the index should include a range of products whose prices fully describe changes in the cost of living and are generally accepted by the public. Including prices over which policy has no control may lead to misleading signals when these prices move out of line. Policymakers in many instances have accordingly opted for a target that excludes certain measurable components that are either unpredictable, volatile or unresponsive to policy. In addition, a choice has to be made between setting a single point or a target range. This choice reflects a trade-off – a narrower band may be interpreted as indicating a stronger commitment to the inflation target, but frequent breaches could undermine credibility. A fixed point target is much more difficult to hit than a band. A single point provides the best focus for inflation expectations and avoids the disadvantage of a band which tends to concentrate expectations towards its upper boundary. A band, however, leaves some discretion to the central bank and can provide more flexibility in the case of unforeseen price shocks. It is also important to decide at what level the target should be set. Preferably it should rather be on the low rather than on the high side. High targets may give the impression that the central bank is not serious about combatting inflation. It is accordingly better to lengthen the period over which the target will be reached than starting at too high a level. The implementation of inflation targeting requires that the authorities must be able to develop a satisfactory forecasting framework. Although South Africa has experienced major structural changes in recent years, it seems that we are in a position to forecast inflation. The Reserve Bank already makes regular inflation forecasts using a large macroeconomic model which is based on a wide range of financial and economic equations. In the application of inflation targeting it will be prudent to supplement this large model with a number of smaller and single equation models. Mervyn King, Deputy Governor of the Bank of England, recently stated that forecasting, more than any other aspect of economics, brings the discipline into disrepute. Forecasts should not be presented as a single number but rather as a probability distribution. The Bank of England has accordingly adopted a so-called fan-chart forecasting technique which shows the relatively likelihood of possible inflation outcomes. Careful consideration will have to be given to these techniques of other central banks before inflation targeting is introduced in South Africa. It is important that the Reserve Bank enhances transparency for the effective operation of an inflation targeting framework. Transparency introduces predictability and helps to ensure that expectations are consistent with the objective of price stability, thus lowering the cost of achieving the inflation target. As pointed out by prominent economists many years ago, monetary policy should avoid exacerbating fluctuations of output and employment by introducing unnecessary uncertainty. A transparent monetary policy will mean that changes in short-term interest rates should not surprise the market. Markets should be able to anticipate decisions taken by the Reserve Bank. Transparency should promote the predictability of policy. In this regard Mervyn King has stated that a successful central bank should be boring, it is like a referee whose success is judged by how little his or her decisions intrude on the game. Although the Reserve Bank has progressed considerably in recent years in providing more detailed information to the market and in explaining its policy stance, the Bank has decided that with the introduction of inflation targeting it will improve the transparency of monetary policy further by periodic testimony to Parliament, the regular publication of a monetary policy review report and focussed statements after the meetings of the Monetary Policy Committee. In both cases the Bank will provide an assessment of how it perceives the underlying economic and financial conditions and explain the monetary policy stance. Conclusion Although inflation targeting is a difficult monetary policy framework to apply in practice, most of the preconditions for its implementation can be met in South Africa. Inflation targeting should lead to closer economic coordination and greater transparency and accountability. It is, however, at the same time important that our house is in order before we implement this framework. In other words we must get our ducks in a row first. Thank you very much. | south african reserve bank | 1,999 | 9 |
Speech by Mr Tito Mboweni, Governor of the South African Reserve Bank, as a contribution to the Africa Dialogue Lecture Series presented by the University of Pretoria's Department of Political Sciences, the Institute for International Affairs and Accord, in the Senate Hall at the University of Pretoria on 21 September 1999. | Mr Mboweni considers the role of the South African Reserve Bank in economic integration in the Southern African Development Community Speech by Mr Tito Mboweni, Governor of the South African Reserve Bank, as a contribution to the Africa Dialogue Lecture Series presented by the University of Pretoria’s Department of Political Sciences, the Institute for International Affairs and Accord, in the Senate Hall at the University of Pretoria on 21 September 1999. * 1. * * Introduction There are many buzzwords in today’s world. One of the most recognisable ones in the economic vocabulary is globalisation. Many people define themselves as being either for or against globalisation. My own view is “good luck” to those who want to demonstrate against globalisation. I would rather people spent time on how they can maximise the benefits of globalisation. But today our discussion is about the role of the Reserve Bank in economic integration of the Southern African Development Community (SADC) which obviously has to be placed within the context of globalisation. Some people blame globalisation for many of the problems confronting the world today, ranging from widening income disparities in the industrialised world to financial crises in emerging markets. But even some of the most vociferous critics acknowledge that globalisation can be a powerful and positive force for generating wealth and reducing poverty, as rising trade volumes create opportunities for entrepreneurs, and developing countries may gain greater access to capital from the rich countries of the world. Globalisation seems to be encouraging economic regionalisation as many big and small economies establish economic blocs to maximise their collective competitive advantage. The advantages of regional economic integration are well known, but it is worth pausing, for the purposes of this discussion, to mention a few. Among others, economic integration enables entrepreneurs to take up new business opportunities by cutting red tape and facilitating the flow of transactions. Integration with neighbouring countries can produce economies of scale when competing with other regions in the world and can be one of the ways that countries ensure that the best use is made of the resources, capabilities and abilities within their region. Economic integration means that individual nations are becoming less important internationally as regional groupings gain in significance, especially when it comes to investment and trade in goods and services. To name a few examples, regional free trade initiatives have either been implemented or are in the process of being implemented in North, Central and South America, East Asia and in the European Union where full financial integration is not far off. Africa also has a number of economic cooperation initiatives, including the Southern African Development Community (SADC) which has 14 member states. The SADC member states are: South Africa, Angola, Botswana, Lesotho, Malawi, Mauritius, Mozambique, Namibia, Swaziland, Tanzania, Zambia, Zimbabwe, the Democratic Republic of the Congo and the Seychelles. The forerunner of the SADC was a regional grouping of nine Southern African states which started working together in 1980 with a view to reducing their economic dependence on the then apartheid ruled South Africa. Over time, more members joined and by the time South Africa entered the fold after the democratic elections of 1994, the aim of the regional grouping was to work towards economic integration. Whilst it is factually correct that South Africa is the largest economy in our region, accounting for some 65% of the region’s gross domestic product in dollar terms, we are, however, on a per capita basis, the third best off — behind Mauritius and Botswana. Mauritius has a GDP per capita of more than $3,500 while South Africa’s is less than $3,000. In the rich countries of the world, per capita incomes are about eight times as high as they are in this subregion of Africa. As part of the process of promoting regional economic integration, each SADC member country was allocated an economic sector to coordinate, based on the country’s actual or potential capacity. South Africa has been allocated responsibility for the coordination of the finance and investment sector of the SADC. The coordination of the sector is led by the Minister of Finance of South Africa. The finance and investment sector was given to South Africa in recognition of its developed financial markets and institutions. The Committee of the SADC Central Bank Governors which meets twice a year, forms part of the finance and investment sector and is chaired by the Governor of the South African Reserve Bank. The Committee of Governors met for the first time in November 1995. Its terms of reference focus, among other things, on closer cooperation among central banks in the SADC in the areas of monetary policy and policy instruments, bank supervision, money and capital markets, international financial relations, payment, clearing and settlement systems, training, and money laundering. Information technology is one of the most important areas of cooperation. The concerns with properly functioning financial and banking systems naturally made Year 2000 preparedness one of our priorities this year. More generally, it is crucial to note that financial and banking issues cannot be looked at in isolation, without reference to other SADC concerns such as trade, industrial and fiscal policies and political factors too. 2. South Africa prepares to open its markets Compared with other regional groupings, the idea of a European Union-like economic union is still some way off for the SADC, although progress is being made towards implementing a free trade agreement. A target implementation date has been set for January next year to begin the process of lowering trade barriers, streamlining customs and border procedures, and harmonising external tariffs. SADC trade and industry ministers are due to meet soon for negotiations on the trade protocol in the run-up to the start of implementation next year. There have been suggestions that South Africa might extend market access concessions on a unilateral basis after certain key agreements have been reached. We understand that South Africa plans to eliminate most duties on imported goods from other SADC countries by 2004 and the region could ultimately develop into a free trade zone. The free trade discussions and negotiations have received some attention in the media. Generally speaking, it seems that people welcome the progress made by the SADC as a sign that it is finally getting down to business. Also in the development programmes are infrastructure developments in the region, such as the Maputo Corridor which has spurred investments into various economic sectors estimated at R35bn. One example of a big investment is the Mozal aluminium smelter, which has triggered the renewal of the Maputo Harbour. A very welcome development indeed. Far less immediately newsworthy, but also very important for the establishment of a regional economic bloc, has been the work done by the Committee of Central Bank Governors. The work is an important building block towards the creation of a free trade zone. One cannot implement free trade in goods and services without having the proper financial systems in place; the work of the Committee of Central Bank Governors can be seen as providing the oil that makes the wheels of commerce turn faster in the region. The implementation of a free trade agreement is made easier if national payments systems function properly and are compatible with individual states in the region. In addition, investors who want to take advantage of the liberalisation of trade will feel more comfortable if there is a high and uniform standard of bank supervision; in other words, legal familiarity, certainty and a good sense of a stable, well regulated and properly supervised banking system. Similarly, investors and potential business partners usually want easy access to reliable basic macroeconomic information of countries in the region. For goods to flow smoothly across borders, it is also important that capital should flow smoothly in the region, while bearing in mind that potentially destabilising and volatile capital swings must be avoided. These are a few examples of how the Committee’s work fits in with the overall concept of economic cooperation and free trade. The Committee’s work has mainly been focussed on the following areas: development of payment, clearing and settlement systems; the impact of exchange controls on the cross-border flow of goods, services and capital in the SADC region; the development of a monetary and financial data base; coordination and training of central bank officials within the region and the collection of information on the legal and operational frameworks of central banks within the region. Cooperation in the field of information technology has been an important focus area for the Committee which has resulted in improved communication and collaboration. 3. Development of the payment, clearing and settlement systems in the SADC region In support of the SADC objective of establishing free trade within the region by 2004, the Committee of Central Bank Governors decided at its inception to develop the payment, clearing and settlement systems of SADC countries. The benefits of improved payments systems include: promotion of economic activity, both regionally and internationally; improved control of monetary aggregates resulting from reducing float levels and minimising delays; a more productive use of resources as a result of lowered transaction costs; improved management of both credit and systemic risk as financial transfers are completed efficiently and quickly; facilitation of financial sector development; improved trust in the security and reliability of payment instruments and international acceptance. One aspect of the SADC payments system project has been an awareness campaign to sensitise a large cross-section of stakeholders in each of the countries about payments system issues. Workshops on payments system issues have been held in most SADC member states. Now that the awareness campaign is complete and information on the existing payments systems in countries has been collected, the next step is to develop a strategic framework for each country – and for the region as a whole. Capacity building is, as always, an important theme. Mauritius has already decided that it is feasible to implement the South African Multiple Option Settlement (SAMOS) system in that country, in line with its goal of real-time gross settlement. Other SADC central banks have also indicated they would like to implement SAMOS to their banking systems. 4. The impact of exchange controls on the cross-border flow of goods, services and capital in the SADC region Exchange controls may be, in the case of many countries, a necessary mechanism in a world in which volatile capital swings can wreak havoc on small economies, as we saw last year. However, controls within a region which is working towards greater economic integration can be a stumbling block in the way to smooth and effective cooperation, as well as a deterrent to investors. The Committee of Central Bank Governors has a subcommittee on exchange controls. Existing controls in each country in the SADC region have been analysed with a view to gradual harmonisation and the removal of controls for transactions within the region. However, the region’s central bank officials recognise that the sequencing and speed of exchange control liberalisation depend on the characteristics of each individual economy and also on the political realities. The target date of 2004 for the creation of a free trade zone implies that all intra-regional exchange controls should be abolished by then. However, the subcommittee on exchange controls felt liberalisation should be completed more rapidly. Controls that directly inhibit the cross-border flow of goods, services and capital should be tackled first. The subcommittee asked that central banks in the region formally report on the progress made on easing exchange controls when the Committee of Central Bank Governors meets again next month. Some countries like Zambia, Mauritius and Botswana have liberalised their exchange controls in a short time. However, rapid easing might not be the correct speed for other countries. Zimbabwe reintroduced exchange controls in the wake of last year’s global financial turmoil. However, the country has indicated that the controls will be reversed as soon as the balance of payments position improves and inflationary pressures subside. Information at our disposal indicates that Zimbabwe will continue to liberalise capital flows gradually. South Africa’s exchange controls favour investment in the SADC region, as requirements for these investments are less onerous. Although foreign direct investment (FDI) in the SADC region accounts for a relatively small portion of the total planned FDI by South Africans, it is nevertheless growing in importance. From March 1995 until mid-September this year, approvals by the exchange control department of the Reserve Bank for direct investment by South African companies in the SADC region totalled R7.85bn. Globally, South African companies have received exchange control approval for a total of R74.5bn in foreign direct investment, or FDI, all over the world. The investment appetite of South African companies in SADC countries has been on the rise. Their growing interest is apparent from the steady rise every year in exchange control approvals for FDI in the SADC region – from less than R500m in 1996 to R1.5bn in 1997, R2.5bn last year and almost R2.9bn so far this year. Based on net asset value, actual foreign direct investment – which differs from approved FDI which has not necessarily taken place yet – by South African companies in the SADC region stood at R3.2bn at the end of December 1997, the latest available figure. The net asset value of total South African investments in the SADC region, including portfolio and fixed investments, was almost R6bn. The investment flows to South Africa from other countries in the region are also fairly sizable. Based on net asset value, total investment from SADC countries in South Africa was valued at R7bn at the end of December 1997. So there is a good two-way flow in the relationship between South Africa as the largest economy and the region as a whole. 5. Gathering of information A database comprising monetary and financial statistics of individual countries has been established and is freely accessible on the Internet at the website www.sadcbankers.org. Each central bank takes full responsibility for the updating and accuracy of its own data. The International Monetary Fund is providing technical assistance for further development of the database. In addition, an information bank has been compiled on the structures and policies of central banks in the region as well as on the financial markets of member states. This information paves the way for future cooperation on monetary policy in the region. A project has also been undertaken to summarise the legal and operational frameworks of each of the central banks in the region, analysing differences in their structures and then proposing measures towards greater compatibility. 6. Cooperation in the field of information The committee of central bank governors established an IT Forum which, among others, aims to develop a common application architecture for bank supervision. The Forum which has obtained funding from the World Bank plans to begin developing common bank supervision models early next year. The Forum has also been keeping track of Year 2000 readiness in member states. Information on the Y2K bug has been shared, and bank supervisors have been encouraged to participate in Y2K certification of financial institutions in each country. 7. The development of financial markets The SADC Committee of Stock Exchanges, which reports to the SADC Ministers of Finance through the Committee of Central Bank Governors, is set to announce the harmonisation of listing requirements in the region. Other projects include the introduction of automated trading into all SADC exchanges, electronic clearing and settlement as well as education and training. On the development of bond markets, agreement was reached that trading in equities and bonds should be accommodated on the same exchange rather than that new bond exchanges be established. It was also decided that stock exchanges that wished to implement bond listings requirements would use the new listings requirements of the South African bond exchange. The South African bond exchange has submitted a proposal for the establishment of a centralised debt securities market for the region. The proposal argued against allowing the development of separate licensed bond exchanges and was in favour of building on existing infrastructure. The Committee of Central Bank Governors has studied the characteristics of money markets in individual states, but no decision has yet been taken on further development of money markets. A SADC Banking Association was established in July last year aimed at encouraging member states to implement internationally accepted banking standards and uniformity of banking legislation. The South African Banking Council is a member of the Association which is chaired at present by Malawi. 8. Conclusion From my report-back to you today on the work of the SADC Committee of Central Bank Governors it should hopefully be clear that the vision of full economic integration, with free and unfettered movement of goods and capital, is still a long way off. However, slowly but surely we are laying the foundation for a robust regional economic bloc. The central banks of the region are working together to put in place a common financial architecture which can form the basis of closer economic integration. Before full economic integration can be attained, we need to have sound financial systems that can withstand sudden international shocks and which can accommodate increased economic activity. We need efficient and coordinated financial markets and reliable and compatible clearing and settlement arrangements between our countries. The SADC finance and investment sector is convinced that it has already laid the foundation for macroeconomic convergence and integration. As the new chairperson of the SADC Committee of Central Bank Governors, I will make every effort to ensure that we continue with the construction of a strong financial infrastructure for the region, so that globalisation can work to the advantage of the Southern African region. In conclusion, I would like to express the hope that the region will have confidence in its ability to make globalisation work in its favour. To illustrate this point, I would like to quote from a speech made last year by President Thabo Mbeki, in which he talked of an African Renaissance and about the weight that past enslavement has placed on Africans’ confidence: “It continues still to weigh down the African mind and spirit, like the ton of lead that the African slave carries on her own shoulders, producing in her and the rest a condition which, in itself, contests any assertion that she is capable of initiative, creativity, individuality and entrepreneurship.” Initiative, creativity, individuality and entrepreneurship – we in the Committee of Central Bank Governors know the people of the SADC region possess these qualities in abundance. We know that Southern Africa has the potential to become a lasting success story. | south african reserve bank | 1,999 | 9 |
Address by Dr Tim Thahane, Deputy Governor of the South African Reserve Bank, at the African-Asian Society, held in Sandton, South Africa, on 5 October 1999. | Mr Thahane discusses Asia’s economic recovery and its implications for the African Renaissance Address by Dr Tim Thahane, Deputy Governor of the South African Reserve Bank, at the African-Asian Society, held in Sandton, South Africa, on 5 October 1999. * 1. * * Introduction The recovery of Asia’s economies in 1999, from the very damaging crises that began in mid-1997, provides significant scope for the development of the African countries and a meaningful contribution to African Renaissance. Since 1994, the African economies have on aggregate traded significantly with the Asian economies reflecting the vast potential benefit that African countries stand to gain from a vigorous and sustained recovery in Asian economies. Asia’s trade surplus to Africa, which stood at US$4.6 billion in 1994, decreased to a deficit of US$1.1 billion in 1997, before increasing substantially to US$5.1 billion in 1998 following the Asian crisis. I will comment first on Japan and then the post-crisis recovery of the Asian economies, of Thailand, the Philippines, Malaysia, Indonesia and Korea. Second, I will define the concept of African Renaissance and the potential contribution of the Asian economic recovery to African Renaissance. Finally, I will briefly touch on the ability of the Asian countries to combine their culture with the acquisition and development of the most advanced technologies and globalization process. 2. Japan’s economic recovery There is a worldwide consensus that a strong economic revival of Japan’s economy would herald a significant recovery for the Asian economies as a whole. Japan’s annual real GDP growth rate, which fell to -2.8% in 1998 is expected to increase significantly to 1.0% in 1999 and to 1.5% by the year 2000. The annual inflation rate in Japan, which rose from 0.1% in 1996 to 1.7% and 0.6% in 1997 and 1998 respectively, is expected to drop to -0.4% by the end of 1999. The annual current account balance in Japan, which reached a deficit of US$121 billion in 1998, is expected to increase further to US$143 billion in 1999 before falling somewhat to US$138 billion in 2000. This expected turnaround in the performance of the Japanese economy is not only critical for Africa’s development but for the whole world. Japan undertakes significant direct trade with Africa. Japanese imports from Africa were US$3.9 billion in 1994, and increased to US$4.9 billion in 1996, before declining to US$3.8 billion in 1998 following the Asian crisis. Similarly, Japanese exports to Africa increased significantly from US$5.8 billion in 1994 to US$6.3 billion in 1996, before dropping to US$4.2 billion in 1998 and US$4.5 billion in 1999. The Japanese economy had a trade surplus of US$1.8 billion with African countries in 1994 and 1995. It turned around to deficits of US$85.4 million and US$515.0 million in 1996 and 1997, respectively, following Japan’s economic slowdown and strengthening of the yen in 1996. The challenge to African economies is to become more competitive in Asian markets, so as to turnaround the trade surplus of US$644.0 million in 1998. The situation is slightly different with SADC. Since 1994, Japan has operated with a significant trade deficit. Japan’s trade deficit with SADC decreased from US$476.4 million in 1994 to US$284.6 million in 1995 and then significantly increased to US$1.0 billion in 1997 before falling somewhat to US$747.8 million in 1998. SADC would benefit significantly from Japan’s economic revival if it were to sustain the level of competitiveness that it has attained thus far. This requires a clear export focus and strategy vis-à-vis the huge Japanese market. It is important not to forget that Japan is the second largest economy in the world and Japan is well-disposed to Africa at this stage. 3. Asia’s economic recovery Following worldwide crises that developed from the southeast Asian economies, recent indications point to a promising economic revival in Asia as a whole, particularly in those countries where the crisis was most severe: Thailand; the Philippines; Indonesia; Malaysia and Korea. The combined annual real GDP growth rate of these countries fell from 6.6% in 1997 to 3.7% in 1998 with severe impact on the gains that had been made to reduce poverty and generate jobs. Growth is now expected to significantly increase to 5.3% in 1999 and 5.4% by 2000. The annual inflation rate which reached a high of 8.0% in 1998, is expected to drop significantly to 3.1% and 3.5% in 1999 and 2000 respectively. The Asian annual current account balance, which stood at a deficit of US$51 billion in 1998 is expected to decline significantly to US$26 billion in 1999 and drop further to US$12 billion in 2000. Net private capital flows in Thailand, the Philippines, Indonesia, Malaysia and Korea fell from US$62.9 billion in 1996 to a negative of US$22.1 billion in 1997 and US$29.6 billion in 1998. They are expected to improve but remain negative at US$18.1 billion in 1999 and US$8.2 billion in 2000. Net direct foreign investment, which has remained positive, is expected to decline from US$10.3 billion in 1997 to US$9.7 billion in 1998. It will still remain positive at US$9.4 billion in 1999 and US$8.4 billion in 2000. Net portfolio investments, which were a negative US$7.3 billion in 1998 are expected to improve significantly to positive levels of US$4.5 billion in 1999 and US$5.6 billion in 2000. The annual current account deficits of Thailand, the Philippines, Malaysia, Indonesia and Korea are expected to improve from a high of US$68.8 billion in 1998 to US$49.3 billion in 1999 and US$29.4 billion in 2000. The annual external debt of Asia, as a percentage of exports of goods and services, which stood at 118.6% in 1998, is expected to decline to 112.5% in 1999 and to 107.9% in 2000. Annual debt service payments are expected to decline from a high of 19.5% in 1998 to 15.7% in 1999 and 14.6% in 2000. The rapid turnaround in these Asian economies is a reflection of the determination and vigour with which the Asian leaders and their people have tackled the challenges that faced them. The international community has played a supportive, though important role in this process of economic recovery. This is one of the major lessons that Africa can draw from this experience. 4. African Renaissance The concept of the African Renaissance generally captures an array of important social, political, economic and cultural aspects that epitomize a revival and vibrant African continent. These various spheres, among others, include education, science and technology. A concerted effort is underway at regional and continental forums to give content and meaning to the concept and to define concrete action plans to bring it to reality early in the 21st century. An African Renaissance Institute to be located in Botswana is soon to be launched. It will be followed by a launch of national chapters including the South African chapter by the first quarter of next year. African Renaissance involves not only governments but more importantly civil society and people at community and local levels who seek to improve the quality of their lives and to hold their leaders accountable. For our purposes, it would be expedient to focus on some of the economic aspects of the African Renaissance, primarily prospects of Africa’s economic growth, reconstruction and development through enhanced intra- and inter-continental trade. In this context, African Renaissance calls for increased economic integration within the African continent to enlarge markets, facilitate free flow of investment, goods and labour. It calls for a more effective participation in the economic globalization process by the African countries and people by embracing change and technology. In this context, the relations with Asia and the lessons it provides are critical lessons for African revival and re-birth. The economic development of the African continent as a whole lags significantly behind in terms of its contributions to global economic output. Africa contributed only 3.3% of the aggregate world economic GDP in 1998 – exactly what the United Kingdom contributed as a single country. Africa’s total share in the global export market of goods and services stood at a paltry 1.8% in 1998 compared to Asia’s 8.1% or the United States’ 13.8%. This means that Africa has a long way to go to improve its contribution to world trade by improving its productivity capability, competitiveness and harnessing of technology and skills. 5. Asian recovery and the African Renaissance The revival and sustenance of vigorous growth in the Asian economies would almost certainly enhance the development of an African Renaissance. Since 1994 and through the crisis of 1997, African-Asian trade has been significant. Trade account figures between Africa and Asia indicate that total annual Asian imports from Africa almost doubled from US$7.4 billion in 1994 to US$14.3 billion in 1997, before receding somewhat to US$9.5 billion in 1998. Imports from SADC alone were US$4.6 billion in 1994 and almost doubled to reach US$9.0 billion in 1997 before dropping to US$5.8 billion in 1998. During the same period, Asian exports to Africa have been fluctuating somewhat between US$11 billion and US$13 billion from 1994 to 1997 before increasing to US$14.5 billion in 1998. Annual exports to SADC increased from US$3.4 billion in 1994 to US$5.6 billion in 1997 with a marginal decline to US$5.5 billion in 1998. The net effect has sustained Asia as being a net exporter within the Asian-African trade with a surplus that decreased from US$4.6 billion in 1994 to a deficit of US$1.1 billion in 1997, and revived strongly to reach US$5.1 billion in 1998. Asia’s net exports to SADC were negative from US$1.2 billion in 1994 to a more substantive deficit of US$3.4 billion in 1997, before a significant improvement in 1998 when a deficit of US$333.4 million was recorded. The development of the African Renaissance should enable African countries to expand trade with all Asian economies so as to balance trade between the two continents. More importantly, the challenge for Africa is to maintain and expand its market share in Asia through strategic, competitive and targeted export drives. 6. Social policies One characteristic feature of the Asian economies has been their ability to combine many aspects of the Asian culture with acquisition of the highest technical skills and to participate effectively in the globalization process. Although several studies have alluded to uniquely Asian policies that: (a) have enhanced employee loyalties to Asian corporations; (b) emphasized Asian management systems; (c) enhanced a culture of high saving; (d) maintained strong social support systems; etc., it is still very difficult to tackle the concept of culture within economics. It should suffice, however, to conclude that the policies themselves are not uniquely Asian, but are implemented by Asians in congruence with Asian norms and values. African Renaissance must come to grips with the synergy and complimentarity of culture and fast and sustainable growth. The economic crisis resulted in significant output losses in affected Asian economies and contributed significantly to increased unemployment rates. However, affected Asian economies increased their social safety nets and public spending substantially to strengthen their social support systems and ensure minimum support levels to those who were worst affected. In Indonesia and Thailand safety net expenditures are expected to rise by 0.5 to 1.0% of GDP in 1999. In Korea, expenditure on social safety nets almost quadrupled from 0.4% of GDP in 1997 to 1.7% in 1999. At the same time, the use of across-the-board price subsidies have been significantly reduced although some – such as subsidies on rice – remain an important component of the social policy framework. The African Renaissance would benefit significantly if it were to study in more detail how the globally robust economies of Asia have managed to sustain much of their distinct culture and commitment to improve the quality of life for all their people. 7. Conclusion My remarks focused on the post-crisis recovery of the Asian economies, with a view to drawing lessons from the Asian economic recoveries for the African Renaissance, and to understanding how Asian countries have managed to sustain their culture despite their economies’ rigorous globalization programs. Available evidence suggests that the Asian economies have definitely re-established a path to high and sustainable economic growth, and are restoring their trade with the world and the African continent. The African Renaissance process will benefit greatly from an enhanced African-Asian trade and cooperation at various levels: culturally, scientifically, politically and economically. There is a lot to be learnt from how Japan and other Asian countries have been transformed through political leadership and foresight, acquisition of skills and technology, and a contribution of cultural norms and aggressive international competitiveness. One major conclusion to be drawn is that a robust embrace of globalization is not inconsistent with African culture, values and norms. Annexes - tables of imports and exports Table 1 African Trade with Japan (US$ millions) Japan’s imports from Africa Angola Botswana Congo, Dem. Rep. of Lesotho Malawi Mauritius Mozambique Namibia Seychelles South Africa Swaziland Tanzania Zambia Zimbabwe 10.4 9.77 82.92 0.05 49.98 5.96 25.98 0.52 2,197.83 11.31 49.36 174.16 148.46 15.73 7.97 80.62 48.41 14.4 34.27 1.71 2,541.86 10.91 64.67 221.84 178.8 22.49 8.47 82.47 26.45 17.36 18.35 3.27 2,832.36 11.27 64.89 192.11 161.57 3.18 6.09 53.31 33.41 24.47 21.69 3.36 2,802.94 14.6 58.92 138.53 188.73 19.95 2.44 44.41 0.01 46.07 27.99 20.97 5.26 2,403.34 10.43 67.69 124.55 155.26 SADC total 2,766.69 3,221.19 3,441.05 3,349.23 2,928.37 Africa 3,934.58 4,530.59 4,900.67 4,679.78 3,848.12 Angola Botswana Congo, Dem. Rep. Of Lesotho Malawi Mauritius Mozambique Namibia Seychelles South Africa Swaziland Tanzania Zambia Zimbabwe 16.4 3.1 40.59 1.34 28.88 72.22 37.3 8.47 1,859.93 5.79 82.13 37.38 93.91 26.47 1.43 11.24 1.95 13.2 75.42 18.27 11.45 2,482.52 107.83 60.05 120.9 36.23 1.18 14.14 4.23 18.69 82.12 20.9 8.23 2,071.16 5.56 77.25 19.15 117.17 60.91 1.49 6.44 3.94 19.92 72.19 31.24 10.74 1,872.15 2.61 79.14 25.18 124.97 44.42 2.62 9.48 4.14 28.86 76.74 21.02 13.97 1,772.8 8.72 77.55 35.12 91.18 SADC total 2,290.34 2,936.53 2,474.45 2,313.87 2,180.53 5,777 6,330.63 4,815.26 4,164.71 4,492.16 Balance with SADC -476.35 -284.66 -966.6 -1,035.36 -747.84 Balance with Africa 1,842.42 1,800.04 -85.41 -515.07 644.04 Japan’s exports to Africa Africa Source: International Monetary Fund. Table 2 African Trade with selected Asian countries (US$ millions) Asian imports from SADC 590.9 82.18 273.47 231.68 527.1 86.95 55.93 1,218.48 104.07 265.19 296.76 891.72 96.12 358.47 1,701.22 206.22 197.53 356.12 1,011.66 292.61 2,827.45 300.12 183.8 384.41 1,520.31 102.25 369.79 1,171.24 298.94 84.58 167.38 899.03 50.78 226.36 1,848.21 3,230.81 3,765.36 5,688.13 2,898.31 65.96 33.91 147.65 219.56 484.17 29.34 134.42 466.85 106.08 182.61 337.13 845.09 25.79 633.92 553.81 137.87 131.75 354.54 908.7 605.45 1,007.1 170.98 89.35 362.11 1,050.32 30.6 574.61 831.26 222.85 96.85 389.97 1,263.04 44.84 463.86 1,115.01 2,597.47 2,692.12 3,285.07 3,312.67 -733.2 -633.34 -1,073.24 -2,403.06 414.36 766.98 261.25 572.68 293.12 770.47 122.44 631.55 1,218.48 467.62 630.43 396.52 1,353.9 170.93 539.4 1,701.22 596.87 697.61 552.44 1,405.42 600.83 4,626.57 645.49 577.2 550.37 2,390.15 195.59 611.87 2,095.44 623.13 421.89 295.49 1,425.35 95.22 656.82 3,418.49 4,777.28 5,698.39 9,597.24 5,613.34 Korea Indonesia Thailand Malaysia China Philippines Singapore 1,912.08 407.56 697.66 344.15 1,363.72 38.3 1,394.51 1,555.06 394.39 854.72 505.42 1,990.39 30.54 1,407.47 1,428.16 459.11 679.22 561.76 2,077.37 1,415.34 3,244.27 539.4 613.85 552.64 2,640.18 36.42 1,348.38 3,136.9 1,041.3 640.69 564.78 3,381.39 51.28 1,225.2 Total (ex. Japan) 6,157.98 6,737.99 6,668.96 8,975.14 10,041.54 Balance 2,739.49 1,960.71 970.57 -622.1 4,428.2 Korea Indonesia Thailand Malaysia China Philippines Singapore Total (ex. Japan) Asian exports to SADC Korea Indonesia Thailand Malaysia China Philippines Singapore Total (ex. Japan) Balance Asian imports from Africa Korea Indonesia Thailand Malaysia China Philippines Singapore Total (ex. Japan) Asian Exports to Africa Source: International Monetary Fund. | south african reserve bank | 1,999 | 10 |
Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the Sun Microsystems Conference 1999, held in Vodaworld, Midrand on 11 October 1999. | Mr Mboweni discusses e-money and its impact on the central bank’s operations Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the Sun Microsystems Conference 1999, held in Vodaworld, Midrand on 11 October 1999. * 1. * * Introduction Electronic commerce, or e-commerce, is the catch-all phrase for many advances in technology centered on the Internet and heralds fundamental changes for the world economy. The expansion of the Internet on a global basis, has made it an ideal means to conduct commerce. In South Africa, as in the rest of the world, the Internet is being used more and more to advertise and sell goods and services. The Internet has brought about a need not only for micro payments, e.g. a small payment of perhaps only a few cents for viewing a specific piece of information, but also growing interest in developing more reliable and secure methods of payment for large commercial transactions. E-commerce and, perhaps more important from the Reserve Bank’s point of view, electronic money will probably have significant implications for most persons and institutions. This evening, I would like to concentrate only on two aspects, namely a comparison between electronic payment methods and the current conventional payment instruments, such as currency and credit cards, and the possible effect that e-money may have on the operations of the Reserve Bank. 2. The development of e-commerce The Internet, and its application to e-commerce is turning many industries inside out. Some firms have tried to only partially adopt the new e-commerce technologies, but are increasingly realising the importance of making e-commerce a seamless, integral part of their business plans. South Africa has begun to reach the stage where the previous wholesale financial markets structures are beginning to change as the Internet spreads through them. Retail investors, empowered by the web, are fast becoming much more proactive. Certain financial institutions face the prospect of traditional revenue streams contracting or disappearing altogether as the Internet brings transparency and efficiency to once closed areas. The financial world is taking e-commerce seriously, but no one knows exactly how or how quickly these new technologies will change the business landscape. However, one thing is certain – e-commerce will speed up the process of globalisation and will lay bare the weaknesses in any institution. Central banks worldwide are considering their positions with regard to electronic commerce, Internet banking and electronic money applications. There are a number of electronic money products which are either in the process of being developed or are already available for electronic payments and banking and which are, or could be, activated through ATMs, telephonic devices, personal computers, intelligent cards and card-reading devices. Most central banks are specifically considering the impact these products and e-commerce will have on their functions, and the regulatory and operational requirements which are necessitated. In South Africa, several major banks have already launched Internet banking services and all the major banking groups are investigating, or developing, multi-purpose smart cards using microchip technology which enable electronic “purse” facilities. Although these new payment technologies are still in various stages of development, the South African Reserve Bank, as other central banks around the world, has a direct interest in anticipating their likely policy implications. Emerging electronic money products may require regulatory adjustment or intervention which will arise from: the need to limit the systemic and other risks which may threaten the stability of, and confidence in, the National Payment System; the need to provide consumers with adequate protection from unfair practices, fraud and financial loss; the need to ensure the central bank’s ability to conduct monetary policy; and the need to assist law enforcement authorities in the prevention of criminal activity. While these products are still being developed, the Bank is reluctant to impose regulation that could hamper the introduction of innovative and promising technologies. At this stage, the Bank is of the view that it should rather concentrate on understanding the emerging technologies and the issues they represent. Opportunities which these new technologies offer should also be investigated and exploited to the benefit of the country as a whole, i.e. how the emerging technologies can be used to make financial services more accessible to those in the low income, unbanked and rural communities in South Africa; and how the emerging technologies can be used for cash displacement and to solve problems such as the cost of cash handling and robberies. 3. The characteristics of electronic payments Basically two methods of making payments can be distinguished. The first is the account transfer system. In this system customers issue instructions to banks to debit the account of the person making a payment and to credit the account of the person receiving the payment. Payment methods which fall into the account transfer category include cheques, debit cards, credit cards and telephone banking. Depending on the type of technology that is used, these payments can in some cases be finalised immediately after they have been made, for example debit card transactions. Other account transfer payments, notably cheques, are conditional, and will only be finalised with a delay. The second method of payments is the direct transfer or token system. In this system money or a form of money is established, which can be directly handed from one person to another, with or without the direct involvement of any bank in the transaction. These forms of money are purchased from an issuer, who ultimately carries the obligation to redeem them. The transaction is final at the point when it occurs, and is not dependent on the operation of some underlying settlement system. Cash is the most widespread example of a token system, but in fact there are a number of other examples, such as multiple-trip train and bus tickets. In determining whether electronically stored monetary value is “money”, it is worth reflecting on the main attributes of currency, i.e. the notes and coins issued by the Reserve Bank. Currency is a standard product and is therefore easily recognised and identified. It is risk-free, in the sense that the Reserve Bank stands fully behind it. It is fully negotiable. Possession of currency is sufficient to establish a right of use, and it can be simply handed to someone else in order to make a payment. Usage is anonymous and not directly traceable. It is convenient and efficient for making small payments. It is valid for payment in all places and circumstances, and its status can only be questioned where forgery is suspected. Payments made by means of currency are definite. They are final and irrevocable at the point when they are made, and are not dependent on the operation of any clearing or settlement arrangements. These attributes collectively imply that currency is generally accepted. However, it is not in all cases the preferred method of payment, particularly for higher value transactions, since use of currency involves handling, storage and security costs which may not arise to the same extent with other methods. Payment by means of certain electronic methods score well on some aspects and poorly on others. However, the relative importance of these various attributes is very dependent on the type of payment being made. Cash can be very convenient in some situations, but a real nuisance in others – and the same is true for other technologies. Probably the key conclusion is that different payment technologies are not inherently inferior or superior to one another. Rather, each one of them has an appropriate place as, indeed, the current happy coexistence of a number of overlapping or competing alternatives clearly indicates. Stored value cards and other new forms of payment will result in some substitution, but the nature and extent of this substitution will depend on a number of factors. People will tend to prefer to use payment technologies which are cheaper, more convenient, and less risky than available alternatives. Many will probably prefer methods which can be used for multiple purposes, rather than having to utilise a variety of methods to meet different needs. The level of acceptance of particular payments by retailers, merchants and other suppliers will obviously have an important influence on the implementation of new approaches. Exactly how these influences will develop remains to be seen. From the Reserve Bank’s point of view stored value cards or the account transfer system is only important as a means of payment, but has no direct bearing on monetary policy. In contrast to this, e-money may have important implications for monetary policy. That is why the Reserve Bank has decided to impose certain rules and regulations on e-money products in terms of its function as overseer of the National Payment System. Before considering the possible monetary policy implications of e-money, I want to briefly describe the criteria that will be used in deciding on the introduction of e-money in the National Payment System. 4. E-money and the National Payment System In the National Payment System, e-money is defined as electronically stored monetary value on a technical device, either card-based or network-based, that functions as a prepaid bearer instrument, which can be widely used for making payments to undertakings other than the issuer, with or without involving bank accounts in the transaction. In introducing e-money into the National Payment System, it must firstly fulfil certain legal requirements in which the rights and obligations of the respective participants must be clearly defined and disclosed. Any proposed e-money scheme will accordingly only be introduced in the National Payment System if it does not contravene the South African Reserve Bank Act, The Banks Act and The National Payment System Act. Secondly, in order to protect the integrity of the National Payment System, the South African Reserve Bank, in its role as overseer of this system, will require insight into risk-related information. The South African Reserve Bank reserves the right to prescribe risk management and security measures prior to implementation of a scheme. Thirdly, the Bank will require that mechanisms are available to measure and control the supply of rand-denominated money. This is necessary because e-money could potentially affect the Reserve Bank’s ability to manage the money supply effectively. Fourthly, only banks are permitted to issue e-money. Primary and intermediary issuers of electronic value will therefore be subject to regulation and supervision by the South African Reserve Bank. Although single purpose schemes will generally fall outside the definition of electronic money, the South African Reserve Bank will determine whether multi-purpose schemes fall within the definition or not. Lastly, issuers will be obliged to redeem electronic money value in central bank money, at par, upon request. The management of the underlying float and redemption of electronic money value by the issuer to the holder must be clearly defined. 5. E-money and monetary policy issues The Reserve Bank’s main interest in e-money is in three areas, i.e. the effect that it may have on the formulation of monetary policy, the issue of banknotes and coins and on the soundness of the financial system. (a) The formulation of monetary policy E-money can be considered as another innovation in a series of new financial arrangements. These new arrangements have all required some adjustments in the formulation of monetary policy, and e-money is not likely to be an exception to the rule. As already indicated, the collection of data on e-money is regarded as essential because the issue of e-money will affect the calculation of the money supply, an important indicator in the formulation of monetary policy in any monetary policy framework. The development of e-money will therefore require a redefinition of the monetary aggregates to include this form of money. It is at this stage difficult to determine what the effect of e-money will be on the value of the money supply. To the extent that e-money replaces the existing banknotes and coins on a one-for-one relationship, the redefinition of the monetary aggregates would leave the demand for money unchanged. However, to the extent that e-money allows people to economise in their overall holdings of currency, it could lead to a decline in the monetary aggregates. Similar deductions can also be made on the likely effect of e-money on deposits included in the monetary aggregates. The large scale introduction of e-money may also influence the velocity of circulation of money, which will have to be taken into consideration by the monetary authorities in the formulation of monetary policy. Nevertheless, the monetary aggregates should continue to be able to play much the same role as they currently play in monetary policy formulation, despite some difficulties that may be experienced in the transition period. (b) Currency issue The Reserve Bank Act gives the Bank the sole right to issue banknotes and coins in South Africa. The provision of currency by the Reserve Bank under a statutory monopoly is seen as a useful public service which provides a basis on which other payment arrangements and contracts must rest. The Bank’s role is to facilitate and encourage overall payment system efficiency by continuing to offer currency as just one payment technology amongst several. Alternative payment technologies and innovations are freely allowed within this framework, and users are allowed to choose freely amongst the competing technologies. At this stage, there is no intention that the Reserve Bank should itself issue stored value cards, or provide other forms of electronic money to the public. However, the possibility that this might happen at some point in the future cannot be completely ruled out. If electronic developments proceed to the point where payment using currency becomes inefficient and costly, then it could prove to be necessary to convert our paper and metal currency issue into electronic form. Electronic payment developments (and any erosion of the currency issue that may result) do not appear to pose any threat to the Reserve Bank’s ability to implement monetary policy in the foreseeable future. Even if they did pose such a threat, the appropriate response would probably not be to seek to control or prevent such developments. It would generally be much better to adapt the monetary policy operational procedures to the realities of the market place. (c) Prudential issues The issue of e-money could be a risky business, because the monetary amount stored on a card or on a network is only as good as the bank or other organisation which has the ultimate ability to pay on that obligation. This may not be a serious concern in the case of low-value balances. However, it becomes much more serious with higher-value balances. Such problems do, of course, not arise in the issuing of banknotes and coins. These currency liabilities form part of the Reserve Bank’s overall liabilities and a guarantee is provided to the bearer that they will be replaced with currency of an equal value. The issue of e-money will also increase the risk of counterfeiting. Depending on the technical characteristics of each system, counterfeiting could take place by physical reproduction of cards, by manufacture of a “re-loading mechanism” which could be fraudulently used to add new balances to authentic cards, or by “hacking” into the payments systems themselves. With some technologies, it might be difficult or impossible for the recipient of an electronic payment, or even for an issuer, to detect an electronic counterfeit. Telephone card fraud alone for example cost Telkom more than R13 million in the three financial years ending August 1999. By contrast, counterfeit currency can usually be detected by a recipient and the Reserve Bank as issuer scrutinises banknotes and coins carefully to prevent counterfeiting. Sophisticated security features will reduce the risk of successful electronic counterfeiting, but with the lucrative possible returns it will be difficult to rule them out. Issuers will therefore have to take great care to ensure that the dangers of counterfeiting is minimised, and they should be vigilant in monitoring their systems and operations so that counterfeiting is quickly detected. Even more important is that when South African residents get involved in payment arrangements which are effectively domiciled outside South Africa, they need to understand who it is that they are dealing with, where the counterparties are legally located, whether they have an appropriate standing, and what potential risks they may face – either by holding balances within a system, or by using those balances in a transaction. This information may not always be readily available or may be difficult to evaluate. Both the holders of new forms of electronic money, and the issuers, face potential risks in certain circumstances. Some of these are reasonably easy to understand and evaluate, and may not be any more serious than the risks which exist at present, such as losing your wallet. However, the risk characteristics of schemes involving elements such as multiple issuers, many members, many business organisations, multiple jurisdictions, delay or complexity in any settlement arrangements, or lack of any audit trails are most certainly not all straightforward. 6. Conclusion The introduction of e-money and for that matter all forms of e-commerce will accordingly create new problems for the business community, but will also create new opportunities for a more efficient payment system. The Reserve Bank is not too concerned about these new developments at this stage. Customer needs are likely to be best met through effective competition, and this will require that genuine choices amongst alternative products are available. Fast and efficient means of pricing trades, handling client relationships and redesigning distribution structures are being enabled by the Internet. More widespread uses of these new methods will create opportunities for financial innovations. However, the Bank will be watching these new developments carefully, in order to ensure that the integrity of South Africa’s financial system is always maintained. | south african reserve bank | 1,999 | 10 |
Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the Annual Convention of the Actuarial Society of South Africa, held in Midrand on 2 November 1999. | Mr Mboweni addresses the topic “signals from the markets: does the yield curve contain useful information for the Reserve Bank?” Address by Mr Tito Mboweni, Governor of the South African Reserve Bank, at the Annual Convention of the Actuarial Society of South Africa, held in Midrand on 2 November 1999. * * * Introduction Federal Reserve chairman Alan Greenspan once famously told a congressman that if what he had said was clear, the congressman must have misunderstood him. Central bankers are always looking into an uncertain future; that is why they are sometimes less direct than the public might want them to be. As the Governor of the Reserve Bank, it is my job to worry about the future even while things are going well in the present. It is the same for central bankers all over the world; the Bank of England and the United States Federal Reserve recently reminded us of the need for pre-emptive action by tightening policy before the actual inflation numbers started to gain momentum. It is this preoccupation with an uncertain future which explains why the word “signal” crops up so often in the language of monetary policy. One only has to read the financial papers to be struck by how often the word is used in the context of central banking. Monetary policymakers are constantly watching for early-warning signals on the economy, and from time to time we, in turn, give signals to the markets and the public on monetary policy. What, then, are the signals that the Reserve Bank watches for from the markets and the economy? The answer to that question would fill quite a few dissertations, and, therefore, cannot be spelled out in detail. Central bankers cannot be too direct, as I have already said. We also have to bear in mind that, because the South African Reserve Bank is still in the process of establishing an inflation-targeting framework, the importance attached to various signals is under serious review. The inflation-targeting framework will not really simplify the range of variables and events deemed to be relevant that much. In the new framework, we would be able to analyse variables and events incorporated in the inflation-targeting models as well as variables and events not explicitly incorporated in the inflation-targeting models, such as bad debts in the banking industry, but which are also important for the maintenance of financial stability. In this regard, we have been watching the effects of the liquidation of Macmed with interest. For today, given that my audience is concerned with long-term investment portfolios, I shall discuss an issue which appears to be something of a favourite topic among South Africa’s investment analysts - the term structure of interest rates, or the yield curve. The market determines different yields on investments of different maturities; of considerable importance is the gap between interest rates on short-dated investments and those with longer maturities. If these interest rates are plotted against unexpired maturity, the result is the yield curve, and of importance is its slope. Does the slope of the yield curve provide the Reserve Bank and the investment community with useful information? Before discussing the issue, it is worth noting that there are many good reasons to take into account signals from the financial markets in reaching monetary policy decisions. For one thing, market prices are up to date, and policymakers therefore do not face the problem that they do with other economic data. Information on the real economy only becomes available after a time lag, and it is possible that by the time enough information has been acquired on, say, trends in capacity utilisation or unit labour costs to make it clear what course of action is necessary, it might be very late in the day. In addition, it seems that some indicators that are relatively current, such as the monetary aggregates, are not sufficient by themselves as early-warning signals of inflation. The most obvious way in which the yield curve can assist the Reserve Bank is in providing information on inflation expectations. But, as I shall argue, the message from the yield curve is not unambiguous in this respect. I shall discuss the issue in general terms first, before mentioning recent developments in the South African capital market and the issues raised by some of the local investment analysts. The yield curve and inflation expectations One of the greatest difficulties which all central banks face is getting a reliable measure of inflation expectations. Difficult though it is, it is nonetheless important to try to monitor inflation expectations, as they play an important role in price and wage setting behaviour. One way of monitoring inflationary expectations is to conduct a survey among the public (which the Reserve Bank intends to do); another way would be to monitor the behaviour of market-determined interest rates, or the yield curve. As you know, the yield curve is upward sloping, or positive, when nominal interest rates on longer-dated bonds are higher than those on shorter-dated securities. It can also be downward sloping, or inverted, if the short-term interest rates exceed the rates on bonds with long-dated maturities. To begin our discussion of the yield curve, it is worth revisiting the Fisher equation, named after American economist Irving Fisher. The textbook equation states that nominal interest rates are equal to the required real rate of return on the funds invested, plus the expected inflation rate over the period of the investment. So it is clear that expected inflation plays an important role. The Fisher equation can be modified to include a risk margin in the calculation of the nominal interest rate. The risk margin can reflect variability in the inflation rate; it will in practice also take account of factors such as political and exchange rate risk. What will happen to capital market interest rates if investors decide they have to revise their expectations of future inflation upwards? Investors in long-term assets who believe future inflation will be higher than initially expected will want to protect their real returns. As a result, they will demand higher nominal interest rates on longer-term bonds. In such a situation, one would expect the yield curve to steepen. Can we say that if the yield curve steepens, it should necessarily be taken as a sign that the expected inflation rate in the future has risen? The answer to that is clearly no; expected inflation is only one factor determining nominal interest rates. An increase in expected inflation should lead to a steepening in the yield curve, but - and this is a crucial point - a steeper yield curve does not necessarily signal a rise in expected inflation. The effect on the yield curve of factors other than expected inflation The yield curve is normally positively sloped; in other words, the longer the duration of the investment, the higher the yields. The positive slope is explained, among others, by the premium on long-term bonds which is required to compensate for the greater risk in keeping paper with longer maturities. So, a positively sloping yield curve does not in itself tell us anything about inflation expectations or the economy. A crucial point in an analysis of the shape of the yield curve is that long bond yields are entirely market-determined while short-term interest rates are influenced by the monetary policy decisions of the central bank - which should, of course, also respect market forces. It follows that a steepening in the yield curve can be caused by monetary easing. Such a steepening will happen when a reduction in short-term interest rates is not accompanied by a commensurate decline in long bond yields. Why would long bond yields not follow short-term interest rates lower to the same extent? The answer to that question is the key to our dilemma in interpreting signals from the markets. It could be that investors in long bonds are looking ahead to an economic upswing and that they are already beginning to anticipate the point in time when the monetary authorities will begin tightening policy again. In such a scenario, it makes sense for longer-term yields to remain relatively high and not to match the declines in short-term interest rates. Then the steepening in the yield curve signals that an economic acceleration is on the cards. Although heightened economic activity obviously increases the risk of inflation, investors who expect the central bank to act pre-emptively will not necessarily modify their inflation expectations. They will, however, expect short-term interest rates to rise in future to nip inflation in the bud. As long-term interest rates can be viewed as reflecting expectations of future short-term interest rates, a steepening in the yield curve can be seen as a sign that short-term interest rates are expected to play catch-up once the economy is in danger of overheating. If the central bank’s policy is in danger of erring on the side of being too loose, the slope of the curve could become abnormally steep. Long bond yields could rise even as short-term interest rates are falling. But an abnormally steep yield curve is not necessarily conclusive evidence of loose monetary policy. It could be a sign of an increased risk premium, which is also part of the calculation of market-determined yields. The risk premium takes into account the danger that inflation expectations might turn out to be wrong. Perhaps more importantly, the risk premium catches all uncertainties; it also relates to exchange rate concerns and even political uncertainty. If the risk premium rises during a period of monetary easing and declining short-term interest rates, it follows that the yield curve will tend to steepen. As I have already mentioned, heightened economic activity increases the risk of inflation. As a result, investors might demand a higher risk premium as economic activity starts gaining momentum, especially if there is any uncertainty over policy. Obviously, policy uncertainty might be entirely misplaced, in which case the market should correct when participants realise their fears over policy are unfounded. I have mentioned that a steepening in the yield curve is probably a sign that economic activity is set to accelerate. Obviously, the argument also works the other way round - an inverted yield curve can be seen as a sign of an impending slowdown in the economy, which could be accompanied by disinflation. The shape of the yield curve can also be affected by financial factors that are not directly related to expectations about inflation or the real economy. One such factor is the relative supplies of different financial assets. If there is an oversupply of long-dated maturities, the result could be higher yields at the longer end of the curve. Known as the market segmentation theory, this approach suggests there is not much movement by investors between different maturity segments in the capital market. The difficulty in reading messages on inflation from the shape of the yield curve was mentioned in a speech to the New Zealand Society of Actuaries in 1995 by the Governor of the Reserve Bank of New Zealand, Donald Brash: “Many central banks monitor the yields on long-term conventional bonds in an attempt to get a reading on inflationary expectations. But there are significant problems in interpreting these yields: how much of the increase ... reflected an increase in concerns about future inflation and how much an increase in real interest rates, a response to the increased demand for capital as the world economy emerged from recession?” In that speech, Mr Brash noted one possible solution to the problem of interpreting the behaviour of long bond yields - the introduction of inflation-adjusted bonds. These securities provide investors with a guaranteed real return on their investments. The South African Department of Finance has said it is seriously considering the introduction of inflation-linked bonds, and it is worth our reflecting on whether their introduction in this country could help the Reserve Bank in its efforts to gauge inflationary expectations. Inflation-linked government bonds Inflation-adjusted bonds, also known as index-linked bonds, systematically compensate investors for the loss of purchasing power as a result of inflation. In a typical inflation-linked bond, both capital and interest, or coupon, payments rise with inflation. In most countries, the consumer price index forms the basis for such indexation. Inflation-linked government bonds used to be associated with financially unstable countries experiencing hyperinflation. However, in recent years, financially stable countries have issued inflation-linked government bonds, including Canada, the United States, the United Kingdom and France. The idea of indexation is most relevant for bonds with longer maturities, as there is more uncertainty with respect to inflation, rather than for shorter-dated securities. There are arguments for and against introducing index-linked bonds. It could be argued that the mere existence of inflation-linked securities is testimony to the fact that the monetary authorities cannot deliver complete price stability. Their introduction could also signify government’s acceptance of inflation as a fact of life which merely needs symptomatic treatment. By guaranteeing investors protection against inflation, government is, in effect, making it easier to live with inflation. But there are many counter-arguments. The taxpayer can save on interest costs if inflation is as low as government expects it to be, because these bonds do not have an inflation risk premium built into their pricing. In addition, these bonds eliminate the incentive for the state to inflate, as its borrowing costs would increase. Other arguments in favour of issuing index-linked bonds include the following: they can protect the purchasing power of accumulated savings; other financial assets do not provide as good a hedge against inflation; they encourage savings; they expand the range of investment opportunities; and they could enable the monetary authorities to obtain useful information on real interest rates and inflation expectations. How can inflation-indexed bonds help the central bank? This new form of bond will, like conventional bonds, also trade in the secondary market. The yield at which it trades is a real yield, as investors are guaranteed compensation for inflation. Therefore the difference between the real yield on the inflation-indexed bond of a certain maturity, and the nominal yield of a conventional bond of the same maturity, can be viewed as the expected inflation rate over the period. In other words, if the nominal yield on a 10-year bond is 15% and the real yield on an inflation-linked 10-year bond is 4%, the expected annual inflation rate over the period is 11%. But this is only true at first glance. Remember, there is a risk premium element in the calculation of the nominal yield on a conventional bond. The risk premium - and not expected inflation - could account for part of the difference between the real yield on the inflation-linked bond and the nominal yield on a conventional bond of the same maturity. It might be difficult to distinguish between the expected inflation component and the risk premium element. Another factor is that indexed bonds, at least initially, might not be traded frequently in the secondary market. There could be an illiquidity premium built into the yield of the index-linked bond. Nevertheless, the fact remains that the introduction of inflation-linked bonds could improve the Reserve Bank’s information on inflation expectations. Recent changes in the shape of the South African yield curve Over a period of about 18 months, the shape of the South African yield curve has been subject to fairly significant changes. From mid-April to August last year, when South Africa was affected by the global emerging markets crisis, the slope of the yield curve was negative; it changed from a slight to a fairly steep inversion. Tight monetary conditions caused yields on short-dated bonds to rise more than yields on long-dated bonds. The overall level of the curve rose, reflecting heightened uncertainties about the future direction of financial policies, nervousness about investment in emerging markets and an upward adjustment of expectations about future inflation. The financial markets settled down gradually in the last three months of 1998 and yields declined when monetary conditions became easier as the exchange rate of the rand improved. From March this year, short-term yields declined to levels below those of long-term yields and the yield curve assumed a positive slope which subsequently steepened. As I have indicated above, it is difficult to read unambiguous signals from these changes in the shape of the yield curve. Nevertheless, these shifts have been noted by the Reserve Bank, as have the frequent comments on the topic of the yield curve by the South African investment community. Last year, when the slope of the yield curve was inverted, some analysts argued that the curve was signalling a sharp slowdown in economic activity. Now that the yield curve is positive and steep, some economists are predicting a significant acceleration in economic activity. Conclusion Empirical studies have found that the yield curve is a good predictor of growth in non-agricultural gross domestic product. So, the recent shifts in the shape of the yield curve appear to confirm what we all sense - the economy has been in a downswing, but the turning point seems to have been reached with the recovery set to gain momentum. The Reserve Bank does not release its forecasts on the economy, but I can mention that forecasts that we have seen of economic growth of the order of magnitude of 3% or so in the millenium year are not out of line. It would be difficult to read more into the signals coming from the financial markets at the moment. As a general rule, we also have to bear in mind that financial markets are not always right, and that rapid adjustments sometimes have to take place when expectations turn out to be wrong. Be that as it may, the signals from the financial markets form part of the mix of factors to which the central bank pays regular attention. But not only does the Reserve Bank look to the markets for signals and for an assessment of monetary policy; the markets also look to the Bank for signals. This two-way communication is an essential element in meeting the Bank’s main objective, which is the maintenance of financial stability. | south african reserve bank | 1,999 | 11 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Pretoria Council for Businesswomen, Pretoria, held on 14 March 2000. | Mr Mboweni: The role of the South African Reserve Bank in the economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Pretoria Council for Businesswomen, Pretoria, held on 14 March 2000. * 1. * * The establishment of the Reserve Bank The South African Reserve Bank was established in 1921 as the central bank of South Africa in terms of a special act of Parliament. The founding of the Reserve Bank was the direct result of disruptions caused by the First World War and formed part of a more comprehensive set of measures meant to deal with unsatisfactory monetary and financial conditions. At that time, the existence of central banks was still not common, and the South African Reserve Bank was only the fourth central bank founded outside Europe. The other three central banks were established in the United States of America, Japan and Java. The Reserve Bank was mainly set up because of the need to issue uniform banknotes and to prevent the over-issue of banknotes. Before the Bank was established an assortment of banknotes were in circulation in South Africa which were issued in terms of the laws of the various provinces. With the formation of the Reserve Bank, it obtained the sole right to issue banknotes in South Africa. The Bank’s first notes were issued to the public in April 1922. At the end of that year the banknotes in circulation amounted to R20 million. At the end of February 2000 the notes and coin in circulation totalled R27,4 billion. The Reserve Bank’s size and operations were at first hampered by various statutory restrictions on its lending and investing. Some expansions to the Bank’s powers to grant credit were brought about by amendments to the Currency and Banking Act in 1923 and 1930. A more comprehensive revision of the Bank’s powers was affected in 1944. Subsequently, many changes were also made to strengthen the bank’s hand in carrying out its functions. These changes reflected a recognition of the Bank’s need for greater freedom of action in its day-to-day operations and an awareness of the need for sufficient policy instruments in conducting monetary policy. Today, the Reserve Bank virtually performs the full range of functions and duties that are customarily carried out by central banks. In addition, the Reserve Bank is actively involved in the marketing of South Africa’s gold production. The main functions of the Reserve Bank are: • the issuing of banknotes and coin; • acting as banker to the government; • acting as a bank to other banks; • providing facilities for the clearing and settlement of claims between banks; • acting as custodian of the country’s gold and other foreign reserves; • acting as “bank of rediscount” and “lender of last resort”; • engaging in public debt management and open-market operations; • collecting, processing and interpreting economic statistics and other information, and • formulating and implementing monetary policy. 2. Legal framework of the Bank The existence, management, powers and functions of the Bank are currently governed by the Reserve Bank Act No 90 of 1989, which came into operation on 1 August 1989. However, the Reserve Bank has also been identified as the central bank of South Africa in the Constitution of the Republic of South Africa. As the Bank is a statutory institution, it is only allowed to perform functions expressly or by implication assigned to or conferred upon it by these two legislative enactments. Since its establishment, the Reserve Bank has always been privately owned. Today, the Bank has more than 700 shareholders. The shares of the Bank are listed on the Johannesburg Stock Exchange and no individual shareholder is allowed to hold more than one-half per cent of the capital of the Bank. The Bank may never pay a dividend of more than 10% per annum on the nominal value of its capital. The Bank is managed by a Board of 14 Directors, seven of whom are elected by the shareholder’s to represent them on the Board. Without holding any shares in the Bank, the Government has the right to appoint the other seven Board members. The seven members appointed by the President includes the Governor and three Deputy Governors, who are full-time executive members, plus three part-time Directors. The Governor and the Deputy Governors are appointed for five years, while all other directors serve for periods of three years. All directors are eligible for reappointment or re-election after the expiration of their terms of office. The Reserve Bank Act provides further that of the seven directors elected by the shareholders, four shall be persons who are or have been actively and primarily engaged in commerce or finance, one shall be a person who is or has been engaged in agriculture and two shall be persons who are or have been engaged in industrial pursuits. Members of Parliament, directors, officers or employees of banks or mutual banks and persons who are not South African citizens resident in the country are disqualified from being appointed or elected as a director of the Bank. The Board of the Reserve Bank has been given an important degree of autonomy for the execution of its duties. In terms of the Constitution: The South African Reserve Bank, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters”. As a creation of government, the Reserve Bank is, of course, accountable to Parliament and the Government has an important say in the activities of the Bank. In terms of section 31 of the Reserve Bank Act the Governor of the Bank must submit a report annually to the Minister of Finance relating to the implementation of monetary policy. Moreover, in terms of section 32 of this Act the Bank must on a monthly basis submit a statement of its assets and liabilities and annually its annual financial statements to the Department of Finance. These reports are then tabled in Parliament by the Minister of Finance. The Governor of the Reserve Bank is also summoned to appear before the Portfolio Committee on Finance from time to time. In these meetings he usually explains the monetary policy stance to committee members and answers questions on the Bank’s views on financial and economic developments. Section 37 of the Reserve Bank Act provides further that if at any time the Minister of Finance is of the opinion that the Bank has failed to comply with any provision of the Act or of a regulation made thereunder, he may by notice in writing require the Board of the Bank to make good or remedy the default within a specified time. If the Board fails to comply with such a notice, the Minister may apply to the Supreme Court for an order compelling the Board to make good or remedy the default, and the Court may make such order thereon as it thinks fit. 3. Primary objective of the Bank In all these endeavours, the primary or strategic objective of the Reserve Bank is to achieve and maintain stable financial conditions in the country. This objective is spelled out in both the Constitution of the Republic and in the South African Reserve Bank Act. In these acts it is recognised that only by protecting the currency can balanced and sustainable economic growth be achieved. It is believed in the Bank, and indeed in most countries of the world, that the potential growth rate of an economy and the optimum creation of employment opportunities can only be attained under stable financial conditions. By fulfilling this primary objective, the Reserve Bank will make its contribution to sustainable higher economic growth in South Africa. The question may be asked what is meant by the term financial stability? In a broad sense financial stability can be defined to include price stability as well as stable conditions in the financial sector as a whole. Price stability is achieved when changes in the general price level do not materially affect the economic decision-making process. Although relative price movements will still have an impact on production, consumption and investment, the rate of inflation or deflation is not an important factor in the decisions taken by producers, consumers and the authorities under stable price conditions. The stability of key institutions and markets in the financial system is achieved when there is a high degree of confidence that the financial infrastructure of the economy is able to meet the requirements of market participants. However, it is important to realise that financial stability does not exclude the failure of individual banks or financial institutions. A financial institution can go bankrupt in stable financial conditions. It is only where systemic risks arise, i.e. where the financial sector as a whole may be influenced by an incident, that the situation can be described as financially unstable. The two elements of financial stability, i.e. price stability and stability of the financial sector, are closely related. Failure to maintain one of these elements provides a very uncertain operating environment for the other, with causality running in both directions. For example, high inflation can lead to tighter monetary policy, higher interest rates, an increase in the non-performing loans of banks and a fall in asset and collateral values, which can cause bank and other failures in the financial sector. Conversely, disruptions in the financial system will make the transmission mechanism of monetary policy less effective and can materially affect changes in the general price level. 4. Monetary policy framework In its objective to establish and maintain financial stability it is therefore important that the Reserve Bank encourages and supports the development of sound and well-managed banking institutions. This is done, firstly, by monitoring the financial risks that banks undertake. The Bank Supervision Department is charged with the responsibility to ensure prudential soundness in the banking system. Secondly, lender-of-last-resort assistance is provided to banks to safeguard the system from systemic risks. This assistance is never provided automatically to any bank that encounters difficulties, but it is only applied in cases where a bank is encountering liquidity shortages and where its failure would pose a serious threat to the financial system as a whole. Financial stability also requires well-developed and efficient functioning financial markets. In this regard it is important to have sufficient banknotes and coin in circulation, so as not to hamper trade and financial transactions. Without a system for the clearance and settlement of bank claims, the payments for transactions would be encumbered. In addition, the Reserve Bank has a vested interest in the development and functioning of the money, capital and foreign exchange markets if it wants to maintain financial stability. In order to achieve price stability, the Minister of Finance announced in his Budget Speech on 23 February 2000 that the government has decided to adopt an inflation-targeting monetary policy framework in South Africa. This means that the authorities are now targeting the rate of inflation directly, instead of setting guidelines for intermediative objectives such as money supply and bank credit extension to bring inflation down to lower levels. The inflation target has been expressed as an average annual rate of increase of between 3 and 6% in the consumer price index excluding the effect of changes in mortgage rates for the year 2002. With the announcement of this new framework the inflation target becomes the overriding objective of monetary policy. The objective of monetary policy is now to hit the target. Missing the target consistently with wide margins will lead to lost prestige and credibility for the central bank. Such a framework for monetary policy can only be successful if the public is certain that the central bank is serious about containing inflation. This new framework has been adopted in South Africa to remove any uncertainties about the monetary policy stance that is adopted by the authorities. Inflation targeting makes policy transparent in the sense that it makes the central bank’s intentions clear in a way that should improve the planning of the private sector. Inflation targeting should also provide an anchor for inflation expectations, lead to greater stability in interest rates if it brings about better coordination of policy measures and clearly defines the accountability of the Reserve Bank. In this new monetary policy framework the operational procedures of the Reserve Bank will basically remain unchanged. The Bank will accordingly continue to influence the total monetary demand in the economy to achieve price stability. The Reserve Bank controls the supply of money through its operations in providing liquidity to the banking sector and by affecting the total demand for money that emanates from the private and public sector. Its operational variable in this process is the level of short-term interest rates. The level of interest rates is determined primarily by total saving in the economy, the inflow of capital, and by the demand for funds from government, businesses and private individuals. The central bank affects the cost of short-term funds through the impact of its actions on the repo rate, i.e. the interest rate at which it provides in the liquidity needs of the banks. In such a framework there is no target for the exchange rate of the rand. The external value of the rand forms part of the results obtained in the economy. 5. Decision-making process In view of the growing complexity of functional relationships between the various economic and financial variables, a detailed and careful analysis has to be made of the underlying economic conditions. A large number of economic indicators are therefore monitored by the Bank to arrive at its monetary policy stance, such as developments in price indices, the level of interest rates, the shape of the yield curve, changes in nominal salaries and wages, nominal unit labour costs, the gap between potential and actual domestic output, money market conditions, the overall balance of payments position, the net open position in foreign exchange and the public sector borrowing requirement. To evaluate the results of such an analysis of the economy a Monetary Policy Committee was created in the Reserve Bank. The Monetary Policy Committee consists of the Governor and Deputy Governors as voting members and senior officials of the Bank as non-voting members. The first meeting of the Monetary Policy Committee was already held in October 1999. At the meetings of this Committee an evaluation is made over a two-day period of international and domestic economic conditions, the expected behaviour of the inflation rate and the current stance of monetary policy. Although the governors of the Bank are the only members with voting rights on the Committee, consensus decisions are normally made. The final decision-making power on monetary policy matters nevertheless is still vested in the Governor’s Committee, i.e. a subcommittee of the Board comprising the Governor and three Deputy Governors. After the completion of every meeting of the Monetary Policy Committee a statement is issued to the public. This statement summarises the more important aspects that were discussed at the meeting and the conclusions that were made. In this statement the monetary policy stance of the Reserve Bank is also formulated. For example, in the last monetary policy statement of 2 March 2000 it was concluded that after taking cognisance of the current economic circumstances and consistent with the inflation target set by the authorities, the Monetary Policy Committee is of the opinion that the current level of the repo rate is appropriate. In accordance with the decision taken at the previous meeting, the Reserve Bank will therefore continue to manage the banks’ daily liquidity requirement in a way that will result in a repo rate at or around 11.75%”. 6. Conclusion As already indicated, this decision was taken after lengthy deliberations and a detailed analysis of the underlying economic conditions in the country by senior staff of the Reserve Bank. More in particular, the latest decision of the Monetary Policy Committee took note of the following economic developments: • Favourable global growth prospects with some signs of an acceleration of inflation in industrial countries and a concomitant rise in their interest rates. • South Arican recovery in domestic economic activity that gathered momentum during the course of 1999. The growth from quarter to quarter in real gross domestic product increased from 2% in the fourth quarter of 1998 to no less than 32% in the fourth quarter of 1999. • With the increase in economic activity, gross domestic expenditure began to pick up and increased at a seasonally adjusted and annualised rate of 42% in the fourth quarter of 1999. This high growth can be ascribed to a rise in consumption expenditure, an increase in the fixed investment of private organisations and a strong accumulation of inventories. • Conditions in the labour market remained depressed with further job losses of about 80 000 being recorded in the first nine months of 1999. • The current account of the balance of payments showed a deficit of 2% of gross domestic product in the fourth quarter of 1999. This deficit did not present any problems to the domestic economy and was wiped out by a net inflow of capital of no less than R14 billion. Moreover, the balance of payments is basically very healthy, which makes it difficult to understand why the external value of the rand recently came under some pressure. • Clear signs of increased inflationary pressures have become apparent in the South African economy. This has been reflected in a rise in the year-on-year rate of the production price index from 5.7% in September 1999 to 8.2% in January 2000. This acceleration in inflation was mainly due to increases in the prices of petrol and diesel, transport equipment and more recently food products. The recent floods experienced in the country, a further increase in international oil prices and the more rapid rise in money supply growth could also cause rising inflation over the short term. • Over the medium to longer term, inflation in South Africa is expected to subside again because of the application of fiscal and monetary discipline, a projected low growth in nominal unit labour costs, international competition and the excess production capacity in the economy. All in all the economic conditions in South Africa are at present much more favourable than at the beginning of the preceding year. With the further improvement in the production structure of the country envisaged in the President’s State of the Nation Address on 4 February 2000, the outlook for the South African economy indeed looks very promising. | south african reserve bank | 2,000 | 3 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Free State Branch of the Economic Society of South Africa and Chamber of Trade and Commerce, Bloemfontein, on 12 April 2000. | T T Mboweni: The objectives of monetary policy with reference to the independence of the South African Reserve Bank Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Free State Branch of the Economic Society of South Africa and Chamber of Trade and Commerce, Bloemfontein, on 12 April 2000. * 1. * * Introduction The task of macroeconomic policy is the promotion of economic growth and development, the creation of more jobs and the employment of more people, the improvement of the living conditions of all the people of the country, and the elimination of unjustifiable discrepancies between average incomes of various groups of participants in economic activity. Monetary policy, being a part of macroeconomic policy, has but an intermediate role to play in the implementation of overall macroeconomic policy. It is expected of monetary policy to create and maintain a stable financial environment within which overall economic activity can be expanded. None of the above ultimate objectives of macroeconomic policy will be attainable in an environment of unstable financial conditions. Although overall financial stability by itself cannot guarantee the achievement of the ultimate macroeconomic objectives, it is an important precondition for reaching those goals. In order to comply with its obligation and to meet its commitment, the central bank should pursue its objectives with a medium and longer term view in mind. Financial stability should, for example, be maintained throughout the business cycle in both the expansion and contraction phases of the economy, and should in the democratic political system of periodic elections, stretch beyond the duration of successive governments. It is inter alia for this reason that central banks need some autonomy for the execution of their duties. 2. Primary objective of the Bank The primary or strategic objective of the Reserve Bank is therefore to achieve and maintain stable financial conditions in the country. This objective is spelled out in both the Constitution of the Republic and in the South African Reserve Bank Act. In these acts it is recognised that only by protecting the currency can balanced and sustainable economic growth be achieved. The question may be asked what is meant by the term financial stability? In a broad sense financial stability can be defined to include price stability as well as stable conditions in the financial sector as a whole. Price stability is achieved when changes in the general price level do not materially affect the economic decision-making process. Although relative price movements will still have an impact on production, consumption and investment, the rate of inflation or deflation is not an important factor in the decisions taken by producers, consumers and the authorities under stable price conditions. The stability of key institutions and markets in the financial system is achieved when there is a high degree of confidence that the financial infrastructure of the economy is able to meet the requirements of market participants. However, it is important to realise that financial stability does not exclude the failure of individual banks or financial institutions. A financial institution can go bankrupt in stable financial conditions. It is only where systemic risks arise, i.e. where the financial sector as a whole may be influenced by an incident, that the situation can be described as financially unstable. The two elements of financial stability, i.e. price stability and stability of the financial sector, are closely related. Failure to maintain one of these elements provides a very uncertain operating environment for the other, with causality running in both directions. For example, high inflation can lead to tighter monetary policy, higher interest rates, and increase in the non-performing loans of banks and a fall in asset and collateral values, which can cause bank and other failures in the financial sector. Conversely, disruptions in the financial system will make the transmission mechanism of monetary policy less effective and can materially affect changes in the general price level. 3. Why is it important to maintain financial stability? There are many convincing reasons why financial stability is regarded as a prerequisite for the promotion and support of economic development. All modern market-oriented economies are based on the extensive use of money as a unit of account, as a means of exchange and as a store of value. Money that changes in value all the time cannot fulfil these functions. Money must be trusted by the public to be a constant yardstick of value, otherwise it will not be acceptable as a means of exchange, and cannot continue to serve as a store of value. The many disadvantages of inflation are well-known. High inflation distorts the allocation of resources and favours investment in non-productive hedge assets. High inflation discourages saving and leads to more consumption. High inflation erodes the competitiveness of local manufacturers and other producers vis-à-vis foreign producers. High inflation leads to an unfair redistribution in wealth by penalising the poor more than the rich. High inflation leads to lower growth, fewer jobs and more unemployment. There can be no rational reason for the support of inflation in any country except by those few financial wizards that have learned how to take advantage of inflation at the cost of their fellow human beings. This may even include the managers of the national budget who have learned through experience that taxation through inflation often meets with less resistance from ill-informed tax payers. For the economy as a whole, however, inflation is always bad. An argument is often made for a trade-off between inflation and growth based on the Philips-curve analysis in terms of which, at a low level of inflation, real growth can be stimulated through an expansionary monetary policy, even if it should create some higher rate of inflation. There may be some truth in this for the short-term but it is easy to prove that a continuing expansionary monetary policy will eventually lead to an acceleration in the rate of inflation. A little bit of inflation once started can easily gain momentum, get out of control and develop into hyper-inflation. It is also true that with modern electronic forecasting techniques and increasing sophistication in the role of rational expectations, the effective period for the trade-off has become very short. 4. How does the Reserve Bank achieve financial stability? Inflation is a monetary phenomenon, i.e. inflation cannot take place without a more rapid increase in the quantity of money than in output, provided that the velocity of circulation of money remains unchanged. Although the causes of inflation are too wide for any individual institution to prevent it from occurring, the Reserve Bank can at all times use the powers at its disposal to reduce inflationary pressures by influencing the growth in money supply and bank credit extension. The Reserve Bank can influence money supply and bank credit extension either by influencing overall liquidity in the banking sector, that is, by influencing the supply of money or by influencing the demand for credit emanating from the private sector. Liquidity in the banking sector can be influenced through various operational instruments, such as changes in minimum cash reserves for banking institutions, open market-operations and short-term money market interventions through swaps and repurchase transactions. The demand for bank credit is to an important extent interest rate driven. By influencing the general level of interest rates, the Reserve Bank can exert some influence on the total demand for credit, and therefore on the money supply. The main operational instrument in this case will normally be the repo rate, that is the interest rate at which the Reserve Bank provides in the liquidity needs of banking institutions. In its objective to establish and maintain financial stability another important responsibility of the Reserve Bank is to encourage and support the development of sound and well-managed banking institutions. The objective of banking supervision is to ensure that banks manage their risks in such a way that systemic risk in the banking sector is minimised, thereby ensuring the safety of depositor’s money. Banking supervision is based to a large extent on the prudential regulation of banks, which is aimed mainly, but not exclusively, at promoting the financial soundness of banks and of the banking system as a whole. In order to fulfil the responsibility for systemic protection of the banking system, bank supervision must ensure the prudential soundness of participants in the banking system. As soon as a bank failure could cause a systemic problem, the prudential and systemic measures pertaining to the supervision of banks converge. If a large bank is in financial difficulty, the expectation of losses may become so widespread that the public loses confidence in the banking system as a whole, causing withdrawals of deposits and general liquidity problems in the banking system. Financial stability also requires well-developed and efficient functioning financial markets. The basic foundation for the functioning of markets is the provision of money. It is therefore an important function of the Reserve Bank to issue banknotes and coin in South Africa. In any payment system there arises the need for clearance and settlement of claims of banks on one another because cheques drawn on any particular bank will in many cases be deposited by their holders with other banks. This function of clearance and settlement has therefore been performed by the Reserve Bank since 1921. In its endeavours to maintain financial stability the Reserve Bank also has a vested interest in the development and functioning of the money, capital and foreign exchange markets. Although the Bank is not directly responsible for the development of the money and capital markets, considerable effort has been made in the past to establish efficient markets in South Africa. For the efficient functioning of the money market, daily cash shortages in the banking system are accommodated by the Bank through the extension of overnight loans against suitable collateral to banks. As custodian of the country’s gold and other foreign reserves the Bank is also involved in the functioning of the foreign exchange market. In recent years, the Bank in close cooperation with the Minister of Finance has made considerable effort to gradually phase out exchange controls and to integrate South African financial markets further with international markets. 5. The autonomy of the central bank In fulfilling its primary objective of creating and maintaining financial stability, it is generally argued that the central bank should be able to do this relatively independently of any government interference or in an autonomous way. The traditional argument in favour of a strong autonomous central bank is that the power to spend money should in some way be separated from the power to create money. According to this argument politicians generally have short-term horizons in determining economic objectives. Many governments have accordingly given way to the temptation to reduce interest rates ahead of elections. This may boost spending and employment in the short term, but ultimately it normally also causes higher inflation over the long term unless the capacity of the economy can meet this higher level of demand. This higher inflation, however, only becomes apparent a couple of years later. An incumbent government concerned about its immediate popularity is likely to be tempted to go for the short-term gains from lower interest rates, even at the risk of promoting somewhat higher inflation further down the road because some other political party may then have to pick up the pieces. Central bankers normally operate on a longer term time scale than politicians and therefore do not face the same temptation to relax policy to achieve short-term objectives. By delegating decisions on interest rates and other monetary matters to such an independent institution, with a clearly defined mandate, society can then hope to achieve a better inflation outcome over the longer term. The main criticism against making central banks autonomous entities is not so much based on economic but rather on political arguments: it is that turning over decisions regarding interest rates, exchange rates, the efficiency of the financial system and other monetary matters to a body of unelected officials is simply “undemocratic”. In a democratic government all decisions should be subject to scrutiny by the elected legislative and the concept of an autonomous central bank is therefore not acceptable. Aside from the fact that there are plenty of other areas of national life in which decision making is delegated to independent unelected officials - the judiciary being the prime example - there is a fundamental confusion here between being autonomous and lacking accountability. No central bank can be totally independent, in the sense that it is not answerable to any one. Even the most autonomous central bank has to report in one form or the other to the legislative, which in any case also has the ultimate power to change the laws relating to the central bank. All the same, there is a difference between a situation in which the policy decisions are under continuous scrutiny, and an arrangement where the central bank reports to the legislative periodically. An important precondition for central bank autonomy is therefore credibility. Central bankers that seek autonomy must commit themselves and their institutions to a programme of action that will support their demands. It is generally believed in this regard that they should fulfil three basic conditions, namely: (i) Central banks should have a clearly defined monetary policy framework and monetary policy operational procedures. Monetary policy should clearly indicate what it is attempting to achieve, how it will achieve it and in what manner it will operate to reach its primary objective. (ii) Both the government and the public should on a continuous basis be informed regarding the monetary policy stance pursued by the central bank. (iii) An efficient institutional framework should exist within which decisions on monetary policy can be made without undue interference by political functionaries. This involves decisions regarding the ownership of a central bank, the management of the bank and the responsibility for monetary policy. The final question then arises: does the South African Reserve Bank fulfil these conditions and what degree of independence does the Reserve Bank have? The Reserve Bank in the past has always clearly indicated what monetary policy framework and monetary operational procedures it follows in the application of monetary policy. Only last week on 6 April we again issued a statement explaining the new monetary policy framework of inflation targeting to the public. In this statement we confirmed that inflation targeting would have no material affect on our operational procedures which we have been applying since March 1998. The South African Reserve Bank also fulfils the second condition for autonomy, namely transparency. The numerical inflation target was announced explicitly to the public to indicate clearly what the Reserve Bank should be held accountable for and to make the application of this framework as transparent as possible. The announcement of the target makes the intentions of monetary policy explicit. If targets are not met, the central bank has to explain what went wrong. Regular reporting on the stance of monetary policy, as is the case internationally, are made to Parliament. The monetary policy stance is communicated regularly to the public. This is done by means of a monetary policy statement after the completion of every meeting of the Monetary Policy Committee. A Monetary Policy Forum has also been established to open an avenue for ongoing discussions on monetary policy and general economic developments and to ensure that the views of interested parties are taken into account in the determination of monetary policy. The Monetary Policy Forum will meet twice a year in the major centres of South Africa to allow as many stakeholders as possible to participate in these discussions. The Reserve Bank will also publish twice a year a Monetary Policy Review to increase transparency in the application of monetary policy. This Monetary Policy Review will attempt to describe in more detail the decisions taken by the central bank and will analyse developments in South Africa and the rest of the world that could affect inflation. Finally, the present institutional framework in South Africa in the form of the South African Reserve Bank Act, Act No. 90 of 1989, provides the Reserve Bank with a great degree of autonomy in its operations. The Reserve Bank’s functional independence on monetary and related policies is clearly stated in Sections 10 and 35 of the South African Reserve Bank Act. Section 35 empowers the Board of the Bank to make rules “for the good government of the Bank and the conduct of its business”. In Section 10 the powers and duties of the central bank are spelled out in great detail. Most of the functions described in this section are the normal functions that one would expect a central bank to perform. In Section 10(2) it is also clearly stated that “the rates at which the Bank will discount or rediscount the various classes of bills, promissory notes and other securities, shall be determined and announced by the Bank from time to time”, clearly giving the Bank the right to determine Bank rate in an autonomous manner. The personal dependence of the Reserve Bank is determined by Section 4 of the Act indicating the conditions of appointment of the Governor, three deputy governors and other board members of the Reserve Bank. This section clearly precludes any person actively involved in politics of becoming a board member of the Bank. Seven of the directors, including the Governor and three deputy governors, are appointed by the State President, while the other seven are elected by the shareholders. By means of these appointments the government, of course, have an effective say in the policies of the Bank. The governors are, however, after their appointment normally allowed to operate in an independent manner. The instrumental independence of the Reserve Bank is clearly spelled out in the Act and the Reserve Bank is precluded in Section 13(f) of making excessive direct purchases of government stock. In this last-mentioned section it is stated that the Bank may not “hold in stocks of the Government of the Republic which have been acquired directly from the Treasury by subscription to new issues, the conversion of existing issues or otherwise, a sum exceeding its paid-up capital and reserve fund plus one-third of its liabilities to the public in the Republic”. This section therefore restricts the direct financing of government deficits. The South African Reserve Bank is also financially independent from the government because of adequate financial resources and complete control over its own budget. 6. Conclusion The South African Reserve Bank is therefore at present, according to all distinguished principles, a fairly autonomous central bank and fulfils all the main conditions necessary for independence. The Constitution of the Republic of South Africa also formally recognises the independence of the Reserve Bank. The Constitution namely states in Section 196 that: “The South African Reserve Bank shall, in the pursuit of its primary objective .... exercise its powers and perform its functions independently, subject only to an Act of Parliament .... provided that there shall be regular consultation between the South African Reserve Bank and the Minister responsible for national financial matters”. | south african reserve bank | 2,000 | 4 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Beeld/Investec Guinness Flight Economist of the Year Banquet, held in Johannesburg, on 12 May 2000. | T T Mboweni: Recent developments in South Africa’s financial markets Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Beeld/Investec Guinness Flight Economist of the Year Banquet, held in Johannesburg, on 12 May 2000. * 1. * * Introduction The South African financial markets have been characterised by great uncertainty in the recent past, leading to a depreciation in the external value of the rand, a decline in share prices and a rise in long-term interest rates and yields. Money market interest rates have remained relatively stable mainly owing to the monetary policy stance adopted by the Reserve Bank. The uncertain conditions in our financial markets were to a large extent due to the strength of the United States dollar, volatility in international financial markets, changes in oil prices and concerns about political developments in Sub-Saharan Africa (SSA), whereas domestic fundamental economic and political factors remained sound and could not be blamed for these episodes. In my address tonight I want to discuss these developments in some detail and will concentrate on: (i) the more important recent developments in the domestic financial markets; (ii) the factors responsible for the greater uncertainty in the markets; (iii) the underlying fundamental factors favouring strong financial markets; and (iv) the monetary policy stance adopted by the authorities in these circumstances. 2. Developments in financial markets From the beginning of the year 2000, our currency, the rand, has depreciated sharply against the United States dollar from a level of R6.15 to the dollar at the end of 1999 to more than R7.00 to the dollar from the first week of May 2000. This represents a depreciation of approximately 15%. The rand also depreciated considerably against the United Kingdom pound and Japanese yen, but faired better against the euro. As a consequence, the weighted average value of the rand has declined by about 7% from the end of 1999 to 11 May 2000. This is nevertheless a significant decrease in the nominal effective exchange rate of the rand which was well in excess of the inflation differential between South Africa and its main trading partners and competitors. After adjustments for these price differentials, the decline in the real effective exchange rate of the rand was probably between 3 and 4% in the first 4½ months of 2000. The weakness of the rand was one of the factors responsible for a reversal in the downward movement of long-term interest rates and yields in South Africa. Domestic bond yields moved sharply downwards in the last four months of 1999 as sentiment in the market for fixed interest securities was positively influenced by the relatively low level of inflation, the fiscal discipline entrenched in the budget of the government and the introduction of an inflation-targeting monetary policy framework. In addition, a prominent credit rating agency, Standard and Poor’s, upgraded South Africa’s foreign-currency denominated debt to an investment grade in February 2000. At the beginning of January 2000 this downward movement in the yield on government bonds came to an end. The daily average yield on these bonds increased from a low of 13.12% on 18 January 2000 to 15.20% on 10 May 2000. The level of the yield curve shifted higher across the full maturity spectrum, with a more pronounced upward movement at the longer end of the curve. Despite this upward movement in rates, the inflation-adjusted yield on long-term bonds rose only marginally because of the rise in overall consumer price inflation, excluding mortgage interest costs, as measured for metropolitan and other urban areas, the so-called CPIX (mu). Trading activity on the Bond Exchange of South Africa was boosted by the uncertainty in the market. Turnover in the secondary bond market increased from an already high average quarterly value of R2.2 trillion in 1999 to an all-time high of R2.8 trillion in the first quarter of 2000. In April 2000 the value of transactions on the Bond Exchange amounted to R0.8 billion. The uncertainties in the foreign exchange market were also reflected in developments on the Johannesburg Stock Exchange. The strong gains in share prices during the last three months of 1999 were followed by a consolidation phase which developed into a substantial correction in the current year due mainly to events in the United States’ stock markets. The daily all-share price index declined by 28% from a record level on 17 January 2000 to a low on 17 April, i.e. its lowest level since 23 September 1999. Subsequently this index increased again by 14½% on 10 May 2000 as investors saw increasingly good value for South African shares. The general decline in share prices from mid-January was at first countered by increases in the share prices of gold mines and information technology enterprises. The decline in the index at that stage was driven by decreases in the share prices of financial institutions, non-gold-mining companies and the industrial consumer sector. From February 2000, when the dollar price of gold fell below US$300 per fine ounce, the gold-mining shares declined by 17% up to the end of April. The general surge internationally in the share prices of the information sector at first supported the prices of these industries in South Africa, but information technology share prices weakened markedly from mid-March. Although conditions in the share market are still volatile, price movements have shown a distinct upward trend since the middle of April 2000. The increases in share prices were discernible in most of the main sectors. The volatility in the market was responsible for a further sharp increase in the value of shares traded to an all-time high of R155 billion in the first quarter of 2000. In contrast to the unstable conditions in the foreign exchange and capital markets, interest rates in the money market were largely unchanged. For example, the bankers’ acceptance rate fluctuated in a narrow range of between 9.83% and 9.92% from the beginning of March, while the rate on interbank funds remained constant at a level of 9.5%. The stability in the money market can mainly be ascribed to the monetary policy stance that the Reserve Bank pursued. 3. Factors responsible for uncertainties in markets The factors responsible for the uncertain conditions in our financial markets arose mainly outside the borders of our country and were largely related to perceptions about the effect on South Africa of developments in neighbouring countries as well as the strength of the US dollar. In the past week, I have visited London and Basel. In the process, I met market participants in London and my colleagues in the Central Banking fraternity at the Bank for International Settlements in Basel. Again and again, it was emphasised that political conflicts in Sub-Saharan Africa were harming investor sentiments, which were not doing South Africa and the region any good at all. One person even referred to what he called “the depressingly present African psychological factor”. Sentiment is an important ingredient in market decisions and public authorities must take cognisance of this. It is clear therefore that conflicts in Sierra Leone, Ethiopia/Eritrea, the Democratic Republic of Congo, Angola and the management of the land question in Zimbabwe have had a major impact on our financial markets. In this connection, and in order to remove any doubts about South Africa’s position, the President of the Republic has committed South Africa to supporting the peaceful resolution of these conflicts and lawful processes of land reform. He further assured everyone that South Africa’s land question will be resolved through an orderly legal and constitutional process. And indeed this is how things should be in open and democratic societies. At the same time, our foreign exchange and capital markets were also seriously affected by the strength of the US dollar. The dollar has in particular strengthened considerably against the euro. From the beginning of the year up to 11 May 2000, the euro has depreciated by about 10% against the dollar. The dollar has also been exceptionally strong against the currencies of Eastern Europe, Australia and some of the Latin American countries. This strength of the dollar and the exceptionally high and sustained economic growth in the United States, led to large foreign investments in that country. In particular, long-term investments from Europe and Japan contributed to the continued economic recovery in the United States. Taking these circumstances into consideration, it is not surprising that non-residents became large net sellers of South African bonds. After having been net investors in South African bonds to the tune of R16.5 billion from the beginning of 1999 until the end of January 2000, non-residents’ net sales of bonds amounted to R13.4 billion up to 10 May 2000. However, the greater proportion of these sales were financed in the market for repurchase transactions, indicating that they do not only reflect disinvestment by non-residents. The change in investor sentiment was echoed in the eurorand market where the net proceeds of rand-denominated bonds issued by non-resident entities also reverted to net redemptions of R0.5 billion in the first quarter of 2000. These net sales of bonds by non-residents contributed in a significant manner to the depreciation of the rand. Non-residents generally remained net purchasers of shares on the Johannesburg Stock Exchange, amounting to R40.6 billion in 1999. The net purchases of shares by non-residents then declined considerably from nearly R7 billion in the fourth quarter of 1999 to R0.6 billion in the first quarter of 2000, before increasing again by R3.4 billion up to 10 May. These purchases continued despite the reduced South African weights in world equity indices and the negative market sentiments about political developments referred to above. The continued attractiveness of South African shares is related, amongst other things, to the sound economic fundamentals in the country. 4. Fundamental economic factors One of the most important factors that foreign investors take into consideration in their evaluation of investment in a specific country is how appropriately the currency of a country is valued. Any suspicion that the currency is over-valued tends to be an important deterrent to the inflow of capital. The nominal trade-weighted value of the rand has declined by 28% from 1995 to 1999, or on average by about 7% per year. This depreciation exceeded the inflation differential between South Africa and its main trading partners and competitive countries. In real terms, the average weighted value of the rand has therefore declined by about 15% over the past four years. A part of these adjustments in the real value of the rand reflected a worsening in the South African terms of trade and reduced import protection and export subsidisation. In September 1994 the import surcharge was lifted, from 1995 exchange controls were relaxed, in mid-1996 the government’s commitment to stepwise tariff reductions was announced and in July 1997 the General Export Incentive Scheme was abolished. Taking these developments into consideration, as well as the continued good performance of manufactured exports, it can still be concluded that the rand is competitively priced and should not really be prone to a sharp correction on a trade-weighted basis. This conclusion is also confirmed by South Africa’s healthy overall balance of payments position. The deficit on the current account of the balance of payments amounted to a low of ½% of gross domestic product in 1999. Moreover, trade figures for the first quarter of 2000 indicate that the current account deficit has probably improved somewhat in the first quarter of 2000. Despite the substantial increase in international oil prices and a recovery in the domestic economy, the current account deficit has therefore been maintained at low levels. This was mainly due to a strong export performance. The favourable growth prospects for the world economy suggest that the demand for South African exports should remain buoyant. In addition to the low current account deficit, South Africa is attracting considerable funds from other countries. In 1999 the net inflow of capital in South Africa exceeded R27 billion and direct investments of non-residents came to R8.4 billion. Preliminary information for the first quarter of 2000 indicate that non-residents’ net sales on the Bond Exchange were more than offset by other capital inflows and that a further net inflow of capital was recorded. This is substantiated by an increase in the gross foreign reserves of the Reserve Bank of nearly R5 billion from the end of 1999 to the end of April 2000 and a considerable decline in the foreign loan commitments of the Reserve Bank. The underlying soundness of the South African economy is confirmed by many other developments. For instance, the economy has moved into a recovery phase, with growth in real gross domestic product reaching a seasonally adjusted annualised rate of 3½% in the fourth quarter of 1999. This growth also became more widespread. Initially it was mainly concentrated in the agricultural and tertiary sectors. In the second half of 1999 growth was recorded in nearly all the major sectors of the economy. Inflationary pressures were well contained in an environment of rising fuel and food prices. Large productivity increases combined with a lower rate of increase in the earnings of workers brought the growth in nominal unit labour costs down to a level of only 3.5% in 1999. Growth in the money supply and bank credit extension remained subdued and there are no signs of excessive demand pressures. In addition, the fiscal picture is sound, with government expenditure concentrating on the social and other needs of the community, and considerable effort being made to improve tax administration. The discipline applied in expenditure allocations and the progress made with revenue collection, resulted in a decline in the public sector borrowing requirement from 5.8% in the fiscal year 1994/95 to 1.7% in the first nine months of the fiscal year 1999/2000. Notwithstanding all these positive developments, employment creation has been disappointing. Considerable effort will have to be made in the coming years to address this serious problem, by amongst others, driving through the process of the restructuring of state assets and the productive side of the economy. 5. Monetary policy From the middle of January 2000 the Reserve Bank managed the daily liquidity requirement in such a way that the repurchase rate remained at a level of 11.75%. As already indicated this led to relatively stable money market interest rates in a climate of general uncertainty in the foreign exchange market and in the domestic capital markets. The question may be asked whether this was the right policy stance. Shouldn’t the Reserve Bank have taken more restrictive measures to relieve the pressures on the exchange rate of the rand? Obviously there may be different views on the stance adopted by the Reserve Bank. In the Bank we reasoned that a monetary tightening would have been the wrong response to date. Although consumer price inflation increased moderately towards the end of 1999 and during the first three months of 2000, this was mainly due to exceptional circumstances and there is little reason to expect that inflation may get out of hand. In fact, economic fundamentals indicate a continued decline in the targeted inflation rate over the medium to longer term. In these circumstances, it is important for the Reserve Bank not to overreact to exchange rate weakness. Too quick a tightening of monetary policy could endanger the growth prospects of South Africa and encourage an outflow of capital. This would put greater and more lasting pressure on the exchange rate of the rand with important consequences for inflation. Besides, if the factors responsible for the weakness in the exchange rate are taken into consideration it seems unlikely that a tightening of monetary policy would have the desired effect of more stability in the foreign exchange market. The policy stance adopted by the authorities does not imply that the value of the exchange rate is regarded as unimportant when setting monetary policy. On the contrary, the impact of exchange rate changes on inflation is carefully taken into account when managing domestic liquidity and determining the repo rate. If signs do emerge of increased inflationary pressures arising from a depreciation of the exchange rate of the rand, the Reserve Bank will not hesitate to take appropriate measures. 6. Conclusion The domestic financial markets have adjusted in a mature manner to the rise in oil prices, adverse developments in other parts of Sub-Saharan Africa, the strength of the dollar and heightened volatility in international financial markets during the first four months of 2000. Had the Reserve Bank attempted to intervene in the currency market in order to slow the process of adjustment to these events, the success of the intervention would have probably been thwarted if only by the strength of the dollar. Moreover, such intervention may well have exacerbated the downward pressure on the value of the rand. The Bank accordingly has rather attempted to maintain stability in the domestic money market. In view of the sound underlying economic conditions in the country, we are of the opinion that this is the correct approach to follow and should eventually lead to stable market conditions at the least cost to the country. The Bank will nevertheless carefully monitor any further developments in the financial markets. “We are indeed living in challenging times!” | south african reserve bank | 2,000 | 5 |
Speech by Ms Gill Marcus, Deputy Governor of the South African Reserve Bank, at the Institute for International Research 9th Annual Conference held in Johannesburg on 18 July 2000. | Gill Marcus: Issues for consideration in mergers and takeovers from a regulatory perspective Speech by Ms Gill Marcus, Deputy Governor of the South African Reserve Bank, at the Institute for International Research 9th Annual Conference held in Johannesburg on 18 July 2000. * 1. * * Introduction Mergers and acquisitions in the financial services sector are receiving a great deal of attention at present. The trend is toward the blurring of the boundaries that separated the various parts of the financial sector, particularly commercial banking, investment banking and insurance. More recently, we have been faced with the prospect of the formation of large financial conglomerates. The ultimate objectives of a financial services institution whether it be a bank, insurance company or securities firm, are, firstly, to be financially safe and sound; secondly, to obtain the confidence of and show fairness to the users of its financial services; and, finally, to be efficient and effective. These objectives should always be consistent with the objectives of the regulatory authorities. The objectives of the regulator are to: • Ensure a safe, sound and stable financial system. • Enhance the confidence of and fairness to investors, by eliminating bad business practices and ensuring healthy competition between financial institutions. • Ensure an efficient and effective financial system. It follows that the strategies adopted by banks as financial services institutions and the objectives set by the regulator have to be consistent with each other. The priorities assigned to the ultimate objectives of a bank may, however, differ from those of the regulator. For instance, the bank may have as its primary ultimate objective the maximisation of shareholder value, as measured by the rate of return on equity. This would be in conflict, however, with regulatory objectives if maximisation of shareholder value were to be achieved by the taking of excessive risks. The primary objective of the Registrar of Banks and, when applicable, the Minister of Finance, therefore, should be to ensure that a merger will not be detrimental to the public interest and also not contrary to the interests of the banks concerned, their depositors or their controlling companies. We must remember that the responsibility of the directors is to act in the best interest of their shareholders and, thereby, improve or maintain the wealth of their shareholders. The interest of the public and depositors is thus not the primary concern or responsibility of the directors. It is, therefore, imperative that the Registrar of Banks and the Minister of Finance protect the interest of depositors. Our task, as regulators, is to ensure that, after a merger, acquisition, reconstruction or takeover, a bank or banking group has: • Suitable shareholders. • Adequate financial strength. • A legal structure that is in line with the bank or banking group’s operational structure. • Management with sufficient expertise and integrity. We are sensitive to the fact that it is not the role of the Bank Supervision Department to judge the wisdom of management decisions and business strategies beyond ensuring that local and international best practice regarding supervision and regulation are met. Our philosophy is that market principles underlie all activities. 2. Regulatory concerns with regard to mergers and takeovers The following are regulatory concerns, because they could impact on the stability of the financial system as a whole: 2.1 Contagion risk In the case of a bank, contagion can best be described as the risk that a problem or problems in one or more associate entities contaminate the bank, leading to negative perceptions of the bank. In some cases, the implications could be so serious as to lead to the failure of the bank. As the potential for contagion increases, so, too, increases the risk of individual financial failure. Although contagion risk is extremely difficult to measure and quantify, it is a risk of which bank management constantly needs to be aware. Banks operate in a highly competitive environment, encouraged by the developments of new markets, instruments and techniques. Although many of these changes provide the means of diversifying risks, they also allow greater risks to be taken. These developments provide challenges to central banks in attaining the appropriate balance between risk and stability in the financial system. It is the central bank’s responsibility to provide a financial system in which the users of financial services can benefit from healthy competition between financial institutions, but, at the same time, to ensure public confidence in the monetary system as a whole. 2.2 Systemic risk Systemic risk is the possibility that the failure of one bank to settle net transactions with other banks will trigger a chain reaction, depriving other banks of funds and, in turn, preventing them from closing their positions. The consequence is frequently loss of confidence in the whole banking system. The effects of conglomeration on systemic risk may not be viewed lightly. If risk is not managed properly within a conglomerate, the repercussions could extend beyond a single institution and, even, into the whole financial sector. The regulator’s ability to monitor and supervise the group riskmanagement practices within banks and banking groups is therefore becoming increasingly important. 2.3 “Lender-of-last-resort” assistance One of the main responsibilities of a central bank is to prevent financial system instabilities. When pressures that cannot be avoided by preventive supervision do arise, central banks should try to contain these pressures through direct central bank intervention, acting as “lender of last resort”. This should never be seen as an automatic facility available to all banks in distress, but should be used only when the failure of a bank would pose a serious threat to the financial system as a whole. The primary aim of the “lender of last resort” facility is therefore not to save the bank in distress, but rather to consider the effect that the failure might have on the system and what should be done to protect the system from contagion. A banking group, including the bank or banks in such a group, could also be contaminated by nonbanking activity. This could result in the central bank having to extend lender-of-last-resort assistance to a wider range of activities. This, in turn, raises issues of competitive neutrality, since lender-of-lastresort assistance is not made available to specialist suppliers of non-banking services provided by bank-based financial conglomerates. 2.4 “Too big to fail” factor What do we mean when we say a financial institution is too big to fail? This term might best be applied to an institution that is so large that its activities make up a significant portion of a country’s payment system, credit-granting process, or other key financial roles. As a result, any substantial disruption in the particular institution’s operations would be likely to have a serious effect on a country’s financial markets, either preventing the markets from operating properly or raising questions about their integrity. The consequence of the “too big to fail” factor is that countries extend protection to large institutions and their customers that is not granted to others. Although the new banking and financial conglomerates may pass our traditional statutory and regulatory guidelines, such combinations require that we refocus our attention on a long-standing and vexing concern. To the extent that institutions become too big to fail and are perceived as being protected by implicit guarantees, the consequences may be serious. Moreover, under these circumstances, our current mix of market and regulatory discipline may tend to shift further away from market discipline and, increasingly, toward regulatory discipline, resulting, perhaps, in a less efficient industry. 3. Regulatory framework The regulatory framework within which supervision takes place, together with the authority, powers and responsibilities of the regulator, is provided by: • The Banks Act, 1990 (Act No. 94 of 1990 – “the Banks Act”), and the Mutual Banks Act, 1993 (Act No. 124 of 1993). • The Regulations relating to Banks and the Regulations relating to Mutual Banks (“the Regulations”). • The Core Principles for Effective Banking Supervision (“Core Principles”). 3.1 The Banks Act The sections of the Banks Act that have a bearing on reconstructions, mergers and acquisitions are the following: Section 37 – Restrictions on shareholding In essence, Section 37 of the Banks Act provides that prior permission must be obtained from the Registrar of Banks if a shareholder wishes to increase its shareholding beyond 15 percent of the voting share capital of a bank or a bank controlling company. Permission is also required for further increases beyond the predefined levels of 24 percent, 49 percent and 75 percent. The approval of the Minister of Finance must be obtained for increases beyond the predefined levels of 49 percent and 75 percent. Permission for the acquisition of shares in a bank or bank controlling company is not given lightly and is granted only if the Registrar of Banks and, when required, the Minister of Finance are satisfied that the proposed acquisition of shares is not contrary to the public interest and is also not contrary to the interest of the bank concerned or its depositors or the controlling company. Section 38 – Nominee shareholdings Essentially, Section 38 of the Banks Act prohibits a bank or bank controlling company from registering its shares in the name of nominees. The objective is to identify the true power behind the bank, because of the potential for the misuse of depositor funds by unscrupulous owners. Section 42 - Restriction of right to control bank Section 42 prohibits a person other than a bank, or an institution that has been approved by the Registrar of Banks, to exercise control over a bank, unless such person is a public company and is registered as a controlling company of such bank. Section 50 – Investments by controlling companies In terms of Section 50 of the Banks Act, the aggregate amount of a bank controlling company’s investments in the following may not exceed 40 percent of its capital and reserve funds: • Undertakings other than banks. • Institutions that conduct business similar to the business of a bank in a country other than the Republic of South Africa. • Controlling companies. • Companies of which the main object is the holding or development of property. It follows therefore that at least 60 percent of the bank controlling company’s capital and reserve funds should be in banking-related business. Section 54 – Mergers Essentially, Section 54 provides that no compromise, amalgamation or arrangement that involves a bank as one of the principal parties to the relevant transaction, and no arrangement for the transfer of all or any part of the assets and liabilities of a bank to another person, shall have legal effect unless the consent of the Minister of Finance, conveyed in writing through the Registrar of Banks, to the transaction in question has been obtained beforehand. The Minister shall not grant his consent unless he is satisfied that: • The transaction in question will not be detrimental to the public interest. • The amalgamation is the amalgamation of banks only. • In the case of a transfer of assets and liabilities that entails the transfer by the transferor bank of the whole or any part of its business as a bank, such transfer is effected to another bank or a person approved by the Registrar. Section 55 - Reconstructions Section 55 of the Banks Act requires that any reconstruction of companies within a banking group requires the prior approval of the Registrar. Section 80 – Shares in any registered insurer Section 80 requires that no bank and no associate of a bank shall, without the prior written approval of the Registrar, either jointly or individually acquire or hold any shares in any registered insurer as defined in Section 1 of the Insurance Act, 1943 (Act No. 27 of 1943), to the extent to which the nominal value of those shares exceeds 49 percent of the nominal value of all the issued shares of such insurer. 3.2 The Regulations Regulation 36 of the Regulations deals with the information that should accompany an application for permission to acquire subsidiaries, branch offices, other interests and representative offices of banks and controlling companies. 3.3 Core Principles The Core Principles for Effective Banking Supervision were issued by the Basel Committee on Banking Supervision in 1997. The particular principles that have a bearing on reconstructions, mergers and acquisitions are the following: Principle 5 – Major acquisitions or investments by a bank In terms of Principle 5, “banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision”. From a supervisory perspective, we need to determine whether the banking organisation has both the financial and the managerial resources to fund the acquisition. We may also need to consider whether the investment is permissible under existing banking legislations. Banking, by its nature, entails taking a wide array of risks. We, as supervisors, need to understand these risks and need to be satisfied that banks are adequately measuring and managing the risks. Principle 20 – Supervision on a consolidated basis Principle 20 states that “an essential element of banking supervision is the ability of supervisors to supervise the banking group on a consolidated basis”. This includes the ability to review both the banking and the non-banking activities conducted by the banking organisation, either directly or indirectly (through subsidiaries and affiliates), and activities conducted at both domestic and foreign offices. In this regard, it is important that we, as supervisors, take into account that the non-financial activities of a bank or group may pose risks to the bank. Principle 23 – Obligations on home-country supervisors In terms of Principle 23, “banking supervisors must practice global consolidated supervision over their internationally active banking organisations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organisations world-wide, primarily at their foreign branches, joint ventures and subsidiaries”. From the above, it is clear that we should take responsibility for our internationally active banking organisations in the capacity of home-country supervisor. In order to assume this responsibility, we should be comfortable with the risks facing these entities and the manner in which these risks are managed. 4. Regulatory principles The considerations that are taken into account by the Registrar when considering applications are the following: 4.1 Shareholding/Ownership structure With regard to the shareholding structure, the following aspects are of importance: Structure A bank must pay appropriate regard to the interests of its depositors. Therefore, no single shareholder (or group) should be in a position to exercise undue influence over the policies and operations of a bank. The shareholding structure should not be a source of weakness and should minimise the risk of contagion from non-bank activities conducted by shareholders in other entities within the conglomerate. Transparency of legal structure Banking groups vary widely in terms of structure, range of activities and complexity. This could complicate the effective supervision of banks within such groups. Furthermore, users of banking services must be able to make a proper assessment of the banking group’s activities and risk profile. 4.2 Group structures As regards group structures, the following are of importance: Nature of business The general philosophy behind the supervision and regulation of bank controlling companies and their subsidiaries is to ensure that banking groups do not affiliate with companies engaged in undesirable practices. Bank controlling companies should confine their activities to the management and control of banks and companies engaged in activities considered to be closely related to banking. Because of the nature of their business, banks tend to invest more in companies that are primarily involved in financial activities. Therefore, financial activities should preferably be structured under a bank, whereas non-financial activities are normally structured under the bank controlling company. In the supervision of financial conglomerates, the primary concerns are contagion, transparency and autonomy. When liquidity and solvency risks manifest themselves in any member of a group, the likelihood of contagion of the banks in a group is a major concern. Pyramid structure We are not very comfortable with pyramid structures. A pyramid structure weakens the control over a banking group and increases the complexity of the group structure. The complexity of a group structure also often reduces transparency. The enlarged group structure in a merger/acquisition should have the fewest layers possible and should be as simple as possible. The group structure should clearly indicate which shareholders exercise control over a group and which owners have the financial responsibility of providing the group with future capital. Cross-shareholdings Large intragroup holdings of capital increase the possibility of financial difficulties in one entity in the group being transmitted more quickly to other entities in the group. Since intragroup capital does not represent externally generated capital, intragroup capital should be excluded from the assessment of group capital. Parallel-owned banks In the case of parallel-owned banks, a bank set up in one jurisdiction has the same ownership as a bank in another jurisdiction, but neither of the banks is a subsidiary of the other. Normally, the controlling companies of such parallel-owned banks are incorporated in unregulated financial centres. There is thus a clear potential for abuse. A working group of the Basel Committee on Banking Supervision recommended that host-country or home-country supervisors should be vigilant in order to ensure that operations of this kind become subject to consolidated supervision. Shelf companies A shelf company is a company that a bank establishes to keep on the “shelf” until such a company is needed for a special purpose. We need to put into place procedures to close any potential supervisory gaps. 4.3 Management structure It is a known fact that by far the most common underlying cause for bank failure is bad management. We cannot involve ourselves in the day-to-day operational decisions or, even, strategies of a bank, since to do so would not only impair our objectivity in assessing the health of a bank, but would be too costly and probably too restrictive. It follows that we have to rely heavily on the competence and integrity of management. Therefore, the following aspects are of importance: Ability and integrity Banks and banking groups should be managed only by directors and management with a proved ability and integrity to pursue the interests of shareholders without harming the interests of depositors. The evaluation of the competence and the integrity of the proposed management and board should include a system of following up references, enquiry from other regulators, accessing publicly available data and reportable offences. Management should at all times put the interests of the organisation and depositors before their own and should act in the best interest of depositors. It is important that the management of a merged entity has the ability to identify the risks and to bed down the merger in the shortest possible time. Experience and skills The proposed management and directors should have the relevant banking experience and skills to conduct the proposed business. For example, if a bank proposes to trade in financial derivatives, the senior management and board should have sufficient specific experience in the management of the risks arising from these products. 4.4 Corporate governance, audit and internal control Aspects relating to corporate governance, audit and internal control that are important include the following: Corporate governance Corporate governance may be described as a system of business management and disclosure of information to stakeholders, within a paradigm of management accountability. The Bank Supervision Department regards sound corporate governance as crucial. Since South Africa is now part of the global markets, it is of the utmost importance that South African corporate-governance processes be aligned with international trends. After a merger or takeover, a banking group has to demonstrate its ability to maintain appropriate corporate governance, management, internal control and risk-management systems, including internal audit and a compliance officer, in order to monitor and limit all the risk exposures of a banking group as of the commencement of business. The merged entity’s internal structure should be sound in terms of generally accepted management principles, and the proposed group structure should not be detrimental to the bank or to the effective supervision of the bank. Audit and internal control Since management cannot be everywhere, management has to rely on systems of internal control to ensure the smooth operation of a bank. It has to be possible for the Bank Supervision Department to evaluate these established controls and procedures independently. We also rely on the independent auditors of a bank to enhance the credibility of the qualitative and quantitative information on which we base our opinion. 4.5 Capital Several aspects relating to capital are relevant: Importance of capital Capital adequacy is a vital measure of the solvency of a banking group and a significant indicator of the level of protection that the banking group has against risks. Ensuring adequate levels of capital promotes public confidence in the particular banking group and the entire banking system. A merged entity should have adequate capital to meet both regulatory requirements and its own internal requirements, taking into account its risk profile. Purposes of capital Capital serves the following four purposes: • It provides a permanent source of revenue for the shareholders and funding for the bank. • It is available to bear risk and to absorb losses. • It provides a base for further growth. • It gives the shareholders reason to ensure that the bank is managed in a safe and sound manner. Capital adequacy Minimum capital-adequacy ratios are necessary to reduce the risk of loss to depositors, creditors and other stakeholders of a bank and to help us to pursue the overall stability of the banking system. The Basel Committee on Banking Supervision recommends that supervisors should apply the minimum capital ratio of 8 percent to all internationally operating banks on both a solo and consolidated basis. In a merger or acquisition, any current or consequential cross-shareholding should also be eradicated in order to avoid double counting of capital. Availability of additional capital We also have to assess the ability of the major shareholders of a merged entity to provide additional capital should the bank or banking group experience financial difficulties. 4.6 Risk concentration Safeguarding against excessive concentration of risk is one of the most important components in any system for the supervision of banking groups. Concentrations of risks cannot be eliminated; concentrations will arise through the specialisation of banks for reasons of competitive advantage and expertise. The risk can and must, however, be contained by ensuring that the exposure of a bank or a banking group is diversified. Banks should manage their credit risk prudently to ensure that there are no undue concentrations of risks to individual entities, associates, industries geographical areas, sectors or banking products. The risks of a merged entity should not be more than the risks of the two stand-alone entities. Increasing supervisory attention has to be paid to the credit exposures of the merged entity. International standards In terms of international standards, a bank or a banking group may not incur an exposure to an individual borrower or a group of closely related borrowers that exceeds 25 percent of the bank or the banking group’s qualifying capital and reserves, and the total of all large exposures may not exceed 800 percent of qualifying capital and reserves of the bank or banking group. 4.7 Public-interest considerations Any merger of two or more banks should be in the public interest. A proposed merger should therefore add some depth to the local banking sector and make a worthwhile contribution to banking services and the banking industry in South Africa. As mentioned earlier, competitive markets is the best assurance that consumers receive the highest quality products at the lowest possible prices. In any merger of two or more banks, there are significant advantages and disadvantages which need to be considered. 4.8 Risk-management profile The emphasis on risk management is most critical at our largest, most sophisticated banks and most internationally active banks. Many of these banks use advanced economic and statistical models to evaluate their market and credit risks. These models are used for a variety of purposes, including allocating capital on a risk-adjusted basis and pricing loans and credit guarantees. 4.9 Information technology system integration Information technology systems should be able to provide management information that is accurate, timeous and relevant to manage the bank’s risks. A bank’s system should be integrated, there should be minimal manual intervention, and the risks emanating within various departments or divisions should be consolidated in the management reports. A bank’s systems should be able to serve the needs of its clients adequately. In any merger, the significant time taken to merge various systems can be seriously detrimental to the ongoing business of the bank. Implementation of information technology systems is one of the biggest risks for a merged entity, and may have substantial negative impact on all stakeholders if all does not go well. 4.10 Merging of different cultures The question of different cultures is prevalent in any merger. A “hostile” merger could increase the difficulty of merging the cultures, especially at senior level. Perhaps the biggest mistake is to ignore the impact of a merger on employees. Too often, employees spend more time worrying about their futures than they do serving customers. Many simply leave, taking their knowledge and experience with them. 4.11 Competition/concentration in banking system The issue of the optimal structure of a banking system has been much discussed in recent years within banking, political and academic circles. The optimal structure of a banking system is discussed every time that the possibility of a merger or a failure of banks is mentioned. Many arguments in favour of, or against a merger between two banks can be put forward. Apart from taking these general principles into account when the desirability of a merger is discussed, the arguments, conditions and considerations specific to a possible merger are just as important. When any merger is proposed, one of the major concerns is that competitiveness of the sector could be diminished. Free competition within the banking system will improve the efficient allocation of resources in the economy, thus enhancing society’s wealth and welfare. Increased competition in the banking system may lead, for example, to undue risk taking and thus reduce stability in the banking system. On the other hand, measures taken to increase stability in the banking system through mergers may lead to reduced competition. When a merger would cause a large concentration in a market that is, or becomes, highly concentrated, we need to give special attention to the impact on competition. High levels of concentration in any banking system could result in relatively high prices for banking services. It is, however, difficult to compare prices before and after a merger in banking because of other factors such as differential central bank policy and inflationary expectations. The banking system’s contribution to the efficient allocation of resources in the economy is reflected by its managerial ability to control input costs (labour, physical capital, deposits) through the utilisation of the returns of scale, scope and efficiency. Operating costs will eventually determine the optimal structure of the banking system in terms of the number of banks, the size of the banks, the number of branches of banks and possible mergers and acquisitions. Competitive markets are our best assurance that consumers receive the highest quality products at the lowest possible prices. 5. Recent developments causing banks to merge Throughout the world, banking industries are undergoing a rapid and sometimes startling process of consolidation, spurred occasionally by hostile takeover bids, but, more often, by friendly mergers by institutions that were once fierce competitors. Several reasons that drive banks to merge can be identified: Firstly, banks are tussling with the same technology, delivery and customer-service issues that have become pressing for major international banks. Banks are feeling forces of globalisation and technological change and must invest huge amounts in their own information technology systems. The electronic revolution also undermines the traditional role of banks as intermediaries between borrowers and savers, in the process reducing banks’ profits. This, in turn, is forcing banks to cut costs more urgently, and a merger with another bank becomes an attractive option for a bank. Advances in information technology also open up a growing array of delivery channels. Online banking, in all its increasingly varied forms, is poised to become a key channel for transacting banking business. The importance of physical branches in a cyber-world may decline and the nature of the services that branches provide will probably change. Technology is here to stay, and the challenge is for bankers to embrace technology to their own and their customers’ advantage. Secondly, in Europe, economic, monetary and financial unity has implied increased competition among banks and is forcing them to seek ways to cut costs and to increase market share. Thirdly, it is believed that the banking and securities industry might in time consolidate into about 15 world mega-firms and that the financial institutions that do not merge soon, increase their size and obtain market share might be left in the cold. Fourthly, it is believed that banks might become too small to compete effectively, except in niches, either in terms of products or geographically. In several countries, governments and regulators are urging banks to merge not because the merger would make them better, safer or more profitable, but because it would allow them to compete internationally with the main American and European banks. What governments and regulators should keep in mind is that, very often, the best way to create local banks that can compete internationally is to allow international banks to compete locally. Fifthly, the choicest merger partners are taken up very rapidly. It is believed that if a bank does not act soon, it might be left with an unattractive merger partner. 6. Disadvantages of bank mergers As long as barriers keep out international competitors, mergers may reduce competition and may hurt consumers. Bigger banks are not necessarily safer than smaller ones. In a report published recently by the Bank for International Settlements, it is stated the current restructuring of the banking industry could cause constraints as competitive pressures interact with stubborn cost structures and heightened incentives for risk taking. This trend is especially dangerous since bigger banks are more likely considered to be “too big to fail”. The international movement towards the consolidation of banking systems has held promise for more efficient, better diversified banks, with more intense competition in local markets. In many cases, especially when acquirers paid a reasonable price and manage the resulting post-merger organisational problems effectively, this promise has certainly come true. There is, however, accumulating evidence in surveys and empirical research that the promise has not always been fulfilled for retail customers in local banking markets. In many cases, neither greater efficiency nor substantial improvements in diversification appear to have been realised. The Bank for International Settlements found, and several large banks are learning, that the alleged benefits of banks merging for reasons of profitability often prove to be illusionary. Bank profitability has fallen in 12 countries despite a wave of consolidation, mainly because acquirers tend, on the one hand, to overpay and, on the other hand, to underestimate organisational problems. 7. Lessons learnt from other mergers and takeovers Despite the continued pace of merger activity, new deals are meeting with increasing scepticism among investors. The reason is simple - most mergers have simply not delivered the benefits that were promised. A study by the US Federal Reserve concluded that 50 percent of mergers by big banks in the United States of America eroded returns, whereas only 17 percent produced positive returns. Although it is not our role to judge the appropriateness of any particular deal, a number of initial lessons may be drawn. I would like to make three comments in this respect: 7.1 Improvement in profitability is not an automatic consequence of a merger Some recent work has shown that the improvement in profitability has not necessarily been related to size and that the definition of optimal size varies according to the type of institution, activity and business conducted. Beyond this observation, the restructuring can come up against significant obstacles. For example, the compatibility of respective information systems might cause specific difficulties, the handling of which may turn out to be delicate. The increasing number of decision-making centres and structural differences may affect the efficiency of internal control systems. Some deals have revealed problems relating to the integration of different corporate cultures. 7.2 To be effective these deals need to be part of strategic plans Another lesson from the American and European experience is that, from now on, credit institutions can no longer contemplate their future without carefully thinking about the changes in their economic, legal and financial environment. Mergers and acquisitions will be successful when they are part of a strategy aimed at striking a balance between the need to strengthen existing product lines (when the comparative advantage is in principle at its greatest) and the diversification of activity, as part of medium-term plans aiming at extensively reorganising both distribution channels and means of production. 7.3 The emergence of trans-national banking groups will bring new risks, requiring closer cooperation between national banking supervisors Banking supervisors are responsible for accompanying the restructuring in order to preserve and reinforce the integrity of the banking system as a whole, notably as regards, in particular, interbank operations and payment systems. Banking supervisors must be vigilant to avoid any particular project bringing additional risks. Risks can increase significantly should larger banks be tempted to conquer new markets. The risk of contagion may grow correspondingly, weakening the banking system as a whole. It is therefore imperative that banking supervisors remain vigilant with regard to increasingly complex operations. 8. Closing remarks The reconstruction of a banking group, or mergers within a banking group, or the acquisition of subsidiaries, joint ventures and branch offices by banks or their controlling companies should be in the interest of stability of the banking system as a whole. It must, however, be stressed that there are no hard and fast rules, because special circumstances, such as the history of a group and certain practicalities, often necessitate a pragmatic approach. As mentioned earlier, it is not our role, as regulators, to judge the wisdom of management decisions and business strategies beyond ensuring that local and international best practice regarding supervision and regulation are met. The restructuring of the banking industry represents a challenge for bankers and for regulators. Besides the strengthening of supervisory arrangements, it is up to the regulators to support the wave of restructuring by continuing to level the playing-field in the banking industry and by eliminating any competitive distortions. This condition needs to be met for restructuring to have its full effects in terms of economic efficiency and proper resource allocation. | south african reserve bank | 2,000 | 7 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 18th Ordinary General Meeting of shareholders, held on 29 August 2000. | T T Mboweni: A broadbrush picture of recent financial and economic developments in South Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 18th Ordinary General Meeting of shareholders, held on 29 August 2000. * * * Introduction The South African Reserve Bank has once again met the many challenges posed by the changing domestic and international environment with great success during the past year. The Bank’s resilience was proven without any doubt in coping with such changes as the implementation of an inflation-targeting monetary policy framework, the information technology and other problems arising with the new millennium, and maintaining financial stability during very volatile conditions. The Bank also succeeded in improving the efficiency and effectiveness of internal administrative procedures and completed a plan to effect employment equity in all occupational categories. The domestic economy also adapted very well to volatile international financial markets and reversals in capital flows. Developments in the rest of the world had both positive and negative effects on South Africa. On the one hand, the economic recovery in many parts of the world, together with continued low inflation, led to higher international commodity prices and an increased demand for South Africa’s exports. On the other hand, certain inherent weaknesses in the world economy had a negative impact on domestic financial markets and, eventually, also on the recovery in domestic production. The external imbalances in the world caused a realignment of currencies, with the dollar becoming notably stronger against the euro. Risks of sudden changes in market sentiment were exacerbated by increases in share and property prices. Furthermore, international oil prices rose steeply when the Organisation of Petroleum Exporting Countries (OPEC) and several other oil producers began to curb production. Prices rose from about US$ 10 per barrel at the beginning of 1999 to levels in excess of US$ 30 per barrel in the first half of 2000. This had a material impact on the import bill and prices in South Africa. Despite these developments, South Africa’s balance of payments remained inherently healthy, and the foreign reserves of the country increased substantially. Developments in some parts of sub-Saharan Africa unfortunately had an adverse influence on international perceptions of South Africa. Socio-political conditions in a number of countries remained unstable, and conflicts continued in parts of the continent. Events in Zimbabwe preceding the general election affected the sentiment of many investors towards the region, and unjustifiably raised questions regarding South Africa’s economic prospects. The understanding by non-residents of the underlying strength of the South African economy was further clouded by perceived structural weaknesses in Africa, the slow pace of skills development, inadequate health facilities, the prevalence of virulent diseases (including HIV/AIDS), and growing poverty and debt. These perceptions disrupted domestic financial markets and real economic activity in South Africa during the first half of 2000. A fundamentally sound balance of payments The regional events, a shift of funds away from commodity-based countries to high-technology and manufacturing-oriented economies, a rearrangement of portfolios as a result of the surging energy prices, and higher international interest rates led to large net sales of domestic securities by non-residents. After being net investors in South African bonds to the amount of R16.5 billion from the beginning of 1999 until the end of January 2000, non-residents became net sellers of bonds totalling R15.3 billion in the next six months up to the end of July 2000. Moreover, the net purchase of shares by non-residents on the Johannesburg Stock Exchange fell from R40.6 billion in 1999 to only R6.8 billion in the first seven months of 2000. At first an inflow of other capital was able to offset the net sales of domestic bonds by non-residents. In 1999 the net inflow of capital, including errors and unrecorded transactions, amounted to R27.1 billion, and in the first quarter of 2000 to a still satisfactory R3.1 billion. However, in the second quarter of 2000 a net outflow of capital was recorded, totalling R5.9 billion. The more permanent inflow of capital in the form of direct investment by non-residents in South Africa remained positive, but was offset by portfolio and trade-related outflows and a further accumulation of foreign assets by residents. Non-resident direct investment in South Africa amounted to R13.3 billion in the eighteen months until June 2000. These direct investment flows, as in other emerging-market economies, can be boosted by large one-off privatisations. Although the current account of the balance of payments moved into a deficit from the second quarter of 1999, the deficit remained relatively small. Throughout 1999 and the first half of 2000 the deficit did not exceed ½% of gross domestic product, and in the second quarter of 2000 a surplus of R5.7 billion at a seasonally adjusted and annualised rate was recorded. This surplus was a remarkable achievement taking into account the substantial increase in the country’s oil import bill as well as sharp increases in the volume of imports from the second half of 1999. The strong performance of the current account can largely be attributed to the growth in merchandise exports. The favourable global economic conditions, a rise in international commodity prices and a competitive exchange rate level in South Africa, led to a considerable increase in both the value and volume of merchandise exports. As a consequence of these developments on the current and financial accounts of the balance of payments, total net gold and other foreign reserves increased by nearly R28 billion from the end of 1998 to March 2000, before declining by R4.4 billion in the next three months. At the end of June 2000 the gross gold and other foreign reserves of the country nevertheless stood at R69.8 billion, which is the equivalent of the value of approximately 15 weeks’ imports of goods and services. Moreover, the utilisation of foreign credit facilities to boost gross foreign reserves was reduced by about R0.3 billion over the eighteen-month period until June 2000. As could be expected, this fundamentally sound balance of payments situation at first resulted in relatively stable conditions in the foreign exchange market. The nominal effective exchange rate of the rand in fact increased by 0.6% from the end of 1998 to the end of 1999. At the beginning of 2000, the external value of the rand began to depreciate in an environment of uncertainty in financial markets arising from the strength of the United States dollar, increases in oil prices and concerns about socio-political developments in sub-Saharan Africa. The weighted value of the rand declined by about 8½% from the end of 1999 up to 30 May 2000. Towards the end of May the behaviour of non-residents in the secondary bond market started to change and the United States dollar weakened somewhat on international foreign exchange markets. Net sales of South African bonds by non-residents of R17.3 billion in the four months ended May 2000 changed to net purchases of R1.6 billion up to 22 August 2000. The nominal effective exchange rate of the rand accordingly, on balance, increased again to a level on 23 August 2000 that was about 5% lower than at the beginning of the year. Buoyant but volatile financial markets The depreciation of the rand was one of the factors contributing to a temporary reversal in the downward movement of long-term interest rates and yields in South Africa during 2000. The monthly average yield on long-term government bonds fell from 18.3% in September 1998 to a daily average of 13.3% in mid-February 2000, influenced by the strength of the rand during that period, low inflation, fiscal discipline and a positive assessment by international rating agencies of South Africa as an investment destination. Subsequently, bond yields reacted hesitantly to perceived changes in financial markets. In March market sentiment deteriorated markedly owing to the weakness in the external value of the rand, rising official interest rates in major financial centres and higher risk premiums on South African assets. The daily average yield on long-term bonds shifted upwards to reach a peak of 15.2% on 10 May 2000, before the return to more stable financial conditions reduced it to 13.7% on 22 August 2000. The monthly average inflation-adjusted yield on long-term government bonds amounted to 5.5% in July 2000, compared with 10% in September 1998. Trading activity in the secondary bond market was boosted by the uncertainty in international markets. A record annual turnover of R8.8 trillion was recorded on the Bond Exchange of South Africa in 1999, followed by R6.2 trillion in the first seven months of 2000, which was about one-quarter more than in the corresponding period of the preceding year. In the primary bond market more active borrowing by private-sector companies compensated for a decline in the net borrowing of the public sector. The share market entered a long and difficult recovery phase after the financial crisis in 1998. The daily average index of all classes of share prices fell by no less than 40% from the end of April 1998 to the end of August 1998, and then rose gradually to a new all-time high on 17 January 2000 of 10% above its previous peak in April 1998. Rising interest rates, the depreciation of the rand and corrections on major international bourses resulted in a decline in the daily average index of share prices of 28% until 17 April 2000, when it began to recover again. On 22 August 2000 the daily average index of all classes of share prices was nevertheless still 9% below its peak on 17 January 2000. The strong recovery of share prices throughout 1999 supported trading activity on the Johannesburg Stock Exchange. The value of shares traded in the secondary share market rose to R448 billion in 1999, which was 40% more than in 1998. Volatility in share prices fuelled trading activity further during 2000. The value of shares traded in the first seven months of this year was 25% higher than in the corresponding period of 1999. In contrast to the unstable conditions in the bond and share markets, interest rates in the money market declined sharply during 1999 and remained largely unchanged during the first seven months of 2000. For example, the call rate on interbank funds declined from 17.75% at the end of 1998 to 9.5% on 31 January 2000 and remained at that level in the ensuing period. Similarly the three-month bankers’ acceptance rate moved down from 17.53% at the end of 1998 to 9.95% on 21 January 2000 and then fluctuated in a narrow range of between 9.83% and 10.25% up to the end of July 2000. The stability in the money market during the first seven months of 2000 can mainly be ascribed to the monetary policy stance pursued by the Reserve Bank. As a result of the changes in long-term and short-term interest rates, the relatively flat yield curve at the beginning of 1999 assumed a steep positive slope over the next eighteen months. This reflected an easing of the monetary policy stance and, in the first five months of 2000, higher long-term yields and interest rates. From the end of May 2000 the differential between long-term and short-term yields began to decline again. A slowdown in economic recovery The South African economy showed clear signs of a vigorous economic recovery during 1999. The annualised quarter-to-quarter growth in the seasonally adjusted real gross domestic product accelerated from 1% in the first quarter of 1999 to 3½% in the fourth quarter. Moreover, the expansion in economic activity became far more widespread in the course of the year. Whereas the agricultural and tertiary sectors had been mainly responsible for the initial rally in production, increases in manufacturing and other secondary sectors made a major contribution to output growth in the second half of 1999. Contrary to general expectations, the rate of expansion in the economy slowed down in the first half of 2000. Growth in real gross domestic product fell to 1% in the first quarter of 2000 and 1½% in the second quarter. To a large extent this was due to a decline in the output of the primary sectors, reflecting poor climatic conditions and an over-supply of coal on international markets. Manufacturing output was also affected by negative business sentiment related to the depreciation of the rand, the withdrawal of portfolio capital by non-residents and socio-political developments in some sub-Saharan African countries. As a result of these developments, the inventory accumulation moderated in the second quarter of 2000. Domestic final demand continued to increase at relatively modest rates of between 1 and 2½% in the four quarters until June 2000. Over this period the government reduced its final consumption expenditure significantly as part of its efforts to maintain fiscal discipline. Public-sector fixed capital formation also declined throughout 1999 and the first half of 2000. This decrease, together with a reduction in private-sector investment, reduced total real gross fixed capital formation by 7% in 1999. However, the rate of decline in total investment levelled off towards the end of the year. Fixed capital formation increased at an annualised rate of 1½% in the first half of 2000 when private companies apparently started to increase capital spending in anticipation of stronger growth in domestic and export demand. In sharp contrast to the developments in other expenditure aggregates, real household consumption expenditure rose steeply over the twelve months up to June 2000. Consumer confidence was high owing to increases in personal disposable income, a fall in bank lending rates and a lowering of effective income-tax rates. Despite this optimism, consumers avoided the use of excessive debt accumulation in financing consumption. Household debt as a ratio of disposable income declined from nearly 60% in the first quarter of 1999 to 57% in the second quarter of 2000. The reluctance of consumers to incur debt stems mainly from the volatility in real interest rates over the past two years. The modest economic growth over the past eighteen months did not lead to meaningful employment creation. Further reductions were recorded in employment in the non-agricultural private sector as well as in the public sector, which were neutralised by increases in the informal sector. At the same time, the growth in nominal unit labour costs slowed down significantly because of lower increases in the labour remuneration per worker and a rise in productivity. The rate of increase in nominal unit labour costs declined from 8.9% in 1998 to 3.2% in 1999 and only 0.5% in the first quarter of 2000, compared with the same period in the preceding year. Discipline in fiscal policy Disciplined fiscal policies and efficient public administration procedures brought the public-sector borrowing requirement down from R25.6 billion in fiscal 1998/99 to R10.9 billion in fiscal 1999/2000. Over the past five years the public-sector borrowing requirement has been reduced from 5.8% of gross domestic product in fiscal 1994/95 to only 1.3% in fiscal 1999/2000. The further decline in the borrowing requirement of the public sector in the past fiscal year can be attributed to substantial improvements in the financial position of the national government, provincial governments and the non-financial public enterprises and corporations. A decline in investment spending by public enterprises and corporations was responsible for approximately 25% of the reduction in the public-sector borrowing requirement. The remaining 75% saving in the borrowing requirement was largely due to the considerable restraint with expenditure allocations exercised by the national government and more efficient procedures for collecting income and other taxes. It is important to note, however, that part of the curtailment in expenditure over the past five years may have been achieved at the cost of the development and maintenance of the economic and social infrastructure of the country. There is a delicate balance between containing expenditure and maintaining the infrastructure required for economic development. Greater price stability The effective fiscal, monetary and other policy measures pursued by the authorities, in conjunction with lower international inflation, succeeded in creating greater price stability in South Africa. In 1998 and 1999 the rate of increase in the consumer price index excluding mortgage interest costs (CPIX) averaged 7% per year. This rate of increase can be compared with inflation rates fluctuating around 15% in the 1980s and early 1990s. During 1999 the twelve-month growth rate in the CPIX slowed down from 7.3% in March 1999 to 6.5% in October, but then accelerated to 8.0% in July 2000. The rise in inflation was largely due to shocks such as higher international oil prices, floods and volatile financial markets. When the effects of the price rise in petrol, diesel and food are omitted from the CPIX, the rate of increase over twelve months in other consumer prices fell from 6.8% in October 1999 to 6.7% in July 2000. The year-on-year increase in the all-goods production price index accelerated from a low rate of 2.3% in March 1998 to 10.1% in April 2000. This rate of increase, which normally precedes changes in consumer prices, slowed down to 8.6% in July 2000 in line with the appreciation in the external value of the rand. Recent developments in monetary aggregates bode well for the inflationary outlook, provided that the direct impact of external shocks wears off and that the secondary effects of the increase in oil prices can be contained. The level of the broadly defined money supply (M3) at the end of June 2000 was virtually the same as at the end of 1999, whereas M3 had increased at an annualised rate of nearly 19% in the second half of 1999. Moreover, the decline in money supply growth was largely concentrated in cheque and transmission deposits and coin and banknotes, ie in that part of M3 reflecting the transaction demand for money. Growth in bank credit extension, which had moved to single-digit levels in the second half of 1999, remained below 10% in the first half of 2000. The demand for overdraft facilities was buoyant in the first six months of 2000. Most of the overdrafts were utilised by the corporate sector to finance working capital. Mortgage advances, instalment sale credit and leasing finance also picked up with the revival in the real-estate market and in expenditure on durable goods. Monetary policy in a volatile environment The volatility in financial markets had a significant influence on monetary policy during the past year. At first, evidence that the emerging-market crisis of 1997/98 was abating made it possible to relax a very stringent monetary policy stance. The repurchase rate of the Reserve Bank was allowed to decline from a peak of 21.85% in early October 1998 to approximately 12% on 24 November 1999. The Monetary Policy Committee then announced that the repurchase rate would be fixed at this level temporarily because of possible disruptions in liquidity relating to the computer problems expected to arise at the year-end date change. The marginal lending rate of the Bank, ie the rate on a standby facility to bridge the unforeseen liquidity needs of banks, was also reduced from 15 to 5 percentage points above the repurchase rate. In addition to these measures, the Reserve Bank deliberately eased liquidity conditions in the money market during the last four months of 1999 to allay fears about the millennium change. When it became apparent that no serious Y2K problems would be experienced, the Reserve Bank reinforced the reserve dependency of banks on central bank funding. Bank liquidity was drained by increasing reverse-repurchase transactions, issuing Reserve Bank debentures and by concluding foreign exchange swaps with banks. From 14 January 2000 the Bank began to resume a variable-rate auction in accordance with the agreed signalling procedures with banks, and indicated that changes in short-term interest rates at that stage warranted an immediate reduction in the repurchase rate by a further 25 basis points. From the middle of January 2000 the Monetary Policy Committee indicated that the repurchase rate should remain at or around a level of 11.75%. The interpretation of this announcement by the banks was that the Reserve Bank wished to keep the repo rate fixed at this level. They accordingly tendered at the daily auctions at exactly this rate. While the Reserve Bank’s objective was to achieve stable money-market interest rates in volatile financial conditions, this did not preclude moderate variations in the repo rate around the 11.75% level. Stable money-market interest rates were regarded as desirable to restrain volatility. In the circumstances, a rise in rates would have failed to counter the effects of the supply-side shocks on domestic prices. Moreover, a number of other factors indicated that the upside risks for inflation would probably be short-lived. Developments such as modest increases in nominal unit labour costs, fiscal discipline, excess production capacity, low growth in money supply and bank credit extension and a prudent monetary policy stance, pointed to a favourable long-term inflation outlook. In a further attempt to create greater certainty about the ultimate objective of monetary policy, an inflation-targeting monetary policy framework was formally adopted in South Africa as part of overall economic policy. This was announced in the Budget Speech by the Minister of Finance on 23 February 2000, with an annual average inflation target range of 3 to 6% for the year 2002 being set. The new framework provides an anchor for the ultimate objective of monetary policy. It helps to focus monetary policy, increases transparency and leads to a clear accountability of the Reserve Bank to the citizens of the country. The successful application of inflation targeting, however, will depend on a concerted, cooperative effort by the key stakeholders, such as government, labour and business. The inflation target was specified as a range to allow the Bank some discretion in taking decisions on the monetary policy stance. The target is calculated as the average annual increase in the overall consumer price index excluding mortgage interest costs in metropolitan and other urban areas for the year 2002. A variant of the headline inflation rate was used, because the overall consumer price index is affected directly by changes in the Reserve Bank’s repurchase rate. By including price changes in metropolitan as well as other urban areas, the most comprehensive price index available in South Africa has been targeted. The year 2002 was selected because of the long lags of between 18 and 24 months before changes in short-term interest rates have an impact on inflation. The adoption of an inflation-targeting monetary policy framework for South Africa has certain important implications. Firstly, the numerical inflation target becomes the overriding objective of monetary policy. Monetary policy operational procedures are concerned overwhelmingly with the attainment of this objective. The objective of the framework is, after all, to achieve the target. However, this does not mean that the central bank is left without any discretion. A rigorously applied rule would deprive the central bank of its ability to deal with unusual or unforeseen circumstances. Secondly, the pursuit of inflation targets does not mean that the Reserve Bank is not concerned about the achievement of sustained high economic growth and employment creation. Monetary policy cannot contribute directly to sustainable economic growth and employment creation. However, by creating a stable financial environment, monetary policy fulfils an important precondition for the attainment of economic development. Empirical evidence has shown that high and variable inflation is bad for economic growth and that price stability is beneficial to a country’s performance. Thirdly, to be successful, inflation targeting requires nominal exchange rate flexibility. Trying to maintain an inappropriate exchange rate may be costly in terms of domestic economic activity. Unrealistically valued currencies may lead to large international capital flows with serious disruptive effects on the domestic economy. In an inflation-targeting monetary policy framework, exchange rates should essentially reflect the domestic monetary and fiscal policies of the authorities and be determined by the supply of and demand for currency in foreign exchange markets. This will result in fluctuations in the exchange rate of the rand, but should at the same time promote domestic economic stability. The Reserve Bank nevertheless takes cognisance of the second-round impact of exchange rate movements on the inflation rate. Fourthly, inflation targeting is a forward-looking approach. Monetary policy is based on the likely path of inflation. In any monetary policy framework a central bank has to decide how its current policy stance will affect future price movements. The difference between inflation targeting and other frameworks is that inflation targeting makes forecasting explicit and more transparent. For this purpose econometric models are applied and changes in economic circumstances are carefully analysed to determine the inflation outlook. With the assistance of a number of other central banks, considerable effort has been made to improve the forecasting capacity of the Reserve Bank. A number of small and simplified models have been developed to forecast inflation. In addition, the Bank has initiated an inflation expectations survey to determine the expected level of inflation. Econometric modelling is only one of the tools used to determine the monetary policy stance. However, the real world cannot be encapsulated adequately by an integrated system of mathematical equations. Econometric models over-simplify actual economic relations. Determining monetary policy requires a much more detailed analysis of factors that may have an impact on inflation. Value judgements are unavoidable. The determination of monetary policy in an inflation-targeting framework therefore remains an art and does not become an exact science. Finally, inflation targeting increases the transparency and accountability of monetary policy because the objective of price stability is expressed as a numerical target to be achieved over a specific period. The public announcement of explicit targets enhances the understanding of the policy objectives. Good governance calls for the Bank to be accountable, particularly in view of its operational independence in achieving the targets. In order to further facilitate an understanding of monetary policy, the policy stance is explained in a statement issued after every meeting of the Monetary Policy Committee, at Monetary Policy Forums in major regional centres, in various publications of the Bank and in speeches and presentations to the public and the Parliamentary Portfolio Committee on Finance. The Reserve Bank also intends to publish a six-monthly Monetary Policy Review to describe in greater detail the policies pursued and instruments applied. However, the Reserve Bank does not intend to publish the minutes of meetings of the Monetary Policy Committee. The statement published after every meeting provides a good reflection of considerations taken into account at the meeting. The Bank also does not intend to publish the structure of its econometric models at this stage because the functioning of these models needs to be evaluated over a long period of time. Disclosure of the models could create uncertainty about policy decisions. Once the models have been validated, the Bank will consider publishing them. At present it is also the objective of the Bank to reduce its net oversold position in foreign currency whenever circumstances allow. The foreign currency exposure of the Reserve Bank adversely affected market sentiment and has increased the volatility in the exchange rate of the rand and in other financial aggregates. Recognising this, a policy of gradually reducing the net open position in foreign currency has been followed. By buying dollars in the market, the net open position in foreign currency of the Bank was reduced from US$ 23.2 billion at the end of September 1998 to US$ 9.9 billion at the end of July 2000. The reduction of the net open position in foreign currency to zero will remove one of the risk factors in the economy. The reduction in the net open foreign position has had the added advantage of reducing the foreign currency exposure of the national government as a ratio of government debt from nearly 43% at the end of September 1998 to approximately 24% at the end of July 2000. The comparable ratio for South Africa’s peer group was some 46% at the end of December 1999. Were the Bank to succeed in reducing the net open foreign position to zero, the foreign currency exposure of the government as a ratio of government debt, at current levels, would amount to only 6%. This low currency exposure makes it easier to borrow funds abroad. Maintaining stability in the financial sector A stable financial environment requires not only low inflation, but also a sound financial sector. This involves stability in the financial markets where transactions can take place at prices reflecting demand and supply forces, and with healthy financial institutions capable of meeting contractual obligations without interruption or outside assistance. Stability in the financial sector and price stability are inextricably interrelated. Failure to maintain one form of stability creates an uncertain operating environment for the other, with causality running in both directions. A lack of price stability could lead to rapid growth in credit extension and higher interest rates, with the danger that borrowers could default on loan commitments. Bank failures may potentially be contagious, which would render monetary instruments ineffective and cause higher inflation. By contrast, stability in the financial sector enhances financial intermediation, improves the allocation of real resources and provides an environment conducive to the implementation of monetary policy. South Africa is fortunate to have a well-developed and sound financial system. Moreover, the domestic banking sector proved remarkably resilient during the global financial turmoil of 1997/98. In the mature South African financial market with a moderate level of private indebtedness and a good regulatory and legal framework, the major banks were able to cope efficiently with the effects of high interest rates and exchange rate volatility. In the past financial year, thorough preparations to avoid the possible impact of the transition to the year 2000 ensured that normal operations were maintained. Some of the smaller banks experienced temporary liquidity problems which were largely solved by allowing the affected banks to discount their cash reserves and statutory liquid-asset portfolios. The funding and other corrective measures enabled the affected banks to restore liquidity positions during the first quarter of 2000. South African banks are well run with sophisticated risk-management systems and corporate-governance structures. They are also well capitalised and had an average risk-weighted capital-adequacy ratio of 12.5% at the end of June 2000, compared with the required minimum ratio of 8% stipulated in the Basel Capital Accord. More than 60% of the banks had a capital-adequacy ratio of at least 15% at the end of June 2000. Although non-performing loans have increased since the international financial crisis, South African banks have made greater provision for bad and doubtful debts. As a ratio of total loans and advances, gross overdues in the banking sector came to only 4.6% in the second quarter of 2000. Provision for doubtful debts amounted to about 60% of total overdues in the same period, which is far more conservative than the international norm of 40%. However, there are signs that the profitability of the banking sector is declining somewhat. Lower income combined with higher operating expenses resulted in marginally lower returns on assets and equity in the first half of 2000. The excess of short-term liabilities over short-term assets for banks stood at 16% of their total funding requirements in June 2000. In view of the robust capital adequacy position of the banks and efficient management procedures, this is not a cause for concern. South African banks in any event maintain adequate levels of liquidity, with liquid assets exceeding the regulatory minimum by nearly 9% in June 2000. The Reserve Bank strives to ensure that effective and efficient banking supervision is in place. A recent assessment undertaken by the International Monetary Fund (IMF) and the World Bank in terms of a Financial Sector Assessment Programme found that South Africa complies with almost all the Basel Core Principles for Effective Banking Supervision. Where some requirements do fall short, proactive steps have already been taken to address them. The imminent promulgation of amendments to the Banks Act and revised Regulations thereunder should further enhance the country’s status in the regulatory environment. In view of the complexity of the financial system and the linkages of banks with other financial activity in the country, a Financial Stability Unit was established in the Reserve Bank in July 2000. This unit will research and analyse ways of promoting and maintaining a stable financial system. The aim is to focus on overall financial stability so as to enhance confidence in the domestic financial system, increase South Africa’s attractiveness as a regional financial centre and attract foreign investment. Considerable attention will be given to strengthening the non-regulatory aspects of the financial regime such as incentive structures, market discipline and corporate governance. A priority will be to help establish a deposit-insurance scheme for South Africa. One of the most important functions of the regulator of banks is to authorise the establishment of new banks. The power to grant licences provides the mechanism for preventing the entry of banks whose presence might be prejudicial to the interests of depositors and the soundness of the banking system. In South Africa our approach is to grant licences to all applicants that comply with a stringent set of entry criteria. These criteria are that the establishment of a bank should be in the public interest; no single shareholder should be able to dictate the bank’s direction without due regard to the interests of its depositors; the bank should be governed and managed by directors and managers with proven ability and integrity to pursue the interests of the owners without harming the interests of depositors; the bank should establish operational and control systems commensurate with the complexity of the risks and exposures it takes; and the bank should be established with sufficient financial strength to ensure adequate capital and sustainable profitability. Banks are monitored continuously to ensure that they remain fundamentally healthy. This has mainly been done through quantitative and qualitative off-site assessments. In 1999 the Bank began the preparatory work for on-site reviews of credit-risk management systems and evaluations of asset quality. The process is expected to become fully operational in the second half of 2000. Substantial progress has also been made with the development of consolidated supervision, ie in reviewing both banking and non-banking activities conducted by a banking group domestically and internationally. Despite all these procedures, it is not possible to guarantee that banks will not experience some difficulties from time to time. In such cases, the policy of the Reserve Bank is to assist only banks which have a temporary liquidity problem, whereas insolvent banks are allowed to exit from the system in an orderly manner which does the least harm to the banking system and depositors. In all cases of bank failure, the bank’s management is replaced and the individuals involved would normally not be permitted to hold influential positions in banks again. When a bank experiences funding difficulties on a short-term basis, lender-of-last-resort assistance is provided to it. Lender-of-last-resort assistance is a recognised responsibility and practice of central banks. The objective of such assistance is to enable the bank concerned to implement corrective measures and to prevent the contagion effect of a run on the bank. The liquidity under the lender-of-last-resort function is provided on a short-term basis only and has to meet certain important preconditions. These preconditions include that the institution has to be solvent; sufficient collateral is available; the institution has sought other reasonably available sources before seeking assistance from the Reserve Bank; the shareholders of the bank have made a reasonable effort to support it; there is no prima facie evidence that the management is not fit and proper, or that the liquidity problem is due to fraud; and the institution has developed and is committed to the implementation of a viable plan of appropriate remedial action to deal with its liquidity problems. In an integrated world economy, it is essential to have close cooperation and that information is shared internationally. This is becoming even more important with the increased foreign participation in the South African banking sector. The Bank continues to develop relations with other banking supervisors to meet the challenges posed by globalisation. At a regional level, the Bank participates actively in the initiatives of the East and Southern Africa Banking Supervisors Group to harmonise the banking legislation and banking supervisory practices of member states and to share information on matters relating to banking supervision. In addition to the banking supervision function, stability in the financial sector depends on the availability of currency in circulation and the maintenance of an efficient national payment, clearing and settlement system. The Bank incurs considerable expense annually to ensure the availability of high-quality currency in circulation in various denominations as a means to execute transactions. As a precaution against possible Y2K problems and an increased demand for currency near the year-end, a large number of additional banknotes were printed during 1999. No difficulties were therefore experienced in meeting the higher demand in the last few weeks of the year. Considerable progress was made with the planning and preparations to take over the provision of bulk cash services to banks from SBV Services (Pty) Ltd. A new currency management strategy was adopted by the Board of the Reserve Bank in February 2000 to deal with this matter. As a consequence, the infrastructure of the Reserve Bank’s branches will be adapted to provide for the increased level of currency-handling activity. Further advances have also been made in the national payment, clearing and settlement system to achieve same-day settlement. At present approximately 76% of all payments in the South African Multiple Option Settlement (SAMOS) system are already made on a same-day basis. In terms of the principles of international best practice, a start was made with introducing further risk-reduction measures in the Payment Clearing House (PCH) batches. PCH agreements are being drafted which will assist the industry to remove high-value payments from inappropriate payment streams and, in time, will enable all payments in the SAMOS system to be settled on a same-day basis. Another important challenge is the financing of small, medium and micro enterprises (SMMEs) which do not have securities or other assets as collateral for needed funds. Because banks lend out money that they receive from depositors, rigorous credit requirements have to be maintained under all circumstances. At the same time SMMEs are expected to make a major contribution to employment creation and economic development. To achieve this, they will obviously require outside finance. The Reserve Bank believes that the development of a microlending industry is essential for this purpose. Microlenders are well placed to provide such finance to SMMEs as they normally have an intimate knowledge of potential customers. Efficient credit-risk management requires an understanding of a customer’s business and the risks associated with loan financing. The Reserve Bank wants to actively promote the microlending industry by fostering community banking and exempting common-bond savings groups and village financial services cooperatives from compliance with the Banks Act, under certain conditions. The establishment of the Micro Finance Regulatory Council (MFRC) should further boost the already rapid growth in microlending. Only microlenders that are affiliated to the MFRC will be allowed to fund themselves by means of deposits in South Africa and conduct their business within a self-regulatory framework. Broadening of external relations Following the normalisation of South Africa’s relations with the rest of the world, senior officials of the Reserve Bank have become more involved with multilateral financial institutions, other central banks and international private financial institutions. A number of meetings were attended at the IMF and the Bank for International Settlements in the past year where discussions were held with other central bankers on current economic and policy developments. The Reserve Bank took an active part in the discussions about the new international financial architecture. Further headway was made with the enhancement of cooperation among the central banks of the Southern African Development Community (SADC). The Committee of Central Bank Governors in the SADC, chaired by the South African Reserve Bank and assisted by a secretariat in the Bank, is implementing projects aimed at facilitating monetary and financial cooperation in the region. These projects include the convergence of payment, clearing and settlement systems in the region; the maintenance of a common monetary and financial database; the development of a common legal framework for central banks; the harmonisation of listing requirements on stock exchanges; and the development of norms for good banking practice in the SADC. Close cooperation in sharing experiences and skills was also achieved in banking supervision, information technology, protective services and human resources development and training. As custodian of South Africa’s foreign reserves, the Bank continues to manage foreign reserve portfolios and foreign credit facilities. In order to increase the efficiency of reserve management, some of the international reserves were handed over to external fund managers to manage on behalf of the Reserve Bank. In this way the Bank expects to benefit in the form of training and technology transfers. In June 2000 syndicated loan facilities amounting to US$ 1.5 billion were successfully finalised to replace a similar loan that had matured. Changes to internal administration In the internal administration of the Reserve Bank a focus area during the past year was the establishment of a Budget Committee which is responsible for preparing and managing the Bank’s operational and capital budgets. This committee gave considerable attention to the budgetary process and procedures followed in the Bank and established definite rules. Roles for the Governors’ Committee, the Budget Committee, the Remuneration Committee and the Procurement Committee were clarified. The budget schedule was revised to synchronise with the strategic plans of departments and to allow more time for the preparation of departmental budgets and the approval of proposals by the Budget Committee. The Year 2000 project, which had started in July 1996 and culminated in the transition to the new millennium, was completed successfully. This was replaced by a number of new projects to ensure the most efficient, cost-effective information technology systems, including the dissemination of economic data and the upgrading of foreign exchange information. Treasury bills were immobilised and assistance was provided to the Strate system for its equity dematerialisation, clearing and settlement system. A paradigm shift in exchange control is under investigation. In the new planned philosophy most transactions will be permitted, except for certain specified exclusions. Emphasis will be placed on the accurate reporting of cross-border transactions. The completion of this study should improve the compilation of the balance of payments and provide more details of transactions in services with non-residents. The first stage of the implementation of this reporting system is envisaged for 2001. Briefing sessions in this regard have already been held with authorised dealers in foreign exchange and the other members of the Common Monetary Area. Like many other central banks, the Reserve Bank is seeking to enhance its effectiveness and efficiency by focusing on its core activities. To this end, considerable emphasis has been placed on the strategic management process. Strategic reviews are undertaken more frequently by the governors, and participation in the process was extended by involving advisers, all heads of departments, branch managers and the managing directors of the subsidiaries. Feedback on the results of these discussions was given to the Board in the form of a strategic framework document which provides general guidelines to departments on aligning departmental strategies and operational plans. In addition, the Bank has embarked on the development of a long-term vision which will serve as the framework for future planning. As part of this Vision 2010 a comprehensive human resources plan has been developed that forms the basis for effecting employment equity. The formulation and implementation of the plan underscore the Bank’s commitment to transforming the institution, eliminating past employment imbalances and making the staff more representative of the population of the country in terms of race, gender and people with disabilities. By the same token, the Bank is cognisant of the need to retain the necessary corporate memory and skills within a transforming environment. The plan endeavours to achieve a staff complement comprising a minimum of 50% Black people and 33% females across all occupational levels by 2005. The achievement of these targets will be complemented by a number of action programmes, which include a special drive to recruit people from the designated groups, accelerated management development and promotions, dedicated training and development, early retirement and redundancy procedures, organisational restructuring, wellness and disability management, and affirmative procurement. The Bank continues to regard the development of the skills and knowledge of its staff as a major responsibility. Emphasis is placed not only on the proficiencies required in its daily activities, but also on human resources development in such diverse fields as adult basic education, languages, business presentations, the conduct of meetings, the power of positive imaging, the personal and professional growth of women, financial and labour relations matters, management and preparing for retirement. The South African Reserve Bank College concentrates on upgrading the central banking skills of individuals to the highest level. The college plays an active role in the SADC Training and Development Forum and presents courses to staff of the Bank, private-sector and tertiary education institutions in South Africa and to individuals nominated by central banks in the SADC region. Concluding remarks and acknowledgements Events during the past year again illustrate how interwoven South Africa has become in the integrated world economy. Globalisation has many benefits for emerging-market economies. Capital movements facilitate the efficient allocation of saving, channel resources into productive uses and promote the financing of international trade and investment. In this way globalisation creates opportunities to increase international trade, economic growth, employment creation and welfare. Unfortunately, like all good things in life, globalisation also has certain disadvantages. In particular, the integration of South Africa into the world economy has made the country more vulnerable to external shocks. These can take the form of supply, demand and financial shocks. In such an uncertain environment the pursuit of financial stability has become even more imperative. Although stability does not provide unconditional protection against reversals in international capital flows, it does forestall uncertainties on the monetary front and can counter excessive volatility. The Reserve Bank therefore remains determined to maintain financial stability in South Africa. In conclusion, I wish to thank the President and Deputy President of the Republic of South Africa, and the Reverend Frank Chikane, Director General of the Presidency, for their support for the work of the South African Reserve Bank. In particular, I wish to express my heartfelt gratitude for their support for the independence of the South African Reserve Bank. I also want to place on record my appreciation to Mr Trevor Manuel, Minister of Finance, Mr Mandisi Mphahlwa, Deputy Minister of Finance, Ms Maria Ramos, Director General of National Treasury, and the staff of the National Treasury for their cooperation with the Bank over the past year. A word of appreciation is also appropriate to Mr Alec Erwin, Minister of Trade and Industry, Dr Alistair Ruiters, Director General, and the staff of the Department of Trade and Industry who have become important collaborators of the Reserve Bank. Informative meetings were held with the Parliamentary Portfolio Committee on Finance, which we found very helpful. I thank my colleagues on the Board, including the deputy governors, for their commitment and undivided loyalty to the Bank. Finally, a word of thanks is also due to the staff of the Reserve Bank for their work during the past year and for their loyal support. | south african reserve bank | 2,000 | 9 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a luncheon of the South African-German Chamber of Commerce and Industry, held in Johannesburg, on 10 October 2000. | T T Mboweni: Recent economic and financial developments in South Africa Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at a luncheon of the South African-German Chamber of Commerce and Industry, held in Johannesburg, on 10 October 2000. * 1. * * Introduction World economic activity expanded at a rapid pace during 1999 and the first nine months of 2000. Forecasts for the growth in global production by the major multilateral institutions for the year 2000 generally vary from 3½ to 4½%. Moreover, the strengthening in world economic activity was fairly broadly based, except for Japan which had negative growth in 1999. However, from the beginning of 2000, Japanese economic growth started to pick up together with a rise in corporate profits and fixed investment in the private sector. Nearly every other region of the world has seen an improvement in economic performance during the past year. Many of the world’s poorest countries, including some in Africa, are recording respectable growth rates. Growth in Europe has picked up remarkably and the United States is enjoying the longest expansion it has ever recorded. The remarkable economic boom in the United States has undoubtedly made an important contribution to the strength of the recovery in the world. But so too have the achievement and maintenance of price stability around the world. Despite a substantial rise in oil prices and strong international demand, inflation in nearly all the industrial countries has remained subdued since the beginning of 1999. 2. Slow economic growth in South Africa In this buoyant economic environment it is rather surprising that the South African economy did not perform better. The high international economic growth was expected to assist growth in the South African economy through increased demand for exports, higher prices on commodity markets and increased investments. After showing clear signs of a vigorous economic recovery during 1999, the economic growth in South Africa slowed down in the first half of 2000. The annualised quarter-to-quarter growth in the seasonally adjusted real gross domestic product at first accelerated from ½% in the fourth quarter of 1998 to 3½% in the fourth quarter of 1999. Contrary to general expectations, it then declined to 1% in the first quarter of 2000 and 1½% in the second quarter. The low economic growth during the first half of 2000 was largely due to a decrease in agricultural output that amounted to 7% after adjustment for seasonal factors and annualised. Torrential rain and flooding affected agricultural production in the northern and eastern parts of the country, and high temperatures and veld fires in the south-western wine and deciduous fruit producing areas caused extensive damage to crops. On top of this, farmers could not harvest the maize crop in the second quarter of 2000 because of the generally wet conditions. Maize output was therefore shifted to the third quarter of 2000 and should be an important plus factor for higher growth in the second half of the year. Economic growth in South Africa during the first half of 2000 was also negatively affected by an oversupply of coal on international markets, so there was less demand for one of South Africa’s important export commodities. Gold output continued to fall, contributing to a further decline in the value added by the mining sector. In addition, manufacturing output was affected by negative business sentiment related to the depreciation of the rand, volatile conditions in financial markets and socio-political developments in some sub-Saharan African countries. Many of these negative factors now seem to have improved, calmed down or disappeared completely. The outlook for economic growth is accordingly much more favourable. Higher growth rates could probably be expected during the second half of 2000 and in 2001. Prospects for long-term production growth, however, are still somewhat bleak in view of the current low fixed investment ratio. Fixed capital formation of about 15% of gross domestic product is not enough to sustain a high rate of output growth and job creation. High sustainable economic growth can only be obtained if there are larger additions to the production capacity of South Africa and increased productivity. We not only need to work harder, we also need to work smarter. Since 1994 there has been a marked improvement in labour productivity. In the past five years the growth in production per worker in the non-agricultural formal sector of the economy has averaged more than 3½% per year. These increases in labour productivity were, however, obtained by substituting new fixed investment to replace labour, rather than by expanding the productive base of the economy. Multifactor productivity, in other words the combined productivity of labour and capital, grew far less impressively than labour productivity alone. According to the findings of the 1999 October Household Survey of Statistics South Africa, employment increased in the year to October 1999. This finding is based on a broader definition of employment, namely employment in the formal sectors including agriculture and some self-employed persons as well as the workers in the informal sector. This survey shows that the overall number of jobs in the economy increased by about 10% to a level of around 10.4 million over the 12 months up to October 1999. The number of unemployed people remained unchanged over this period, resulting in a decline in the official unemployment rate. The official rate measures the unemployed as a percentage of the economically active population. This rate declined from just more than 25% in October 1998 to about 23% in October 1999. According to this survey, South Africa was therefore able to provide work to its growing population and to reduce the number of unemployed people, even at relatively modest economic growth rates. One should, however, immediately add that a large proportion of the increase in employment took place in the informal sector of the economy, meaning in the segment of the economy that has a low potential for rapid growth. Development in the South African economy is currently taking place in low-growth sectors with low fixed investment. At the same time, our savings ratio has declined to about 16% of gross domestic product. Despite the important structural changes that the government has undertaken and the sound macroeconomic policy measures that have been applied, the economy still is not poised to obtain high sustainable economic growth. This objective will require further adjustments to make the country even more investor friendly, to attract direct foreign investors and to counter any negative socio-economic issues. When determining policy, careful consideration is given to factors that could improve the general business mood and investments in South Africa. 3. Financial stability Some people also believe that we need lower real interest rates in South Africa if we want to achieve higher fixed investments and sustainably high economic growth. This is, of course, a valid argument. At low interest rates, the user cost of capital is lower and business people would be more inclined to invest their money in risky but probably lucrative capital projects. In this way the fixed investment ratio of the country would be increased, leading to higher growth and more employment opportunities. If only the real world was that simple, how easy my task would be as Governor of the Reserve Bank. Unfortunately, it is well known that a lenient monetary policy with low interest rates and the creation of money, does not lead to higher economic growth. The old adage is still true, it is like “pushing on a string”. Creating more money only leads to higher inflation. If it was so easy to achieve higher economic growth, there would be hardly any poor countries left in the world. I know that I am ridiculing the argument for lower real interest rates. Naturally, it is not easy to determine where the correct level of real interest rates should be to achieve high economic growth and maintain price stability. It should, however, be realised that the interest rate is the price for money. The Reserve Bank can only influence short-term interest rates through the application of monetary policy operational procedures. Although shorter-term interest rates influence the level of longer-term interest rates, other factors are also important when determining these rates. For example, at times you may find that the Reserve Bank reduces the repo rate, which lowers money market interest rates but leads to higher longer-term interest rates because of expected higher inflation. The Reserve Bank therefore only has an indirect influence on the level of the long-term interest rates that affect investor decisions. Moreover, the Reserve Bank cannot arbitrarily set short-term interest rates without taking careful note of underlying economic and financial conditions, and it is not the function of the Bank to promote economic growth in an artificial manner. At most, the Reserve Bank can only create stable financial conditions, which are generally regarded as an important precondition for high sustainable economic growth. This we have attempted to do over the past decade in a way that would have the least harmful effect on real economic activity. The policies followed by the Bank, together with fiscal and other policy measures, succeeded in creating greater price stability in South Africa. In 1998 and 1999 the rate of increase in the consumer price index excluding mortgage interest costs (CPIX) averaged 7% a year. This rate of increase can be compared with inflation rates fluctuating around 15% in the 1980s and early 1990s. The endeavours of the Reserve Bank to create these stable financial conditions were at times seriously hampered by exogenous shocks, particularly by volatile capital movements. In the past year we were again influenced dramatically by this volatility in foreign portfolio investments in South Africa. Non-resident investors sold large amounts of domestic securities because of socio-political events in Africa, a shift of funds away from commodity-based countries to high-technology and manufacturing-oriented economies, a rearrangement of portfolios as a result of surging energy prices and higher international interest rates. After being net investors in South African bonds to the amount of R16.5 billion from the beginning of 1999 until the end of January 2000, non-residents became net sellers of bonds totalling R15.3 billion in the next six months up to the end of July 2000. Moreover, the net purchases of shares by non-residents on the Johannesburg Stock Exchange fell from R40.6 billion in 1999 to only R6.8 billion in the first seven months of 2000. Non-residents’ net sales of bonds then changed to net purchases of R2.8 billion in July and August, before they again became net sellers to the amount of R5.2 billion in September 2000. Fortunately, over the same three months, they remained large net purchasers of South African shares on our stock exchange. These purchases amounted to R9.2 billion, which neutralised their sales on the Bond Exchange. These substantial fluctuations were recorded in the financial transactions of South Africa, despite a fundamentally sound balance of payments position. Although the current account of the balance of payments moved into a deficit from the second quarter of 1999, the deficit remained relatively small. Throughout 1999 and the first half of 2000 the deficit did not exceed ½% of gross domestic product, and in the second quarter of 2000 a surplus of R5.7 billion at a seasonally adjusted and annualised rate was recorded. This surplus was a remarkable achievement taking into account the substantial increase in the country’s oil import bill. The bigger bill was due to a rise in the price of oil from about US$ 10 per barrel at the beginning of 1999 to prices in excess of US$ 30 in the first half of 2000. The strong performance of the current account can largely be attributed to the growth in merchandise exports which neutralised increased imports. The favourable economic conditions in the world, a rise in international commodity prices and a competitive exchange rate level in South Africa led to a considerable increase in both the value and the volume of exports. As a result of this fundamentally sound balance of payments situation, the gross gold and other foreign reserves of the country have increased substantially. At the end of 1998 the total foreign reserves of the country amounted to R42.1 billion, which was equivalent to the value of about 10 weeks’ imports of goods and services. At the end of June 2000 the total foreign reserves amounted to nearly R70 billion, or to 17 weeks’ imports of goods and services. Moreover, the utilisation of foreign credit facilities to boost gross foreign reserves was marginally reduced over this same period, indicating that the Reserve Bank did not borrow funds abroad to support the level of the foreign reserves. 4. Exchange rate of the rand In these circumstances one would have expected the external value of the rand to be strong, and indeed this was the case during 1999. The nominal effective exchange rate of the rand in fact increased by 0.6% from the end of 1998 to the end of 1999. This strengthening of the rand was boosted by the listing of prominent South African companies on the London Stock Exchange which encouraged a large net inflow of portfolio capital. Only in the middle of 1999 was the strengthening of the rand interrupted for a while when problems in Latin America and a steep decline in the gold price led to a sharp depreciation of the rand. This lasted only for a short time and the rand, on balance, strengthened again during the last half of the year. From the beginning of the year 2000, the rand at times came under severe pressure. It has depreciated against the United States dollar from a level of R6.15 to the dollar at the end of 1999 to a level fluctuating between R7.20 to R7.30 to the dollar in the last week of September. This represents a depreciation of nearly 18%. The rand generally also depreciated against most of the other major currencies, but to a much lesser extent than against the dollar. As a consequence, the weighted average value of the rand declined by about 7% during the first nine months of 2000. This decrease was much higher than the inflation differential between South Africa and its main trading partners and competitors. After adjustments for these price differentials, the rand probably declined at a roughly estimated 3% in real terms over the same period. The weakness of the rand was largely related to developments outside the borders of South Africa. In particular, the exchange rate of the rand was seriously affected by the strength of the US dollar. The general weakness of currencies against the US dollar is demonstrated by depreciations of almost 14% for the euro, 10% for pound sterling and 20% for the Australian dollar from the beginning of the year until the end of September 2000. The strength of the dollar was related mainly to the exceptionally high and sustained growth in the United States, which encouraged long-term investments from Europe and Japan to flow into America. The recent sharp depreciation of the euro against the dollar led to a coordinated intervention by central banks in the United States, Britain, Europe and Japan to support Europe’s ailing currency. It has been estimated that the central banks of these countries spent about US$ 3 billion to US$ 5 billion to buy euros in the last week of September. As a result the euro’s value against the dollar promptly rose from below 85 cents to around 90 cents. Subsequently it has fallen back again and was trading between 85 cents to 90 cents at the beginning of October. Although it did have this immediate impact, it is doubtful if this one-off intervention will have the desired effect over a longer time period. Intervention normally only works if it is aimed at stopping speculative capital flows, if it signals a change in underlying policies, if it is strongly supported by all parties participating and if the central banks are prepared to intervene repeatedly and in large amounts. These are also the main reasons that the South African Reserve Bank did not intervene in the foreign exchange market. In fact the Reserve Bank has continued to buy small amounts of dollars in the market to improve its net oversold open position in foreign exchange. After this position had improved from US$ 23.2 billion at the end of September 1998 to US$ 10.3 billion at the end of March 2000, the Bank continued to bring this position down slowly to US$ 9.6 billion at the end of September 2000. This was part of the Reserve Bank’s objective to reduce its net open position in foreign exchange to zero, in order to remove one of the perceived risk factors in the economy. Any intervention in the foreign exchange market to support the exchange rate of the rand may well have made the downward pressure on the value of the rand worse, in view of this risk factor. The success of such intervention would in any case have probably also been thwarted by the general strength of the US dollar. 5. Concluding remarks As could be expected, the depreciation of the rand and the substantial rise in energy and food prices affected price increases in South Africa. For example, the year-on-year increase in the CPIX accelerated from 6.5% in October 1999 to 8.2% in August 2000. If fuel and food prices are excluded, CPIX inflation declined slightly from 6.8% to 6.6% over the same period. Similarly, the year-on-year increase in production prices accelerated from 5.7% in September 1999 to 10.1% in April 2000, and then declined slightly to 9.3% in August 2000. However, if energy and food priced are omitted, the year-on-year increase in production prices has continued to accelerate from a low of 3.2% in November 1999 to 5.3% in August 2000. This upward trend was mainly due to increases in the prices of imported goods, while domestically generated inflation has shown a declining tendency from April 2000. Despite the upward pressures on domestic prices arising from the depreciation of the rand and the rise in the prices of energy and food, the Reserve Bank resisted the temptation to increase interest rates. Instead, the Bank pursued a policy to encourage stable money market rates in order to restrain the effects of volatile financial markets on the real economy. Under the circumstances, a rise in interest rates would not have countered the effects of supply side shocks on domestic prices. The domestic fundamental factors for inflation also remained favourable. These include seven main factors: (i) a further slowdown in the year-on-year rate of increase in nominal unit labour costs from an already low 4.5% in the second quarter of 1999 to 2.2% in the second quarter of 2000; (ii) surplus production capacity in the economy, as reflected by the utilisation of production capacity in manufacturing of only about 79% in the first quarter of 2000. (iii) no signs of excessive growth in demand, with domestic final demand increasing only at a seasonally adjusted and annualised rate of 2½% and a surplus on the current account of the balance of payments in the second quarter of 2000; (iv) a sluggish growth in money supply of 8.6% over the 12 months to August 2000; (v) a low year-on-year rate of increase in total domestic bank credit extension of 7.1% in August 2000 and no signs that consumers have become willing to borrow excessively; (vi) continued prudent fiscal policies with government carefully monitoring expenditure; and (vii) signs that the rate of increase in food prices seems to be levelling off. All these factors indicate that the inflation target of the authorities will be attained in 2002. The Reserve Bank will nevertheless continue to carefully monitor underlying economic developments, and will not hesitate to take the necessary steps if changed circumstances do indicate a danger that the inflation targets may not be met. We remain fully committed to meeting our inflation target of 6-3% of CPIX by end of calendar year 2002. | south african reserve bank | 2,000 | 10 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Reuters Forum Lecture, held in Johannesburg, on 11 October 2000. | T T Mboweni: Central bank independence Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Reuters Forum Lecture, held in Johannesburg, on 11 October 2000. * * * “Independence signifies ignoring pressures, whatever its source. The independence of central banks goes, ... beyond independence from political, executive and legislative power. For me it also equates with independence from private or collective economic interests, autonomy versus the short term, frequently imposed by capital markets and, finally, freedom of action vis-à-vis the monetary policy of other central banks.” Prime Minister Lionel Jospin. Paris, May 2000. 1. Introduction I am extremely pleased at this invitation to present this inaugural address in the Reuters Forum Lecture series. This is an important initiative and I wish you well for the sustained success of this lecture series. We have chosen to discuss the issue of central bank independence since the topic is both current and highly significant. Incidentally when the Banque de France organised their bicentennial celebrations in May this year, they chose the topic of central bank independence as the theme for the colloquium. At the said Banque de France colloquium, the Prime Minister of the French Republic, Monsieur Lionel Jospin remarked that: “the increased power and influence of central banks, the greater visibility of their role and their leaders, have inevitably focused attention on their role, their efficiency, the principles underlying their actions and, in some cases, their place in the democratic way of life.” Central banking is of cardinal importance in any country because of the legal right normally granted to central banks to create money. This money can serve as a means of payment, a unit of account and a store of value. One of the important issues immediately arising after granting this right to a central bank, is whether this function should fall under the ultimate control of the executive branch of government - the cabinet and its administrative departments - or whether parliament should leave this responsibility to be freely executed by an independent, autonomous powerful institution run by unelected people. 2. Advantages of an independent central bank The traditional argument in favour of a strong, independent central bank is that the power to spend money should in some way be separated from the power to create money. Numerous episodes in the world’s economic history testify to a government’s potential abuse of its power to create money. Around the third century AD in the Roman Empire, for instance, the silver coins collected by the tax authorities were melted and combined with inferior metals, yielding many more coins to spend on the Caesar’s priorities than the initial tax take. With too much money chasing too few goods, the end result was high inflation. Much the same has happened all too frequently with paper money systems. Many governments have given way to the temptation to reduce interest rates ahead of elections. This may boost spending and employment in the short term, but ultimately it usually also causes higher inflation over the long term, unless the capacity of the economy can meet this higher level of demand. This higher inflation, however, only becomes apparent a couple of years later. An elected government concerned about its immediate popularity might be tempted to go for the short-term gains from lower interest rates, even at the risk of promoting somewhat higher inflation further down the road, because some other political party may then have to pick up the pieces. Central bankers normally operate on a longer-term time scale than politicians and therefore do not face the same temptation to relax policy to achieve short-term objectives. By delegating decisions about interest rates and other monetary matters to such an independent institution, with a clearly defined mandate, society can hope to achieve a better inflation outcome over the longer term. A number of studies have been undertaken to determine whether this argument is valid. These studies all seem to come to the following three conclusions. Firstly, they provided evidence of a negative correlation between central bank independence and long-term inflation. A low inflation rate is therefore more likely to be found in countries with independent central banks than in countries where the central bank is subject to government control. Secondly, they showed that there is a negative correlation between central bank independence and the long-term budget deficit expressed as a percentage of a country’s gross national product. Countries with independent central banks tend to have smaller budget deficits than those with government-controlled central banks. Thirdly, the studies in general did not find any evidence of a correlation between the independent status of a central bank and production growth. It therefore does not follow that production or employment will suffer as a result of the independent status of the central banks over the medium to long term. 3. Risks of central bank independence Some critics of an independent central bank argue that although the average inflation rate and the degree of central bank independence are negatively correlated, this relationship does not reflect any causal link running from central bank independence to low inflation. They argue that countries where the electorate is particularly averse to inflation, are more willing to keep inflation down. These countries are also more likely to have made their monetary authorities functionally independent so as to help preserve low inflation. Germany, affected severely by the hyperinflation of the Weimar Republic, is an obvious case in point. Conversely, countries where the electorate are more tolerant of inflation, are also less inclined to see monetary policy turned over to an autonomous central bank. These critics claim that average inflation is determined by history and the preferences of a country’s inhabitants with causality running from inflation to the institutional structure. According to this view, attempts to impose an independent central bank and with it a more purposeful anti-inflationary stance in a country tolerant of inflation, are doomed to failure. The outcry against restrictive policies would simply be too great for the central bank to withstand. This argument is not very convincing and does not seem to fit, for instance, the recent experience of New Zealand. For most of the postwar period the Reserve Bank of New Zealand was one of the least independent central banks in the OECD. However, in 1988 it was transformed into one of the most autonomous, with a very clear mandate to fight inflation. This helped the inflation rate to plummet from double-digit levels to under 2%, which strongly suggests that the structure of monetary institutions together with the determination to combat inflation, can be highly successful. Another argument against the autonomy of central banks is that they form part of overall economic policy and that there can be no meaningful separation between fiscal policy, monetary policy, labour policy, trade policy or for that matter any other policy measures. If such a separation is attempted and if policies run at cross-purposes, then conflicting objectives will have to be solved one way or another. In the process, a conflict between the policies may inflict considerable damage on the economy. There is clearly substance in the argument that a tightly coordinated package of policies has a better chance of success than a set of conflicting ones. It can nevertheless be argued that such conflicts may be inevitable over the short term, as long as central banks have the primary responsibility for controlling inflation. However, over the long term, stable financial conditions promote sustainably higher economic growth rates, increased welfare and more employment opportunities. The main criticism against making central banks autonomous entities is based not so much on economic as on political arguments. The political argument is that turning over decisions about interest rates, exchange rates, the efficiency of the financial system and other monetary matters to a body of unelected officials, is simply “undemocratic”. In a democratic society, it is argued, all decisions should be subject to scrutiny by the elected members of the legislature and the concept of an autonomous central bank is therefore not acceptable. Although there are plenty of other areas of national life where decision making is delegated to independent unelected officials - the judiciary is a prime example - there is a fundamental confusion here between being independent and lacking accountability. No central bank can be totally independent, in the sense that it is not answerable to anyone. Even the most autonomous central bank has to report in some form or another to the legislature, which in any case also has the ultimate power to change the laws governing the central bank. All the same, there is a difference between a situation where policy decisions are under continuous scrutiny, and an arrangement where the central bank reports to the legislature periodically. The issue of independence and accountability also turns on the nature of the relationship between the government and the legislature as the political authorities on the one hand and the central bank on the other. At the same colloquium mentioned above, Monsieur Jean-Claude Trichet, Governor of the Banque de France, observed that: “respecting independence does not mean a lack of dialogue, on the contrary. However, it is true that an independent central bank is neither accountable to the executive power, nor to parliament, nor any other political institution. In France this was decided by the law makers, and in Europe by the will of the people and the European Parliaments, which ratified the Maastricht Treaty.” In the case of the European Central Bank (ECB), the independence of the Bank is explained under Article 7 of the Statute which says that: “When exercising the powers and carrying out the tasks and duties conferred on them by this Treaty and this Statute, neither the ECB, nor a national bank, nor any member of their decision-making bodies shall seek or take instructions from community institutions or bodies, from any government of a member state or from any other body.” The key issues here quite clearly are independence, accountability and dialogue with the political authorities. In South Africa the Governor of the Reserve Bank must submit a report annually to the Minister of Finance relating to the implementation of monetary policy. In terms of Section 32 of the Reserve Bank Act, the Bank must also on a monthly basis submit a statement of assets and liabilities and annually its financial statements to the Department of Finance. These reports are then tabled in Parliament by the Minister of Finance. Moreover, Section 37 of the Act provides further that if at any time the Minister of Finance is of the opinion that the Bank has failed to comply with any provision of the act or of a regulation made thereunder, he may by notice in writing require the Board of the Bank to make good or remedy the default within a specified time. If the Board fails to comply with such a notice, the Minister may apply to the Supreme Court for an order compelling the Board to make good or remedy the default, and the Court may make such order thereon as it deems fit. 4. Conditions for independence In view of these risks involved in central bank independence, there are usually three preconditions for central bank autonomy. Firstly, there should be a clearly spelled out legal and operational framework in which monetary policy is conducted. In the legal framework, the central bank’s independence should be defined to avoid any misconceptions of what the central bank is supposed to achieve. In the monetary policy framework, the central bank must indicate what it is attempting to achieve, what operational variables it will apply and what monetary instruments it will use to achieve its objective. Because credibility is usually not gained overnight, it is important that a longer-term programme should be drawn up to show how the central bank will fulfil its mission. A second condition for greater autonomy is transparency. The government and the public should continuously be informed of the monetary policy programme followed by the central bank. Regular discussions between the central bank and the government will be necessary and some form of accountability to parliament will have to be established. It is also important to explain monetary policy decisions regularly to the public, together with an assessment of the progress made in achieving stated objectives. Priorities in the programme as well as operational instruments should be clearly spelled out, in order to keep the public well informed about developments and changes in monetary policy. The third condition for central bank autonomy is the creation of an efficient institutional framework within which decisions on monetary policy and on its implementation can be made, without undue interference by political functionaries. This involves decisions regarding: (i) functional independence, which means the right to decide on all matters regarding monetary policy and price stability; (ii) personnel independence, which covers the selection and appointment of Board members with a high professional competence and without an obligation to yield to political and other pressures; (iii) instrumental independence, which means control over the instruments that affect the inflation process, including in particular the prevention of any direct financing of government deficits; and (iv) financial independence, which requires the central bank to have access to adequate financial resources of its own and full control over its own budget. 5. Legal and operational procedures in South Africa The legal framework may provide an important foundation on which independence can be built, by giving clearly defined tasks to the central bank and demanding compliance in carrying out those tasks. By the early 1990s, when South Africa’s Constitution was being drafted, central bank independence had already become a fairly widely accepted element of sound central banking in the international debate. This acceptance was shaped by the dismal experience of the many countries that had suffered high inflation in the 1970s and 1980s. Both the interim and the final Constitution of the Republic of South Africa therefore provide for an independent central bank. Section 224(2) of the Constitution states very clearly: “The South African Reserve Bank, in pursuit of its primary object must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.” In operating within this legal framework, the Reserve Bank has indicated that its primary goal in the South African economic system is the achievement and maintenance of financial stability. The Bank believes that it is essential that South Africa has a growing economy based on the principles of a market system, private and social initiative, effective competition and social fairness. It recognises, in the performance of its duties, the need to pursue balanced economic development and growth. In the pursuance of its responsibilities, the Reserve Bank assumes responsibility for: (i) assisting the government, as well as other members of the community of South Africa, in the formulation and implementation of economic policy; (ii) formulating and implementing monetary policy in such a way that the primary goal of monetary policy will be achieved in the interest of the whole community; (iii) ensuring that the South African money, banking and financial system as a whole is sound, meets the requirements of the community and keeps abreast of developments in international finance; and (iv) informing the South African community and all interested stakeholders abroad about monetary policy generally, and the South African economic situation in particular. As is well known, South Africa adopted a formal inflation-targeting framework for monetary policy in February of this year. Time does not allow a long discussion of this framework. However, it may be noted that it makes the aim of monetary policy much clearer, ie the achievement of an average annual increase of 3 to 6% for CPIX inflation in 2002. The government chose to set the 3 to 6% target level. The setting of monetary policy instrument values (like the level of the “repo rate”) is entirely up to the Reserve Bank. Therefore the inflation-targeting variable chosen provides for the instrument independence of the Reserve Bank, but not goal independence. By means of the mission statement and an explanatory memorandum about the adoption of an inflation-targeting monetary policy framework, the public has been informed about the objectives of monetary policy. On the basis of this information the public can therefore evaluate the actions of the Reserve Bank in attaining these objectives. 6. Transparency of monetary policy The South African Reserve Bank also fulfils the second condition for independence, namely transparency. Government and the public are provided with a stream of information on the monetary policy stance. Some of my staff and I regularly appear before the Parliamentary Portfolio Committee on Finance. We also issue comprehensive statements following each meeting of the Bank’s Monetary Policy Committee. The Reserve Bank’s Quarterly Bulletin, Annual Economic Report and Governor’s Address at the annual meeting of shareholders provide comprehensive analyses of macroeconomic events. A six-monthly Monetary Policy Review will soon be introduced, describing in more detail the decisions taken by the Reserve Bank. Policy is also explained by the Governors of the Bank and comments on policy are heard at the Monetary Policy Forum meetings. These meetings are held twice a year in the main centres - at least one in each province - and involve organised business, labour, politicians, academics and the media. 7. Institutional independence in South Africa Finally, the present institutional framework in South Africa in the form of the South African Reserve Bank Act, Act No 90 of 1989, allows the Reserve Bank a great degree of autonomy in its operations. The Reserve Bank’s functional independence in monetary and related policies is clearly stated in Sections 10 and 35 of the South African Reserve Bank Act. Section 35 empowers the Board of the Bank to make rules “for the good government of the Bank and the conduct of its business”. In Section 10 the powers and duties of the central bank are spelled out in great detail. Most of the functions described in this section are the normal functions that one would expect a central bank to perform. Section 10(2) also clearly states that “the rates at which the Bank will discount or rediscount the various classes of bills, promissory notes and other securities, shall be determined and announced by the Bank from time to time”, plainly giving the Bank the right to determine Bank rate, or rather the repo rate, in an autonomous manner. As banker to the government, however, the Bank administers exchange control regulations, monitors the prudential soundness in the banking system and handles the weekly tenders for Treasury bills and government securities. The Reserve Bank also takes care of various aspects of South Africa’s dealings and relations with institutions such as the International Monetary Fund and the World Bank on behalf of the government. In performing these activities, the Bank only acts as an agent of government and the final responsibility and decision-making rest with the Minister of Finance. This kind of activity can undermine the functional independence of the Reserve Bank. The personnel independence of the Reserve Bank is determined in Section 4 of the Act, indicating the conditions of appointment of the Governor, three deputy governors and other Board members of the Reserve Bank. This section clearly precludes any person actively involved in politics, non-residents or officials of private banks from becoming a member of the Board of the Bank. Seven of the directors, including the Governor and three deputy governors, are appointed by the President of the Republic, and the other seven are elected by the shareholders. By means of these appointments the government, of course, does, as some would argue, have an effective say in the policies of the Bank. The governors, however, after their appointment, normally operate independently without fear or favour. Certain conditions are given in the Regulations under the Reserve Bank Act which will disqualify a person for remaining a Board member, such as conviction for theft, fraud, forgery or perjury. However, mechanisms for the dismissal of governors are not entrenched in the Act. Grounds for dismissal and the actual procedure could perhaps be more explicitly stated in legislation to improve the functioning of the Reserve Bank. Consideration could also be given to lengthening the tenure of office of the Governor and deputy governors, say to seven years, to improve the autonomy of the Bank further by separating the five-yearly political cycle from the appointments of governors. The instrumental independence of the Reserve Bank is also clearly spelled out in the Act and the Reserve Bank is precluded in Section 13(f) from making excessive direct purchases of government stock. This section states that the Bank may not “hold in stocks of the Government of the Republic which have been acquired directly from the Treasury by subscription to new issues, the conversion of existing issues or otherwise, a sum exceeding its paid-up capital and reserve fund plus one third of its liabilities to the public in the Republic”. This section therefore restricts the direct financing of government deficits. At the same time, the Act also allows the Reserve Bank to provide unsecured loans and advances to government and companies in which it has acquired shares. Although there are limits on government borrowing, serious consideration in the revision of the Reserve Bank Act should be given to removing this potentially dangerous provision. The South African Reserve Bank is also financially independent from the government because of its adequate financial resources and full control over its own budget. 8. Conclusion In pursuing financial stability, the South African Reserve Bank is relatively well aligned with international best practice. It operates autonomously within a legal framework which affords it a substantial degree of independence, while remaining accountable to Parliament. But ultimately it is the appreciation by the public at large of the importance of financial stability, and their understanding of and support for the role of the Reserve Bank in this regard, that is needed to entrench and develop the Bank’s independence. To this end, ongoing communication between the Reserve Bank and all levels of society is essential. In this connection, Governor Jean-Claude Trichet asked the question: “So to whom is the central bank accountable? In the end, I think it is accountable to public opinion itself. It is our great responsibility to communicate with public opinion as a whole, and not just market operators and investors. This communication must be as direct and precise as possible, in terms as simple as the subject matter allows while remaining very professional.” While we are fully aware that we face many daunting challenges, it is gratifying to note the degree of financial stability that has been attained over the past years. And it is exciting to note that financial stability provides a sound basis for sustainable strong economic growth and development; more and more evidence suggests that central bank independence and prudent policies in general are starting to pay off in South Africa. | south african reserve bank | 2,000 | 10 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Black Management Forum Conference 2000 in Gauteng on 13 October 2000. | T T Mboweni: Global competitiveness - is South Africa ready? Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Black Management Forum Conference 2000 in Gauteng on 13 October 2000. * 1. * * Introduction Financial markets around the world are being integrated into a single global market and, whether we like it or not, emerging and developing countries are being drawn into this process. The growing economic interdependence of countries worldwide can be seen in the greater volume and variety of cross-border transactions and in the faster and more widespread diffusion of technology. Technological progress has improved transportation and communications, enhanced information awareness and information processing, and set the stage for new products and innovations. Although these markets still do not form a single global village, they are already so interdependent that they have altered the environment in which the provision of financial services takes place. One of the most important results of globalisation has been the huge upsurge in cross-border financial transactions. This, in turn, has meant that shocks in one “national” market are quickly transmitted to other “national” markets with the speed never thought of decades ago. The contagion effect of the recent crisis in East Asia is a good example. Another consequence of globalisation, is increased competition. Financial liberalisation, the removal of controls and the breakdown of international barriers, make it possible for new entrants to participate in markets which were previously closed to them. In view of the size of these enterprises and their involvement in many countries in the world, they are usually well-placed to provide specialised services to clients at relatively low costs. The increased competition makes new demands on old established enterprises and they must either adapt or die. 2. Globalisation and financial institutions Financial institutions all over the world have responded to these changes in different ways. Some entered into strategic alliances with foreign or domestic enterprises. Others positioned themselves by specialising in the provision of certain specific services. Yet others chose to consolidate and form large groups. This approach led to takeovers and amalgamations of financial activity in new companies that provide a broad spectrum of financial services to consumers. In South Africa the financial system has also been undergoing major modernisation and strengthening. The impetus for this change came after 1994 when foreign financial institutions began to participate directly in the South African market. The policy followed by the authorities of gradually removing exchange controls, opened up new opportunities for the diversification of investments. As a result, foreign financial institutions set up large numbers of subsidiaries, branches or representative offices in South Africa. At first the domestic financial institutions felt the impact of increased competition, but they now seem to have adapted well to the changed circumstances and have introduced various measures to improve their efficiency. The depth, breadth and stature of South Africa’s financial markets has been increased by a number of important developments in recent years. The development of a eurorand bond market, the introduction of primary dealers in bond auctions and the successful launching of a domestic medium-term note programme deepened the South African bond market. Financial instruments have also been diversified and aligned more closely with developments in international capital markets. The Johannesburg Stock Exchange has been restructured to provide for electronic screen trading, corporate and non-resident participation, negotiated commissions and dual capacity trading by brokers. The stock exchange has also successfully forged links with other exchanges in Southern Africa, and now shares with the Namibian Stock Exchange a system for trading, clearing and settlement. Electronic clearing and settlement, the phased dematerialisation of shares and their registration in a central securities depository, are currently being introduced. The objective is to reduce settlement risk through delivery against payments linked to the National Payment, Clearing and Settlement System. It is important to realise that institutions that have greater international distribution and delivery capacity can compete better on a global basis. While merger and acquisition activity continues to grow rapidly in the world, the South African market has been relatively quiet in this regard since the market crash of September 1998. Although the past years have seen high-profile listings on the London Stock Exchange of South African Breweries, Old Mutual, Anglo American and Didata, there have been relatively few new listings or rights issues on the Johannesburg Stock Exchange. Moderate growth in share prices has tended to slow merger and acquisition activity, but cross-border acquisitions by South African companies have entrenched South Africa as part of the global economy and highlighted the need to be globally competitive. The world of competitive global finance clearly favours players with a global scale and reach. This means that financial institutions must have research facilities to keep them up to date with international developments, they must have access to global markets and they must have products that can be marketed internationally. For many South African institutions, this implies a complete change in culture and in the behaviour of their staff, and probably also a realignment of their organisational structures. Financial institutions in a global environment will, in particular, rely heavily on information to target potential clients, assess their needs and objectives, manage their portfolios, construct investment strategies and allocate assets. In this regard the Internet has emerged as a key competitive arena for the future of financial services. Web-based commerce has added new complexity and unpredictability to the world of commercial and retail banking, mutual funds and brokers, back-office processors and financial software providers. Institutions that do not have a clear strategic focus will find it increasingly difficult to maintain their positions as competition gets tougher. They will have to identify a specific focus for their business, because it may become difficult to compete successfully in all the various fields and instruments. Careful planning and organisation are needed in this integrated world to ensure that the needs of clients are well served. Clients have become increasingly performance sensitive. This makes it essential to monitor structures and products to keep performance inconsistencies to a minimum. 3. Globalisation and financial regulation Greater global competitiveness also poses new challenges to financial regulation for ensuring financial stability. The recent experience in a number of countries has clearly indicated that there is a real danger of financial instability from globalised financial markets and large and volatile international capital flows. The Asian crisis was magnified by bad loans, weak balance sheets and lack of transparency in financial reporting. Research shows clearly that emerging markets with sound financial systems are better able to manage the effects of international financial crises. Partially in response to some negative effects of globalisation, several international institutions such as the Basel Committee on Banking Supervision, the Bank for International Settlements (BIS), the World Bank and the International Monetary Fund (IMF) have done studies on reforming the international financial architecture. The cooperative global efforts on reform have been concentrating on five major areas. The first area is to make timely, reliable statistical data available to the market and the public, as well as information about economic and financial policies, practices and decision-making. Important progress in this area includes the establishment of the Special Data Dissemination Standard of the IMF and the release of Public Information Notices following the conclusion of the Article IV consultation process between the IMF and member countries. It is agreed that greater transparency will enhance the understanding by the public of economic policy measures of government, strengthen credibility and make market participants less uncertain in their decision-making. The second area is the creation of internationally accepted practices. Key progress in this area includes the development of the Code of Good Practices on Fiscal Transparency, the Code of Good Practices on Transparency in Monetary and Financial Policies and guidelines concerning financial sector soundness. Adherence to these international best practices and codes should help to ensure that economies function properly. The third area is the strengthening of the financial sector. The assumption is that banks and other financial institutions need to improve internal practices, including risk assessment and risk management. At the same time the official sector needs to upgrade the supervision and regulation of the financial sector to keep pace with the modern global economy. To achieve these objectives, the Basel Committee has developed the Core Principles for Effective Banking Supervision, while the Committee on Payments and Settlement Systems has drawn up the Core Principles for Systemically Important Payment Systems. Universal principles for insurance as well as security market regulation have also been developed. The fourth area of financial sector reform concerns involving the private sector in crisis prevention. The involvement of the private sector should limit moral hazard, strengthen market discipline and improve the repayment of loans. The fifth area of reform concentrates on the prevention of systemic instability. Most of the international best practices and codes have been established to minimise the effects that the insolvency of a financial institution may have on other institutions. In addition, the IMF has created a Contingent Credit Line facility as a precautionary defence for countries with strong economic policies. This facility has been designed to prevent the balance of payments problems that could arise from international financial contagion. South Africa has been actively involved in discussions on the new international financial architecture. We recently also participated in a Financial System Stability Assessment undertaken by the IMF and the World Bank. The report on South Africa has not been published, but found that the South African financial system is robust and that the financial sector’s legal framework is impressive. The assessment was further that South Africa is in broad compliance with recognised best practice in the fields of security, insurance and banking regulation and that we are making substantial efforts to ensure transparency. Despite this favourable assessment, we must nevertheless continue to strive for sufficiently accountable, transparent and effective cooperation between the various agencies for the smooth running of South Africa’s financial markets. This should instil public confidence in the financial system. The Banks Act and the regulations governing the activities of the banks have been amended to bring them into line with international developments. In addition, the Reserve Bank has established a Financial Stability Unit (FSU) to focus on the overall stability of the financial sector and its preparedness for global competition. One of the functions of the FSU is to keep abreast of international developments as far as stability issues are concerned. The unit should ensure that the South African financial system remains resilient in an environment of global competition. It has also been created to ensure effective cooperation with the Financial Services Board. The Reserve Bank’s Financial Stability Unit will continuously assess developments in the domestic financial system to ensure that we obtain early warnings of any signs of a potential crisis. The FSU will also investigate the overall design of the financial regulatory regime, with special emphasis on aspects of regulation that are difficult to implement. Its aim will be to strengthen structures, ensure better management of risk in financial institutions and improve corporate governance. The work of the unit will cut across a number of other areas, including the need for improved disclosure and how to foster more effective cooperation among players in the financial system. The establishment of the Financial Stability Unit further demonstrates that South Africa is increasingly being equipped to become an international financial centre. A large part of the unit’s work since its establishment has consisted mostly of information gathering and follow-up work arising from the agenda of the Financial Stability Forum of the Group of Seven industrial countries. The Financial Stability Forum aims to bring together the regulators from the Group of Seven countries to exchange ideas on how to achieve greater soundness in financial systems. It has produced guidelines on deposit insurance and key standards for sound financial systems, as well as on implementing these guidelines and standards. Although South Africa is not a member of the G7, representatives of our country have participated in meetings of the Forum’s working groups. 4. Globalisation and monetary policy Globalisation and increased competitiveness have also created additional challenges for monetary policy. The internationalisation of investment decisions has made South Africa more prone to volatile capital movements. This was clearly illustrated by the behaviour of portfolio investments by nonresidents in recent years. For example, the net purchases of South African bonds by non-residents amounted to R16 billion in the first four months of 1998. This was followed by a reduction in their holdings of R26 billion in the last eight months of 1998. From the beginning of 1999 until the end of January 2000 they again became net investors in South African bonds to the amount of R16.5 billion. Subsequently, from February to August, they again sold domestic bonds on a net basis totalling R12.5 billion. In seeking to ensure stability in the overall balance of payments position of South Africa, volatile capital movements are making it imperative for South Africa to reduce inflation. The pursuit of price stability and the success achieved by many countries in bringing their inflation rates down to low levels have left South Africa with no other alternative than to bring our inflation in step with that of the rest of the world and to keep it there. If this is not achieved in the coming years, market adjustments will take place to compensate for the inflation differential. Such adjustments could include large disruptive capital outflows, a depreciation in the external value of the rand and high interest rates. The thrust of monetary policy in the new globalised financial environment must therefore be the pursuance of price stability. Fortunately the Reserve Bank has already chosen to follow this course and success in bringing inflation down is within our grasp. Unfortunately such a policy stance does not provide unconditional protection against speculative capital outflows. The decisions of international investors are based on international interest rates, exchange rates and such factors as political stability. These factors are beyond the control of the central bank. The only approach that the Reserve Bank can follow is to do its important bit for stability, growth and employment creation, and that means establishing and maintaining financial stability. However, the way in which this objective is pursued, is in the hands of the Reserve Bank. Recently an inflation-targeting monetary policy framework was adopted for this purpose. Inflation targeting has been used in many other countries with great success. With the adoption of this approach to monetary policy in South Africa, the authorities attempted to create greater certainty about what monetary policy wants to achieve. No one is left in the dark any longer. Everyone should know by now that the Reserve Bank’s ultimate objective is an annual average inflation target range of 3 to 6% for the year 2002. This new framework has helped to focus monetary policy, has promoted transparency and has led to a clearer public accountability of the Reserve Bank. Globalisation and increased international competition have made it important for the Reserve Bank to adopt inflation targeting as its policy approach. International capital flows and liberalised financial markets obscure the relationship between money supply, interest rates and inflation. In an integrated world economy the money supply becomes a less reliable anchor for monetary policy, forcing the authorities to take a different approach. A fixed exchange rate system would also be a difficult monetary policy framework to pursue in a world experiencing large and volatile capital movements. This was clear from the developments in Mexico during the tequila crisis and in Thailand, Malaysia and Indonesia during 1998 when large amounts of capital were withdrawn from emerging-market economies. However, some countries, such as Hong Kong and Argentina, have applied a system of fixed exchange rates with some success, while maintaining price stability. Their success was due to consistent monetary policies and well-regulated financial systems. Flexible exchange rate regimes nevertheless seem to shelter countries more effectively from the exogenous shocks that are typical of greater economic integration. Trying to maintain an exchange rate target may be costly in terms of less activity in the domestic economy. In an inflation-targeting framework, exchange rates are generally allowed to reflect the supply of and demand for currency in foreign exchange markets. By allowing the exchange rate to be flexible, interest rates become more stable and reversals in international capital flows do not disrupt domestic economic activity as much. This does not mean that large exchange rate changes do not have serious effects on production. Naturally they have a direct impact on the country’s international economic activity. Depending on the importance of the external sector they could also have a serious impact on domestic production growth, job creation and inflation. However, large changes in interest rates generally have a larger impact on domestic activity than exchange rate adjustments. The art of central banking is to make these essential adjustments to the economy with the least harm to domestic economic activity and job creation. 5. Conclusion Globalisation and greater competition pose interesting challenges on a micro and macro level for enterprises and the public authorities. Financial institutions and markets need to make many adjustments to cope with this changed environment. Similarly, public authorities face new problems without easy answers. These issues have led to a considerable effort by international organisations to improve the world’s financial architecture. At the same time, national public authorities had to apply their minds to the policy approaches that the integrated world economy require. Financial institutions, financial markets and the monetary authorities in South Africa have adapted in a flexible and wellconsidered manner to changes in the world economy. We seem to have made the correct changes under the circumstances, and these changes should contribute to sustainable high economic growth and job creation in the medium to long term. | south african reserve bank | 2,000 | 10 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Diplomatic Forum, Rand Afrikaans University, Johannesburg, on 25 October 2000. | T T Mboweni: South Africa’s integration into the global economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Diplomatic Forum, Rand Afrikaans University, Johannesburg, on 25 October 2000. * * * “Globalisation refers to an evolving pattern of cross-border activities of firms, involving international investment, trade and collaboration for the purposes of product development, production and sourcing, and marketing. It is driven by firm strategies to exploit competitive advantages internationally, use favourable local inputs and infrastructure, and locate in final markets. These strategies are shaped by declining communication and transport costs, and rising R&D costs; macroeconomic trends and exchange rate fluctuations; and liberalisation of trade, investment and capital movements”. OECD Jobs Study. Facts, Analysis, Strategies. 1994. 1. Introduction Globalisation is not a new phenomenon. There have been many periods of global economic integration, followed by periods of backlash. Despite these occasional disruptions, the degree of economic integration in the world has been rising over time. Especially since the Second World War, the pace of economic integration has become more rapid. Technological progress has improved transportation and communications, enhanced information awareness and information processing, and has set the stage for new products and innovations. These developments make it much easier for national markets to be globally integrated. Although these markets still do not form a global village, they have become so interdependent that they are changing the environment in which economic activity takes place. This new economic environment has, however, also brought about certain disadvantages, such as the large reversals in international capital flows and resulting economic crises in many countries. Towards the end of last year, these crises led to protests against free trade and “global capitalism”. Demonstrations were particularly strong in the City of London and at the World Trade Organisation round of negotiations in Seattle. More recently the meetings of the IMF and World Bank in Washington and Prague during April and September 2000 were also the focus of protests against globalisation and the debt burden of some developing countries. Despite these demonstrations, global economic integration today is greater than it has ever been and is likely to become even stronger in the coming years. 2. Consequences and lessons of globalisation New technologies will continue to make the world a smaller place. The linkages between stock exchanges in many countries increased significantly in the 1990s. Recent empirical evidence shows that due to the elimination of obstacles to free trade, greater financial market integration has led to greater market efficiency and better risk-and-return combinations for investors. There has been a sharp increase in the weight of foreign assets in the portfolios of some agents, as well as the correlation between the relevant stock indices and the ability of each market return to explain the behaviour of returns in other markets. The disadvantage of the greater integration of financial markets is that it reduces the ability of domestically focused policies to deal with the problems arising in the respective domestic financial markets. South African share prices are increasingly influenced by the views of international investors. Developments in London, New York, Frankfurt and Tokyo often have a greater influence on domestic share prices than actual developments in South Africa. South Africa has seen major swings in foreign exchange flows, interest and exchange rates in recent years. Under these circumstances, errors of judgement may be easily made with domestic macroeconomic policy that could have a detrimental effect on aggregate domestic economic activity in South Africa. It can be said that the greater the level of integration of the global market, the greater the need for worldwide supervision. One of the important questions in this regard is whether such worldwide supervision should be provided by a single international supervisor or by a closely linked group of supervisors. South Africa’s sophisticated financial system compares favourably with those of most industrialised countries and surpasses those of many emerging-market countries. Although great strides have been made in recent years with global and regional integration, the process of financial integration has had a few setbacks. South Africa has experienced the contagion effects of periodic emerging markets crisis that forced painful adjustments. The Mexican crisis, and more recently the Asian crisis, were unlike any seen before and spread quickly around the world. They quickly took on systemic proportions and could only be addressed through the immediate mobilisation of substantial international effort. The Asian crisis in 1997 and 1998 was characterised by three important factors. Firstly there were macroeconomic imbalances, along with massive outflows of short-term capital. Secondly there was an acute crisis in the financial sector, reflecting institutional and banking practice weaknesses. Thirdly an economic management model was applied which was not in keeping with the new demands of a globalised economy. Before massive financial assistance could be considered for these countries, a set of measures or rules was required that would lead to greater transparency, better management and anti-corruption efforts. Furthermore, the relationship among corporations, banks and governments needed immediate fundamental changes. Some analysts believe that the Asian crisis did not stem from so-called “crony capitalism” but from economic liberalisation. They postulate that a flood of speculative capital first caused a real-estate bubble, which affected the rest of the economies when the bubble burst. The problem therefore was not a lack of openness but too much of it, too soon. They also suggest that as capital rushed out of Asia, countries like Taiwan and others still had sound fundamentals - budget surpluses, low inflation, high savings rates. Some critics also maintain that the IMF’s actions made a bad situation worse. Draconian prescriptions, such as bank closures, budget cuts, higher interest rates and structural reforms intended to root out everything wrong with the Asian approach to the economic policy, had an excessive deflationary effect. Whether the IMF’s actions were entirely appropriate in all instances during the Asian crisis is a matter for another day, but the important characteristic distinguishing the Asian crisis from other crises was the prominence of private financial institutions and other private enterprises as both creditors and debtors. As Michel Camdessus, former Managing Director of the IMF, pointed out, a number of trends in the integration of capital markets stand out. These trends make the process more complex, and include the following: The domestic private sector is playing a far more important role in the economy of most countries. Domestic financial and capital markets have sprung up in Beijing and Moscow and a host of other cities in the developing world. The foreign investment community is far more diverse, comprising direct investors, portfolio investors, banks and bondholders. The different types of investment have responded to globalisation in different ways and even during crisis periods flows of direct investment have in many instances not fallen steeply. It is too simple to conceive of nations as belonging to either the debtor or creditor group. There are powerful flows in many directions. The largest source of direct foreign investment in Asia is, for example, Asia itself. Korea, Hong Kong, Thailand and Japan are all important sources of foreign investment within the region, and remain so even though some were at the heart of the Asian crises. Globalisation accelerates and spreads the international consequences of domestic policies. No country can escape the consequences of globalisation, and all countries are being called upon to ensure “rigour and transparency in overall economic management; banking and financial sector soundness; reform of the institutions of the state in terms of seeking public sector efficiency, appropriate regulation, emphasis on the rule of law, independence of the judiciary (and the central banks), anti-corruption measures, etc.; and growth that is centered on human development”. Whether a country is large or small, a financial crisis can become systemic through contagion on the globalised markets. The domestic economic policies of the major industrialised countries have in recent years increasingly taken into account their potential worldwide impact. This duty of universal responsibility is also becoming important for all countries, large and small. As globalisation progresses, all countries take a measure of responsibility for the stability of the international financial system and the quality of world growth. This adds commitment and responsibility that are required of every government in the management of their economies. Globalisation also concerns the worldwide integration of financial markets. Therefore active participation in this integration process implies that monetary and fiscal policies have to be subjected to the disciplines of the international market. Globalisation mercilessly exposes the shortcomings in national economic policies in countries that do not apply the universal “laws” for prudent macroeconomic management. The process of globalisation accentuates the pressure for change and for greater coordination and harmonisation of economic policies. The World Bank, IMF, OECD and other international organisations are encouraging countries to discover what the consequences are of the circular relationship between the integrity of monetary and financial management, high-quality growth, and poverty reduction. Without poverty reduction, the first two have little chance of enduring, and without the first two, any efforts to reduce poverty will take longer and be less successful. 3. South Africa’s re-entry into the global economy Since 1994 South Africa has introduced major changes to domestic political, social and economic structures. After years of apartheid-induced isolation from the global economy, countries lifted sanctions and companies ceased disinvesting from South Africa. Profitable opportunities were opened up for South Africa to reintegrate its economy into the global economy. South Africa’s integration into the global economy had important implications for the South African banking sector. The official policy has been to open up the South African banking sector to foreign participation, and to expose South African banking institutions to foreign competition. As a result of this policy, 15 foreign banks have registered branches in South Africa and 60 foreign banks do business in the country through representative offices. The South African banking sector remains sound and well-managed. Some mergers are taking place in line with world trends, and the 35 domestic banks are rationalising their activities to face the challenges of globalisation. The four big banks in South Africa have assets of over R500 billion. The registered banks in our country have an aggregate balance sheet of some R772 billion as at the end of August 2000 with capital and reserves of R71,4 billion. The South African Reserve Bank is responsible for bank regulation and supervision which is based entirely on the recommendations of the Basel Committee. Regulation and supervision concentrates on the management of risk exposures within each banking institution. Exchange controls were relaxed by removing all restrictions on current account transactions, and on the inward and outward transfer of funds by non-residents, and then by gradually enabling residents to invest specific amounts of capital outside the country. As a step along the indicated path of systematically abolishing exchange controls, all such controls over non-residents were abolished in March 1995 when the dual exchange rate system was terminated. The result was that the financial rand disappeared and the proceeds of local sales of non-resident-owned South African assets were regarded as freely transferable from the Republic and could also be freely used in the Republic for any other purpose. In March 1997, the Minister of Finance also announced that individuals who are tax-payers in good standing would be allowed to invest a specified amount of their savings in any manner abroad and in fixed property in SADC countries. Alternatively, they would be allowed to hold foreign currency deposits, up to a defined limit, with South African authorised foreign-exchange dealers or with foreign banks outside South Africa. In February 1999 the Minister also increased the amount that South African corporates investing abroad could remit from South Africa from up to R30 million per new investment project in foreign countries and R50 million in SADC to R50 million and R250 million respectively. The large capital inflows over the past few years have enabled the Reserve Bank to increase the country’s official foreign reserves from the equivalent of 6½ weeks’ worth of imports of goods and services at the end of 1994 to 14½ weeks’ worth at the end of June 2000. The increase in the country’s official foreign reserves in recent years also made it possible to substantially relax exchange controls over the period. Government took the lead in reintroducing South Africa gradually to the global markets for public loan issues. A number of issues were made in the global and Yankee US dollar markets, in Sterling, Deutsche Mark and in the Samurai Yen market. South African private corporates were also encouraged to raise funds through equity and bond issues in international capital markets, and were allowed to use part of the proceeds from such issues for financing the expansion of their activities in the rest of the world. South African institutional investors, such as insurers and pension funds, were allowed to exchange part of their rand-denominated portfolios for foreign-currency denominated assets through swap transactions entered into with foreign counterparts. In accordance with the principle of relaxing exchange controls, permission was granted in June 1995 to South African institutional investors (long-term insurers, pension funds and unit trusts) to exchange, through approved asset swap transactions, part of their South African portfolio for foreign securities. In March 1997 it was announced that institutions that qualified for asset swaps would be broadened to include regulated fund managers registered with the Financial Services Board. With effect from July 1997, portfolio managers registered with the Financial Services Board as well as stockbroking firms which are members of either the Johannesburg Stock Exchange, the Bond Exchange of South Africa or the South African Futures Exchange, could also apply to acquire foreign portfolio investments by way of asset swaps. Integration into the world financial markets required a major restructuring of the institutional arrangements in the South African capital markets. The Johannesburg Stock Exchange (JSE) introduced changes to provide for corporate ownership, foreign ownership of stockbrokerage firms, dual capacity trading, negotiated commissions, and electronic screen trading. The JSE is continuing to improve its facilities by providing for the immobilisation and dematerialisation of shares, and for improved clearing and settlement arrangements. The total value of shares traded on the JSE increased from R63 billion in 1995 to R448 billion in 1999. The most spectacular increase in volumes over the past few years took place in the Bond Exchange of South Africa. Total turnover in this market increased from R2 trillion in 1995 to R8,8 trillion in 1999. The relaxation of South African exchange controls made an important contribution to the development of the Bond Exchange and transactions by non-residents in this market have increased significantly. The adjustments that have occurred in the South African economy, and on South African monetary policies during the past few years, were necessary and timely. These adjustments were needed to restore and maintain overall economic equilibrium. South Africa has increasingly developed robust financial, economic and foreign exchange markets. This latter market is growing rapidly and its daily average turnover now exceeds $9 billion. Another interesting development following the globalisation process is the emergence of a Euro-rand market. The outstanding nominal amount of rand-denominated loans raised in this market by South African and non-South African borrowers from non-South African investors, is now almost R202 billion. A part of these loan issues is usually hedged by investing in South African bonds. 4. Globalisation and monetary policy The reintegration of South Africa into the world economy and the liberalisation of financial markets also have important implications for monetary policy. As Bill McDonough, President of the Federal Reserve Bank, pointed out in 1998: “The technology for processing information and making this information widely available has fundamentally altered the way the world channels saving into investment. No longer does the global economy rely primarily on loans from commercial banks to meet its financing and investment needs. Rather, more than even before, the global economy of today looks to funds from the fixed-income and related capital markets to intermediate its credit needs. Because the global capital markets have become so important in the credit intermediation process, the economic well-being of us all depends on the orderly flow of funds in these markets. The flow of these funds, in turn, increasingly relies on price signals generated by trading activity that takes place daily in these markets. The reliance on secondary market trading for price discovery constitutes the fundamental difference between funds from securities markets and loans from banks”. This change in the way that savings are channelled to investments has resulted in greater volatility in international capital movements. Recent non-resident transactions on our Bond Exchange are a clear reflection of this greater volatility in international capital flows. In such a situation, it is more important than ever before to create and maintain a sound environment for foreign investment in a country. This makes it more imperative for monetary policy to pursue clearly stated objectives. Increasingly throughout the world, central banks are pursuing price stability as their basic policy focus. Where countries have high rates of inflation which are out of line with the rest of the world, disruptive capital flows could occur because of fears of currency misalignments. The closer integration of the world economy has therefore focused the ultimate objective of monetary policy and made it even more important to attain this objective. It should, however, also be realised that such a policy stance does not provide unconditional protection against speculative capital outflows. External economic shocks or perceived poor policy measures can still trigger a reversal in capital movements. Monetary policy cannot prevent these reversals. International investors make their decisions on the basis of a wide variety of developments, including price stability. The best approach that central banks can follow is to pursue financial stability in a transparent and accountable manner so that they can at least forestall any uncertainties in this regard. Although the objective of monetary policy has been better focussed within the context of globalisation, the integrated world economy has resulted in a more complex mechanism for transmitting monetary policy. The relationship between changes in interest rates, money supply and inflation has become less clear under these new conditions, compared with the period when South Africa was more isolated from external influences. As a result of large international capital flows, the effects of policy changes are being transmitted to a greater extent through critical indicators such as bond yields and exchange rates. There are of course longer time lags between policy changes and their desired impact on the real economy. These changes in the transmission mechanism of monetary policy have reduced the credibility of the money supply as an intermediate guideline for policy. The integration of financial markets and financial innovations made the demand-for-money function less stable. This was clearly reflected in a consistent decline in the income velocity of circulation of M3 money of nearly 15 per cent from the end of 1994 to the end of 1999. The money supply accordingly became a less reliable anchor for monetary policy. Volatile capital movements further complicate the transmission mechanism under floating exchange rates, because of the impact that exchange rate changes have on the foreign transactions of a country. In a closed economy, the transmission mechanism runs from increases in the repo rate and other short-term interest rates through to longer-term interest rates and asset prices and then to aggregate demand and prices. The open economy version of the transmission mechanism under floating exchange rates runs from interest rates, to nominal exchange rates, to the absolute and relative prices of tradeable goods and eventually to the prices of non-tradeable goods. In view of this more complicated transmission mechanism in a reintegrated global economy, the Reserve Bank has had to reconsider the framework that it applied in pursuing price stability. Informal inflation targeting using intermediate money supply guidelines was obviously no longer suitable in the changed international environment. From the beginning of this year, the authorities therefore decided to adopt inflation targeting as the formal monetary policy framework of the South African Reserve Bank. This framework should focus monetary policy, increase transparency and lead to a clearer accountability of the Reserve Bank. Such a framework also allows for exchange rate flexibility. Exchange rates should essentially be determined by the supply of and demand for currency in foreign exchange markets. 5. Conclusion The Reserve Bank’s approach to globalisation has been to adapt our framework as well as the banking structure of the country to comply with the international best practice as understood by international investors and regulators. This approach recognises the important contribution that these investors can make to real economic growth, development and employment creation in South Africa. I remain optimistic about the benefits our country will derive from engaging in the financial globalisation process and the constructive role that monetary policy will play in this process by ensuring financial stability. What we are seeing in many countries, is an improvement in governance, and the establishment of transparent, arm’s length relationships among governments, corporations and financial institutions, that are typical of mature markets. We are also witnessing the global acceptance by political leaders of the independence of central banks as a critical factor for credible monetary policy. I actually have a nice quote from Prime Minister Lionel Jospin of France. He says that: “Independence signifies ignoring pressures, whatever its source. The independence of central banks goes ... beyond independence from political, executive and legislative power. For me it also equates with independence from private or collective economic interests, autonomy versus the short-term, frequently imposed by capital markets and, finally, freedom of action vis-à-vis the monetary policy of other central banks”. There are greater responsibilities on all sides. Just as the public sector is being called upon to change and improve codes of good practice, so too the private sector has to follow suit by complying with these international norms and codes of good practice. Thank you very much. | south african reserve bank | 2,000 | 10 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the business conference of the Bureau for Economic Research, held in Stellenbosch on 17 November 2000. | T T Mboweni: Economic growth, inflation and monetary policy in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the business conference of the Bureau for Economic Research, held in Stellenbosch on 17 November 2000. * 1. * * Introduction It should by now be well-known that the mission of the South African Reserve Bank is to achieve and maintain stable financial conditions in our country. This objective is spelled out in both the Constitution of the Republic and in the South African Reserve Bank Act. In these acts it is recognised that only by protecting the value of the currency can balanced and sustainable economic growth be achieved. It is believed in the Bank, and indeed in most countries of the world, that the potential for economic growth and creating job opportunities can only be fulfilled under stable financial conditions. By achieving this primary objective the Reserve Bank will make its contribution to sustainable higher economic growth in South Africa. Some economists and other commentators on monetary policy in South Africa seem to think that the Reserve Bank is applying an over-zealous monetary policy stance to achieve its primary objective of price stability. They argue that the Bank is obsessed with inflation at the expense of economic growth and job creation. At the current level of the inflation rate, this implies that an inflation rate of 8% is too low to be treated as a serious concern. The Bank should therefore provide more liquidity to the money market, allow the interest rate on repurchase transactions to fall and in this way encourage the economy to grow more rapidly. In the Bank we believe that it would be a big mistake to shift the goal of monetary policy away from controlling inflation to promoting economic growth. 2. The determinants of economic growth Economic growth is basically determined by three factors, namely: (i) the quantity of capital and labour available in a country; (ii) the quality of capital and labour; and (iii) the ingenuity of people in combining the available production resources in the creation of goods and services. Output will rise if more production resources are put to work, or where a given supply of labour and capital is utilised more productively. Nowhere does the aggregate stock of money or the aggregate price level form part of the determinants of any production model for sustained long-term economic growth. Government policies, including monetary policy, affect the growth of domestic output to the extent that they affect the quantity and productivity of capital and labour. For example, government policies that restrict commercial activities for fear that these activities may cause undue environmental or ecological damage, raise the cost of doing business and make firms less productive. Obviously there may be good reasons to have such policies, but they can harm productive activity and economic growth. Monetary policy is only one element of overall macroeconomic policy, and can only affect the production process through its impact on interest rates. There are two main channels of monetary policy. One is through the effect that interest rate changes have on the exchange rate of a currency, and the other is through the effect that interest rate changes have on demand. Therefore monetary policy has an impact on economic activity and growth through the workings of foreign and domestic markets for goods and services. Economic growth involves the allocation of production factors to productive use and this allocation of resources takes place in markets. In a modern economic system, markets for goods and services, and for production factors, function more efficiently because of the existence of money as a medium of exchange. Without such a medium of exchange, barter trade would take place and most modern market arrangements would simply cease to exist. Money allows markets to allocate economic resources to sectors of economic activity in a highly efficient and cost-effective way. In a market economy, exchange values are expressed in terms of money prices which are determined by the forces of supply and demand. When a good or service is in short supply, or when demand increases relative to the supply of a good or service, the price will rise. This signals to suppliers that they must shift resources in response to the change in relative prices, or to buyers that they must economise on their purchases. The productive allocation of resources needs clear signals about relative price changes. This is where monetary policy really comes into the picture. Sound monetary policy makes price signals clearer. In an environment of overall price stability, it is much easier to detect changes in relative prices. Bad monetary policy clouds the picture. When prices are always in a state of flux, it is hard to make out whether a particular price change is signalling a change in relative scarcity or whether it is simply part of an inflationary process where all prices keep on rising. The uncertainties that inflation creates make the problem worse. The mere possibility of inflation creates uncertainty about the true meaning of changes in the prices of individual goods and services. This uncertainty could lead to the misallocation of resources, which would reduce economic growth. This problem is nowhere more serious than in the capital market. Inflation uncertainty raises the risk premium that investors require and increases the cost of capital, thus lowering fixed capital formation. Lower investment means lower future growth and less future income. If producers and consumers feel confident that the average price level will remain stable, they can be more certain that price changes indicate true shifts in demand and supply. Obviously a monetary policy that maintains price stability can improve the efficient functioning of markets. This promotes the full and productive employment of resources. As Alan Greenspan once stated, a monetary policy that prevents inflation from being a factor in the decision making of businesses and consumers, is a monetary policy that best promotes economic growth. Empirical evidence shows that high inflation has a negative correlation with economic growth. In countries where inflation is high, economic growth is normally low. Many economists are therefore convinced that inflation is undesirable and should be avoided at all costs. Recent economic research has cast some doubt on this argument. In principle, there is likely to be a reversal somewhere in the inverse relationship between inflation and growth as there are no grounds for believing that continuously declining prices, i.e. deflation, are good for growth. Stanley Fischer of the International Monetary Fund (IMF) found that the inverse relationship would hold, even at low rates of inflation. Another study by Barro confirmed this inverse relationship, but found that it was relatively weak. Increasing inflation by 1% led to only a small reduction of less than 0.03% in growth, according to Barro. A range of other studies found no effects from inflation on growth. Sarel, a researcher at the IMF, came to the conclusion that: “When inflation is low, it has no significant negative effect on economic growth: the effect may even be positive. But when inflation is high, it has a powerful negative effect on growth. The structural break is estimated to occur where the average annual rate of inflation is 8%.” Despite this uncertainty about the negative correlation between inflation and growth at inflation rates below 8%, there is still no evidence of a positive correlation between inflation and growth over any long period of time. In any case, if the inflation rate is close to 8%, it still seems wise to follow a policy countering a general increase in prices, because it could easily move to levels above 8% and accelerate further. In South Africa the 1970s were a decade of high inflation compared with the 1960s. Inflation had averaged 2.6% per year between 1960 and 1970. In 1974 inflation moved to higher than 10% and averaged 10.2% per year from 1970 to 1980. If inflation was good for growth, one would have expected faster growth in the 1970s than in the 1960s. This did not happen. Quite the contrary happened. Economic growth slowed down from 5.7% per year in the 1960s to 3.4% in the 1970s. There were broadly similar slowdowns in growth and accelerations in inflation in other parts of the world during the 1970s. In the 1980s inflation in South Africa accelerated to 14.6% per year, and growth fell back further to 1.5%. By contrast, most of the advanced countries brought inflation under control and their economic performance generally started to improve. A striking example is the United States, which now seems to be cruising along a path of strong and sustained economic growth with low inflation. In South Africa inflation slowed down to about 7½% between 1993 and 1999. Although there were many other factors conducive to higher economic growth over this period, it seems to be more than pure coincidence that the growth in domestic production averaged 2½% per year. 3. Other major disadvantages of inflation Apart from the negative impact that inflation has on growth and wealth creation, inflation also affects income distribution and worsens inequality in a number of ways. Inflation can have a direct impact on income distribution where wage increases are below the inflation rate or where marginal tax rates are not adjusted to take account of nominal adjustments in wages. Inflation can indirectly also affect income distribution by slowing output growth and hence job opportunities. What is more, the rich can invest their surplus income in assets such as real estate and tradeable securities, and in many instances benefit from non-taxed inflation-induced capital gains. The poor are usually not able to do this and may see their saving at banks being whittled away by high inflation. A perhaps even more important argument against an artificial stimulation of the economy through the creation of money, lower interest rates and higher inflation, is that in a globalised economic environment this may lead to the withdrawal of foreign capital. If non-residents start expecting a depreciation in a country’s currency, they will probably immediately react by withdrawing the funds that they have invested in such a country. Foreign investors can do this easily now that world financial markets are better integrated. If large amounts of capital are withdrawn this could even lead to an exchange rate crisis with a sharp rise in inflation. Inflation has many other disadvantages which, all in all, can only lead to the conclusion that the central bank must always carefully monitor economic developments to maintain price and financial stability. No country can afford to move out of line with the inflation rates in the rest of the world. 4. Monetary policy and business cycles If it is so obvious that excessive money creation does not contribute to sustained economic growth, why do we hear from supposedly well-informed opinion makers that monetary policy is too tight and that it is putting a lid on real economic growth? My considered view is that some of these commentators often expect more from monetary policy than it can deliver. They tend to confuse short-term accelerations in output growth with long-term sustainable economic growth. This confusion arises because monetary policy affects aggregate domestic spending, and under certain circumstances a rise in spending can push output higher. Such an increase in output will show up in growth in the short run that will be higher than the potential growth rate of the economy. Such a short-term growth acceleration can be attained when there is an under-utilisation of resources. If there is a great deal of slack in the economy, then increased spending can raise the level of output. However, both the level and the growth rate of production are limited by the supply and quality of productive resources. If the employable resources are of poor quality, then output cannot increase unless there is a strong increase in the productivity of the resources already being used. At full utilisation of productive capacity, and here one recognises that in our modern technology-driven economy some resources are simply not employable in the short run, higher spending will lead to higher prices but no increase in output. Under some circumstances, faster monetary growth and lower interest rates can increase demand. This in turn can lead to higher sales and output with little change in prices. Under slightly different conditions, increased demand leads to inflation with little or no boost in output. The impact that a change in monetary policy will have on spending and production is uncertain at best. Determining whether such a change would affect production instead of inflation will depend to a large extent on the stage of the business cycle. Everyone involved in economic analysis will immediately agree that it is extremely difficult to determine the business cycle stance. The Reserve Bank compiles business cycle indicators for this purpose, but usually it is only possible to determine where the economy is in the business cycle a long time after the event because there is a delay in the compilation of statistics. Moreover, clear trends are needed in information before deductions can be made about turning points in the business cycle. Even if we were able to determine accurately the business cycle stance and the extent that the production capacity of the economy is being used, it is still doubtful that monetary policy would be useful in active business-cycle management. Changes in monetary policy instruments have a long and variable lag before they have an effect on economic conditions. These lags and the fact that their length could change over time prevent any effective fine-tuning of real economic activity. To be effective, changes in monetary policy would require a forecast of the business cycle stance in the next 18 to 24 months. If it is difficult to determine the current business cycle stance, one can safely assume that it is even more difficult, if not impossible, to forecast accurately whether there will be surplus production capacity or excessive demand conditions in the economy in two years’ time. Monetary policy affects prices not only through the impact of changes in the money stock on aggregate demand, but also through inflation expectations. A major advantage of a medium to longer-term monetary policy approach is the credibility that it gives to the actions of the monetary authorities. By operating over a longer time frame, it creates a basis for its own success because of its effects on inflation expectations. The active business-cycle management of monetary policy is usually less credible. 5. Monetary policy and inflation So far I have indicated that low inflation can make a significant contribution to growth and prosperity through its effects on resource allocation in a market-based economic system. This conclusion does not mean much if monetary policy cannot achieve and maintain low inflation. Fortunately, evidence and opinion largely agree on this issue. One of the few topics that macroeconomists generally agree on is that inflation is first and foremost a monetary phenomenon. Inflation results from a long-term expansion of the money supply which is greater than the economy’s ability to increase the production of goods and services. Furthermore, there is widespread agreement that the supply of money is determined in the long run by central banks. Thus, the South African Reserve Bank can regulate its own balance sheet and the growth in the money supply, achieve low inflation and maintain it. In fact, the Bank is expected to do just that. An important indicator that the Reserve Bank should have available in pursuing the objective of price stability is estimates of the stock of money supply over time. To this end, the Bank’s Research Department meticulously consolidates the balance sheets of banks at the end of each month. The consolidated deposit liabilities of the banks, along with the value of notes and coin in circulation, are summarised in the monetary aggregates labelled M1A, M1, M2 and M3. In the past, the change in the broad monetary aggregate M3, relative to a pre-announced desired or guideline rate of change, was used for policy making. This approach to monetary policy making was based on the assumption that there was a fairly stable short-run relationship between changes in M3 and changes in nominal aggregate spending. Unfortunately this relationship became less reliable over time. As a result the Reserve Bank started to monitor a wider variety of economic indicators and, from the beginning of this year, shifted to formal inflation targeting. At present, monetary policy decisions are anchored directly to the achievement of a specified average inflation rate of between 3 and 6% in 2002. It is important to note that monetary policy decision making is not an exact science, and possibly never will be, even with the most accurate macroeconomic measurements imaginable. This is why the Bank cannot base a policy decision on the deviation of a rather uncertain inflation forecast from a targeted future rate. But neither can policy decisions be a matter of sweeping, broad impressions based upon anecdotal evidence and partial information. What the members of the Monetary Policy Committee of the Bank do is to make the best professionally informed analysis they can of all the sources of information at their disposal, relating to every important market in the economy. Then they constantly review and modify their judgements, in the light of new information as it becomes available. Policy decisions are highly complex and the Monetary Policy Committee does not take them lightly. Decisions are definitely not two-dimensional and take far more factors into consideration than an inflation and growth perspective. The committee uses a vast array of official economic statistics and financial market data, and all the publicly available and some private surveys and commentaries, to make a decision about the monetary policy stance. What is more, the Bank openly releases the facts as they are available to us, as well as the analyses made by the Monetary Policy Committee and by the research staff, regularly through the statements of the committee and in the publication of the Quarterly Bulletin and the Annual Economic Report. All policy decisions are nevertheless always taken with a view to achieving and maintaining financial stability. 6. Concluding remarks Some commentators have rather dated views that monetary policy decisions should be aimed at maximising economic growth in the short run. I believe that the primary role of monetary policy is to preserve the purchasing value of the rand by keeping inflation low. This is also the mandate given to the Bank. To achieve this mandate, a medium to long-term approach to monetary policy formulation is followed in the form of inflation targets. Such a well-defined objective of monetary policy provides a clear understanding of the objective of monetary policy so that our economy can operate efficiently. This will promote a return to full employment and strong economic growth. Price stability is an essential ingredient in the recipe for maximum sustainable economic growth, and it is the only contribution that monetary policy can make. There is no more important task for the South African Reserve Bank than pursuing a policy aimed at preserving the value of the rand. | south african reserve bank | 2,000 | 11 |
Address by Mr. T.T. Mboweni, Governor of the South African Reserve Bank, at the Rotary Club of Pinelands, Cape Town, 23 February 2001 | T.T. Mboweni: Trends in economic growth Address by Mr. T.T. Mboweni, Governor of the South African Reserve Bank, at the Rotary Club of Pinelands, Cape Town, 23 February 2001. * * * Introduction Ladies and gentleman, it is indeed a great honour and a privilege to be invited here to speak at this special induction meeting. I thank you for seeing fit to elect me as an Honorary Member of the Rotary Club of Pinelands. The topic I have chosen to talk about this evening is economic growth. It is a subject that affects us all, as citizens of South Africa, and it is something in which we all share; something from which we all reap the benefits. I have noted during my recent international visits (to the US, London and Davos), that many people have become focused on South Africa's low growth rate. Over the past 40 years, the country's economic growth has declined from an average rate of 5 per cent per year in the 10 years immediately prior to the first oil crisis of 1973 to just over half of that in the latter years of the 1990s; not nearly enough to create and sustain the levels of employment we would like to see. Economic growth since 1963 Between 1963 and 1973 growth in real GDP came to 5,0 per cent on average, and a large degree of financial stability and low inflation prevailed. The manufacturing sector expanded production, on average, by a solid 8 per cent per year over the period, although much of this was a result of the import replacement policies and protectionist measures in force at the time. The services industry was also expanding strongly at an average rate of 5,5 per cent per annum. Non-gold mining output expanded at a vibrant arithmetic mean rate of 7 per cent per annum while the gold mining sector reaped the benefits of new mine developments up to 1970 and a higher gold price thereafter. From the expenditure side, all domestic expenditure components recorded strong growth during this period. Gross fixed capital formation was exceptionally strong, with a recorded average growth rate of 9 per cent per annum. The expansion of the capital stock was widespread and considerable attention was given to infrastructure spending. The supply side of the economy was also boosted by the immigration of a considerable number of entrepreneurial and highly skilled people. Education and training of the whole South African population unfortunately did not receive the required attention, which came back to haunt us later on. For the next 10 years, from 1973 to 1983, the country’s real GDP growth dwindled to 2,6 per cent per annum. In the early 1970s, the semi-fixed exchange rate system, which had been in force up to that time in most parts of the world, broke down, reducing the discipline imposed on policy makers. The first oil price shock together with a substantial increase in the gold price initiated an inflation spiral and financial conditions became less stable with inflation rising to double-digit levels from 1974. Growth in manufacturing slowed to 3,4 per cent per annum, as momentum could not be sustained given the more uncertain economic environment and the shortages of highly skilled people. Still, growth in the tertiary sectors remained relatively buoyant at 3,5 per cent per annum. Non-gold mining output expanded by 3,6 per cent per annum during this period, with coal performing well as the high price of crude oil lifted the prices of all energy-related minerals. Although gold production contracted as ore grades were reduced to prolong the lives of mines, gold mining profits remained robust because of the high gold price. The high gold price of 1979 and 1980 acted as a buffer and protected South Africa from the effects of the second oil crisis in 1979, ensuring record growth in 1980. However, this artificial boost did not last as the gold price declined from its $800 a fine ounce peak. Fixed capital formation remained positive during 1973-83, although its average growth rate slowed down appreciably to 2,8 per cent per annum. But final consumption expenditure by general government recorded the strongest growth rate amongst the expenditure components. During this period, its growth rate averaged 5,3 per cent per year. As South Africa became more isolated from the international arena, growth contracted. From 1983 to 1993 real GDP growth fell to a mere 1,0 per cent average per annum. Manufacturing grew at only 0,3 per cent per annum, and confidence was shaken as international pressure, sanctions and internal dissatisfaction mounted. Financial instability severely undermined the economy. Consumer price inflation peaked at 20,7 per cent in January 1986 and the prime overdraft rate rose from 14 per cent in 1983 to 25 per cent in 1984 before declining to 12 per cent at the end of 1986. The subdued gold price also impacted negatively on the economy. Only agriculture, which is an inherently volatile sector, managed to grow at a rate in excess of the 2,2 per cent per annum population growth rate. On the expenditure side, fixed capital formation fell by 3,2 per cent per annum. Household consumption growth declined while government consumption grew at an average rate of 2,9 per cent per annum and once again came to the fore as the strongest expenditure component. However, this implied a higher tax burden for the man in the street and large government dissaving, which could not be sustained. From 1993 to 1999 (and incidentally also from 1993 to the third quarter of 2000) real GDP growth accelerated once more to some 2,6 per cent per annum. Confidence started to return, not only as sanctions were abandoned but also especially as evidence accumulated that economic policies were going to be prudent, sustainable and transparent. The improved growth rate was achieved in spite of adverse external shocks such as the East Asian markets crisis, some 3 years ago, and the floods early last year. The strongest growth over this period was recorded in the services industries, which averaged 3,3 per cent per annum. Growth in the transport and communications industry was especially vibrant, amounting to approximately 7,2 per cent per annum. A relatively strong performance of this sector, driven by technology and tourism, is likely for many years to come. Viewed from the expenditure side, gross fixed capital formation picked up from extremely low levels, growing at a rate of 5,1 per cent per annum. Given the opening-up of the economy, reduced protection and the fact that it was highly concentrated in the private sector, this capital formation is likely to be economically productive and sustainable. The high rate of expansion in fixed capital formation was achieved in spite of the adverse shocks I have already mentioned. From 1993 to 1999 both exports and imports rose strongly as international integration proceeded. Foreign direct investment flows into South Africa have picked up somewhat since the late 1980s and early 1990s, but have not reached healthy levels. Foreign direct investment into South Africa has averaged around 1 per cent of GDP per year since 1994. Almost certainly, the planned privatisation over the next three years will help to boost this figure. While South Africa's depressed growth has become something of an overriding concern for many, we must not forget the sharp acceleration in growth recorded during the course of last year. Revised quarterly growth figures showed that the economy was more buoyant than had initially been forecasted by many economists and resulted in third quarter growth of 3,8 per cent, seasonally adjusted and annualised, when compared with the second quarter. Macro-economic fundamentals And we must not forget, too, the progress that has been made in shaping South Africa's macro-economic fundamentals to within internationally accepted standards. Economists, analysts and observers have long agreed, and I am sure that you will agree, on the successes that have been achieved over the past decade in sprucing up the country's macro-economic situation. Major economic restructuring, which was absolutely necessary in South Africa's case, often leads to a prolonged period of subdued economic activity. We have every reason to believe that the economic is now poised to maintain higher growth rates in future. Inflation Over the last 10 years, inflation has come down steadily from the double-digit figures of the 1980s and the early 1990s. From 1989 to 1992, consumer price inflation rates of some 14 to 15 per cent were recorded. The index then decelerated to single-digit rates from 1993, as the effects of the tight monetary policies of the preceding four years came to fruition. By the close of the millennium further progress had been made on the inflation front and in 1999 and 2000 the average consumer price inflation rate slowed down to a level of 5,2 per cent and 5,3 per cent per annum. CPIX, the CPI index excluding mortgage costs, is the measure targeted by the Reserve Bank in its inflation-fighting strategy and is closely monitored by the Bank. According to this policy, CPIX must fall to a rate between 6 and 3 per cent by the year 2002. CPIX inflation has proved sticky over the past year and averaged 6,9 per cent in 1999 and 7,7 per cent in 2000, mainly as a result of high international oil prices. The most recent data, released on Tuesday this week, indicates CPIX was at a level of 7,7 per cent in January 2001. Most analysts B and the Reserve Bank B expect CPIX to slow down further over the course of the year, given the prudent monetary and fiscal policies that have now been put in place. Incidentally, while CPIX data is not officially available before 1997, the Reserve Bank estimates that CPIX inflation would have peaked at between 17 and 18 per cent in 1991 and 1992 - a full 10 per centage points higher than where it now stands. Current account of the balance of payments Progress on the current account of the balance of payments has also been evident over the past decade. The country was forced to maintain current account surpluses from the mid-1980s to 1994. This was related to the 1985 debt standstill and the international isolation of the South African government, which acted as a barrier to foreign investment and other capital flows to South Africa. With foreign debt having to be repaid, South Africa had no option but to run its affairs so that exports exceeded imports, thereby earning foreign exchange. The political transition in 1994 set the scene for normalisation of South Africa's financial ties with the rest of the world. From 1995 South Africa ran current account deficits but kept these contained at less than 2 per cent of GDP. The deficits were easily financed through net capital inflows, which were sizeable enough not only to pay for the excess of imports over exports but also to build up South Africa's gold and foreign exchange holdings to a record level. Late last year, holdings of gold and foreign exchange exceeded the equivalent of 15 weeks' worth of imports, against the internationally accepted norm of around 12 weeks. In spite of a low gold price, high oil prices and unfavourable conditions in certain trading partner countries in the wake of the emerging markets crisis, South Africa has managed to record very small deficits on its current account in recent quarters. Over the past decade both exports and imports have increased relative to GDP, as can be expected as part of the process of globalisation. South Africa's authorities have added momentum to globalisation by phasing in lower import duties in terms of the World Trade Organisation agreements. This has been painful, but has enhanced South Africa's international competitiveness and ability to grow on a sustainable basis. The volume of non-gold exports has risen at an average rate of around 7 per cent a year since the early 1990s - much faster than GDP growth - which enables the country to finance imports largely needed for investment purposes. Debt levels During the decade we are looking at, government debt rose from 36,4 per cent of GDP in 1989 to 50,4 per cent in 1999, before receding to 48,1 per cent in 2000. Its most rapid rises were recorded when the government incurred large deficits from 1992 to 1994. However, South Africa's debt levels stayed firmly below the 60 per cent level, which is deemed by the Maastricht Treaty participants as the level beyond which fiscal health is at risk. South Africa's foreign debt receded from 26,8 per cent of GDP in 1989 to just above 20 per cent in the early 1990s. As international borrowing was resumed from 1994, foreign debt rose significantly to 29,9 per cent of GDP in 1999. But this is still quite low in comparison with other developing countries. The South African private sector's indebtedness to the banking system has risen over the past decade. From a level of 58 per cent of GDP in 1989, bank credit to the private sector rose to 67 per cent in 1999. This was a sign of increasing intermediation of credit and financial development in the economy - so-called financial deepening.. Budget deficits Similar progress has been made on the government's budget deficits. The relatively low budget deficits and high government expenditure during the fiscal years of the late 1980s to the early 1990s were largely achieved through increased tax revenues. However, in the 1991/1992 fiscal year the deficit doubled to 3,7 per cent of GDP, as the recession impacted negatively on revenue while expenditure growth accelerated. There was no respite in the 1992/1993 fiscal year when the recession deepened and expenditure accelerated sharply after drought aid had been disbursed in the wake of the worst drought in half a century. This propelled the budget deficit to a record high of 7,3 per cent of GDP, a level that was clearly not sustainable. After fluctuating around 5 per cent of GDP, the deficit fell below 3 per cent of GDP after the 1997/1998 fiscal year. This was achieved through a combination of budgeting in accordance with the country's most pressing priorities, strict expenditure control and improved tax collection. With a budget deficit of below 3 per cent, South Africa's finances compare favourably with internationally acceptable levels. Fiscal policy Coupled with these improvements, the degree of transparency in fiscal policy was strengthened with the introduction of the three-year Medium-Term Expenditure Framework, which marked a departure from the one-year budget announcements. The three-year framework has provided certainty, a crucial factor for financial stability, and an opportunity for decisions to be informed by public debate. Clear objectives are set out for fiscal policy, such as the elimination of government dissaving and reducing the tax burden on society. This prudent approach has kept South Africa out of a debt trap where government's deficit, government debt and the interest cost of such debt spiral out of control. The strategy has also contained government's interest costs, enabling more funds to be redirected to the priority areas where the most pressing needs have been identified. Although capital expenditure was initially a casualty of the strict control over government spending, it is now set to accelerate, given the fiscal room for maneuver that the government has created. Although 10 years is a relatively short period in economic terms, the trends that emerge since 1993 underline the solid foundation and relative macro-economic stability that has been achieved in South Africa. The policies that are in place will ensure that this strong foundation will be strengthened further to enable the country to embrace any challenges that may arise. While much success is evident from the side of the government concerning the country's macro-economic framework, the responses to the government's policies have at times been slow. For example, the agricultural sector has undergone immense challenges as South Africa shifted away from the excessive state regulation and intervention which characterised agricultural markets in the past. In keeping with the global trends the majority of agricultural marketing schemes and control boards have been phased out. The agricultural markets have been liberalised and access to them broadened through legislation. As a result, farming has become market-driven and not productiondriven, and this naturally leads to greater agricultural price volatility. The removal of these marketing boards should create space for competition, but we are only beginning to see some encouraging signs that farmers are reacting appropriately to the new agricultural policies. As a central bank we continue to be encouraged by what we hear from the government. In his state of the nation address earlier this month, President Thabo Mbeki indicated that the government was set to embark on a programme of action, starting with the economy. The President noted the general consensus that we have established the necessary level of macroeconomic balance and stability, and have turned away from the precarious position we found ourselves in during 1994. This, as the President said, was in spite a very volatile international environment. President Mbeki also observed that South Africa's economic growth rate, aggregate savings and investment rates remain too low. The President went on to say, and I quote: While continuing to focus on the maintenance of the correct macroeconomic balances, we have therefore decided to pay detailed attention to the critical microeconomic issues. In particular we have decided that this year the government itself, in all its spheres, and the public sector as a whole, must make a decisive and integrated contribution towards meeting the economic challenges the country faces. The objectives we seek to achieve are moving the economy onto a high-growth path, increasing its competitiveness and efficiency, raising employment levels and reducing poverty and persistent inequalities. The government will draw on the advice of some of the world's top economists, lower input costs and strive to create a climate of certainty. By doing this, the government is showing its commitment to the economic well being of South Africa. We at the Reserve Bank are convinced that the micro-reforms will play an important role in boosting growth and job creation. Concluding remarks Ladies and gentlemen, we at the South African Reserve Bank must also do our bit. We believe, as most central banks do, that sustained high economic growth and creation of employment opportunities can only be fulfilled when stable financial conditions prevail. This is the objective of the Bank: to achieve and maintain stable financial conditions in our country. This task is spelled out in both the Constitution and in the South African Reserve Bank Act. The primary role of monetary policy, therefore, is to keep inflation in check, which is an essential ingredient in the recipe for sustainable economic growth. We aim to do this through our approach of inflation targeting. By all counts, this pillar of growth is coming into place, and our economic growth rate will be set against this more healthy background. | south african reserve bank | 2,001 | 2 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the annual banquet of the Institute of Bankers, Johannesburg, 6 March 2001. | T T Mboweni: Transparency and the public understanding of monetary policy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the annual banquet of the Institute of Bankers, Johannesburg, 6 March 2001 * 1. * * Introduction Good evening ladies and gentleman. I thank you for inviting me here this evening to speak at this prestigious event. The Institute of Bankers is an important organisation and encompasses an industry that is, as I am sure you are well aware, crucial to the South African Reserve Bank as a partner in our commitment to maintain and enhance the stability of the country’s financial sector. My remarks this evening centre on "Transparency and the Public Understanding of Monetary Policy". The public understanding of what we aim to do at the Reserve Bank is something that concerns us deeply. It is something that should go hand in hand with the work of the Bank and it is central to the Bank’s commitment of making monetary policy transparent to the people affected by it – the citizens of South Africa. First I will discuss the Reserve Bank’s monetary policy framework and the developments that have occurred in this area recently. I will then move onto the institutional arrangements for the conduct of monetary policy, the work of the Monetary Policy Committee and the Bank’s modelling and forecasting activities. Finally, I will say a few words about the central objective of the South African Reserve Bank. 2. The monetary policy framework We announced the adoption of the inflation targeting monetary policy framework in February just over a year ago. The formal adoption of an inflation targeting framework indicated a shift from the previous informal policy framework. In the past, monetary policy had embraced an eclectic approach in which recognition was formally given to a medium to longer-term stance of monetary policy by monitoring developments in a number of financial aggregates and not only money supply and bank credit extension. The eclectic approach to monetary policy was applied during the 1990s, against the background of explicitly articulated guidelines for money supply growth. This framework recognised that the Reserve Bank had to combat inflation, as outlined in the Constitution and the Reserve Bank Act. However, since the Bank’s policies had their most direct impact in the area of money and credit, intermediate guidelines were set for growth in money supply. It was argued that if money supply growth could be contained, too much money would not be chasing too few goods, and inflation would be brought under control. While formally it was stated that broad money supply growth should fall in the range of 6 to 10 percent per annum (since the mid-1990s), in practice the Bank adopted a relatively flexible approach where these guidelines were indeed treated as guidelines only. A further guideline for growth in total bank credit extension of around 10 percent was also adopted. But when these guidelines were exceeded by considerable margins, this was on occasion tolerated without strong policy adjustments, on the basis of developments in other variables. In practice it was quite apparent that growth in the money supply could sometimes be a misleading indicator of current and future inflation. Accordingly, a number of other variables were also analysed in deciding upon the appropriate monetary policy stance. These included the pace of growth in the banking sector’s credit extension, movements in consumer price and production price inflation, domestic production and expenditure, the balance of payments and exchange rate situation, and the fiscal policy stance. The inflationary potential of developments in all these and many other variables was assessed on an ongoing basis. Accordingly, growth in money supply was not really the pivotal variable around which monetary policy revolved - although excessive growth in money supply certainly did signal the need for additional caution. However, money supply growth was deemed to be important and was formally recognised as the intermediate target variable. What has since changed? Instead of targeting guidelines for intermediate objectives, the Reserve Bank now directly targets inflation. It monitors and analyses a whole range of factors that can affect the rate of inflation. The inflation rate, or more specifically CPIX, which is the headline consumer price index excluding mortgage costs, has to fall between 6 and 3 percent by the end of the calendar year 2002. It is within this target and this monetary policy framework that the South African Reserve Bank will strive to achieve in the short term what we are mandated to do: that is to achieve price stability. Such a framework for monetary policy ensures that monetary policy is transparent, in that the authorities have a definite and measurable aim in their conduct of monetary policy. And at the same time, it should give the citizens of this country an aspect of clarity about the future as it makes clear the Bank’s intentions. In so doing, inflation targeting should also ease the burden and take the "guesswork" out of many of the decisions that businesses have to make when planning for future expansion and investment. It should also provide an anchor for inflation expectations and guide both employers and employees when undertaking forward-looking negotiations. However, it must be emphasised that at least some of the success of the inflation targeting framework rests on whether it is fully understood by labour, business, the private sector and the other sectors of the economy. If these sectors understand that the Bank targets inflation and that it is committed to the chosen target, this will engender public confidence about the Reserve Bank’s monetary policy procedures. I will now turn to the specifics of our inflation targeting monetary policy framework. The Reserve Bank monitors a number of factors that have a direct influence on inflation. These include the growth in money supply and bank credit extension, the changes in nominal and real salaries and wages, the nominal unit labour costs, the gap between potential and actual national output, the exchange rate developments and import prices. The oil price is another factor that has played a major part in domestic inflationary trends of late and one that we have closely monitored. This exogenous factor is one over which we have little control. Another exogenous factor is food prices, which can be volatile as a result of drought or floods. And administered prices, those influenced by government or monopolies including medical and education costs, also have an impact on domestic inflationary trends. In order to monitor these factors, the Reserve Bank has embraced the system of a small core model supported by other models. It has moved away from the single large-scale macroeconomic model, in keeping with international developments. The aim is to keep the core model concise so as to focus on the key economic variables that influence inflation, as I have already mentioned. The core model incorporates some basic assumptions about the economy. It presupposes, among other things, that higher output cannot be achieved in the face of persistently higher inflation and that the level of prices in money terms and the rate of inflation in the longer term depend on monetary policy. Changes in monetary policy, that is changes in the Bank’s repo rate, are transmitted through the economy via various channels, the so-called transmission mechanism. However, the transmission mechanism is a complex structure and can encompass a large number of cause and effect scenarios. The traditional channel is the direct effect of changes in interest rates on demand and supply. Changes in the repo rate have a direct effect on other interest rates, the exchange rate and decisions on spending and investment. Changes in the repo rate, therefore, affect the demand for and the supply of goods and services. The pressure of demand against the supply capacity of the economy is the key factor influencing domestic inflationary pressures. The link between the Reserve Bank’s modelling activities and its forecasting process is indirect and far from the mechanical, "black box" approach favoured by scientists. There is no mechanical process in which the forecast directly determines the policy decision. It must be remembered that the econometric models and forecasts are tools to help the Reserve Bank solve economic problems. They are also only one set of tools used in the policy decision-making process. I will illustrate my point by referring to a summary from the Bank of England on the use of models and the Monetary Policy Committee’s responsibilities. This summary encapsulates the philosophy behind the use of models and forecasts at the Reserve Bank. I quote: "In an ever-changing economy, no single model can possibly assimilate in a comprehensive way all the factors that matter for policy. Forming judgements about those factors, and their implications for policy, is the job of the Committee, not something that can be abdicated to models or even modellers. But economic models are indispensable tools in that process." To return to the broader picture, while inflation targeting forms the framework for the Reserve Bank’s monetary policy, it must be remembered that monetary policy is only a part of macroeconomic policy. The task of macroeconomic policy is to promote economic growth and development, create employment, improve the living conditions of all the people of the country, and eliminate the unjustifiable discrepancies between the disparate average incomes of various groups in the economy. Monetary policy has a narrower focus but it occupies an important component of the foundation upon which the broader goals of macroeconomic policy rest. Monetary policy aims to create and maintain a stable financial environment within which overall economic activity can be expanded, jobs created and poverty reduced. This monetary policy objective is supported by the legal obligations of the Reserve Bank as set out in the Constitution of the Republic and in the South African Reserve Bank Act. These statutes state that the primary objective of monetary policy is to protect the value of the currency in order to obtain balanced and sustainable economic growth in South Africa. This requires the achievement of two objectives: price stability and stable conditions in the financial sector. Price stability is said to occur when changes in the general price level do not materially affect the economic decision-making processes. Although relative price movements will still have an impact on production, consumption, saving and investment, the rate of inflation should be so low that it is no longer an important factor in the economic decision making process. We can say that stable conditions prevail in the financial sector when there is a high degree of confidence that the financial institutions and financial markets are able to meet their contractual obligations. These stable conditions, however, do not preclude the failure of individual financial institutions. A financial institution can fail and be allowed to fail even under stable financial conditions. It is only when there is the threat of systemic risk and an important part of the financial sector is at risk that the situation can be described as financially unstable. Since inflation is our main focus, you may question where the exchange rate of the rand fits into the monetary policy framework? Targeting inflation does not mean that the exchange rate of the rand is ignored. On the contrary, the impact of the exchange rate on inflation is what concerns us and this is what we closely monitor. The impact of the fluctuations in the exchange rate on inflation is carefully considered when we go about the daily task of managing domestic liquidity and determining the repo rate. If signs do emerge of increased inflationary pressures arising from a depreciation of the exchange rate of the Rand, in the absence of any other counterveiling factors referred to above, then monetary policy would have to respond in the appropriate way. This, however, does not imply that the Reserve Bank will defend a specific level of the exchange rate. 3. Institutional arrangements for monetary policy Our commitment to transparent monetary policy goes hand in hand with the attempts we have already made in communicating both our intentions and the outcomes of our meetings to the public. The Monetary Policy Committee was set up shortly before South Africa adopted the inflation targeting framework for monetary policy. The 14-member-MPC, as it is known in short, meets seven times a year. It first met on 13 October 1999. The task of its meetings is to decide on the monetary policy stance, with a focus on the inflation targets that must be met in the target year. A press conference is held after the two-day meeting has been concluded and the Committee releases a statement fleshing out the developments in the international and domestic economy and the reasons for its monetary policy stance relating to these prevalent developments. The Reserve Bank has also convened Monetary Policy Forums, which as the name suggests, provide a forum for open discussions on monetary policy and general economic developments. The MPFs are held twice a year in the major centres of the country and engage with labour, business, community and other organisations. The Forums also ensure that the views of interested parties are taken into account when determining monetary policy. This endeavour is an earnest attempt on our part to communicate monetary policy and economic issues with the broadest spectrum of people. Unfortunately, to date, these Forums are not that well attended, particularly on the part of the trade union movement. The Reserve Bank will also publish a Monetary Policy Review twice a year to increase the understanding of its conduct of monetary policy. The first Review will be published on 19 March this year and will describe the monetary policy framework in more detail. It will also analyse local and international economic developments and the inflationary trends arising from these. The Reserve Bank will also publish its inflation forecasts in the form of a fan chart. The fan chart is used by many central banks to illustrate their inflation forecasts. So-called confidence bands are used to signify varying degrees of certainty for each broadly expected level of inflation. Last but not least, the Reserve Bank regularly reports to parliament on the stance of monetary policy. This is in line with international practice and this is part of our accountability to the citizens of South Africa. 4. MPC decisions at times still misunderstood Despite our efforts at creating transparent and open channels of communication on the conduct of monetary policy and the centrality of inflation targeting, many people in South Africa are still fixated on the fluctuations in the exchange rate of the Rand. Questions will be asked of me not about changes in consumer prices. But, almost certainly, questions will arise when the exchange rate depreciates. Together with this, the Monetary Policy Committee’s decisions are misunderstood from time to time. One of those times was on 16 October last year when the Monetary Policy Committee convened a special meeting in between its regular scheduled meetings to review the effects of developments on the country’s inflation outlook. We decided to underprovide in the banking sector’s liquidity requirement thereby leading to a rise in the repurchase rate to 12 percent. Some saw this move as a strategy aimed at protecting the rand. Yet the Committee made it quite clear that this was not the case. It gave the following reasons, and I quote: "At the end of its previous meeting (21 September 2000), the Committee expressed concern about the second-round price effects of the depreciation in the exchange rate of the rand and the continued high prices of petroleum. Trade statistics that have been released since the last meeting indicate that the surplus on the current account of the balance of payments in the second quarter of 2000 could have changed to a deficit in the third quarter. At the same time non-residents again became net sellers of South African bonds, signalling a possible shortfall on the financial account. As a result of these changes and the continued strength of the US dollar, downward pressure was exerted on the rand with concomitant import price increases, raising the risk of higher inflation. These tendencies were aggravated by continued high levels of international petroleum prices." Because of these developments and their likely impact on future price developments and expectations, the Monetary Policy Committee went on to say that it had decided to revise its monetary policy stance. Once again, I quote: "It was concluded that a modest increase in interest rates at this stage may avoid later steep increases in rates in order to meet the inflation target." To give effect to this, the Reserve Bank marginally under-provided in the liquidity requirement of the banks at the daily repo auction on October 17, expecting this to lead to an increase of some 25 basis points in the repurchase rate. Upon evaluating the outcome of its decision at its next Monetary Policy Committee meeting, the Committee said although prime lending rates were unchanged after the 25 basis point rise in the repo rate, other money market rates generally rose. Expectations of future rate increases also heightened immediately after the increase in the repurchase rate. Statistics confirmed the Committee’s concern that the current account of the balance of payments would slip into a deficit from the second to the third quarter of 2000. This current account deficit, the slowdown in the inflow of portfolio capital from the beginning of September 1999 and the reversal in sentiment towards emerging markets put further pressure on the exchange rate of the rand, the Committee said. The concern was that the Rand’s depreciation could have inflationary consequences if it was not countered by other developments. Although the weakness in the rand, the steep rise in the cost of imported crude oil and an upward shift in food prices led to a sharp increase in consumer prices excluding mortgage costs (CPIX), the Monetary Policy Committee emphasised that the exogenous shocks were not as yet then leading to visible second-round effects on consumer prices. However, the Committee cautioned that there were signs that the second-round effects of these external shocks were appearing in domestic production prices. The production price index, excluding crude oil and food prices, rose steeply from 3,2 per cent in November 1999 to 5,7 per cent in September 2000. And the Committee also warned that this could indicate that CPIX inflation would be affected indirectly by external factors in the following months since increases in production prices usually precede increases in consumer price inflation. The influence of those factors on consumer prices, the Committee said, would depend on competitive forces in the economy and would be tempered in the medium term by prudent fiscal and monetary policies. 5. Conclusion On occasions such as these, it is important for us to re-focus our attention on the Reserve Bank’s central objective and the framework under which our mandated objectives are to be achieved. To put it another way, it is important to place the Reserve Bank’s actions in context. Let me reiterate: our overriding monetary policy objective is to achieve price stability and we aim to achieve this through the framework of targeting inflation. I will stress what many of you have heard me say before: although we monitor a number of variables to extrapolate their potential impact on inflation, it is the rate of inflation that we target. The Reserve Bank’s objectives are enshrined in the Constitution and in the laws of the land. The two elements of financial stability - price stability and the stability of the financial sector - are closely related. If we fail in one area, this will result in uncertainty in the other. We regard financial stability as an important precondition for sustainable high growth and employment creation. Conversely, high rates of inflation can distort the allocation of resources and it can lead to the unequal distribution of wealth. It is against this background, then, that we place our conduct of monetary policy squarely within the objective of price stability and within the framework of inflation targeting. Kea leboga. | south african reserve bank | 2,001 | 3 |
Address by Mr TT Mboweni, Governor of the South African Reserve Bank, at the Annual Competition Conference, Johannesburg, 29 March 2001 | TT Mboweni: Central banking, competition and concurrent jurisdiction Address by Mr TT Mboweni, Governor of the South African Reserve Bank, at the Annual Competition Conference, Johannesburg, 29 March 2001. * 1. * * Introduction Good evening ladies and gentlemen. I thank you for inviting me here this evening to address this conference at a time when competition policy and enforcement are rapidly increasing in prominence throughout the world. This is indeed a stimulating time for you as you grapple with the challenges that confront you. It is perhaps unusual for a central banker to be addressing an anti-trust conference such as this one. At first glance, the worlds occupied by the Reserve Bank and the competition authority are at opposite ends of the economic policy spectrum. Whereas the central bank is characteristically identified as the guardian of macro-economic stability, the competition authority is concerned with regulating micro-behaviour. This includes investigating and adjudicating business practices and ensuring that the structure of the economy promotes competition and facilitates access. The importance of the microeconomic sphere cannot be under-estimated. I have mentioned in the past that microeconomic reforms are important in driving the South African economy forward. President Thabo Mbeki noted in his address at the opening of parliament earlier this year, that we have reached the necessary level of macroeconomic balance and stability. He observed that the time was right to focus on the critical microeconomic issues, more particularly the public sector. 2. Complementary functions A deeper look at the functions and broad objectives of the Reserve Bank and the competition authorities reveals that we share more than is apparent at first glance. We use significantly distinct instruments, but we share a common objective to be attained through our regulatory functions and regulatory tasks – that of promoting growth and enhanced economic opportunity. Since the central bank cannot realise its key objective of securing financial stability in the absence of soundly functioning financial markets, it has a critically important regulatory function. The Bank has to ensure that the institutions that play a central role in the financial markets understand and abide by the rules that are necessary for the effective functioning of the market. A case in point was three years ago, when the international economy was hit by the Asian crisis. Many policymakers and analysts insisted that the economic fundamentals of some of the worst-hit Asian countries were sound and bolstered by strong monetary and fiscal policies. Interestingly, some of these countries had experienced high growth and strong foreign capital inflows up to the crisis. However, upon deeper scrutiny, it became apparent that the authorities responsible for macroeconomic policy had neglected their regulatory role. It is now widely recognised that inadequately framed and enforced rules, what are now widely called governance problems, and an inadequate regulatory structure underpinned the crises in the countries that once earned the title of the Asian Tigers. From this conclusion, it is obvious to see why the International Monetary Fund’s reaction was to focus on regulatory reform in the aftermath of the crisis, and significantly, this focus continues today. The most recent example is Turkey, where an economic crisis has highlighted the pressing need for the restructuring of state banks, a point the authorities are taking in hand and acting upon. The rules monitored and enforced by both the central banks and the competition authorities are amongst the key pillars of the regulatory framework which are necessary to ensure the effective functioning of an economy. The competition authorities and the financial regulators are mutually responsible for regulating the structure of markets and the behaviour of the market participants. While we both respect the markets, we also realise that, like all other institutions, they require clear and predictable rules for their effective functioning and they require an agency that is able and willing to enforce those rules. The criteria that we use in our regulating function naturally diverge because our immediate objectives are different. But many of the features that are essential to the effective functioning of a central bank are equally necessary for an effective competition authority. 3. Pre-requisites for effective functioning Two of these shared features are technical competence and independence. Anybody who has worked in a regulatory agency – be it a central bank, a competition authority or a sector regulator – will recognise the immense technical complexity of the work these agencies undertake. We need to attract the kind of staff and inculcate the kind of ethos that produce work of the highest technical quality. If our decisions are to provide certainty to investors and confidence to the society at large, they must be rooted in solid and reliable data reinforced by cutting edge analysis. The pressure to produce state-ofthe-art regulation is intensified by the fact that regulators should never imagine that one rule, or one mode of interpretation, is good forever. Regulators work in a dynamic and rapidly evolving environment and their work and policies must be able to reflect this. Regulators must ensure that their rules are respected but they must take care not to become too rule-bound, and in so doing lose sight of the purpose served by the rules. It is relatively easy to provide either certainty or flexibility: to provide both presupposes unusual levels of competence and confidence on the part of the regulator. Regulators also need to be able to take decisions fearlessly and independently. Much is said about the importance and the necessity of central bank independence. Those who worry about this seem to be primarily concerned about the central bank’s relationship with government. They are concerned to ensure that the central bank should not deploy the powerful levers at its disposal simply to assure the short-term popularity of the government of the day. The Constitution determines that the Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice. Although the instruments of a competition authority are less direct in their effect than those at the disposal of a central bank, the authority will also have to maintain a necessary distance from the public authority if it is to carry out its regulatory task successfully. But it is also important - maybe more important - to maintain independence from the powerful private interests that would seek to influence the way in which a competition authority exercises its functions. I will not review the shortcomings of some of the previous behaviours in the area of banking and financial market regulation – they are well known and we are still grappling with the fall-out. Suffice to say that we are both dealing in an area where powerful, well-resourced private interests will spare no expense in attempting to sway their regulator. This is a complex area because one must certainly be willing to listen to the regulated; but listening to them should not compromise the ability to make independent decisions. 4. The proposed merger between Standard Bank Investment Corporation and Nedcor I will now turn to a recent example that shows both the dynamic environment in which the Reserve Bank and the competition authorities operate and the interaction between the two bodies. The proposed merger between two of the country’s four biggest commercial banks, Nedcor and Standard Bank Investment Corporation, provides such an example. However, it must be pointed out that the situation exposed what may be called a regulatory gap in the regulatory frameworks of the two agencies. This gap is subsequently being addressed. The Reserve Bank received an application from Nedcor to acquire a majority shareholding in Standard Bank Investment Corporation on 30 November 1999. In this situation, as in others, the regulator must remain objective and not act as a matchmaker or precipitate a trend. In section 37 of the Banks Act the application for a merger and the framework of merger considerations are subject to a formal process which aims to remove as much of the subjectivity as possible. The duty to consult with other regulatory bodies is of paramount importance. In any application of this sort, section 37 of the Banks Act requires a decision to be made by the Minister of Finance, after the Registrar of Banks has made a recommendation, subsequent to consultation with the Competition Commission. The Registrar also has to engage the two banks in discussions, consult with other domestic and international regulators, and consult with the Governor and Deputy Governors of the Reserve Bank. Further, the Banks Act prescribes that the competition authorities must be consulted on competition issues in an application of this nature. However, prior to the amendments to the Competition Act, which came into effect in February this year, the Act did not apply to applications "subject to or authorised by public regulation". Further, section 54 of the Banks Act says that no arrangement involving a bank and no arrangement for the transfer of the bank’s assets and liabilities, or a part of them, can be legally executed unless the consent of the minister of finance is conveyed through the Registrar. This section does not contain a provision requiring consultation with the Competition Commission. In applications like these, the Minister of Finance has to be satisfied that the proposal is not contrary to the interests of the public, the depositors, and the bank concerned or to its controlling company. The Minister of Finance rejected Nedcor’s bid based on the grounds, among others, that South Africa’s already highly concentrated banking sector would be compounded by the merger; the size of the merged bank would affect the banking authorities’ ability to contain systemic crises; and the potential social costs, such as job losses, outweighed the efficiency gains of the merger. The Minister of Finance took into account the recommendations of the Registrar of Banks and the Competition Commission, which had both opposed Nedcor’s bid on the grounds of pub lic interest. In this case, the Supreme Court of Appeal ruled that the Registrar and the Minister of Finance had sole jurisdiction over share acquisitions in banks and banking mergers. As a result of this judgement, the Department of Trade and Industry made certain amendments to the Competition Act. It deleted the provision that the Competition Act did not apply to acts authorised by public regulation. Further, the Minister of Finance has the power to exclude the Competition Commission’s jurisdiction by issuing a notice. 5. Concurrent jurisdiction The amendments established a concurrent jurisdiction between the Competition Commission, the Registrar and the Minister of Finance. This concurrent jurisdiction has to be managed with an applicable agreement, according to section 31A, which was inserted into the Competition Act. These agreements must be negotiated with the various regulatory authorities within the relevant industries to "coordinate and harmonise the exercise of jurisdiction over competition matters". But in the case of bank mergers, the Competition Commission’s powers are qualified further with the provision that the Minister of Finance is, if he deems it to be in the public interest, entitled to assert jurisdiction over these transactions. In the light of this regulatory gap and the amendments to the various laws that arose as a result of it, the Competition Commission and the Reserve Bank’s Bank Supervision Department met on 9 March this year to begin drawing up a Memorandum of Understanding. This Memorandum would set out how the agencies would proceed under the concurrent jurisdiction framework. Only issues of broad principle were discussed but it seems clear that the Bank Supervision Department will perform its duties in terms of the Banks Act as before, including consultation with the Competition Commission. The Competition Commission would then perform its duties in terms of the Competition Act. Share acquisitions in banks or mergers between two or more banks may legally then only proceed once all the approvals have been granted. Although the principles of the agreement have been fleshed out, the Memorandum of Understanding has not yet been finalised and efforts are ongoing to thrash out the mechanics of the cooperation. We believe this Memorandum of Understanding is a matter of urgency. This agreement is important for a number of reasons. Among them, that the operations of the regulatory authorities with jurisdiction over the banking sector must in themselves be regulated. Given the importance of the banking sector to the country’s economy and financial system, the work and interaction of the various regulators must be set down in an orderly, predictable fashion, so as not to compromise the different interests that arise. And of course, the operations of the regulator must at all times be shaped by the very objectives it is trying to achieve. Among these are to ensure that banks are safe and sound, to ensure that the bank’s customers have faith and confidence in the bank and the banking system, and to ensure that banks operate efficiently and effectively. 6. Competition and the economy It is of course not only the regulatory function that the Reserve Bank and the Competition Commission have in common. The competition authorities and the central bank are both concerned with economic regulation, with regulation that produces desired economic outcomes. Whereas the Bank’s interventions are at the macro end of the spectrum, the competition authorities are concerned with interventions in the micro-economy. But both are essential and it is an appreciation of this that accounts for my frequent reference to the importance of microeconomic reform. At the risk of oversimplifying the matter, if we at the macro-economic end provide the stable platform without which growth will not occur, then it is the micro-economic interventions that put in place the key incentives that guide the investment decisions by individual firms, that ensure that the pattern of investment will not only be able to realise the necessary commercial returns but that will also ensure optimal social returns. Our respective actions and interventions will often be scrutinised against these economic criteria. You will often be judged publicly by those who believe that what is good for them is good for the economy. In fact, this is frequently not the case and some of the sternest tests of your independence will come from those cases where you are forced to defend your actions against those who argue that your actions, by undermining the interests of important firms, are, thereby, harming the economy. In this light I have been interested to read some of the responses in the media to the competition authorities’ activities. Some of these critics are concerned that your activities are not sufficiently geared to the need to build ‘national champions’. They are concerned that the price worth paying for the attainment of international competitiveness is the dominance of world class companies in our small economy and that merger regulation somehow repels foreign investors. This is asserted time and again, despite evidence to the contrary. Hence, we know – and Michael Porter’s work on Japan is interesting in this regard – that success in international markets is heavily influenced by the extent of competition in the domestic market. It stands to reason that companies that are able to extract monopoly profits in their domestic market will have little interest and, often, little ability to face up to the arduous business of penetrating competitive international markets. We know that foreign companies find this a difficult market to penetrate precisely because of the high levels of monopolisation. Surely vigorous merger scrutiny is not likely to hit foreign investors who have no presence in this market – on the contrary they will be the ones encouraged to invest by anti-trust merger regulation. In particular, robust anti-trust enforcement will facilitate those previously excluded by the high levels of concentration and by practices that have served to reserve markets for the privileged few. 7. Competition and prices The regulator’s role in ordering a market defined by competitive forces is as much a necessity for the economy and economic stability as is competition itself. Competition enforces a strict discipline on the price formation process. Random price shocks arising from the dominant position of a single supplier in the market are largely prevented through increased competition. Although such price shocks are not inflationary in the strict sense of the word, they do help to perpetuate an "inflation psychosis" because they influence consumers’ expectations of future inflation. What usually happens in the aftermath of a one-off price shock, is that the overall price level rises and that during the adjustment process, the actual inflation rate is higher than it would otherwise have been. The rands in consumers’ pockets will buy less as they then experience a decline in their purchasing power, all other things being equal. An inflation spiral may unfold if they are compensated for this loss in purchasing power by pay rises, for example. The immediate price effect of a random shock cannot be controlled by the central bank. For instance, no level of interest rates will be sufficient if a monopoly supplier lifts the price of its product. However, such a one-off price increase can have a knock-on effect and drive up the prices of all other goods if monetary policy-makers are not sufficiently vigilant. By raising the level of competition in the economic system, one important source of random price shocks is reduced or eliminated. And a major obstacle in the way of a successful counter-inflationary monetary policy will be removed. This is important because, as you know, we adopted the inflation targeting framework for monetary policy in February last year. This means that we target inflation primarily but must also take into consideration the variables that impact on inflation. In terms of the target, CPIX, which is the headline consumer price index excluding mortgage costs, must average between 6 and 3 percent in the year 2002. 8. Conclusion I have made a real effort to speak to diverse constituencies and stakeholders within the economy, to have them understand why the Bank adopted the inflation targeting framework and why the Bank is sometimes obliged to take decisions that appear to conflict with some of their short-term interests. I firmly believe that we can not carry out our task effectively if the general population is not informed about the framework of our decisions. The competition authorities, the Reserve Bank and other institutions must be cognisant of the socioeconomic factors that dominate the South African landscape as well as be guided by their primary objectives. I note that your legislation allows for elaborate efficiency defenses both in the case of mergers and even in the case of restrictive agreements. Exemptions are permitted for practices that can be shown to promote exports, small business and black economic empowerment. These all represent critical social and economic goals and they may, on a case by case basis, necessitate a departure from strict anti-trust enforcement. But you are entitled to approach requests for exemption with a certain degree of skepticism – after all the best tonic for export growth and for the promotion of access to the economy is, in most cases, likely to be competition itself rather than exemptions from the competitive process. I wish you well. Thank you. | south african reserve bank | 2,001 | 4 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the ACI meeting, held in Pretoria, 14 May 2001 | T T Mboweni: Volatility in the currency markets and its impact on monetary policy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the ACI meeting, held in Pretoria, 14 May 2001. * 1. * * Introduction I would like to thank ACI for the opportunity to address you this evening. Of course I have been aware of the existence of ACI but I was reminded about it again when Mr Gibbs backed the Code of Trading Principles, as agreed to by sixteen leading intermediaries in the foreign exchange market, and released it to the press on 22 February 2001. The Reserve Bank values ACI’s endorsement of these Trading Principles. I thank you all for your willingness to come to Pretoria as I believe that most of you work in Johannesburg. I understand also that your presence reflects a common interest in financial markets – and not merely a desire to gain an advantage over your competitors by obtaining better insights into the thought-processes of central bankers! Apparently many of you are foreign exchange dealers or are close to the foreign exchange market, so I have chosen to talk to you about volatility in the currency market and about monetary policy. I will first attempt to give some background information against which volatility in the currency markets has developed and will then proceed to discuss developments in some of the major and emerging market currencies. The focus will then move to developments in the exchange rate of the rand and its potential impact on inflation and consequently on monetary policy in South Africa. I will also, as far as I am able, attempt to address some other areas you may be interested in. 2. Developments in the currency markets in 2000 and 2001 The so-called "emerging markets crisis" in 1997 and in 1998 was a major event which adversely affected many emerging market economies. Currency weakness and tighter monetary policies impacted significantly on economic performance, as was the case in South Africa. We certainly looked forward to a period of relative calm from 1999 onwards. Unfortunately, the financial markets have not afforded us this opportunity and volatility has been a somewhat persistent feature of the financial markets in the year 2000 and 2001 to date. The most volatile markets have been the stock markets, particularly those trading technology stocks – and probably also media and telecommunication stocks – the well-known trilogy, TMT stocks. However, the volatility has also extended to the fixed income and currency markets. In the case of stock markets, the Nasdaq for example has declined by no less than 37 per cent in the calendar year 2000 and by a further 17,6 per cent in the current year to date. According to Bloomberg news services, the historical price volatility over a ten-day period reached levels in excess of 70 per cent per annum in April 2001. In early January 2001, the volatility appeared to be even higher. From its peak on 10 March 2000, the Nasdaq has fallen by a staggering 58,3 per cent. The Dow Jones index has also declined but not by the same magnitude. It declined by 5½ per cent during 2000 and has remained virtually unchanged in the year to date, with historical volatility reaching levels around 32 per cent in March and April of this year. Other stock market indices have declined in sympathy with Wall Street. Fortunately, as a matter of interest, the all share price index of the JSE Securities Exchange has increased by some 5,1 per cent since the beginning of 2000 to date. For most of the last decade the financial world has closely watched the economic expansion of the United States, which seemed to defy what had been learnt about business cycles, and the concomitant monetary policy tightening by the Federal Reserve from late 1999. Similarly, in the euro area and in the United Kingdom, both the ECB and the Bank of England were also in monetary policy tightening modes for most of 2000. The tightening in the euro area and in the UK, however, was in reaction to inflationary pressures which resulted mainly from higher oil prices. Based on a perception that monetary policy was entering an uncertain phase in the major economies of the world in the latter half 2000, plus given the demanding price earnings ratios on the so-called hi-tech shares especially, market participants seemed to react more forcefully to macroeconomic news than usual, thus exacerbating the volatility. Stock markets in general turned positive in January 2001 with the announcement of a 50 basis points reduction in the Federal Reserve’s target for the fed funds rate on 3 January 2001. This was followed by a further 50 basis points cut on 31 January. This buoyed markets, at least temporarily. However, perceptions again deteriorated on fears that the United States might be heading for a recession which could eventually result in depressed world economic activity. A principal feature in the currency markets during 2000 and 2001 has been the strength of the US dollar in the international financial markets. One of the important factors behind the strong US dollar were capital flows into the United States stemming mainly from its vibrant economic growth. Whilst the United States was, and might still be, the major net recipient of capital and the euro area the world’s largest provider of foreign corporate investment in particular, it was not surprising that the euro remained under pressure and that the US dollar remained very strong. It is, however, currently not so easy to explain the resilience of the US dollar with the United States’ economic prospects having changed over the last six months. As a result of the strong US dollar, many currencies have weakened against the US dollar in 2000 and 2001 to date. The euro declined to its lowest level ever against the US dollar on 26 October 2000 when it breached US$0,83. It subsequently recovered but remains under pressure. The Australian dollar and New Zealand dollar have declined by 26,0 and 24,1 per cent respectively since the beginning of 2000 to date. Most currencies of emerging markets which have freely floating exchange rate regimes, have also declined significantly since the beginning of 2000 to date. When the euro depreciated below the key resistance level of US$0,85 on 20 September 2000, the ECB reacted and, with the assistance of the G7 central banks, intervened on 22 September 2000. In the aftermath of the intervention, the euro appreciated to US$0,90. The recovery of the euro was, however, short-lived. The ECB again intervened on Friday 27 October 2000, this time without the assistance of G7 central banks. A third intervention package, also estimated at US$1 billion, was introduced to the market on 6 November 2000. This pushed the euro from a level of US$0,86 to US$0,87. It is interesting to note that Mr Horst Köhler, Managing Director of the International Monetary Fund, gave the ECB a vote of support for its intervention and said the Bank had acted ‘appropriately’ when intervening on behalf of the euro. He furthermore said: "Co-ordinated activities are appropriate and can work. Intervention is a legitimate instrument but it has to be very selective to have an impact." It is perhaps also worth mentioning that the Reserve Bank of Australia has also intervened in their foreign exchange market in order to support the external value of their currency. 3. Developments in the rand exchange rate As is perhaps to be expected from a relatively open economy, the South African rand was not immune to the developments in the world’s currency markets. The rand declined by 22,9 per cent against the US dollar in calendar 2000 and by a further 5,4 per cent in the current year to date. However, measured against a basket of South Africa’s most important trading partners, the rand has fared better, helped by the weakness of the euro, pound sterling and the yen. The trade weighted index value of the rand declined by 12½ per cent in 2000 and by only 0,9 per cent since the beginning of this year to date. Besides the strong US dollar, other developments have also impacted with varying degrees of significance on the rand. Firstly, the increase in oil prices, coupled with a significant decline in the exchange rate of the rand against the US dollar, raised concerns in the first half of 2000, in particular, of mounting inflation and the possible impact on the Bank’s inflation target. Secondly, concerns about South Africa’s ability to achieve higher and sustainable economic growth rates was also a concern for many participants in the financial markets. Thirdly, for a few months in 2000, the rand reacted adversely to political and economic developments in Zimbabwe. Notwithstanding continued re-assurances by the South African Government that the rule of law would be maintained and with scant regard to the considerable differences between the two countries, foreigners, as well as South Africans, were concerned at the prospect, however remote, of lawlessness spreading to South Africa. Fortunately, this factor is hardly mentioned in the market at the moment. Fourthly, and not for the first time, the net open forward position (NOFP) of the Reserve Bank has played a role in rand volatility. Notwithstanding the fact that many countries find themselves in an over-borrowed position i.e. when the reserves and international indebtedness of the government and central bank are added there would be a negative balance. The perception that the Reserve Bank needs to buy foreign exchange from the market to close out the NOFP leads to a perceived "one way bet" on the fortunes of the rand. This is a misguided notion, however, as the Reserve Bank realises that buying US dollars from the market, as and when conditions permit, has achieved what could reasonably be expected. Our policy position is that we will continue to work the NOFP down as and when economic and financial conditions are favourable. For example, from privatisation proceeds as and when available; international borrowing by government as and when it occurs; and possibly once-off inflows of a permanent nature as may accrue from the corporate sector. The exchange rate of the rand is far more of a two-way risk than many market participants realise. Perhaps it would also be appropriate, having touched on the NOFP issue, to reiterate the successful reduction in this position which has occurred over the past number of months. As at 31 December 1998, the NOFP stood at US$22,5 billion and it has steadily been reduced to a level of US$9,0 billion as at 30 April 2001. This is, in our view, an important milestone in the implementation of our policy. The reasons mentioned above, and others, have culminated in higher volatility levels for the rand. In 1997 the average one-month historical volatility of the rand was 4,5 per cent. It increased to an average of 12,6 per cent in 1998 – having been around 35 per cent in the midst of the Asian crisis – before decreasing to an average level around 9 per cent for 2000. For the current year to date, the average one-month historical volatility is 12,3 per cent, much higher than in previous years. But as mentioned before, we are in good company. 4. The impact of currency volatility on monetary policy Before turning to the impact of currency volatility on monetary policy, it is important that we spend a few minutes refreshing our memories about the recent economic developments in South Africa. Economic growth appears to have levelled off in the first three months of 2001, although activity has remained at a relatively high level. Still, the creation of employment opportunities for South Africa’s growing population remains the major challenge facing the country. South Africa’s overall balance of payments position remained sound during the first quarter of 2001, with a further small surplus being recorded on the current account of the balance of payments and the value of the international reserves of the country rising slightly. The growth over 12 months in the broadly defined money supply (M3) accelerated from 7,5 per cent in December 2000 to 9,4 per cent in February 2001 and further to 12,8 per cent in March. The growth in bank credit extension also accelerated in the first quarter of 2001. Continued discipline was maintained in the finances of the fiscus with expenditure only marginally exceeding the budgeted amount for fiscal 2000/2001 and revenue rising rapidly largely owing to improved administrative procedures. Although the depreciation of the rand exerted untoward pressure on the prices of imported goods, the overall effect on prices was counteracted by the somewhat temporary decline in international oil prices combined with moderate inflation rates in South Africa’s main trading partner countries. Production and consumer price inflation have, therefore, tended downwards. All in all, South Africa’s economic performance is good. With the advent of inflation targeting as a monetary policy framework in South Africa, the relative importance of the exchange rate has also changed. Whereas previously the Reserve Bank might have interpreted its mission of protecting the value of the rand quite literally to encompass the possibility of intervention in the foreign exchange market, we are now more prepared to accept the valuation of the market on the exchange rate. Within this new framework we focus more on the longer term inflationary consequences of any decline in the value of the exchange rate as an additional factor to be considered when deciding on the appropriate stance of domestic monetary policy. This emphasis on inflation per se, however, does not imply that the Reserve Bank is indifferent to developments in the exchange rate and, in particular, to the level of volatility. The fact that various other currencies have weakened by more than the rand, or have been more volatile, does not mean that the Bank is unaware of the damage done by a depreciating currency to South Africa’ s economy via inflation, or, for that matter, to foreigners who invest in South Africa. South Africa remains committed to gradual exchange control liberalisation, but there are times when the authorities are concerned by the fickleness of international capital flows, and, I dare to say, by pure speculative transactions by non-residents in our markets. To illustrate the fickleness of capital flows, South Africa experienced net portfolio inflows for the two years 1998 and 1999 of the order of R87 billion. In the subsequent year a net outflow to the tune of R2,8 billion was recorded and for the current year to date there have been net positive flows again to an amount of some R6,2 billion. These figures refer to foreign investment in equity as well as bonds. The flows from the bond market on their own have been far more volatile. In the emerging world, South Africa is characterised by relatively liquid financial markets. Over a longer period of time this is certainly a factor which should attract global investors. In the shorter period, however, the Bank has the impression that this might engender pure speculative activity. Often bad news in distant countries leads to a weakening of the rand with no regard to positive developments in the South African economy. This is certainly a problem with which we are grappling. There is no turning back on the road of exchange control liberalisation, but that does not preclude better scrutiny of the application of rules that are in existence. In this connection, we are encouraged by the adoption of the code of Trading Principles by a dozen or so banks operating in South Africa. In particular, section 2 of the principles which says: "Foreign exchange managers have a particular responsibility in the execution of orders at volatile times. Intermediaries should take care to discuss with customers t he risks of operating in these environments and the possible scrutiny of actions. Market makers may reserve the right to refuse customer transactions that they feel may further disrupt or have the intent to disrupt the market." This is indeed positive. Nonetheless, volatility is, of course, part of our economic system. Cycles of boom and bust, "irrational exuberance" and gloom, occur from time to time. With the benefit of hindsight, it is now clear that the surge in the American stock markets, in particular, in recent years was overdone and a sharp correction, with the attendant volatility, was inevitable. This has had some implications for currency markets as well. Uncomfortable as this might be for central banks focusing on inflation and stability, it is inevitable and we have to live with it – sit tight, grit our teeth and suffer in silence. It does make life difficult for central bankers as volatility might disguise underlying trends that require monetary policy adjustments. 5. Non-resident participation in the foreign exchange market Before I conclude my address, I would like to mention a few statistics on the South African foreign exchange market which you may find interesting. The average net daily turnover on the South African foreign exchange market amounted to US$7,4 billion per day in March 2001. Of this turnover, non-residents accounted for almost 56 per cent, while resident clients accounted for only about 8 per cent. Inter-bank transactions among the authorised dealers account for the balance. Non-residents continue to dominate swap market activity with about 60 per cent of swap turnover attributable to their participation. Their activity in the spot and outright forward markets has also increased substantially. In March 2001, non-residents accounted for almost 46 per cent of turnover in the spot and forward market, compared to 34 per cent in January 2000. This increase in non-resident participation in the foreign exchange market could be explained by the decline in the number of foreign banks which provide rand liquidity in London and possibly also by increased trading in the rand. 6. Conclusion Notwithstanding the volatility in the exchange rate of the rand, we are convinced that there is every reason to be confident regarding the future path of the rand. With prudent fiscal and monetary policies in particular, and good economic policies in general, being in place, we are expecting the current relatively modest but sustainable economic growth to continue. In these circumstances the current account should be a positive factor with South African exports performing relatively well. Inflation is coming down slowly but surely and, of importance to you, by no stretch of the imagination can the rand be regarded as overvalued. May I conclude by quoting a press release by the Bank for International Settlements: "Maintaining price stability is the best contribution central banks can make to continued prosperity." We reiterate our commitment to pursue the appropriate monetary policy to achieve the target range of 6 to 3 per cent in CPIX (MU) on average in 2002. Thank you. | south african reserve bank | 2,001 | 5 |
Address by Professor T T Mboweni, Governor of the South African Reserve Bank, at the 6th Africa Regional Girl Guides Conference, Cape Town, 2 July 2001. | T T Mboweni: Building Africa’s future Address by Professor T T Mboweni, Governor of the South African Reserve Bank, at the 6th Africa Regional Girl Guides Conference, Cape Town, 2 July 2001. * 1. * * Introduction Good morning Premier, honoured guests, ladies and gentlemen. I thank you for inviting me here today and I am honoured to be included on this occasion. Some of your responsibilities as members of the World Association of Girl Guides and Girl Scouts lie in preparing the young women of today for the positions of strength and leadership they will occupy in the future. These young women will be the ones we look towards for guidance and leadership in the coming period. We have a duty to lead them, instil in them solid values, ideals and morals, among these a respect for democratic authority and education, such as your organisation upholds. If we fail in this duty, we will be doing ourselves and future generations a great deal of disservice. It is vital that we instil a sense of discipline in the youth in our care. It is this sense of discipline which will mould them to grow up to be reliable, respected, and independent-minded adults. I commend you for the worthy tasks you have both set for yourselves and achieved. The youth you lead and nurture have a vital role to play in the future of this country and this continent. They are the leaders of the African Renaissance. The future we envisage is very different to the reality of today but it is heavily influenced by it. I will give a brief overview of where we stand in Africa and in South Africa, particularly. And then I will discuss the possible path ahead of this continent and country and how the young people you have under your wing could make a valuable contribution. 2. The need for change Your organisation is, as is this continent, in the throes of immense change. I was particularly struck by a statement contained in one of your pamphlets, and that is: "Why change is necessary". Change is inevitable, we cannot stop it. What we can do, however, is to manage change so that it becomes an instrument for the better, not worse, of all our people. The Girl Guides South Africa and the World Association of Girl Guides and Girls Scouts are well-placed. As part of an international organisation you are in a prime position to reach beyond your national boundaries, to become citizens of the world and draw on your immense human resources in making life a little brighter for all our people. There are windows of opportunity within this process and it is up to all of us to identify those opportunities and choose how we are going to take advantage of them, how we are going to turn night into day. The transformation of South Africa to democracy is a good example of how change could be managed for the good of all. It is painful for some, joyous for others, and the outcome could have been a costly confrontation with destructive consequences. Yet, as most of you know, some have referred to this change as a miracle. But I fear that the time has come when we can no longer ride on the coat tails of that "miracle", we in South Africa need to get down and do some serious work. This continent and this country face a number of key challenges going forward. Just as you strive to alter the face of your organisation to deepen certain values and to embrace others, so we as a country and a continent broadly face the challenge of developing our people, and in so doing, propelling our continent to the fore in the international arena. When President Thabo Mbeki was inaugurated on 16 June 1999, he had these words to say: "Recorded history and the material things that time left behind also speak of Africa's historic contribution to the universe of philosophy, the natural sciences, human settlement and organisation and the creative arts. Being certain that not always were we the children of the abyss, we will do what we have to do to achieve our own Renaissance. "We trust that what we will do will not only better our own condition as a people, but will also make a contribution, however small, to the success of Africa's Renaissance, towards the identification of the century ahead of us as the African Century." Indeed, our President’s words have encapsulated the growing awareness in this globalised world that the bettering of people’s lives must accompany efforts towards sustainable economic growth and development. No longer are the world’s citizens a means to an economic end, but it has become increasingly recognised that they must be part of the end result. The modern day measures of country success are no longer solely high economic growth rates and balance of payment surpluses, but include the broader development goals that these high growth rates and budget surpluses can help to generate. In other words, the overriding challenge we face has become broader, deeper and infinitely more complex than was thought of before. This growing awareness has been the catalyst behind the development of the Millennium African Renaissance Programme or MAP. The Programme, which is being spearheaded by President Thabo Mbeki, Nigerian President Olusegun Obasanjo and Algeria’s President Abdelaziz Bouteflika, is aimed at achieving strong sustainable economic growth, boosting Africa’s share in world exports over the next five years and accelerating the achievement of various development goals. The Programme, although still in its infancy, demonstrates a concerted collective effort on the part of African leaders to overcome the continent’s poverty and drive the continent forward to become a significant role player to be reckoned with in the global arena. The success of this Programme also relies on the goodwill, cooperation (the G7 in particular) and willingness of our industrialised counterparts to join us. While the Millennium African Renaissance Programme is broad in focus, we must not omit the Southern African Development Community from this discussion. Many of the objectives contained in the SADC treaty, which was signed in 1992, are echoed along these broader goals. Among the objectives are to achieve development and economic growth within the framework of regional integration, to alleviate poverty, enhance the standard and quality of life of the citizens of the region and support the socially disadvantaged. The SADC treaty also lists the promotion of self-sustaining development on the basis of collective self-reliance and the interdependence of member states as one of its objectives. In achieving these goals, SADC recognises that sound and co-operative economic policies are key elements. South Africa has been given the task of co-ordinating SADC’s Finance and Investment Sector. Within this the South African Reserve Bank plays a pivotal role in that it chairs the Committee of Central Bank Governors in SADC. 3. The current development picture Let me take a moment to paint a picture of where Africa, and particularly Sub-Saharan Africa, stands at present. Africa remains the world’s poorest continent. Currently, the world’s richest 20 per cent of countries claim an 82 per cent share of global exports. The poorest 20 per cent of countries get a one per cent share. Similarly, the richest 20 per cent attract two thirds of the world’s foreign direct investment. In contrast, the poorest 20 per cent attract a meagre one per cent of foreign direct investment. These 1997 figures from the Human Development Report Office highlight the stark disparities between the world’s rich and poor. And the accompanying public outcry over these differences, reflected in the often vociferous and violent protests at IMF, World Bank and WTO meetings around the world, serve to highlight even further the international realisation that the collective effort towards economic and social development must be intensified. The World Bank’s World Development Indicators 2000 report concludes that the proportion of povertystricken people can be halved by 2015. This assertion rests on two conditions, namely that economic growth resumes and that inequality between the world’s poorest and richest countries does not increase. According to this report, a sixth of the world’s population, primarily in the developed world, received nearly 80 percent of world income while the poorest 57 percent of the world’s population received only 6 percent of world income. However, there has been some progress in fighting poverty. In East Asia the proportion of people living in extreme poverty has fallen sharply since 1987, mainly because of progress in China. But in almost all other developing regions the number of poor people has been on the increase. In South Asia the number of people living in extreme poverty rose from 495 million to 522 million, an increase of 5,1 percent. However, in Sub-Saharan Africa the number of very poor people increased by about 48 million to 291 million – that is an increase of some 16,1 percent. The report also points out that 17 developing countries managed to reduce their mortality rates of children under the age of five between 1990 and 1998. But in 13 countries the mortality rates worsened. Many of these are African countries where armed conflicts and the spread of HIV/AIDS have compounded the evils of poverty. In terms of economic growth, Asia once again scores highly. Over the years from 1990 to 1998, the fastest growing region in terms of Gross National Product per capita was East Asia and the Pacific with growth averaging 6,4 percent. South Asia followed with 3,8 percent. The Middle East and North Africa showed small gains while Sub-Saharan Africa fell behind with a negative growth rate of 0,3 percent. Still, the positive aspect is that the service industry has been progressing in developing countries. This includes Sub-Saharan Africa, which has been shifting towards the service sector. However, the World Bank indicates that this has been at the expense of industry, with the share of agriculture remaining more or less constant at 17 per cent. The World Bank’s African Development Indicators for 2001 shows that growth on the continent slowed significantly after 1998. Average per capita GDP fell by almost 1 per cent from 1998 to 1999 while official aid to Sub-Saharan Africa fell from US$32 per head in 1990 to US$19 by 1998. This occurred despite the improvements in some of these countries social and economic policies. The World Bank gives this reason, and I quote: "The slowdown in growth was the result of regional and civil wars, poor governance in some countries, and serious external shocks such as the rapid hike in oil prices at the same time that export earnings from primary commodities collapsed." The report cautions that growth needs to be above an annualised rate of 5 percent to prevent a rise in the number of poor people on the continent. Some progress is evident. Fourteen African countries have grown by an average 4 percent a year during the 1990s with a further 10 countries growing at rates above 3 percent a year. This report concludes: "Africa’s future economic growth will depend less on exploiting its natural resources, which are being depleted and are subject to long-run price declines, and more on its labour skills and its ability to accelerate a demographic transition. " South Africa is ranked as having a medium level of human development, according to the United Nations Development Programme (UNDP). This is a similar level as found in countries such as Jordan, Sri Lanka, Turkey, Indonesia and Botswana. The Human development Index, compiled by the United Nations Development Program, is a measure of what are termed "average achievements" in basic human development. The HDI measures a country’s development in terms of income, education levels and life expectancy. The value of the HDI ranges between 0 and 1. South Africa’s HDI of 0,628 as measured in 1998 is lower than Canada’s 0,932. It is slightly lower than all developing countries index of 0,637 but higher than Sub-Saharan Africa’s 0,430. However, if we look at the scenario which factors Aids into the results and compare it with a scenario in which the illness is not taken into account we get very different pictures and thus, logically, the situations will produce different development responses. In a "no Aids" scenario, South Africa’s Human Development Index is estimated at 0,647 for this year, but it falls to 0,597 in an Aids scenario. In 2005 the country’s HDI is estimated at 0,65, and falls to 0,565 in the Aids scenario. And the estimates for 2010 show 0,654 for a non-Aids scenario compared with 0,542 for an Aids scenario. This is one very grave hurdle that we all, as citizens of the world, are facing. The recent death of little Nkosi Johnson who died at the age of 12 at the beginning of June 2001 highlighted a poignant and personal account of suffering that is being played out in millions of homes around the world. Nkosi, who was born with HIV-Aids, focused our attention on this very real problem and in his own way he made his mark. Little boy Nkosi survived for a decade longer than the doctors expected. He stole the hearts and minds of many people in South Africa, and undoubtedly throughout the world, when he walked on to the stage at the 13th International Aids Conference in Durban last year and told the audience of his plight. Nkosi’s story shows us what we can achieve, no matter who we are or what age we are. And in his own way, he extends a challenge to each one of us who are committed to making our mark. I commend the Girl Guide Association of South Africa on its HIV/AIDS programme. I am particularly impressed that your Association had the foresight to tackle HIV/AIDS awareness nine years ago. And I am similarly impressed about the work you are doing to make the lives of those afflicted a little easier. Not only did little Nkosi Johnson make his mark at last year’s Aids conference in Durban, but the Girl Guide Association of South Africa did too. I urge you to persevere in your partnership with the Department of Health on their HIV/AIDS education programme. Education can move mountains. Empowering the youth by imparting the appropriate knowledge and skills will help them to protect themselves and face the challenges of life. In a bid to address the three-pronged scourge of low education, poor health and welfare services, the South African government’s budgets over the past few years have focused increasingly on these key areas. This does appear to be paying off to some extent. The rate of illiteracy has shown a downward trend since 1985. From an illiteracy rate of 21 per cent among people 15 years and older in 1985, South Africa’s illiteracy fell to 16 per cent in 1997, according to the World Bank’s African Development Indicators for 2000. In line with this, the number of pupils enrolling in primary schools has been on an upward slope. South Africa’s life expectancy at birth has also increased from 58 years in 1982 to 65 years in 1997. Infant mortality has dropped from 6,3 per cent in 1982 to 4,8 per cent in 1997. But South Africa, and indeed Africa, needs to boost its savings rates. Africa’s savings amounted to 27,1 percent of GDP during 1975 to 1984, but for the 1990s the World Bank’s 2000 report estimates the level at 17,6 percent. South Africa’s savings amounted to 15 percent of GDP last year. You, as an organisation pride yourself on teaching your members the values of thrift and prudence. I would ask you to go one step further. As you educate your members about the importance of savings, without which the economy cannot reach prolonged high growth rates, educate them to be educators for the wider community. We have a dearth of economic literacy on this continent and we need resourceful people like yourselves to become well-versed in basic economic principles and make this knowledge available to the communities you serve. 4. The pre-requisites for the success of the African renaissance So, where do we go from here? I have already mentioned some of the challenges we face. These are surmountable. However, there are certain pre-requisites we, as a continent and a country, should aim to achieve before we can claim any success along the road of the African Renaissance and its broader goals. After meeting with sub-Saharan African leaders earlier this year, Horst Kohler, the International Monetary Fund’s managing director, mentioned that the prospects for rapid growth, which he argued was indispensable for reducing poverty, will and I quote: "depend on the ability of those countries to unlock the creative energies of their people. African leaders," he said, "know that there is no alternative to integration into the global economy. This approach requires investment in human capital and infrastructure as well as the right economic policies and institutions. It requires, especially, an economic climate that encourages private sector investment." The collective efforts brought together for the fulfilment of the Millennium African Renaissance Programme should unlock the creative energies of the African people, it should give Africa’s leadership a new focus and it should encourage unwavering efforts to eradicate poverty, and bring about democracy and good governance. I suspect that sustainable development rests on a complex interplay of factors, an important one being good governance and accountability of a government to its citizens, full participation by the citizens in the political life of their countries, as well as sustainable economic growth and development. It is from a sound economic base, the optimum economic climate, that we can then progress to take our place among the leaders of the twenty-first century. Firstly, we should contain our general government deficits to not exceed more than 3 per cent of gross domestic product. South Africa has had mixed success against this criteria. The relatively high budget deficits and high government expenditure during the late 1980s to the early 1990s were largely the consequence of bad economic management based on multiple financing of apartheid programmes. I am happy to say that the budget deficit fell below 3 per cent of GDP after the 1997/1998 fiscal year. This was achieved through a combination of budgeting in accordance with the country's most pressing needs, strict expenditure control and improved tax collection. With a budget deficit of below 3 per cent, South Africa's finances compare favourably with internationally acceptable levels and we could easily become member of the E.U. Secondly, general government’s gross debt should be kept to less than 60 percent of GDP. South Africa’s debt levels have in recent years stayed firmly below this level. Gross debt above this level is deemed by the Maastricht Treaty participants as the level beyond which fiscal health is at risk. Thirdly, countries should aim for flexible relatively stable exchange rates. And fourthly, price stability is key to attracting investment and boosting economic performance. The South African Reserve Bank embraced the ethos of price stability when we adopted an inflation targeting framework at the beginning of the year 2000. Under this framework the South African Reserve Bank aims to contain the Consumer Price Index less mortgage costs (CPIX) measure of inflation, to between 6 and 3 percent by 2002. In this way we should achieve a significant measure of price stability. Over the last 10 years, inflation has come down steadily from the double-digit figures of the 1980s and the early 1990s. According to the latest figures CPIX is at 6,7 percent for April. Inflation has proved sticky over the past year or so mainly because of high international oil prices. 5. Conclusion By containing inflation and by ensuring that price stability prevails, the Reserve Bank contributes towards creating an environment in which individuals, households and businesses can thrive. The views of serious economists have changed markedly over the past 50 or so years. It is now recognised that high inflation cannot be good for economic growth. Following on this theoretically and practically, the Bank makes its contribution towards the broad development goals we are all striving towards. And this must be backed by robust and decisive decision-making institutions that are shaped by good governance, transparency, accountability and democratic full participation by all the people in the political lives of their countries. The Girl Guide Association of South Africa and the World Association of Girl Guides and Girl Scouts have an equally important role to play. Just as little Nkosi Johnson highlighted his HIV/AIDS plight and the plight of many others, so each and every one of us in our own small way can make a valuable contribution to the communities we work in daily. As is human nature, we rarely realise how powerful we can be. Many of us are more inclined to apathy than activity. But you are doing good work. You fall into the many pockets of excellence scattered all over the continent of Africa today. As you go about your work, we challenge you to nurture in these young women the patriotic, peaceful, democratic, caring creative and entrepreneurial spirit which will spur on the dream of our African Renaissance. For it is through the future generations of leaders who can think creatively and democratically, who become innovators and find unique solutions to age-old difficulties that we could truly become a force to be reckoned with. An African continent whose time has come. In closing, then, I say build on your successes and embrace the challenges, both new and old. I wish you well in your endeavours. Thank you for having me here. God bless. | south african reserve bank | 2,001 | 7 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Southern African-German Chamber of Commerce and Industry, Cape Town, 13 July 2001. | T T Mboweni: Observations on recent economic developments Address by Mr T T Mboweni, Governor of the South African Reserve Bank, to the Southern AfricanGerman Chamber of Commerce and Industry, Cape Town, 13 July 2001. * 1. * * Introduction Good afternoon ladies and gentlemen. I thank you for inviting me here to address you today. I stand before you at a rather uncertain global economic time. But despite the world economic slowdown and the question marks over future growth prospects, trade between South Africa and Europe has been on the increase. The Euro area has been less affected by the global slowdown, and South Africa, with its close ties to the region, has also been somewhat cushioned. South African imports from Europe rose by 20 per cent in April 2001 compared with April 2000. South Africa’s exports to Europe rose by 34 per cent over the same period. Likewise, South African-German economic relations have prospered over the past year. In 2000, trade between South Africa and Germany reached an all time high with combined trade amounting to DM13,4 billion, or R50 billion at the current exchange rate. South Africa’s imports from Germany increased by 19,9 per cent and South Africa’s exports to Germany rose by 23,2 per cent last year. This was the fifth consecutive year where South African exports showed double-digit increases. Semi-finished and chemical products were among the South African exports that showed significant increases. The biggest growing import items were manufactured products such as vehicles and transport equipment as well as machinery and electric equipment. Clearly, Germany remains one of South Africa’s significant trading partners and German companies continue to invest substantially in this country. Chambers of Commerce and Industry undoubtedly enhance the strong bilateral and trade relations between the two countries, such as yourselves. I see that over the past four years you have extended your activities to the neighboring countries in the Southern African Development Community to include Botswana, Malawi, Namibia, Seychelles, Tanzania and Zambia, to name just a few. By viewing the region as a whole, you share our broader vision of closer regional ties. SADC, as a region, strives to achieve economic growth and development through sound economic policies and cooperation. Within this the South African Reserve Bank plays a pivotal role. It chairs the Committee of Central Bank Governors in SADC. This Committee focuses on issues of financial policy and investment, development finance and macro-economic policies – important to boost the economic integration of the region. Regional integration will give the region a stronger platform from which to participate in the global economy. For the remainder of my time with you, I am going to give you some observations on the recent economic developments in South Africa. This may give you an indication as to what the short-term holds. But first let me return to the trends in the global economy. Forecasts of slowing growth abound. In the IMF’s world economic outlook published in April this year, it noted that prospects for global growth had weakened significantly since 2000. However, of some comfort is that the IMF expects the slowdown to be short-lived. The second half of the year should see a pick up in US economic activity, growth in Europe is expected to remain “reasonably robust”, and recovery in Japan is forecast to resume next year. Japan faces the challenge of addressing structural weaknesses, especially in its financial and corporate sectors. This global slowdown is bound to affect emerging market economies. And with this in mind, we must be vigilant. In this environment, commodity prices, upon which so many developing countries depend, are expected to weaken. Indeed, the IMF notes, that prospects in these developing markets, like South Africa, depend on maintaining investor confidence. However, the IMF acknowledges that these markets have made significant progress in reducing their external and financial sector weaknesses. Many of them have moved towards sustainable exchange rate regimes and prudent debt and reserve management policies. Against this backdrop of slowing world economic activity, the Reserve Bank’s composite leading business cycle indicator regained some momentum in the three months ending February. Similarly the composite coincident business cycle indicator was on a definite upward trend from May 2000 to February 2001. Preliminary indications are that this upward momentum persisted in the following months. However, by the end of the first quarter it became clear to us at the Reserve Bank that South Africa could not escape the world economic downturn as weaker international demand affected export volumes in the first quarter. 2. Domestic output and domestic expenditure The decline in export volumes contributed to a decline in economic growth. From 4 per cent in the third quarter of last year, growth slowed to 3 per cent in the fourth quarter. Growth fell further to 2 per cent in the first quarter of this year. The slowing growth was largely restricted to the agricultural sector in the fourth quarter of 2000. However, by the first quarter of this year, the weakness reached other sectors of the economy. Agricultural output dropped at an annualised rate of 6 per cent in the first quarter, coming off a high base. Although mining output rose slightly, this was not near the levels seen at the beginning of 2000. Demand for platinum and coal remained firm but diamond stockpiling continued in the face of weaker demand. Of some worry is that the sector that bore the brunt of the slowdown was the manufacturing sector. The growth rate in this sector slowed down from an annualised 4,5 per cent in the fourth quarter to a mere 1 per cent in the first quarter. This is somewhat puzzling because there appears to be strong demand for manufactured goods. Domestic demand remained strong in the first quarter with household and government consumption expenditure rising. However, the growth in real fixed capital formation and inventory investment accelerated. However, it was net inventory investment which slowed down the growth in aggregate spending in the fourth quarter of 2000. An acceleration in inventory levels followed in the first quarter of 2001. This suggests that producers are positive about South Africa’s future growth prospects and anticipate an increase in domestic demand. Household spending was still holding firm in the first quarter of 2001. Real final consumption expenditure by households increased at a quarter-on-quarter seasonally adjusted and annualised rate of 3 per cent in the first quarter, slightly lower than the 3,5 per cent recorded for the fourth quarter of 2000. The weakness was mainly due to a slowdown in spending on services other than communications services. A rise of 28% in the purchase of cellular telephones over the past year was not enough to cushion this. The real gross fixed capital formation accelerated steadily in the 12 months to the first quarter. The private and general government sector registered high fixed capital formation but there was a decline in the public corporations sector. The private sector continued to expand communication infrastructure. General government also increased their outlays on infrastructure spending, although from a very low base. Total fixed capital formation amounted to approximately 15,5 per cent of GDP in the first quarter. 3. Employment and labour remuneration South Africa is labouring under a scenario of low growth that appears insufficient to create the levels of employment we would like to see. However, it must be remembered that a drop in formal unemployment does not necessarily imply an equal rise in the number of the unemployed. Often those who are no longer employed in the formal sectors of the economy enter the informal sectors or become self-employed. From 1999 to 2000, employment fell in the formal private and public non-agricultural sector. On average, public sector employment fell by 4,1 per cent in 2000. Non-agricultural private sector employment fell by 2,0 per cent from 1999 to 2000. The findings of the September 2000 Labour Force Survey, which measures total employment and unemployment and tracks the trends in the labour market, concluded that 25,8 per cent of the economically active population was unemployed. Wage growth presents a mixed picture. Nominal wage growth in the private sector amounted to 8,8 per cent in 2000. This is the lowest rate of increase in the past 30 years. However, public sector pay increases outstripped the private sector. On average, public sector employees earned 9,4 per cent more in 2000 than in 1999. But, on the positive side, labour productivity has been rising in the formal non-agricultural sectors. This is partly due to efficiencies gained from new technologies. On average labour productivity growth reached 6,0 per cent in 2000 – the highest rate of increase in thirty years. As a result of the robust growth in labour productivity and moderate increases in remuneration per worker, the growth in nominal unit labour costs in the manufacturing sector slowed down to a year-on-year rate of just 0,8 per cent in 2000. This has important positive implications for price stability and inflation. 4. Prices The South African Reserve Bank introduced inflation targeting last year. Within this framework, we target CPIX inflation, which is headline consumer inflation excluding mortgage costs. This measure of inflation must fall between 6 and 3 per cent on average in 2002. In assessing the inflation outlook, we look at many aspects. These include global oil prices, which has been a main driver of inflation recently, the exchange rate of the rand, private sector demand and nominal unit labour costs, among other factors. During last year there was a significant rise in prices because of pressure from food and energy prices. At our Monetary Policy Committee meeting in the middle of June we reduced the repo rate by 100 basis points. This caused the commercial banks, in turn, to drop their consumer interest rates. The repo rate decision was based on a number of factors. Among these were clear indications that consumer and production price inflation was slowing. Measured from quarter to quarter, seasonally adjusted and annualised, CPIX inflation came down from 8,8 per cent in the second quarter of 2000 to 6,1 per cent in the first quarter of 2001. The moderation in price increases was mainly the result of more moderate rises in food and energy prices, which had shown exceptionally large increases in 2000. More fundamentally, the slowdown in inflation was related to the moderate rise in unit labour costs over the past two years. In our Monetary Policy Committee statement we noted that with continued fiscal and monetary discipline, the target range of inflation in the year 2002 was achievable. The rate of imported inflation in production prices has declined from 15 per cent year-on-year in December to 11,8 per cent in May. Inflation in domestically produced goods slowed from a year-on-year rate of 8 per cent in November 2000 to 7,5 per cent in May. This was largely because of declining food prices which had a positive impact. Similarly, the headline CPI accelerated from 1,7 per cent in October 1999 to 7,8 per cent in February 2001 but declined to 6,4 per cent year on year in May. Although we remain reasonably confident of meeting our inflation target, we nonetheless remain vigilant. There are some forces at work that may obstruct the gradual decline we have witnessed up until now. These include the faster growth in aggregate demand over output, uncertainties about the stability of the oil price, and possible delayed second-round effects from the rand’s depreciation of last year. Although the rand depreciated by 1,3 per cent during the first quarter of this year, it appreciated by 1,2 per cent against the basket of currencies during the second quarter. Against the dollar the rand depreciated by 5,9 per cent in the first quarter. However, during the second quarter, the rand depreciated against the dollar by only 0,6 per cent. 5. Exchange rate of the rand Having declined from a level of about R7,50 against the US dollar early in January 2001 to levels around R8,00 at the end of May, the rand seemed to stabilise against the US dollar in June. The monthly average exchange rate of the rand against the dollar in June 2001 was R8,05. However, from 3 July 2001 the rand weakened against the US dollar to a level of R8,2403 on 9 July reaching an all time low of R8,2456 in intra-day trading. Subsequently the rand declined further to a level of R8,34 on 11 July 2001. Since the beginning of the year, the rand has depreciated by about 9,5 per cent against the US dollar. This is in line with a weaker performance of most currencies against the dollar in the first half of the year. The general weakness of currencies against the US dollar is demonstrated by comparable depreciations of almost 8,7 per cent for the euro, 5,7 per cent for pound sterling and 8,6 per cent for the Australian dollar. On a trade-weighted basis, the rand is weaker by 3,6 per cent since the beginning of the year. A factor which has recently cast a shadow over the rand has been a general increase in risk-aversion by international investors. The increase in risk aversion is partly explained by weaker stock markets, a deterioration in the global economy and by developments in specific emerging markets such as in Argentina and Turkey. South Africa is certainly not the only emerging market to be impacted negatively. In particular, the currencies of Brazil, Turkey and Indonesia have been affected much more, and have declined by 28, 92½ and 18½ per cent respectively since the beginning for the year. 6. Foreign trade and payments South Africa’s surplus on the current account of the balance of payments widened from R2,5 billion in the fourth quarter of 2000 to R6,9 billion or 0,7 per cent of GDP in the first quarter of 2001. This was mainly because of the slight improvement in the trade surplus and a more substantial improvement in the services account. South Africa’s trade performance has been nothing short of stellar. The surplus on the trade account increased slightly in the first quarter from R37 billion in the fourth quarter of 2000. This goes some way to fulfilling our hopes of an export-led recovery for the South African economy. However, weaker global demand has caused the physical quantity of exported goods to decline by about 0,5 per cent in the first quarter of 2001 compared with the fourth quarter of 2000. But export prices in rand terms increased by 3,4 per cent over the same period. The country’s gold and foreign exchange reserves are on an upward trend, having risen from R69,1 billion at the end of December 1999 to R87,8 billion at the end of the first quarter this year. This is equal to 16 week’s worth of imports. The Reserve Bank’s net open forward position in foreign currency has been declining. We expect to see continued improvements in this position and we reiterate our commitment to reduce this position to zero, as and when circumstances permit. From US$13 billion at the end of December 1999 the NOFP fell to US$9 billion at the end of April. Our latest figures show the NOFP at just over half of that, US$5,3 billion, at the end of June. Of course, with foreign portfolio investment into South Africa remaining fairly volatile, we are obliged to rely on more permanent inflows. Foreign portfolio investment into South Africa changed from an outflow of R1,8 billion in the fourth quarter of 2000 to an inflow of R3,5 billion in the first quarter of 2001. The acquisition of portfolio assets by South African residents, i.e. an outflow of capital, declined from R3,1 billion to an estimated R0,2 billion over the same period. The growth in broad money supply has been on an accelerating trend since November last year. From year-on-year growth of 7,5 per cent in December, growth in money supply increased to 13,5 per cent in May. The low base for year-on-year calculations in 2000 explains the return to double-digit rates. Credit extension to the private sector, which forms the bulk of money supply in this country, registered rises of more than 11 per cent in the last three months of 2000. However, in the first five months of this year, credit extended to the private sector slowed to below 10 per cent. 7. Government finances The government’s revenues have been on the increase recently, mainly because of improved revenue collection. The result of the higher-than-budgeted revenue and close-to-budgeted expenditure for the 2000/2001 fiscal year was a deficit before borrowing and debt repayment equal to 2 per cent of GDP. This marked an improvement on the 2,3 per cent recorded in the previous fiscal year. The reduction in the deficit to below 3 per cent of GDP coupled with government debt below the 60 per cent level, which is deemed by the Maastricht Treaty participants as the level beyond which fiscal health is at risk, paint a robust picture. National government debt has decreased from 48,1 per cent of GDP at the end of March 2000 to 46,5 per cent at the end of March 2001. 8. Conclusion I will conclude by saying that within this economic picture, we at the Reserve Bank play a prominent part. By maintaining financial and price stability, through inflation targeting, we contribute towards the goals of sustained higher economic growth and the creation of employment opportunities. The primary role of monetary policy is to keep inflation in check, which is an essential ingredient in the recipe for sustainable economic growth. There is some reason for optimism about the prospects of economic growth. As we noted in our Quarterly Bulletin of June 2001 the economy has been in recovery mode since the third quarter of 1999 and yet it has not exhibited some of the imbalances typical of previous expansionary periods. Inflation is on a declining trend and unit labour costs are contributing to this. The household sector is in a financially healthier position and individual bankruptcies have fallen by 62% from April 2000 to April 2001. Bank balance sheets are sound. And the deficit on the current account of the balance of payments has turned into a surplus driven by the expansion in export earnings. I am convinced that the Southern African-German Chamber of Commerce and Industry can likewise make a contribution. By fostering trade and business ties between Southern Africa and Germany, and specifically targeting small and medium enterprises, which must be the job creators in this economy, you are contributing to putting this country and region onto a higher growth path. Africa is now part of the global economy, which brings its own pressures. Often these pressures are ones that we have no control over. We have a much more open economy, some trade barriers have come down and we are no longer politically isolated. With the transition to a democratic South Africa, confidence has begun to return with the mounting evidence that economic policies are prudent and transparent. It is on these foundations that we will continue to build upon. We count on you as our valued partners. Danke. Rea leboga. | south african reserve bank | 2,001 | 7 |
Address by Professor T T Mboweni, Governor of the South African Reserve Bank, at the University of South Africa, Pretoria, 23 August 2001. | T T Mboweni: Recent economic and financial developments Address by Professor T T Mboweni, Governor of the South African Reserve Bank, at the University of South Africa, Pretoria, 23 August 2001. * 1. * * Introduction Ladies and gentlemen, honoured guests. I wish to thank you for the honour you have bestowed on me by choosing me as the recipient of your award for Excellence in Managing the South African Financial Environment. In accepting this award and thanking you for extending it to me, I would like to make a few comments about the recent economic and financial developments in South Africa. I will touch on the recent price developments, the exchange rate, and developments in other emerging markets. 2. Recent economic developments Towards the end of 2000 the South African economy had not been seriously affected by the world economic downturn. But by the first quarter of this year, it became clearer that we would probably be adversely affected by the slowing activity in the major world economies. As we mentioned in our latest Quarterly Bulletin, published in June, the recorded decline in export volumes contributed to a slowing down in domestic growth from 3 per cent in the fourth quarter of last year to 2 per cent in the first quarter of this year. Although growth had already slowed from 4 per cent in the third quarter of 2000, the slowdown had largely been confined to the agricultural sector. But in the first quarter of this year, the weakness spread to other sectors of the economy. Of some worry is that the sector that bore the brunt of the slowdown was the manufacturing sector. The growth rate in this sector slowed from an annualised 4.5 per cent in the fourth quarter to a mere 1 per cent in the first quarter. This is somewhat puzzling because there appears to be strong demand for manufactured goods. Domestic demand remained strong in the first quarter with household and government consumption expenditure rising and growth in real fixed capital formation and inventory investment accelerating. The welcome acceleration in inventory levels followed a steep drop in net inventory investment from the third to fourth quarters of 2000. This suggests that producers are positive about South Africa’s future growth prospects and anticipate a sizeable increase in domestic demand. 3. Price developments Inflation in the prices of consumer goods and services moderated meaningfully in the first half of 2001. The year-on-year rate of increase in the consumer price index for metropolitan and other urban areas excluding mortgage cost (CPIX) - the benchmark indicator for inflation-targeting purposes - has declined from 8.2 per cent in August 2000 to 6.4 per cent in July 2001. This rate of increase is only 0.4 percentage points above the upper limit of the inflation target range of between 3 and 6 per cent set for 2002. When measured from quarter to quarter and expressed at an annualised rate, the shortterm pace of CPIX inflation has almost halved from 7.8 per cent in the first quarter of 2001 to 4.5 per cent in the second quarter. “Headline” CPI inflation or the year-on-year rate of increase in the overall consumer price index for metropolitan areas slowed down from 7.8 per cent in February 2001 to 5.3 per cent in July. Increases in the prices of consumer services decelerated quite significantly. In the case of housingrelated services, price increases moderated from a year-on-year rate of 8.1 per cent in February 2001 to 2.8 per cent in July. Housing-related services include mortgage rates, house rent and domestic workers' wages. Expressed at a seasonally adjusted and annualised rate, the rate of increase in the prices of all consumer services fell from 13.4 per cent in the first quarter of 2001 to only 4.2 per cent in the second quarter. Smaller increases in the prices of other services, apart from housing-related services, also contributed to the decline in the inflation in the prices of all consumer services. The year-on-year rate of increase in the prices of consumer goods fell back from 8.7 per cent in August 2000 to 5.2 per cent in July 2001. Declines in the price of food, which had risen steeply in 2000, helped to bring down the inflation rate. In contrast to the moderation in consumer price inflation, production price inflation has advanced at a firmer pace in recent months. Measured over periods of twelve months, the rate of increase in the all-goods production price index rose from 8.1 per cent in April 2001 to 8.6 per cent in May, June and July. The year-on-year rate of increase in the prices of domestically produced goods which had receded from 8.0 per cent in November 2000 to 6.9 per cent in April 2001, accelerated to 8.2 per cent in July. Rising food price inflation, though still at a modest level, contributed most to the pick-up in inflation in the prices of domestically produced goods. The higher inflation in the prices of domestically produced goods has been partly offset by a deceleration in the rates of increase in the prices of imported goods in recent months. Imported inflation, when measured over periods of twelve months, declined from 15.0 per cent in December 2000 to 9.2 per cent in July 2001. The decline in imported inflation over this period was primarily due to lower international oil prices and the increase in the value of the rand in May and June 2001. Coupled with declining inflation in trading-partner countries, this contributed meaningfully to the slowdown in imported inflation. 4. Exchange rate developments The performance of the rand/dollar exchange rate has been disappointing in recent times. It has traded between R8.01 on 4 July 2001 and R8.45 on 22 August. Whilst I have often said that commentators should focus on the trade-weighted value of the rand, as a deterioration in the value of the rand against the US dollar might merely reflect the strength of the US dollar on the international exchanges, the traded-weighted value of the rand has also succumbed to negative sentiment. It is currently around 8 per cent weaker than at the end of last year. Why is the exchange rate of the rand currently under pressure? The reasons cited in the market are the following: in the first instance, currencies perceived to belong in the emerging markets asset class have been adversely affected by, in particular, developments in Argentina and Turkey. There are concerns in the market that, notwithstanding the official aid packages, with their accompanying conditionalities, Argentina’s economic problems could prove difficult to resolve. Sentiment towards the rand has been clearly affected by fears of contagion. Secondly, developments in Zimbabwe, in particular with respect to their land-reform programme, have also been cited as explanatory factors. The impact of these developments was compounded this week following a report on Bloomberg. Mr Thami KaPlaatjie, Secretary-General of the Pan-Africanist Congress of South Africa, reportedly supported Zimbabwe’s approach to land reform and criticised those who oppose it as negating the interests of Africans. Furthermore, he reportedly also told journalists that the problem of land in South Africa will, when it explodes, be of enormous proportions - “too ghastly to contemplate” were his words. (I believe Mr KaPlaatjie was not speaking in his official capacity but, I must stress, the damage was done.) I would like to repeat what I said yesterday at the Annual African Investment Conference held in Stellenbosch. I am concerned that developments in Zimbabwe have tended to have an adverse effect on our markets, in particular our currency and bond markets. I would like to reiterate that firstly, the land question in Zimbabwe needs to be resolved in accordance with the law and in an orderly fashion which finds a solution that is beneficial to the political and economic imperatives of Zimbabwe and the region. Secondly, the current state of restlessness in Zimbabwe should really be brought to an end to allow the economies of Southern Africa to stabilise. Thirdly, our markets need to learn to differentiate between developments in one Southern African country and another. Here in South Africa the political leadership has consistently stated that land reform will take place according to the law as guided by the Constitution and the need for historical redress and food production. I hope the market players are listening to what is being said. Fourthly, from the Reserve Bank’s point of view we are highly appreciative of the efforts of the Southern African Development Community in trying to assist in a resolution of the Zimbabwean question. And finally, we should always be aware that the financial markets are affected by a multiplicity of factors, not just one factor. Since developments in one emerging market will from time to time affect another, it is therefore important that emerging markets design their policies and programmes to receive the maximum benefit from globalisation. An “injury to one tends to be an injury to all”. The final factor which has been mentioned in the market has been the perceived increase in strike action and threatened labour unrest. Of course, the rand sometimes is pressurised by the perception that it is a “commodity currency”, or concerns may emerge regarding the privatisation process in South Africa, or regarding the so-called NOFP, the net open foreign currency position of the Reserve Bank. Movements in the value of the rand can also, of course, be exacerbated by pure speculative trading activity in the foreign exchange market. Undoubtedly, however, the first three factors I mentioned earlier have dominated market sentiment and commentary in recent days. I believe that the pressures on the rand are really, truly and honestly overdone. Cognisance has to be taken of South Africa’s sound economic fundamentals to allay these contagion fears which might emerge if economic conditions in Argentina, Zimbabwe and Turkey deteriorate. Secondly, the South African Government has given a clear and unequivocal commitment to the rule of law and has recently been seen implementing court decisions without delay in respect of a land-occupation problem at Bredell. Fears regarding any land-reform programme in South Africa are unfounded. The best defence of a currency lies in the economic management of the country. South Africa pursues and will continue to pursue prudent macro-economic policies. I have no doubt that a carefully considered analysis of South Africa will lead to a retracement in the value of the rand’s trade-weighted index. 5. Developments in other emerging markets The increase of international financial transactions and international capital flows has brought with it an increase in the potential risks of a reversal. This sudden and large reversal of short-term capital flows has caused international financial crises in Mexico (1994-1995), Asia (1997-1998), Brazil (19981999) and more recently in Argentina and Turkey. Argentina’s economic performance deteriorated significantly from mid-1998 in the aftermath of the Asia, Brazil and Russia crises. After a short-lived pickup in the last quarter of 1999, the economy again stagnated in 2000. This reflected the fiscal tightening on domestic demand, a drop in business and consumer confidence, and the progressive hardening of financing conditions in international markets. The government responded with a strengthened growth-oriented economic strategy aimed at promoting and ensuring medium-term sustainability of the fiscal and external financial situations. It centred on a strong commitment by the government to reduce fiscal deficits. The IMF supported this strengthened economic programme and increased Argentina’s access to IMF financing in January this year. Argentina also received new loan commitments from other sources. Favourable developments that followed the agreement on the programme and financing package were interrupted in early March 2001 by a new crisis. The principle catalyst was evidence of a major deterioration in the fiscal performance, but internal political disagreements and increased uncertainty in international markets were contributing factors. In June 2001, the government completed a nearly US$ 30 billion debt exchange with its major domestic and international creditors. Argentina’s financial conditions improved somewhat but this proved to be temporary and Argentina’s financial asset prices started falling in mid-July 2001 as analysts questioned Argentina’s ability to meet payments on almost US$ 130 billion public debt. President Fernando De la Rua tried to reassure investors in July by announcing a series of strict measures to cut government spending and limit tax evasion. Argentina’s stocks, however, fell sharply thereafter as investors questioned President De la Rua’s proposed spending cuts and other economic measures designed to reduce Argentina’s ballooning deficit. This package of measures, designed to achieve a zero fiscal deficit, was finally approved by Argentina’s Congress at the end of July 2001 after much debate. Fears of a regional crisis in Latin America, however, eased when Horst Kohler, the IMF’s managing director, this week informed the Executive Board of the Fund that he was prepared to recommend an augmentation of Argentina’s current stand-by credit facility by approximately US$ 8 billion to about US$ 22 billion. Similarly, Turkey’s economy experienced considerable growth since 1994 but had entered a recession by 1999 as a result of tight fiscal policies and the earlier Russian crisis. With high public deficits and a public sector making net payments of external debt after 1994, the pressure grew on Turkey’s financial markets. The lack of depth of these financial markets and the volatile inflation rate paved the way for sustained high real interest rates. The high real interest rate paid on domestic debt therefore increased the borrowing requirements of the public sector. All this created a vicious circle of debt and interest payments, pushing Turkey into an ever more difficult financial position. The deterioration of the public financial balance, the rise in domestic debt due to continued high real interest rates, the acceleration of inflation rates and the continuing economic contraction made it necessary to embark on a medium-term economic austerity programme. This programme was designed to free Turkey from high inflation, restore macro-economic fundamentals and address structural weaknesses in the economy. For most of 2000, the government’s economic programme made good progress. Consumer price inflation declined rapidly from 68.8 per cent in January 2000 to 33.4 per cent in February 2001, the lowest level since 1986. GNP growth also accelerated sharply from a contraction of 6.1 per cent in 1999 to an expansion of 6 per cent in 2000. However, a severe banking crisis in late November 2000 was accompanied by a massive capital outflow. The crisis was triggered by liquidity problems in some medium-sized banks, which had positioned themselves aggressively for continued declines in interest rates. The underlying cause of the crisis, however, appears to be the significant deterioration in the current account and the delays in the privatisation programme which were causing interest rates to rise from September, and more markedly from around mid-November 2000. The severe liquidity squeeze and growing bank distress was accompanied by pressure on overnight interest rates and government bond yields. The capital outflow was only halted, and devaluation fears allayed when the IMF announced in December 2000 an additional US$ 7 billion to alleviate the balance of payment difficulties stemming from the recent crisis. Interest rates declined and there was a modest rise in capital flows in January 2001. In February 2001, a second financial crisis was triggered by a political dispute between Prime Minister Bulent Ecevit and President Ahmet Necdet Sezer. The dispute raised concern that the country’s threeparty coalition government might collapse and raised doubts about the authorities’ commitment to reform. Market confidence in the system was shattered and the Turkish lira faced a fresh major attack in February 2001. The central bank spent US$ 4.5 billion, one sixth of its reserves, to defend the lira. These attempts, however, failed to restore confidence and the Turkish authorities decided on 22 February 2001 to allow the lira to float freely. Turkey’s economic programme was again strengthened following the crisis that led to the floating of the lira. The new economic framework included increased transparency, accountability and good governance in both the private and public sectors. The improved programme aimed to strengthen the primary fiscal position of the public sector, reduce the government’s immediate borrowing requirement and address major bank restructuring. Market sentiment, however, again started to deteriorate in early July 2001 when the IMF postponed a portion of the Turkish loan. The differences between the IMF and the Turkish authorities were fortunately resolved and the IMF approved the eighth review of Turkey’s economic programme supported by the three-year Stand-By Arrangement on 12 July 2001. The IMF’s Executive Board also completed the ninth review of Turkey’s economic programme on 3 August 2001. This decision will enable Turkey to draw an additional US$ 1.5 billion from the IMF. The IMF is convinced that there are encouraging signs that the economic downturn in Turkey is bottoming out, and that the targeted lowering of inflation is materialising, which could permit declines in interest rates. The IMF is also encouraged by the considerable progress in the structural reform agenda, especially in restructuring the banking system. However, the Turkish lira has again started to depreciate rapidly since the beginning of August as confidence in Turkey’s ability to repay US$ 26 billion of debt (before the end of this year) has been shaken by repeated disputes between members of the governing coalition. The Turkish authorities have also decided to formally make an inflation target the nominal anchor of Turkey’s monetary policy beginning in the fourth quarter of this year. The effects of the Mexican, Asian and Russian crises spread from one country to another in a process commonly known as contagion. But in this case, the available evidence indicates no broad-based contagion from Argentina and Turkey to emerging markets in general at this stage. However, according to the IMF, the potential for broader-based contagion still remains. Concerns about Argentina did spill over into the region, notably to Brazil, which is also suffering from domestic difficulties. I once again appeal to our markets to judge South Africa on its performance and not on the basis of emerging market perception. And once again, my heartfelt thanks to you. | south african reserve bank | 2,001 | 8 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Gala Banquet of the Independent News & Media International Advisory Board, Cape Town, 6 February 2002. | T T Mboweni: Globalisation and implications for monetary policy in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Gala Banquet of the Independent News & Media International Advisory Board, Cape Town, 6 February 2002. * 1. * * Introduction In December last year, I was invited to give evidence on globalisation before the Economic Affairs Sub-Committee of the House of Lords, Westminster. I was naturally pleased with the invitation and took advantage of the occasion to engage the Lords and Ladies about how globalisation impacts on the fortunes of developing countries or the so-called emerging markets. All of us use the term globalisation everyday and so do the Lords and Ladies at the House of Lords. Everyone has their understanding of what the term is all about and how globalisation impacts on all of us. The Lords and Ladies wanted to know from me what the positives and negatives of globalisation were on South Africa. This evening, at this gala banquet for such a gathering of eminent persons of the International Advisory Board of the Independent media group, I can only highlight certain aspects of globalisation in order to contribute to the table discussions, fully aware that after such intensive meetings all of us want a relaxed evening. I have of late often wondered what the difference in substance is between globalisation and imperialism. After some casual analysis, it seems that the two differ with respect to colonisation, division of the world into spheres of influence and the intensity and level of the dominance of finance capital in the world economy. Globalisation could generally be taken to encompass the more liberalised and increased flow of goods, services, capital and finance across national economies. Globalisation is therefore not a new phenomenon. The degree of economic integration in the world has been rising over time. Technological progress has improved transportation and communications, enhanced information awareness and information processing, and has set the stage for new products and innovations. These developments make it much easier for national markets to be globally integrated. Although these markets still do not form a global village, they have become so interdependent that they are changing the environment in which economic activity takes place. This new economic environment has, however, also brought about certain disadvantages, such as large reversals in international capital flows and financial contagion even on those countries with sound economic fundamentals. These developments have led to protests against "global capitalism". Demonstrations against globalisation are particularly strong at meetings of the IMF, World Bank, G8 and the World Economic Forum. Despite these demonstrations, global economic integration today is far greater than it has ever been and is likely to become even stronger in the coming years. 2. The impact of globalisation on South Africa The re-entry of South Africa into the globalised financial markets and the opening up to international competition led to a sharp increase in the participation by non-residents in the domestic financial markets. Non-residents are now responsible for about one-third of the turnover on the JSE Securities Exchange SA and approximately one-eighth of the volumes on the South African Bond Exchange. This has caused share and bond prices, as well as the exchange rate of the rand to be increasingly influenced by developments in the rest of the world – particularly in emerging markets. These transactions by non-residents contributed materially to substantial increases in financial sector activity. Turnover on the South African Bond Exchange, for example, increased from R2,0 trillion in 1995 to R12,4 trillion in 2001, while the total value of shares traded on the stock exchange rose from R63 billion to R606 billion over the same period. In the foreign exchange market volumes increased from a net average daily turnover of US$2,7 billion in 1995 to US$9,6 billion in 2001. Market activity was still fairly brisk in November and December last year, with the net average daily turnover averaging US$8 billion. Integration into the world financial markets required a major restructuring of the institutional arrangements in the South African capital markets. The JSE Securities Exchange SA introduced reforms to provide for corporate ownership, foreign ownership of stockbrokers, dual capacity trading, negotiated commissions, and electronic screen trading. The securities exchange is continuing to improve its facilities by providing for the immobilisation and dematerialisation of shares, and for improved clearing and settlement arrangements. These changes and the substantial increase in portfolio investments and trade finance by nonresidents contributed to a large inflow of capital but also resulted in greater volatility in the capital movements between South Africa and the rest of the world. A nearly consistent net outflow of capital of R48,3 billion in the period from 1984 to the middle of 1994 was turned around to a net inflow of capital of R61,3 billion from 1995 to 2000. However, this inflow of capital fluctuated sharply from R16,6 billion in 1995 to R3,0 billion in 1996, R21,3 billion in 1997, R8,8 billion in 1998, R29,3 billion in 1999 and R8,2 billion in 2000. The large inflow of funds over the past few years has enabled the Reserve Bank to increase the official reserves of the country from the equivalent of 6 weeks’ worth of imports of goods and services in 1994 to 20 weeks’ worth at the end of September 2001. The increase in the country's official reserves in recent years also made it possible to substantially relax exchange controls. South Africa's re-entry into the international economy and structural changes implemented in the country provided a platform for improved economic growth. An uninterrupted series of 17 quarterly increases in the real gross domestic product came to an end in the third quarter of 1998 when total real value added in the economy declined at an annualised rate of 12 per cent. This setback was short-lived and aggregate output recovered in subsequent quarters. For the period 1994 to 2000, growth in the real gross domestic product averaged 2½ per cent. Trade reforms and the restructuring of some domestic assets increased domestic competition. However, the higher growth in domestic production was achieved with only a moderate increase in total employment, while employment in the formal non-agricultural sectors continued to decline – an issue of extreme concern to all of us. The re-integration of the South African economy was accompanied by shifts in the economic structure of the country. The relative share of agriculture in gross domestic product declined from 5 per cent in 1994 to 4 per cent in 2000. The share of mining in gross domestic product therefore declined from 7½ per cent in 1994 to 6 per cent in 2000. Although the contribution of the manufacturing sector to GDP has declined from 21 per cent in 1994 to 18,5 per cent in 2000, the real value added by this sector grew by an annual average of 2 per cent for the same period. The sector was buoyed by strong consumption spending from 1994 to 1997. Trade reform increased manufacturers' access to international markets, but at the same time increasingly exposed the sector to competition. The rollout of infrastructure to previously disadvantaged communities ensured continued growth in the electricity, gas and water sector since 1994. The tertiary sector's share of gross domestic product increased significantly from 60 per cent in 1994 to 65 per cent in 2000. This growth can be attributed to an expansion of the transport sector, improved telecommunications infrastructure and growth in the financial and business services sector. Growth in the latter sub-sector was driven by the intermediation of large capital inflows, a substantial investment in the local market by foreign financial institutions and an increased cross-border provision of financial services. 3. Challenges of globalisation in South Africa Globalisation offers people the opportunity to improve the quality of their lives through increased trade and financial integration among countries, lower communication and transport costs and technological change. However, these opportunities are mainly available to those people who are highly educated or have highly developed skills and have access to well-functioning labour and capital markets. Many people are not as privileged and are therefore excluded. South Africa's challenge has been to ensure that the marginalised parts of the community are included in the process of growth and development. Government’s key priorities have therefore been investing in people through better schooling, skills development, extending municipal infrastructure, targeting support for industrial clusters, small business development, strategic trade linkages, extending electrification and telecommunication networks. 4. Globalisation and monetary policy The reintegration of South Africa into the world economy and the liberalisation of financial markets also have important implications for structured finance. As Bill McDonough president of the New York Federal Reserve Bank pointed out in 1998: "The technology for processing information and making this information widely available has fundamentally altered the way the world channels saving into investment. No longer does the global economy rely primarily on loans from commercial banks to meet its financing and investment needs. Rather, more than ever before, the global economy of today looks to funds from the fixed-income and related capital markets to intermediate its credit needs. Because the global capital markets have become so important in the credit intermediation process, the economic well-being of us all depends on the orderly flow of funds in these markets. The flow of these funds, in turn, increasingly relies on price signals generated by trading activity that takes place daily in these markets. The reliance on secondary market trading for price discovery constitutes the fundamental difference between funds from securities markets and loans from banks." This change in the way that savings are channelled to investments has resulted in greater volatility in international capital movements. Recent non-resident transactions on our Bond Exchange are a clear reflection of this greater volatility in international capital flows. In such a situation, it is more important than ever before to create and maintain a sound environment for investment in a country. This makes it more imperative for monetary policy to pursue clearly stated objectives. Increasingly throughout the world, central banks are pursuing price stability as their basic policy focus. Where countries have high rates of inflation which are out of line with the rest of the world, disruptive capital flows could occur because of fears of currency misalignments. The closer integration of the world economy has therefore focused the ultimate objective of monetary policy and made it even more important to attain this objective. It should, however, also be realised that such a policy stance does not provide unconditional protection against speculative capital outflows. External economic shocks or perceived poor policy measures can still trigger a reversal in capital movements. Monetary policy cannot prevent these reversals. International investors make their decisions on the basis of a wide variety of developments, including price stability. The best approach that central banks can follow is to pursue financial stability in a transparent and accountable manner so that they can at least forestall any uncertainties in this regard. Although the objective of monetary policy has been better focussed within the context of globalisation, the integrated world economy has resulted in a more complex mechanism for transmitting monetary policy. The relationship between changes in interest rates, money supply and inflation has become less clear under these new conditions, compared with the period when South Africa was more isolated from external influences. As a result of large international capital flows, the effects of policy changes are being transmitted to a greater extent through critical indicators such as bond yields and exchange rates. These changes in the transmission mechanism of monetary policy have reduced the credibility of the money supply as an intermediate guideline for policy. The integration of financial markets and financial innovations made the demand-for-money function less stable. This was clearly reflected in a consistent decline in the income velocity of circulation of M3 of about 13 per cent from 1994 to 2000. The income velocity of circulation of M3 continued to decline strongly in the first three quarters of 2001. The money supply accordingly became a less reliable anchor for monetary policy. Volatile capital movements further complicate the transmission mechanism under floating exchange rates, because of the impact that exchange rate changes have on the foreign transactions of a country. In a closed economy, the transmission mechanism runs from increases in the repo rate and other short-term interest rates through to longer-term interest rates and asset prices and then to aggregate demand and prices. The open economy version of the transmission mechanism under floating exchange rates runs from interest rates, to nominal exchange rates, to the absolute and relative prices of tradeable goods and eventually to the prices of non-tradeable goods. In view of this more complicated transmission mechanism in a reintegrated global economy, the Reserve Bank has had to reconsider the framework that it applied in pursuing price stability. Informal inflation targeting using intermediate money supply guidelines was obviously no longer suitable in the changed international environment. In February 2000 the authorities therefore decided to adopt inflation targeting as the formal monetary policy framework of the South African Reserve Bank. In addition, considerable effort was made to increase the transparency of monetary policy. 5. Conclusion Global economic integration has led to new and more complex relationships between macroeconomic variables. There have been significant changes in innovation and productivity which call for revisions of the existing economic models. Global economic integration allows new macroeconomic conditions to be transmitted rapidly and extensively through new channels. Central banks increasingly confront new and rapidly changing technologies and methods of payment. There are several kinds of uncertainty and, therefore, different types of information are needed. These include information on the current state of the economy and information on how the monetary policy instruments affect inflation and economic activity. From the above discussion it is apparent that although the reintegration of South Africa in the world economy has brought many advantages to South Africa, it has also forced more discipline on the management of the economy and on business enterprises. In an international economy any doubts about the appropriateness of economic policy, quickly become apparent in international investors' decisions. Ill-judged economic policy measures can lead to painful adjustments forced on economies through the actions of participants in the markets. I remain optimistic about the benefits our country will derive from engaging in the globalisation process and the constructive role that monetary policy will play in this process by ensuring financial stability. We are also witnessing the global acceptance by political leaders of the independence of central banks as a critical factor for credible monetary policy. There are greater responsibilities on all sides. Just as the public sector is being called upon to change and improve codes of good practice, so too the private sector has to follow suit by complying with these international norms and codes of good practice. I thank you. | south african reserve bank | 2,002 | 2 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Nieman Society of Southern Africa Annual Dinner, Cape Town, 9 February 2002. | T T Mboweni: Prospects for the global economy in 2002 Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Nieman Society of Southern Africa Annual Dinner, Cape Town, 9 February 2002. * 1. * * Introduction Ladies and Gentlemen. I thank you for inviting me to speak at this, your annual dinner. I congratulate you as a group of individuals who have been recognized for your excellence. You have a responsibility to continue this pursuit of excellence. Indeed, this should be a guiding characteristic for all of us. The year 2001 can appropriately be described as a depressing year. It started with the sudden cut in the US Federal Funds rate, which marked the first official acknowledgement of the unexpectedly sharp and sudden downturn in the US economy. The slowdown of the US growth juggernaut after almost a decade of exceptional growth had a profound effect on most countries and regions. Initially there was a widespread belief that the euro area would be insulated from the fallout, given the high levels of intra-regional trade. It soon became clear that this optimism was misplaced, and that Europe would not replace the US as the locomotive for world growth. Not surprisingly, most emerging markets followed soon after. This was particularly the case in the technology-dependent Asian countries which were badly affected by the bursting of the Nasdaq bubble. The generalised slowdown was further exacerbated by the tragic events of September 11, which turned out to be the low point of a bad year. Although 2002 started off with many economies either in recession or close to it, the mood is one of cautious optimism that the worst of the global downturn is behind us. Growth forecasts are being continually revised by all the major fund managers and multilateral organisations. The latest forecast from the International Monetary Fund in December is for world growth of 2,4 per cent, the same as for 2001. However this figure was marked down significantly from the 3,5 per cent predicted in the October World Economic Outlook (WEO). The latter forecasts had been prepared before the September 11 events. Despite the significantly lower global growth forecast, these numbers do assume a recovery from the second half of the year. 2. Increase synchronisation of cycles The current downturn has strongly reinforced the pivotal role of the US economy. Strong US growth had been instrumental in overcoming the Asian crisis of 1997/8. The story could have been very different had the US and Europe not been growing strongly at the time. In 2001 it was the locomotive itself that had stalled, resulting in a generalised world downturn. The nature of this downturn has implications for the future prospects for the world economy. Few analyses of the current downturn fail to mention the increased synchronicity of economic cycles across regions. In April 2001 the UNCTAD Trade and Development Report had argued that without a coordinated global policy response, the slowdown in the United States would produce a synchronous cyclical downturn in the world economy. In December the IMF World Economic Outlook remarked that a particularly disturbing feature of the current slowdown is its synchronicity across nearly all regions, "the most marked for at least two decades." The WEO attributes this partly to common shocks, (including the sharp oil price increases) and the bursting of the information technology bubble, both of which had a world-wide impact. Furthermore, increased international linkages, particularly in the financial and corporate sectors, have played an important role, and this is expected to be a continuing trend. Finally it is argued that the synchronicity of the downturn may also reflect delays in implementing structural reforms, notably in Japan and the euro area, resulting in these countries being less well placed to take up the slack when the long expansion in the United States came to an end. Although the downturn was strongly synchronised, there is less agreement as to whether this will apply to the recovery. There seems little doubt, though, that the US will lead the global upturn. Some analysts argue that although the downturn was synchronised, the US recovery would considerably precede the European and Japanese recoveries. Others argue that synchronisation on the downside means synchronisation on the upside as well. Early indications are that the emerging Asian economies are likely to be in the best position to follow a US manufacturing upturn. 3. Outlook for the United States The general consensus is that the US economy is likely to make a significant recovery by the middle of the year. If the forecasts are correct, it will have been one of the mildest US recessions ever. Although the WEO forecasts a US growth rate of only 0,7 per cent for the year, this assumes a considerable strengthening during the year and growth in the fourth quarter of 2002 is expected to be 2,5 per cent compared to the fourth quarter of 2001. A number of factors appear to confirm this imminent recovery. The lower oil price will play its part, and there are also signs that the US has reached the bottom of the inventory cycle. Higher equity prices and more positive consumer and business sentiment are also apparent in various surveys. Added to this is the fact that a significant amount of macroeconomic stimulus is on the way. Although the Fed appears to have ended its cycle of monetary easing, the full effects of the progressive declines in interest rates are still to be felt. Furthermore, fiscal policy changes are still being implemented. Although the tax reform bill got held up in Congress, the increase in government expenditure in the fourth quarter will compensate for this in the meantime. A further indicator of the turnaround is the recently released fourth quarter growth figures which were unexpectedly high and point to the possibility that the US recession may be over, or at the least that the worst is over. Underpinning this low but positive growth number of 0,2 per cent are sustained high levels of consumer expenditure, which account for almost two thirds of economic activity in the US. However we should be rather cautious before jumping to premature conclusions on the basis of these figures. Firstly, expenditure on durable goods increased by an unsustainable 38.4 per cent (quarter-on-quarter annualised) compared with an increase of 0,9 per cent in the third quarter. This was mainly due to the zero interest financing incentives offered on durables, particularly motor vehicles. Secondly, we should not be too surprised if the revised figures for the fourth quarter (due on 28 February) are significantly different to that of the provisional data which are "advance estimates". We need only think back to the third quarter of 2001 when the initial estimates for quarterly US GDP growth were an unexpectedly high at –0,4 per cent, whereas the final estimates were –1,3 per cent, more in line with the original expectations. Therefore the chances are good that the final figures for the fourth quarter will be significantly different to what has been published. Whatever the final figures, consumer confidence surveys do suggest that consumer confidence indices have reached their highest levels since August, suggesting that the worst may well be over. Despite increasingly positive indicators, analysts are, however, divided about the strength and the sustainability of the recovery in the US. There is a widely held view that the turnaround will either be subdued, or of limited duration, or even turn out to be a "double dip" if final demand does not respond to the initial inventory build-up. The basis for this view is the historically high level of debt of US households and corporations. It is argued that for a sustained recovery, consumer spending needs to rise significantly. However this will be constrained by the fact that debt-strapped consumers will have little scope for increasing levels of consumption which remained uncharacteristically high during the recession (and which contributed to the mildness of the recession). As The Economist recently noted, ‘the root cause of this recession was the bursting of one of the biggest financial bubbles in history. It is wishful thinking to believe that such a binge can be followed by one of the mildest recessions in history- and a resumption of rapid growth.’ Notwithstanding the fears about private and corporate debt build-ups, the US Fed is fairly sanguine about the state of the banking system, a view widely shared by the optimists. At a meeting at the Bank for International Settlements earlier in 2001, US Fed officials argued that relative to other recessions the banking system was in a very healthy position. This could allow for a quick recovery as the banking system would not have to go through a period of restructuring and consolidation. Such restructuring inevitably holds up the pace of recovery for which bank credit is an important element. The relatively healthy state of the banking system is a major reason why the US recession is unlikely to become a Japanese-type deflation. 4. The Euro area The current downturn has shown that the euro area is more dependent on the fortunes of the US economy than was previously believed. Despite the high level of intra-regional trade, a significant proportion of trade between the US and Europe was between subsidiaries of multinational companies. According to IMF estimates, this related-party trade accounted for approximately 65 per cent of all US imports from Germany in 2000. Apart from this trade channel, increased European investment in the US made the euro area more vulnerable to declines in US profits and equity prices. These factors also make the euro area increasingly dependent on the US for a recovery stimulus. The IMF forecast for the euro area is 1,2 per cent for 2002, a full percentage point lower than projected in October. However within the euro area a fairly wide dispersion of growth rates is expected, with German growth expected to be a weak 0,7 per cent, compared to 1,3 per cent in France. A widely held view, echoed by the OECD Economic Outlook and the IMF is that in order to underpin a recovery and to raise potential output, Europe requires more structural reforms to overcome existing rigidities that characterise the region. The OECD Economic Outlook for example had argued that more needs to be done "to reduce rigidities, encourage labour supply, lower structural unemployment and improve the entrepreneurial climate. Product markets are also still too segmented and financial markets not well integrated….." Unlike in the US, there will be less reliance on direct macroeconomic stimulation. There appears to be little scope for fiscal stimulation in the face of increased budget deficits as a result of lower tax receipts and the need to maintain fiscal sustainability. As in many countries and regions, a disproportionately heavy burden for adjustment has been placed on monetary policy for macroeconomic stabilisation. The ECB has, correctly in my view, maintained a determined focus on inflation outcomes, and has had to endure criticism from a wide variety of quarters. But the bottom line is that the euro area, as elsewhere, cannot rely on its central bank to be the growth engine. 5. Japan Japan experienced two recessions and persistently low growth throughout the 1990s. Unfortunately the outlook for Japan remains negative, partly because restructuring of the banking system is taking longer than anticipated. Although the IMF expects a modest recovery later on in the year, for the year as a whole the economy is expected to contract by 1 per cent with continuing deflation. This outlook has a high level of risk, particularly on the downside. According to the WEO, a key concern is of a vicious cycle involving weakening growth, increased corporate bankruptcies and increasing concerns about the health of the banking sector. The roots of the Japanese crisis lie in the deregulation of the bond market which meant that the banks’ traditional corporate customers found cheaper financing elsewhere. The need for the banks to find new lines of business resulted in increased speculative property lending, at the height of the Japanese property bubble. In addition, lending was increased to borrowers in emerging Asian countries and the banks also bought equity at the height of the stock market boom. When the stock and property markets crashed, and the Asian crisis hit, the results for the financial sector were disastrous. Even before September 11, the Japanese economy had entered a new period of weakness, and is now effectively caught in a situation where the traditional macroeconomic responses are constrained. The low levels of interest rates mean that the Bank of Japan has limited scope for an effective response. Fiscal policy was seen as the main policy tool, but very quickly the debt to GDP ratio rose to alarmingly high levels at about 135 per cent, the highest in the OECD. This of course puts a brake on further fiscal stimuli, although tax reform measures have been mooted for later this year. At the same time the new reform programme committed the government to a reduced deficit at a time when unemployment had reached the highest levels in 34 years. Furthermore, discretionary fiscal actions could well be offset by higher household saving, due to increased concerns about long-term fiscal sustainability. Japan is not only in trouble due to problems with its banking sector, it also has suffered from the bursting of the IT bubble. Exports have declined significantly over the past year and continued weakness in the electronics market is expected. Most indicators remain negative, particularly in the manufacturing sector which is characterised by excess capacity, declining employment and falling inventories. Japan will be helped to some extent by an upswing in the US and Asia. What is clear however is that Japan will not be one of the locomotives of that upswing. Despite the rhetoric to the contrary, there does not seem to be the political will deal with the problem of the non-performing bank loans. This will have macroeconomic costs in the short-run, but the reform of the banking system and corporate restructuring is essential for the overall recovery of Japan. 6. Emerging markets Not surprisingly the downturn in the industrial countries resulted in widespread declines in economic activity in developing countries and a less favourable environment for international trade and financial flows. Weak global growth hits those economies most that are dependent on trade, irrespective of whether they are exporters of technology or manufacturing, or commodity exporters. Furthermore emerging markets are negatively affected by the decline in capital flows and the increased risk aversion of investors. The Institute of International Finance, for example, estimated inflows to emerging markets for 2001 at US$106 billion, compared with the earlier forecast of US$140 billion. The decline is ascribed to heightened risk aversion. Similarly, while world exports were expected to rise by 2,5 per cent last year, earnings of emerging markets were projected to decline by 2 per cent. 7. Asia The weakness of Japan is not only a problem for the broader global recovery, but for emerging Asia in particular. Most of the Asian countries have strong export ties to Japan and the continued weakness blocks off an important export destination. One factor that could offset this is the continuing emergence of China which has to a large extent been shielded from the downturn. At the East Asia regional summit of the World Economic Forum held in Hong Kong in October of 2001, developments in the Chinese economy dominated the discussions. Although the emergence of China was seen as positive for the region, it was also viewed with some trepidation in some of the countries, particularly Hong Kong. It is an irony that the most closed economies in Asia i.e. China and Japan, determine the future prospects of some of the most open economies in the world. Growth projections for Asia were also revised down by the IMF, with recovery delayed into 2002. The newly industrialised economies of Asian and ASEAN were badly affected by the lower European, Japanese and US growth and the collapse of the global electronics cycle, with Hong Kong and Singapore being particularly vulnerable, and Taiwan experiencing its first recession since World War II. These countries are only expected to grow by around 1 per cent in 2002. The forecast for the ASEAN countries for 2002 is 2,9 per cent, although for developing Asia the forecast is 5,6 per cent, buoyed by a 6,8 growth forecast for China. Although the outlook for this region is relatively bright, particularly given the lower dependence on external capital flows, its heavy exposure to the electronics cycle make it vulnerable to developments in that industry. 8. Latin America The outlook for Latin America remains overshadowed by developments in Argentina, but it appears that the worst of the contagion effects appear to be over. Although the Argentinean crisis was not caused by the general world downturn, the satisfactory resolution of the crisis in Argentina does have an implication for the general ‘risk appetite’ in the industrial countries, and therefore for capital flows to emerging markets in general. The adjustment in Argentina is likely to be painful, and drawn-out, and is likely to remain a source of economic uncertainty and instability for some time and the recession is expected to persist through 2002. Latin American growth in general is forecast to be 1,7 per cent in 2002, with Mexico having the lowest growth forecast at 1,2 per cent (apart form Argentina). Mexico’s membership of NAFTA makes it more vulnerable to economic downturn in the US, whereas other Latin American countries have greater trade exposure to Europe. External financing requirements are relatively large in this region, and growth prospects will therefore be affected by a resumption of ‘normal’ capital flows. 9. Africa The IMF’s growth forecast for Africa is a relatively high 3,5 per cent for this year. But a wide dispersion of growth rates is expected, reflecting variations in the mix of commodity dependence, economic policy developments and other country-specific influences. For example Mozambique is expected to grow by 8 per cent while the Zimbabwean economy is forecast to contract by around 6 per cent. Africa is expected to be affected most by developments in commodity prices. Oil exporters such as Algeria, Angola, Nigeria will be negatively affected by lower oil prices, although this will provide a cushion to oil importers. The view of the WEO however is that the growth outlook for many African economies is expected to be held back by falling prices of almost all non-fuel commodities, especially coffee and cotton. The stronger the general global recovery, the quicker these commodity prices are expected to recover. However the problem is that a strong global recovery could result in oil price developments that swamp the positive impact on many of the commodities that African countries are dependent upon. The IMF forecasts growth for South Africa at 2,3 per cent for 2002. Just as the rest of Africa will be affected by developments in commodity prices, so too will South Africa. 10. Conclusion In conclusion, the United States appears to be on the brink of a turnaround from what will have been a relatively short and mild recession. Unfortunately other countries were not so fortunate, and their recoveries remain dependent on the strength and duration of the US recovery. From a South African perspective, this bodes well for a recovery in commodity prices, and therefore an improved export performance. However there is always the risk that the prophets of doom will be correct and that the recovery in the US and therefore in the rest of the world will be short-lived. What the current recession has highlighted is the increased dependence of the world on the health of the US economy. Whereas there had been a view that the emergence of different trading blocs such as the EU and an Asian bloc (a tri-polar solution) could reduce dependence on the US, trade and financial linkages have become even stronger, thereby increasing the degree of synchronicity. The recession has also highlighted the disproportionate burden placed on monetary policy to bring about the required real adjustments. This raises a question of the efficiency of the current international financial architecture that renders the whole world increasingly dependent on the state of the US economy. Emerging markets are hardest hit as capital flows dry up precisely at times when they are needed. There is a need for global mechanisms to inject international liquidity into the world economy during times of stress. Reform of the international financial system is always on the agenda, but very little progress gets made. Discussions are intensified during times of crisis - following the Asian crisis there was much talk about reforms that would prevent a repeat of such crises. The resolution of the crisis reduced the urgency for such reforms. Similarly, the end of the current global recession will reduce the pressures for reform, particularly of financing arrangements, for emerging markets. But there is clearly something amiss with a system that is increasingly centralised. Unless there is concerted pressure for reform in the multilateral organisations, little will be done until the next crisis is upon us. There is a growing recognition that the fate of the world economy cannot and should not be left to the policy responses of the US to events in that country. Thank you. | south african reserve bank | 2,002 | 2 |
Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Founding Congress of the Executive Management Institute of Southern Africa, Johannesburg, 7 May 2002. | T T Mboweni: Recent economic developments Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Founding Congress of the Executive Management Institute of Southern Africa, Johannesburg, 7 May 2002. * 1. * * Introduction Ladies and Gentlemen. I am honoured to address the Founding Congress of the Executive Management Institute of Southern Africa and I thank you for the opportunity. I will first discuss international economic developments, before turning to the domestic economy. There have recently been encouraging signs that the global slowdown has bottomed out. The IMF also confirmed in the April World Economic Outlook that a global recovery is under way. Business and consumer confidence have strengthened, leading indicators have turned up, industrial production is levelling off, and commodity prices have begun to pick up. The United States is leading the upturn, but there are also signs of recovery in Europe and some countries in Asia. The recent global slowdown has drawn attention to the synchronisation of business cycles in nearly all regions. According to the Fund, the downturn has been the most synchronised in two decades. The IMF ascribes this synchronicity to common shocks such as the higher oil prices, the bursting of the information technology bubble and the tightening of monetary policies from mid-1999 to end-2000. Increased financial and corporate international linkages have also played a role. This, however, raises the question of whether the recoveries in different regions will be as synchronised as the downturn. The IMF forecasts projected global growth of 2,8 per cent in 2002, somewhat higher than expected in December 2001. The WTO projects that global merchandise trade will increase by 1 per cent this year following a 4 per cent decline in 2001. However, growth in the United States – and countries with close economic links to the United States – has been revised significantly upward, as the pace of recovery has exceeded expectations. The full impact of the pickup will only be felt in 2003 when global growth is expected to rise to 4,0 per cent. The Organisation for Economic Co-operation and Development (OECD) also recently projected that economic growth among its member states would be significantly higher this year than in 2001. OECD GDP growth is expected to accelerate gradually from 1,0 per cent in 2001 to 1,8 per cent and 3,0 per cent in 2002 and 2003 respectively. 2. Oil prices After surging to $32 per barrel at the end of 2000, crude oil prices weakened in 2001 with the slowdown in the world economy. The price of Brent crude reached a six-month high of $27 per barrel in early April 2002 as a result of the tension in the Middle East, the economic recovery in the United States, Iraq's 30-day sales embargo and a disruption in oil supplies caused by a strike at Venezuela's state oil company. However, with Saudi Arabia pledging to replace Iraqi exports and the ousting of the Venezuelan president fuelling expectations of a less stringent oil policy, the price dropped to $23 per barrel in the middle of April. With the return of President Chavez to power the oil price once again increased to levels above $27 per barrel. Crude oil prices, however, recently fell more than 1 per cent after Israeli forces pulled out of the Palestinian leader's headquarters, easing concern that the conflict may escalate and disrupt Middle East oil flows. 3. Prospects for the US Among the industrialised countries, the upturn is expected to be the strongest in the United States. This upswing is driven by a sharp turnaround in the inventory cycle, as well as substantial reductions in interest rates and tax cuts over the past year. In the first quarter of 2002 the United States economy grew at a seasonally adjusted and annualised rate of 5,8 per cent, following an increase of 1,7 per cent in the previous quarter and a contraction of 1,3 per cent in the third quarter of 2001. This is the strongest pace in more than two years underpinned by increases in consumer spending and the yearlong trend of sharp cutbacks in business inventories is showing signs of tapering off. The acceleration in real GDP growth in the first quarter of 2002 primarily reflected upturns in private inventory investment, exports and residential fixed investment. A gradual strengthening in business investment is expected to underpin the recovery in the second half of 2002 and into 2003. 4. Euro area and the United Kingdom The euro area economy had contracted at a seasonally adjusted and annualised rate of 0,7 per cent in the last quarter of 2001, but a gradual recovery is in progress with depleted inventories being rebuilt and international trade picking up. Growth in the euro area in 2002 is projected to be lower than in 2001, but the economy is expected to gain momentum in the second half of this year, and reaching 2,9 per cent in 2003. Inflation in the euro area is currently somewhat higher than expected as a result of the higher oil prices. The ECB warned that if the increase in oil prices is sustained, it would also have an impact on inflation rates during the rest of 2002. In the United Kingdom, for 2001 as a whole, real GDP growth averaged 2,2 per cent, the highest among the G-7 countries. The United Kingdom could, however, not avoid the global slowdown, which caused quarter-on-quarter growth in 2001 to decelerate registering zero growth in the fourth quarter of 2001. The economy, however, managed to recover marginally in the first quarter of 2002 with preliminary estimates showing that GDP increased by a seasonally adjusted and annualised rate of 0,3 per cent. Given the United Kingdom's significant exposure to economic and financial developments in the United States, improvements in the US economy are expected to positively impact on economic prospects in the United Kingdom. This will support continuing growth in domestic demand resulting from the more expansionary monetary policy since the beginning of 2001 and a fiscal stimulus, largely in the form of planned rises in general government spending. Growth for 2002 is expected to average 2 per cent. 5. Japan Japan continues to experience recession – the most severe of the past decade. However, the increasing economic activity in the United States and Asian economies has led to an increase in Japanese exports. This increase in exports, which accounts for about 10 per cent of the economy, recently prompted the Bank of Japan to raise its assessment of the economy for the second straight month – the first back-to-back upgrade in 19 months. The Japanese central bank stated in its April monthly report that the Japanese economy still continues to deteriorate as a whole, but concluded that the pace has moderated somewhat. 6. Emerging economies Recent economic attention on Latin America has focused on the crisis in Argentina and its implications for the rest of the region. Argentina's financial markets came under increasing pressure in 2001 because of the growing fear of a debt default and the end of the peso's peg to the dollar. A 66 per cent decline in the peso since the government abandoned a decade-old peg to the dollar in early January has triggered steep price increases. In March, inflation was 4 per cent (month-on-month), the highest in 11 years. Despite months of talks on an IMF sponsored recovery package, both the Argentinean government and the IMF remain divided on a number of issues. Contagion from Argentina to neighbouring countries has been limited, with the exception of Uruguay. With the exception of Argentina and Uruguay, Latin America should experience better growth as a result of the economic recovery in the United States and Europe. Economic growth in most developing Asian countries slowed significantly during the year as external demand deteriorated in 2001. However, despite being affected by weak external markets, some countries such as the People's Republic of China, India and Vietnam maintained relatively robust growth. In contrast, South Asian growth accelerated as slowing export expansion was offset by improvement in the performance of the agricultural sector. In Central Asia, growth was higher in 2001, in part because of large investments mainly in the energy sector. It seems that strong consumer spending in some of the Asian economies is providing some cushion against external shocks. In countries like South Korea, the Philippines, Thailand and Malaysia where interest rates were aggressively reduced in 2001, overall consumer spending rose much faster as exports fell. On the contrary, Hong Kong, Singapore and Taiwan (economies most hit by the global slowdown) saw consumer spending falling during the same period due to their reluctance in cutting interest rates. The Asian Development Bank, however, expects economic activity to recover in the second half of this year, following the revival of exports in the United States and a stabilisation of domestic sentiment. GDP in developing Asia is projected by the IMF to grow by 5,9 per cent in 2002, but as global economic growth gathers momentum; the economy is forecast to strengthened by 6,4 per cent in 2003. 7. Domestic economic developments Turning now to domestic economic conditions, recent events have been interesting to say the least. Against the extreme volatility in the financial markets, and in particular in the foreign exchange market, real-sector developments have been relatively stable. Growth in the real gross domestic product in 2001 as a whole amounted to 2,2 per cent, marginally exceeding population growth and signifying a small per capita increase. Focusing more closely on the second half of the year, the seasonally adjusted and annualised growth rate in real gross domestic product accelerated from 1 per cent in the third quarter of 2001 to 2½ per cent in the fourth quarter. This can be attributed to robust growth registered in the real value added by the non-primary sectors of the economy. While agricultural and mining output volumes contracted in the final quarter of last year, the other sectors expanded. Manufacturing in particular did well towards the end of last year, led by production of motor vehicles and parts, chemicals and basic metals. Manufacturing production rose at a strong annualised rate of 5½ per cent in the final quarter of 2001. Impressive output growth was also recorded by the transport, storage and communication sector where a third cellular telephone operator started business, by the financial services industry, and by the wholesale and retail trade sectors. The construction industry also at last seems to be recovering from the setbacks suffered in the late 1990s, and its real value added rose by 4 per cent in 2001 – double positive in that it also adds to the economy's productive capacity. On that score it is notable that in manufacturing, where the utilisation of production capacity is regularly monitored, the utilisation rate stood at 79,4 per cent in the fourth quarter of 2001. This is still more than four percentage points below the peak rate recorded in 1995, indicating sufficient productive capacity to accommodate a further output expansion. Some indications of bottlenecks in the transport sector are, however, worrying. While our capacity to communicate electronically is advancing in leaps and bounds, ordinary transport of people and goods sometimes seems to be a problem. Some of the construction industry's recent pick-up in activity will help to resolve that problem. Looking at real activity from the expenditure side, the growth in real final consumption expenditure by households accelerated from 2½ per cent in the third quarter of 2001 to 3½ per cent in the fourth quarter. This was mainly due to increases recorded in real expenditure on durable and semi-durable goods. Pre-emptive buying in anticipation of future price increases supported the level of durable purchases. The growth in real final consumption expenditure by general government accelerated somewhat from an annualised rate of 2½ per cent in the third quarter of 2001 to 3 per cent in the fourth quarter. This was concentrated in real spending on intermediate goods and services such as medicine. Following years of pruning real government outlays, the interest and debt burden of government has been brought down to the point where resources can be redirected towards more and better service delivery. Real gross fixed capital formation increased at a seasonally adjusted and annualised rate of 5½ per cent in the fourth quarter of 2001. The higher tempo of real gross fixed capital formation towards the end of 2001 was fairly widely dispersed, with the manufacturing, finance, mining and community, social and personal services sectors playing prominent roles. So far, the production and expenditure information for the first quarter of 2002 presents a bit of a mixed bag, with domestic vehicles sales for example down while manufacturing output continues to rise. Turning to the external sector, the rand's fortunes appear to have turned somewhat and the weighted exchange rate of the rand has recovered by some 13,45 per cent from 31 December 2001 to 7 May 2002. South Africa's foreign trade balance – our exports minus our imports - was adversely affected by the slowdown in the world economy. Somewhat disappointing trade balance data up to January 2002 were followed by strong trade surpluses in both February and March; the March surplus, seasonally adjusted, stood at a record level. The exchange rate depreciation has boosted South Africa's international competitiveness considerably, and producers are reacting to it. However, it remains essential to avoid the erosion through domestic inflation of this competitive edge. As a percentage of gross domestic product, the deficit on the current account of the balance of payments shrank from 1,1 per cent in the third quarter of 2001 to 0,3 per cent in the fourth quarter. For 2001 as a whole the deficit amounted to R1,7 billion or 0,2 per cent of gross domestic product. Import cover, defined as the value of gross international reserves relative to the value of imported goods and services, improved from 20 weeks' worth of goods and services at the end of September 2001 to 24 weeks' worth at the end of December. The Reserve Bank's net open position in foreign currency – the amount to which the Bank is exposed to exchange rate risk – has also fallen to less than US$2 billion at present, against a peak value of more than US$23 billion some four years ago. Accordingly, perceived weaknesses of the past have been removed. A $2 billion open position in a $100 billion GDP economy which exports $30 billion per annum is quite well-contained. CPIX inflation over twelve months (i.e. year-on-year increases in consumer prices in metropolitan and other urban areas, excluding interest cost of mortgage bonds) initially fell below 6 per cent in the three months to September 2001, but subsequently picked up to 8,0 per cent in the year to March 2002. Headline inflation rose from 4,0 per cent in October 2001 to 6,6 per cent over the same period. The acceleration in both these measures of inflation in the last few months, was a consequence of higher rates of increase in the prices of consumer food products that, in their turn, were associated with the decline in the exchange value of the rand. Essentially driven by a slowdown in imported inflation at the time, the year-on-year rate of increase in the all-goods production price index slowed down from 10,0 per cent in December 2000 to 7,8 per cent in September 2001. It then accelerated sharply to 14,1 per cent in March 2002 on account of the depreciation in the value of the rand and the related surge in the imported component of the production price index and in the prices of import-competing domestically-produced goods. To this account of inflation developments must also be added the fact that both the money supply and bank credit extension are rising at double-digit rates. As far as the money supply is concerned, the growth over twelve months in M3 accelerated from 17,0 per cent in December 2001 to around 19 per cent in both January and February 2002, receding slightly to 18 per cent in March. Financial market volatility contributed to the public's strong demand for monetary assets. Finally, government's finances are healthy due to firm control over expenditure and continued buoyancy in tax collections. The national government's deficit before borrowing for 2001/02 amounted to some 1½ per cent of GDP, which indicates a high level of discipline. The non-financial public-sector borrowing requirement amounted to R11,5 billion in fiscal 2000/01, or 1,3 per cent of gross domestic product. The non-financial public-sector borrowing requirement in the first nine months of fiscal 2001/02 amounted to a surplus of R3,4 billion, or 0,5 per cent of gross domestic product. 8. Conclusion In conclusion, it appears as that the slowdown in the global economy seems to have tapered off. The industrialised world, led by the United States, is experiencing vast improvements in economic conditions. This augurs well for economic prospects in the world economy. In general the emerging economies are expected to benefit from a resurgence in external demand. However, it is important to realise that there are some risks that threaten the pace and magnitude of the global recovery. The volatile geopolitical environment surrounding the oil market is one such risk. Further, with the upturn in economic activity, it is to be expected that government spending that helped to make the recession short-lived will be curtailed. In addition, expansionary monetary policy that has been a characteristic of the last year will become more contractionary to keep inflationary pressures in check. Economic growth is not sustainable in an inflationary environment and is easier to achieve within an expansionary monetary policy framework, but becomes more challenging within a contractionary policy framework. However, it is important to realise that this is a challenge that we can successfully confront. It is within this context, a global one, that the Executive Management Institute of South Africa has to place itself. In order to train the managers and business leaders of tomorrow, you must grasp the complexities of the environment that confronts them. I commend Emisa for its community work and I wish you well as you chart your future course. | south african reserve bank | 2,002 | 5 |
Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Founding Congress of the Executive Management Institute of Southern Africa, Johannesburg, 5 July 2002. | T T Mboweni: Recent economic developments Keynote address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Founding Congress of the Executive Management Institute of Southern Africa, Johannesburg, 5 July 2002. * 1. * * Introduction Ladies and Gentlemen. I am honoured to address the Founding Congress of the Executive Management Institute of Southern Africa and I thank you for the opportunity. I will first discuss international economic developments, before turning to the domestic economy. There have recently been encouraging signs that the global slowdown has bottomed out. The IMF also confirmed in the April World Economic Outlook that a global recovery is under way. Business and consumer confidence have strengthened, leading indicators have turned up, industrial production is levelling off, and commodity prices have begun to pick up. The United States is leading the upturn, but there are also signs of recovery in Europe and some countries in Asia. The recent global slowdown has drawn attention to the synchronisation of business cycles in nearly all regions. According to the Fund, the downturn has been the most synchronised in two decades. The IMF ascribes this synchronicity to common shocks such as the higher oil prices, the bursting of the information technology bubble and the tightening of monetary policies from mid-1999 to end-2000. Increased financial and corporate international linkages have also played a role. This, however, raises the question of whether the recoveries in different regions will be as synchronised as the downturn. The IMF forecasts projected global growth of 2,8 per cent in 2002, somewhat higher than expected in December 2001. The WTO projects that global merchandise trade will increase by 1 per cent this year following a 4 per cent decline in 2001. However, growth in the United States - and countries with close economic links to the United States - has been revised significantly upward, as the pace of recovery has exceeded expectations. The full impact of the pickup will only be felt in 2003 when global growth is expected to rise to 4,0 per cent. The Organisation for Economic Co-operation and Development (OECD) also recently projected that economic growth among its member states would be significantly higher this year than in 2001. OECD GDP growth is expected to accelerate gradually from 1,0 per cent in 2001 to 1,8 per cent and 3,0 per cent in 2002 and 2003 respectively. 2. Oil prices After surging to $32 per barrel at the end of 2000, crude oil prices weakened in 2001 with the slowdown in the world economy. The price of Brent crude reached a six-month high of $27 per barrel in early April 2002 as a result of the tension in the Middle East, the economic recovery in the United States, Iraq’s 30-day sales embargo and a disruption in oil supplies caused by a strike at Venezuela’s state oil company. However, with Saudi Arabia pledging to replace Iraqi exports and the ousting of the Venezuelan president fuelling expectations of a less stringent oil policy, the price dropped to $23 per barrel in the middle of April. With the return of President Chavez to power the oil price once again increased to levels above $27 per barrel. Crude oil prices, however, recently fell more than 1 per cent after Israeli forces pulled out of the Palestinian leader’s headquarters, easing concern that the conflict may escalate and disrupt Middle East oil flows. 3. Prospects for the US Among the industrialised countries, the upturn is expected to be the strongest in the United States. This upswing is driven by a sharp turnaround in the inventory cycle, as well as substantial reductions in interest rates and tax cuts over the past year. In the first quarter of 2002 the United States economy grew at a seasonally adjusted and annualised rate of 5,8 per cent, following an increase of 1,7 per cent in the previous quarter and a contraction of 1,3 per cent in the third quarter of 2001. This is the strongest pace in more than two years underpinned by increases in consumer spending and the yearlong trend of sharp cutbacks in business inventories is showing signs of tapering off. The acceleration in real GDP growth in the first quarter of 2002 primarily reflected upturns in private inventory investment, exports and residential fixed investment. A gradual strengthening in business investment is expected to underpin the recovery in the second half of 2002 and into 2003. 4. Euro area and the United Kingdom The euro area economy had contracted at a seasonally adjusted and annualised rate of 0,7 per cent in the last quarter of 2001, but a gradual recovery is in progress with depleted inventories being rebuilt and international trade picking up. Growth in the euro area in 2002 is projected to be lower than in 2001, but the economy is expected to gain momentum in the second half of this year, and reaching 2,9 per cent in 2003. Inflation in the euro area is currently somewhat higher than expected as a result of the higher oil prices. The ECB warned that if the increase in oil prices is sustained, it would also have an impact on inflation rates during the rest of 2002. In the United Kingdom, for 2001 as a whole, real GDP growth averaged 2,2 per cent, the highest among the G-7 countries. The United Kingdom could, however, not avoid the global slowdown, which caused quarter-on-quarter growth in 2001 to decelerate registering zero growth in the fourth quarter of 2001. The economy, however, managed to recover marginally in the first quarter of 2002 with preliminary estimates showing that GDP increased by a seasonally adjusted and annualised rate of 0,3 per cent. Given the United Kingdom’s significant exposure to economic and financial developments in the United States, improvements in the US economy are expected to positively impact on economic prospects in the United Kingdom. This will support continuing growth in domestic demand resulting from the more expansionary monetary policy since the beginning of 2001 and a fiscal stimulus, largely in the form of planned rises in general government spending. Growth for 2002 is expected to average 2 per cent. 5. Japan Japan continues to experience recession - the most severe of the past decade. However, the increasing economic activity in the United States and Asian economies has led to an increase in Japanese exports. This increase in exports, which accounts for about 10 per cent of the economy, recently prompted the Bank of Japan to raise its assessment of the economy for the second straight month - the first back-to-back upgrade in 19 months. The Japanese central bank stated in its April monthly report that the Japanese economy still continues to deteriorate as a whole, but concluded that the pace has moderated somewhat. 6. Emerging economies Recent economic attention on Latin America has focused on the crisis in Argentina and its implications for the rest of the region. Argentina’s financial markets came under increasing pressure in 2001 because of the growing fear of a debt default and the end of the peso’s peg to the dollar. A 66 per cent decline in the peso since the government abandoned a decade-old peg to the dollar in early January has triggered steep price increases. In March, inflation was 4 per cent (month-on-month), the highest in 11 years. Despite months of talks on an IMF sponsored recovery package, both the Argentinean government and the IMF remain divided on a number of issues. Contagion from Argentina to neighbouring countries has been limited, with the exception of Uruguay. With the exception of Argentina and Uruguay, Latin America should experience better growth as a result of the economic recovery in the United States and Europe. Economic growth in most developing Asian countries slowed significantly during the year as external demand deteriorated in 2001. However, despite being affected by weak external markets, some countries such as the People’s Republic of China, India and Vietnam maintained relatively robust growth. In contrast, South Asian growth accelerated as slowing export expansion was offset by improvement in the performance of the agricultural sector. In Central Asia, growth was higher in 2001, in part because of large investments mainly in the energy sector. It seems that strong consumer spending in some of the Asian economies is providing some cushion against external shocks. In countries like South Korea, the Philippines, Thailand and Malaysia where interest rates were aggressively reduced in 2001, overall consumer spending rose much faster as exports fell. On the contrary, Hong Kong, Singapore and Taiwan (economies most hit by the global slowdown) saw consumer spending falling during the same period due to their reluctance in cutting interest rates. The Asian Development Bank, however, expects economic activity to recover in the second half of this year, following the revival of exports in the United States and a stabilisation of domestic sentiment. GDP in developing Asia is projected by the IMF to grow by 5,9 per cent in 2002, but as global economic growth gathers momentum; the economy is forecast to strengthened by 6,4 per cent in 2003. 7. Domestic economic developments Turning now to domestic economic conditions, recent events have been interesting to say the least. Against the extreme volatility in the financial markets, and in particular in the foreign exchange market, real-sector developments have been relatively stable. Growth in the real gross domestic product in 2001 as a whole amounted to 2,2 per cent, marginally exceeding population growth and signifying a small per capita increase. Focusing more closely on the second half of the year, the seasonally adjusted and annualised growth rate in real gross domestic product accelerated from 1 per cent in the third quarter of 2001 to 2½ per cent in the fourth quarter. This can be attributed to robust growth registered in the real value added by the non-primary sectors of the economy. While agricultural and mining output volumes contracted in the final quarter of last year, the other sectors expanded. Manufacturing in particular did well towards the end of last year, led by production of motor vehicles and parts, chemicals and basic metals. Manufacturing production rose at a strong annualised rate of 5½ per cent in the final quarter of 2001. Impressive output growth was also recorded by the transport, storage and communication sector where a third cellular telephone operator started business, by the financial services industry, and by the wholesale and retail trade sectors. The construction industry also at last seems to be recovering from the setbacks suffered in the late 1990s, and its real value added rose by 4 per cent in 2001 - double positive in that it also adds to the economy’s productive capacity. On that score it is notable that in manufacturing, where the utilisation of production capacity is regularly monitored, the utilisation rate stood at 79,4 per cent in the fourth quarter of 2001. This is still more than four percentage points below the peak rate recorded in 1995, indicating sufficient productive capacity to accommodate a further output expansion. Some indications of bottlenecks in the transport sector are, however, worrying. While our capacity to communicate electronically is advancing in leaps and bounds, ordinary transport of people and goods sometimes seems to be a problem. Some of the construction industry’s recent pick-up in activity will help to resolve that problem. Looking at real activity from the expenditure side, the growth in real final consumption expenditure by households accelerated from 2½ per cent in the third quarter of 2001 to 3½ per cent in the fourth quarter. This was mainly due to increases recorded in real expenditure on durable and semi-durable goods. Pre-emptive buying in anticipation of future price increases supported the level of durable purchases. The growth in real final consumption expenditure by general government accelerated somewhat from an annualised rate of 2½ per cent in the third quarter of 2001 to 3 per cent in the fourth quarter. This was concentrated in real spending on intermediate goods and services such as medicine. Following years of pruning real government outlays, the interest and debt burden of government has been brought down to the point where resources can be redirected towards more and better service delivery. Real gross fixed capital formation increased at a seasonally adjusted and annualised rate of 5½ per cent in the fourth quarter of 2001. The higher tempo of real gross fixed capital formation towards the end of 2001 was fairly widely dispersed, with the manufacturing, finance, mining and community, social and personal services sectors playing prominent roles. So far, the production and expenditure information for the first quarter of 2002 presents a bit of a mixed bag, with domestic vehicles sales for example down while manufacturing output continues to rise. Turning to the external sector, the rand’s fortunes appear to have turned somewhat and the weighted exchange rate of the rand has recovered by some 13,45 per cent from 31 December 2001 to 7 May 2002. South Africa’s foreign trade balance - our exports minus our imports - was adversely affected by the slowdown in the world economy. Somewhat disappointing trade balance data up to January 2002 were followed by strong trade surpluses in both February and March; the March surplus, seasonally adjusted, stood at a record level. The exchange rate depreciation has boosted South Africa’s international competitiveness considerably, and producers are reacting to it. However, it remains essential to avoid the erosion through domestic inflation of this competitive edge. As a percentage of gross domestic product, the deficit on the current account of the balance of payments shrank from 1,1 per cent in the third quarter of 2001 to 0,3 per cent in the fourth quarter. For 2001 as a whole the deficit amounted to R1,7 billion or 0,2 per cent of gross domestic product. Import cover, defined as the value of gross international reserves relative to the value of imported goods and services, improved from 20 weeks’ worth of goods and services at the end of September 2001 to 24 weeks’ worth at the end of December. The Reserve Bank’s net open position in foreign currency - the amount to which the Bank is exposed to exchange rate risk - has also fallen to less than US$2 billion at present, against a peak value of more than US$23 billion some four years ago. Accordingly, perceived weaknesses of the past have been removed. A $2 billion open position in a $100 billion GDP economy which exports $30 billion per annum is quite well-contained. CPIX inflation over twelve months (i.e. year-on-year increases in consumer prices in metropolitan and other urban areas, excluding interest cost of mortgage bonds) initially fell below 6 per cent in the three months to September 2001, but subsequently picked up to 8,0 per cent in the year to March 2002. Headline inflation rose from 4,0 per cent in October 2001 to 6,6 per cent over the same period. The acceleration in both these measures of inflation in the last few months, was a consequence of higher rates of increase in the prices of consumer food products that, in their turn, were associated with the decline in the exchange value of the rand. Essentially driven by a slowdown in imported inflation at the time, the year-on-year rate of increase in the all-goods production price index slowed down from 10,0 per cent in December 2000 to 7,8 per cent in September 2001. It then accelerated sharply to 14,1 per cent in March 2002 on account of the depreciation in the value of the rand and the related surge in the imported component of the production price index and in the prices of import-competing domestically-produced goods. To this account of inflation developments must also be added the fact that both the money supply and bank credit extension are rising at double-digit rates. As far as the money supply is concerned, the growth over twelve months in M3 accelerated from 17,0 per cent in December 2001 to around 19 per cent in both January and February 2002, receding slightly to 18 per cent in March. Financial market volatility contributed to the public’s strong demand for monetary assets. Finally, government’s finances are healthy due to firm control over expenditure and continued buoyancy in tax collections. The national government’s deficit before borrowing for 2001/02 amounted to some 1½ per cent of GDP, which indicates a high level of discipline. The non-financial public-sector borrowing requirement amounted to R11,5 billion in fiscal 2000/01, or 1,3 per cent of gross domestic product. The non-financial public-sector borrowing requirement in the first nine months of fiscal 2001/02 amounted to a surplus of R3,4 billion, or 0,5 per cent of gross domestic product. 8. Conclusion In conclusion, it appears as that the slowdown in the global economy seems to have tapered off. The industrialised world, led by the United States, is experiencing vast improvements in economic conditions. This augurs well for economic prospects in the world economy. In general the emerging economies are expected to benefit from a resurgence in external demand. However, it is important to realise that there are some risks that threaten the pace and magnitude of the global recovery. The volatile geopolitical environment surrounding the oil market is one such risk. Further, with the upturn in economic activity, it is to be expected that government spending that helped to make the recession short-lived will be curtailed. In addition, expansionary monetary policy that has been a characteristic of the last year will become more contractionary to keep inflationary pressures in check. Economic growth is not sustainable in an inflationary environment and is easier to achieve within an expansionary monetary policy framework, but becomes more challenging within a contractionary policy framework. However, it is important to realise that this is a challenge that we can successfully confront. It is within this context, a global one, that the Executive Management Institute of South Africa has to place itself. In order to train the managers and business leaders of tomorrow, you must grasp the complexities of the environment that confronts them. I commend Emisa for its community work and I wish you well as you chart your future course. | south african reserve bank | 2,002 | 7 |
Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the formal opening of the 12th International Conference of Bank Supervisors, Cape Town, 18 September 2002. | T T Mboweni: ICBS opening statement Remarks by Mr T T Mboweni, Governor of the South African Reserve Bank, at the formal opening of the 12th International Conference of Bank Supervisors, Cape Town, 18 September 2002. * * * Good morning ladies and gentlemen. On behalf of the South African Reserve Bank, welcome to sunny South Africa. It is indeed a privilege for us to be hosting the twelfth International Conference of Banking Supervisors (ICBS). This gathering of the world's bank supervisors has been taking place every two years since 1979, in some of the most attractive venues in the world. And I am sure you will agree that Cape Town is no exception. The ICBS has become an essential forum to promote cooperation among national banking supervisory authorities in the arduous task of supervising international banking. This year it will enable about 280 representatives from some 130 countries to exchange views on a range of current issues of common concern. One has only to glance at the programme and advance documentation to realise that ICBS 2002 will be among the most important and most demanding for delegates ever held. The steady build-up of inter-linkages and complexity in global financial systems, the events of 11 September 2001, the protracted tardy growth in the key economies of the world, and the systemic financial crises in a number of emerging market countries have all contributed to an acute awareness of the inherent fragility of the global financial system. Bank regulation and supervision is right up there in the first line of defence against financial instability, and from what I can see, the international best practice setting authorities have not dallied in responding to the challenges. Extensive work by the Bank for International Settlements (BIS), the Basel Committee on Banking Supervision (BCBS), the Financial Stability Forum (FSF), as well as many other international organisations and national supervisory authorities, will form a solid base for the discussions in the next two days. The discussions on dealing with weak banks and international bank insolvency are clearly important in these times of turmoil. Since capital is an effective, yet costly, buffer to protect depositors from the effects of banking problems, the scheduled discussion on the draft Basel II Capital Accord is very opportune. The draft accord holds the promise of ensuring that banks will have capital more relevant to their real risks, closing the gap between regulatory capital and economic capital, and eliminating many of the regulatory arbitrage opportunities that exist in the current framework. It is important that the ultimate accord is applicable not only to developed countries with banks that have sophisticated risk management models and formally rated credit risks, but also to emerging market economies and banks with portfolios of retail and small/medium enterprise (SME) loans. I am particularly pleased to note the intended discussions on the transition of emerging countries to Basel II. We await in anticipation the results of the forthcoming Quantitative Impact Study (QIS), in which South Africa is participating fully. In fact, the multinational team responsible for driving the study held an important meeting here in Cape Town just last week. I am confident that South African regulators and banks will be ready to implement the Basel II Accord by 2006. The topics relating to money laundering and "knowing your customer" processes, and those relating to operational risk, are critically important in light of the build-up of terrorist threats to financial stability. I am told that many of the countries represented here are working hard at testing the readiness of their financial systems to endure sudden crisis events, as well as ensuring that the financial system is not abused by terrorist organisations to help fund their activities. And of course, the recent spate of corporate failures around the world has made discussions on corporate governance the more imperative. So, it is indeed a remarkably relevant and extremely demanding programme in anyone's book. I am impressed, and I wish you well. South Africa is regarded as having a dual economy. On the one hand it is an emerging market with its fair share of challenges regarding economic growth, wealth distribution, and inflation. In particular, we face the challenges of high unemployment, a low savings level, a high HIV/Aids infection rate, and a volatile currency. We are also severely affected by commodity prices, especially oil and gold. On the other hand, South Africa is blessed with a sophisticated, privately owned, financial system comparable in many respects with the best of the developed economies. The financial sector is well regulated, as confirmed by the IMF and World Bank's joint Financial Sector Assessment Programme (FSAP). The banking sector is more than adequately capitalised, and its risks are well managed. Unfortunately, our financial sector is highly concentrated, a natural legacy of our shameful apartheid past. There is also an underlying problem of lack of broad access to basic financial services for the majority of the population, which is why I have noted with interest the topic of microfinance in emerging market economies on tomorrow's programme. In this regard it may be of interest to note that a review of the entire regulatory architecture in South Africa is currently underway to ensure that it remains appropriate to our needs going forward. These and other challenges are, however, being tackled enthusiastically in a consultative manner, and we remain highly optimistic about the stability of our financial system, the growth prospects of our economy, and the future of our country. Being so integrally part of Africa, you can be sure that our enthusiasm also extends to the impact of the New Partnership for Africa's Development (NEPAD) process on the future of our continent. I view the fact that ICBS 2002 is being held in South Africa, the first time outside of the developed countries, as a symbolic indication that emerging market countries are recognised as willing and able to throw their weight behind the achievement a robust global financial system. We have been involved in best practice setting processes for a long time, paying specific attention to the special circumstances in emerging countries. Efforts in our region to harmonise regulatory and supervisory practices are well known, and the annual meeting of the Eastern and Southern African grouping of bank supervisors (ESAF) yesterday in this venue has surely advanced that cause further. We can be proudly confident that the Southern African Development Community (SADC) countries will not be found lacking in the quest to ensure that there is no weak link in the global financial system through which disturbances can be propagated. I wish you the greatest of success in all your deliberations. My final hope is that you, and your accompanying partners, enjoy the beauty of Cape Town and the many interesting aspects of our diverse society. Hopefully this will not be too much of a distraction to you, and that you are able to maintain the focus and concentration that will be required if this conference is to succeed in helping bank supervisors face up to the many challenges going forward. Thank you. | south african reserve bank | 2,002 | 9 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the eighty-second ordinary general meeting of shareholders, 27 August 2002. | T T Mboweni: Recent financial and economic developments in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the eighty-second ordinary general meeting of shareholders, 27 August 2002. * * * Introduction The South African Reserve Bank was again confronted by many challenges during the past year. I am, however, glad to say that, as on previous occasions, the Bank coped well. Although some ground was lost in containing inflation owing to the exogenous shocks that affected the economy, remedial action has been taken to bring the inflation rate down towards the targeted levels. A period of consolidation in the banking sector was handled in an effective manner so as to ensure continued domestic financial stability. Attention was given to the regulatory structure of the banking sector to continue protecting the funds of depositors and to ensure that the intermediation of savings runs smoothly. The efficiency and effectiveness of internal administrative procedures were improved further and considerable progress was made with transforming the composition of the Bank’s staff to better reflect the demographics of the country. Recent economic developments The South African economy also did well in a rapidly changing political and economic world. A comprehensive review of recent economic developments in South Africa is contained in the Reserve Bank’s Annual Economic Report, which was released this morning. In my address I therefore wish to highlight only the following developments: South Africa, like most other emerging-market economies, was affected considerably by the attacks on the United States of America in September 2001, the uncertainties that this created politically as well as in the business world, the continued relatively high levels of oil prices and the strong downturn in world economic activity. The resulting decline in the volume of our exports in the second half of 2001 affected domestic economic growth. In addition, greater risk aversion to investment in developing countries had a marked impact on capital flows to South Africa. In response to the weakness in world economic activity, monetary policy in most countries became more accommodative and interest rates were brought down significantly. In some countries, fiscal measures were also taken to stimulate activity. These measures now seem to be bearing fruit and a world economic recovery should be of significant benefit to South Africa. The most important effect of world political and economic developments on South Africa was that they contributed materially to the volatility in the external value of the rand during the past year. After the value of the rand had been relatively stable in the first six months of 2001, it depreciated steeply in the second half of the year. As a result, the nominal effective exchange rate of the rand decreased by about 34 per cent in the second half of the year. Towards the end of 2001 the external value of the rand began to recover and the weighted exchange rate recouped about 20 per cent of its losses up to the end of May 2002. In the following two months the rand fluctuated around this new level but, on balance, declined by just more than 7 per cent. This brought the nominal effective exchange rate of the rand back to about 27 per cent below its level at the beginning of 2001. A number of factors contributed to the depreciation in the value of the rand during 2001. These included a weak export performance and a strong increase in imports and dividend payments to nonresidents. The resultant deficit on the current account of the balance of payments was accompanied by a net outflow of portfolio capital. This outflow stemmed from the perceived higher risk of investing in emerging-market economies, the problems experienced in Argentina and later Brazil, instability in Zimbabwe, and unfounded expectations of imminent exchange-control relaxations in South Africa. Eventually, international investors began to regard the external value of the rand as a one-way bet, exporters delayed repatriating their foreign-earned currency and importers switched financing from foreign to domestic sources. In other words, there was a typical speculative bandwagon effect. After the authorities had reminded the market about the sound economic fundamentals in South Africa in a statement on 20 December 2001, and it became clear that the exchange rate of the rand had over-reacted, this whole process was reversed. Exporters stopped delaying the transfer of their proceeds, importers shifted back to foreign financing for purchases and international investors were again willing to invest large sums in domestic shares and bonds. International conditions calmed down somewhat and the world economy began to recover. At the same time the current account of South Africa’s balance of payments moved into surplus, mainly owing to a decline in dividend payments to the rest of the world and a rise in exports. The depreciated external value of the rand has undoubtedly strengthened the price competitiveness of domestic producers and could lead to a strong export performance. Substituting domestically produced goods for imported goods should further promote economic growth. The South African economy also proved to be quite resilient to the world economic slowdown in the period under review. Despite a synchronised decline in the growth of most of our major trading partners, the growth rate in real gross domestic product only declined moderately from 3,4 per cent in 2000 to 2,2 per cent in 2001 and 2,3 per cent in the first half of 2002. The positive production growth in generally depressed world economic conditions could be attributed to continued strong domestic demand for goods and services. Final consumption expenditure by households and general government contributed to the pick-up in spending, but the largest contribution came from investment, especially fixed investment by the private sector. After declining in the second half of 2001, the volume of exports also began to rise in the first half of 2002. As could be expected with the strong domestic final demand for goods and services, the saving performance of the South African economy remained at a low level. In the past five years, gross saving as a ratio of gross domestic product has continued to fluctuate between about 15 and 16 per cent, which is too low to finance the growth performance the country needs for creating enough employment opportunities. The consistently low saving ratio has persisted despite a substantial improvement in government saving. After being a large dissaver a few years ago, government has made a positive contribution to saving since 2001. Corporate saving, which still represents the mainstay of the domestic saving effort, has weakened considerably over the past five years, while household saving remained at low levels. The steady growth performance in South Africa was accompanied by substantially higher labour productivity. The real output per worker in the non-agricultural sectors had increased by only about 1 per cent per year in the period from 1985 to 1995, but rose at an average annual rate of nearly 41/2 per cent from 1995 to the first half of 2002. Higher labour productivity was the combined result of an increase in output and a reduction in formal-sector employment. Producers preferred to employ capital rather than labour. Economising on the utilisation of labour resources was in part the result of a decline in the user cost of capital. But it was also brought about by factors such as a declining gold price and the opening up of the economy to international competition, which made the use of cost-saving production methods more urgent. Concerted efforts by government to reduce the public-sector deficit contributed further to a decline in formal non-agricultural employment. More than one million employment opportunities have therefore been lost since the peak of the employment cycle in 1989. Employment growth has occurred largely in the informal sectors of the economy and in other forms of self-employment. Unemployment in South Africa nevertheless remains a major problem, with nearly 30 per cent of the economically active population out of work. On the monetary front, the broadly defined money supply grew vigorously during 2001 and the first half of 2002, and reached a year-on-year level of 18,1 per cent in June 2002. Most of this growth was in the form of increased short and medium-term deposits by corporates. This could imply that companies are uncertain about the outlook for the economy and that investors are restructuring their portfolios. It may, however, also be an indication that depositors are positioning themselves for future spending. The risk for monetary policy is that in the long run, there is a close correlation between the rates of increase in the money supply and the general level of prices. The growth in total bank credit extension measured over twelve months moved into the double-digit range towards the end of 2001, but slowed down again to 9,6 per cent in June 2002, compared with 6,9 per cent in June 2001. This increase occurred mainly in the demand of the private sector for funds and arose largely from increases in trade finance, mortgage borrowing by households, instalment sale credit and leasing financing. In the financial markets the private corporate bond market expanded significantly in the past year as the government financed most of its borrowing requirements on international capital markets. From the beginning of 2002, part of the companies’ needs for capital was financed in the primary share market when the prices of shares improved considerably. New record turnover levels in the secondary bond and share markets were attained in the year ended June 2002. The decline that has been discernible in bond yields from the second half of 1998 was related to a dwindling supply of public-sector fixed-interest securities and lower inflation expectations that came to an abrupt end in the last quarter of 2001. The depreciation of the rand and resulting inflation fears drove bond yields sharply higher, but the mood in the bond market seems to have turned more positive from the beginning of April 2002. Monetary policy continued to be supported by fiscal policy in securing financial stability. In the fiscal year 2001/02 the public-sector borrowing requirement amounted to only 0,6 per cent of gross domestic product. In fiscal 1996/97 it had still been as high as 5,6 per cent. This substantial improvement in the finances of the fiscus was achieved by more efficient tax collection methods and disciplined expenditure programmes. As a result, the rise in public debt relative to gross domestic product was stopped and the interest burden of government eased considerably. This afforded government the opportunity to grant significant tax relief and to expand infrastructural development. Monetary policy After pursuing a relatively neutral monetary policy stance during 2000 and the first half of 2001, the Reserve Bank relaxed monetary policy from the middle of 2001. The neutral monetary policy stance was maintained in a period of low expected future rates of inflation and a slowdown in economic activity. However, the twelve-month growth rate in the consumer price index excluding mortgage interest cost (CPIX) continued to rise steadily from 6,5 per cent in October 1999 to 8,1 per cent in September 2000. This rise in consumer prices was largely related to international developments, such as rising oil prices, general upward pressure on international commodity prices and a depreciation in the external value of the rand. Although these exogenous factors became a threat to monetary stability, most domestic factors remained positive for the containment of inflation. Greater stability in domestic interest rates also seemed warranted to counter the heightened volatility in many financial markets. This policy stance was highly effective as there were few signs of the secondary effects of the weaker currency. In fact, inflationary expectations declined, nominal unit labour cost increased only moderately and growth in the money supply slowed down. Internationally the oil price declined, world economic activity began to slow down and interest rates were reduced aggressively. The twelve-month growth rate of the CPIX was turned around and declined to 6,5 per cent in May 2001 and to 5,8 per cent in September. Taking all these developments into consideration, the Monetary Policy Committee decided to relax monetary policy. The repurchase rate was first reduced by 100 basis points on 15 June 2001 and by a further 50 basis points on 20 September 2001. This brought the repurchase rate down to a level of 9,5 per cent, compared with its peak of 21,85 per cent in early October 1998. However, towards the end of 2001 it became clear that the favourable environment for inflation had changed. Subsequently, two important develop-ments led the Reserve Bank to reconsider its monetary policy stance. Firstly, the inflation targets for the three years after 2002 were announced by the Minister of Finance. The target for 2003 was kept unchanged at an annual average rate of increase in the CPIX of between 3 and 6 per cent, but this range was lowered to an average of 3 to 5 per cent for the next two years. This clearly reflected government’s commitment to the adjustment of policies to bring the inflation rate down to lower levels. Secondly, the external value of the rand began to depreciate sharply in September. The pass-through from the depreciated exchange rate to inflation had been surprisingly muted in 2000, but the sharp downward movement of the rand in the last quarter of 2001 inevitably had a significant impact on inflation. Before this change the challenge to monetary policy had been how to deal with external shocks that had not been putting undue pressure on domestic inflation. The new challenges were how to deal with external shocks that were now beginning to have a significant impact on current and expected inflation, and to avoid an inflation spiral. Inflationary pressures began to pick up during the last quarter of 2001. Food prices were initially the main factor contributing to the acceleration in inflation. These food price increases were partly related to the depreciated value of the rand as domestic prices approximated those determined internationally since the deregulation of agriculture. In particular, maize prices were significantly affected by the depreciation in the value of the rand. The maize price has wide economic significance in South Africa. White maize is a staple food for many South Africans and 90 per cent of yellow maize is used as feed in the meat, dairy, poultry and egg industries. Apart from the depreciation of the value of the rand, supply and demand factors also contributed to the more than doubling of the spot prices of both white and yellow maize between June 2001 and January 2002. Later the increase in consumer prices became more broadly based, in line with the sharp depreciation of the currency. Rising expectations of price increases became an important factor in the inflationary process, as was clearly reflected by the pre-emptive buying of durable goods by households in the fourth quarter of 2001. As the depreciated rand pushed prices higher, the twelve-month rate of increase in the CPIX started moving upwards from the psychologically important level of below 6 per cent in September 2001 to 9,9 per cent in July 2002. The quarter-to-quarter rate of increase in CPIX inflation was even more pronounced, rising from a seasonally adjusted and annualised level of 6,8 per cent in the fourth quarter of 2001 to 11,6 per cent in the first quarter of 2002 and 12,1 per cent in the second quarter. The twelve-month rate of increase in the all-goods production price index accelerated from 7,8 per cent in September 2001 to the even more alarming level of 14,4 per cent in June 2002. These developments soon indicated that the inflation target for 2002 could be in jeopardy. Moreover, given the lags between the implementation of monetary policy and its impact on inflation, estimated at between 12 to 24 months, there was very little that monetary policy could do to rectify this. However, the Bank remains committed to the objective of price stability and policy became focused on the targets for 2003 and 2004. The first response of the Bank to the rising inflationary pressures was to convene an unscheduled meeting of the Monetary Policy Committee early in January 2002. Although the exact feed-through of the depreciated value of the rand to inflation was still unclear at that stage, a number of developments indicated that it might be prudent to adopt a more restrictive monetary policy stance. These developments included a reversal of the downward trend in oil prices, indications that higher inflation expectations were becoming entrenched, higher wage demands, a more rapid rate of increase in unit labour cost and large increases in money supply and bank credit extension. In view of these developments the Monetary Policy Committee decided to raise the repurchase rate by 100 basis points in order to prevent an inflation spiral. Monetary policy was tightened further at the March and June meetings of the Monetary Policy Committee. In both cases the repurchase rate was increased by 100 basis points, bringing the rate to 12,5 per cent on 14 June 2002. By March it was clear that inflation expectations had been adversely affected by the depreciation of the rand. In addition there was concern about the continued high rate of growth of money-supply aggregates and bank credit extension, the state of the balance of payments and the rising trend in unit labour cost. It was argued that a tighter monetary policy at that stage could avoid more drastic interest rate increases in future if the stricter stance was successful in dampening inflationary pressures. By June, it was apparent that the upward trends of inflation and inflation expectations had maintained their momentum, and that growth in unit labour cost and money supply developments remained unfavourable. The Monetary Policy Committee, however, also identified some positive developments that could reduce the pressure on inflation. These developments included the partial recovery of the rand, the appearance of a surplus on both the current and financial accounts of the balance of payments, the continued low level of capacity utilisation and the maintenance of fiscal discipline. The latest forecasts of the Bank show that, given this tightened stance of monetary policy and barring any unforeseen negative shocks, the inflation target for 2003 could be met. However, the average annual rate of increase in the CPIX will probably be close to the upper end of the target range and the risks to the forecast are on the upside. As such, it seems unlikely that monetary policy will be relaxed in the foreseeable future. Although the current stance of monetary policy may be perceived as negative for short-term growth and employment creation, such a view must be compared with the alternative of even higher future interest rate levels, if inflation is not brought under control. Furthermore, the tax concessions granted in the last budget should benefit consumption, and the significant depreciation in the external value of the rand should promote production, particularly of exported goods. Exchange rate policy As outlined earlier, the external value of the rand came under severe pressure during the second half of 2001. The currency then stabilised in early 2002 and strengthened slowly but consistently until the end of May. Since the beginning of June the exchange rate of the rand has fluctuated widely around its newly established levels. The rand has continued to be negatively affected by developments in emerging markets, and events in 2002 in Argentina and Brazil, for example, could hamper the short-term outlook for the rand. For this reason the Reserve Bank strongly supports the government’s policy that the remaining exchange control regulations should be very gradually relaxed. Despite the relatively volatile movements in the exchange rate of the rand and even when it became apparent that the depreciation of the rand towards the end of 2001 was based largely on speculative transactions unrelated to underlying conditions, the thrust of exchange rate policy remained unchanged. The exchange rate of the rand is therefore essentially determined by the supply and demand conditions in the market for foreign exchange. At the same time, it remains a stated objective of the Bank to gradually close down the net oversold open foreign reserve position. The existence of this net oversold open position has been perceived as a source of weakness for the rand, and has contributed to negative sentiment towards the currency. However, it is also recognised that if the net open foreign reserve position is reduced too quickly, it could contribute to rand weakness. The Bank therefore announced in a statement on 14 October 2001 that we would in future not intervene by purchasing foreign exchange directly from the market to reduce this position. The net open foreign reserve position would instead be expunged from the cash flows derived from the proceeds of privatisation and the government’s off-shore borrowing. This does not imply that all the proceeds from these sources will always be used to achieve this objective. For example, part of the proceeds from the sale of Transnet’s interest in M-Cell was not used to reduce the Bank’s open position. In accordance with this objective, the Bank reduced the net open foreign reserve position from US$23,2 billion at the end of September 1998 to US$11,5 billion at the end of January 2000, i.e. during a period of overall strength in the balance of payments. When the overall balance of payments then began to deteriorate, the open position was brought down far more slowly to US$9,0 billion at the end of April 2001. The net open position was reduced to US$4,8 billion at the end of July 2001 with the proceeds obtained from the restructuring of the Anglo American Corporation and the De Beers mining company, and from foreign borrowing by government. The net open foreign reserve position was reduced further to US$1,8 billion at the end of July 2002 following the stated approach that the Bank adopted in October 2001. This reduction was basically the result of three major sources, namely the transfer of a syndicated loan liability of US$1,5 billion from the Reserve Bank to the National Treasury; the reopening of an existing dollar bond by the South African government which raised US$274 million for delivery against the oversold forward book; and the issuing of a new US$1 billion bond by the National Treasury for delivery against the forward book. While the Bank remains committed to eliminating the net open foreign reserve position, at its current level of US$1,8 billion this position should no longer be perceived as a source of vulnerability. Financial stability International developments also affected domestic financial stability during the past year. The attacks on the United States of America on 11 September 2001 illustrated an enormous systemic risk to financial systems worldwide as well as the key role that central banks must play in such circumstances. The increase in the international linkages among financial institutions adds to the risk in such events. The weakening position of Japanese banks also continues to be a source of vulnerability for inter-national financial markets. Furthermore, corporate governance standards and structures, as well as the credibility of the accounting profession, are being questioned after revelations about the corruption in and resultant failure of a number of large and well-known corporations in the United States of America. The corporate failures in the United States have impacted significantly on markets worldwide, with many stock exchanges shedding considerable value. This again demonstrates the importance of restructuring the financial architecture. Closer to home, trade and financial links expose South Africa to the contagion effects of recent adverse developments in Zimbabwe, which are closely monitored. Domestically the South African banking sector was characterised by a process of consolidation triggered by the difficulties of some small banks. This trend intensified after the announcement that Saambou Bank Limited, the seventh-largest bank in South Africa, would be placed under curatorship from 9 February 2002. As a result, there were significant withdrawals of deposits from some smaller banks in general and BoE Bank Limited in particular. This spurred the Reserve Bank to take a proactive and leading role in co-ordinating the actions of all key players in the banking sector, which led to an agreement between the private and public sectors on the management of liquidity by recycling cash flows and handling the orderly exit of Saambou Bank from the banking sector. The withdrawal of deposits from some banks prompted the joint action by the Bank and the National Treasury to restore the confidence of depositors, by guaranteeing all the deposits of BoE Bank Limited. BoE also accelerated the planned sale of its mortgage book to FirstRand Bank to manage its liquidity position. The activities of Saambou Bank and BoE were merged with those of some of the big four banks in South Africa. The liquidity problems of some of the smaller banks induced them to cancel their banking registrations and to carry on with niche operations. Other smaller banks are redesigning their ownership structures and in some cases downsizing their balance sheets. Despite these developments over the past year, South Africa’s banking system remains sound. Domestic banks are well-managed and have sophisticated risk management as well as corporate governance structures in place. Banks are well-capitalised, with an average risk-weighted capital adequacy ratio of 12,1 per cent at the end of June 2002. This can be compared with the new and higher required capital adequacy ratio of 10 per cent introduced in October 2001. Total bank funding grew by 22,4 per cent during the year up to the end of June 2002. The growth in total assets of 18,8 per cent over the same period to a level of R1 065 billion was mainly the result of an increase of 21,4 per cent in total loans and advances. The assets of the four big banks as a ratio of the total assets of the banking sector rose from 68,8 per cent on 30 June 2001 to 70,5 per cent on 30 June 2002. At the latter date the foreign banks operating in South Africa held 8,4 per cent of the total banking assets, compared with 6 per cent the previous year. Despite the difficulties encountered over the past year, the liquidity of the banking sector is generally adequate. The average daily amount of liquid assets held in June 2002 exceeded the prescribed prudential minimum by about 9 per cent. However, the reported profitability of the banking sector has continued to decline as margins on earnings decreased and operating expenses increased. Non-performing loans amounted to R26 billion in June 2002. This represents only about 3 per cent of total loans and advances, which compares well with international standards. The provisions made by banks for non-performing loans were adequate, even in terms of international best practice standards. The debt-servicing capacities of households also showed no signs of fragility. The ratios of household debt to disposable income and of household debt to financial assets both decreased over the past year. The single regulator The problems encountered in the banking sector earlier this year illustrated in the most definite manner that it is important that banking supervision in South Africa should remain part of the functions of the Reserve Bank. The blurring of boundaries between the financial services provided by banks, insurers and securities traders has prompted certain developed countries around the world to consolidate the different supervisory agencies under one roof. It is commonly recognised that the potential benefits of assessing the risk management functions of financial conglomerates on a holistic basis are very attractive for developed countries with integrated financial markets and ample regulatory resources. In South Africa the banking supervision function was transferred to the central bank in 1987 because it was regarded as the institution most suited to carrying out this function. Since then, even in the face of many abnormal circumstances, banking supervision has been carried out to the highest international best practice. Over this period, experience has shown that banking supervision is closely aligned with the other functions of the Reserve Bank. With the recent liquidity problems of some small banks, it was again evident that a least-cost resolution of a banking crisis would always depend on a special collegial interaction between the Registrar of Banks and at least four other departments in the Bank. The policy formulation, decision making, co-ordination and rapid execution of the many interventions that were necessary would have been almost inconceivable in a situation where the supervision of banks was not part of the Bank. Stability in the banking sector is so integral to the monetary policy transmission mechanism, that a central bank must always be involved in banking supervision. Unlike other financial institutions, banks potentially pose a systemic risk because of the nature of their contracts. Their assets are typically long term and uncertain in value, whereas their liabilities are generally short term and certain in value. The banking sector is therefore prone to contagion as soon as confidence in any bank is undermined. These characteristics give rise to the commonly accepted approach of regulating banks in a discretionary manner. A rules-based approach to banking regulation would be inappropriate because every case of distress in the system is unique. Supervision consequently has to be risk-based and proactive. The banking supervision function in the Reserve Bank has caused many problems and frustrations, and the temptation to pass the responsibility on to another agency is great. However, the capacity to perform effective banking supervision is crucial to price and financial stability. After careful consideration of the issue, I am therefore convinced that it is in the best interests of the South African economy that banking supervision should remain in the Bank. At the same time, I also realise that close co-operation should exist between the different regulatory authorities to address the need for consolidated supervision. Co-operative working arrangements between regulators are essential to address the ever-increasing demands of sound regulation, the hallmark of which consists of decisiveness, timely action and proactive intervention when required. Regulating the banking sector The different approaches adopted to handling the liquidity problem of banks in the past year have created considerable uncertainty about the principles applied in regulating the banking sector. This again emphasises that the execution of this function should be made as transparent and business-like as possible. The objective of bank supervision is to ensure stability, efficiency and depositor protection in banking. A stable financial environment is essential for the working of the economy and the attainment of price stability. A sound banking system contributes to the effectiveness of intermediation, maturity transformation, payment facilitation, credit allocation and financial discipline. Moreover, banks play an important role in collecting savings, allocating resources and providing liquidity. The registration of banks is the first step to achieve stability in the banking system. Stability is promoted by preventing applicants with potentially destabilising weaknesses, such as unqualified or unscrupulous manage-ment or insufficient capital, from entering the system. Unfortunately, there is no reliable formula to determine whether a bank will fail or succeed. The regulator can only apply international regulatory and supervisory norms to the supervision of banks. The South African authorities have adopted the 25 principles contained in the Core Principles for Effective Banking Supervision of the Basel Committee for Banking Supervision, to construct an effective supervisory structure in the country. In deciding on whether a banking licence will be granted to an applicant, an assessment is made of the institution’s business plan, shareholding structure, capital base, directors and senior management, internal controls and projected financial conditions. This evaluation of an application is not a mechanical process, but is in a sense abstract and subjective. Every application is regarded as unique. Once a bank has been established it must be monitored continuously to ensure that it remains fundamentally healthy. This monitoring process involves a quantitative and qualitative assessment of a bank’s soundness. The quantitative assessment entails an analysis and evaluation of defined riskbased data received from banks on a monthly basis, to determine whether they are within prescribed prudential limits and whether their financial positions fall within acceptable norms. The qualitative assessment consists of the examination and evaluation of whether risks are being managed properly. This assessment is done within a framework of corporate governance structures. Despite every effort by the supervisors to ensure a healthy banking system, they cannot guarantee the safety and soundness of individual banks at all times. Where a bank encounters difficulties, special contingency measures are applied. The general approach followed in providing financial assistance is that the bank in distress is experiencing only temporary liquidity problems. By contrast, an insolvent bank or one with ongoing liquidity problems is required to exit from the banking system in an orderly, efficient manner with minimum losses to depositors and the least harm to the public’s confidence in the banking system as a whole. Special action is taken in a case where a temporary liquidity problem is identified. As every case is different, these actions may vary from one case to another. A broad framework for the contingency procedures has nevertheless been developed. A plan for remedial action is normally drawn up, in close co-operation with the bank concerned. Possible solutions may range from new capital injections by shareholders to measures designed to attract and retain large deposits. In addition, the relevant bank may be allowed to obtain liquidity by discounting liquid assets and by utilising its minimum cash reserves to cover cash outflows. If none of these measures can solve the liquidity problem of the bank in distress, the Reserve Bank may, as lender of last resort, be approached for special assistance in certain circumstances. This special assistance is granted only against collateral of acceptable assets pledged by the bank or a government guarantee because the Reserve Bank is prohibited by statute from making unsecured loans. The Bank’s policy and practice of solving liquidity problems have recently received considerable attention. Two reports were published in the past year. One was on the failure of Regal Treasury Private Bank Limited. The other report was on the financial assistance package to Bankorp (and later to Absa) in the late 1980s and early 1990s. The panel of experts, known as the Davis Panel, found in the latter report that the assistance had averted a systemic crisis. The panel members also concluded that the procedure for dealing with banks in distress had been refined and now conformed to current international best practice. In reviewing the support provided recently to Saambou Bank and the repayment of all the depositors’ money, three of the members of the Davis Panel found that all the actions taken complied with the Reserve Bank’s established procedures. Contrary to possible public perceptions, the authorities did not give any special positive or negative treatment to Saambou Bank’s depositors or shareholders. To create a safety net for depositors, the Policy Board for Financial Services and Regulation has formulated a proposal on designing a deposit-insurance scheme for South Africa. The main purpose of the scheme is to protect small depositors from losses if a bank fails. Membership will be compulsory for all registered banks and separate funds could be established for non-bank financial institutions. The level of coverage still has to be determined, but it would be low enough to avoid creating a moral hazard, yet high enough to inspire confidence. The relationship between auditors and the regulator has always been regarded as extremely important. Recent international events involving the auditing profession have again illustrated the critical role that auditors should play in ensuring that the accounts of institutions are a fair reflection of their financial position. For this reason, a decision was taken to establish an Auditor-Regulator College to create a structure for regular interaction with and compliance training for the auditing profession. The college will play a major role in training and strengthening the banking supervisory process in South Africa. Procedures have also been implemented to introduce banking legislation which will, for the first time, effectively deal with management deficiencies in banks. The proposed legislation will, among other things, provide for the removal by the regulator of directors and managers of banks who are not considered to be fit and proper to perform such appointments. These improvements to the regulation of banking are being undertaken to safeguard the funds of depositors and to ensure that South Africa maintains a recognised, stable banking system. However, the Bank is also aware of the need to broaden the access of individuals and small and medium-sized enterprises to basic banking services and funding. To this end, the approach in the past was to encourage registered banks to provide such services and to exempt certain approved non-bank financial institutions, such as stokvels, credit unions and village financial services co-operatives, from the requirements of the Banks Act provided that these institutions comply with certain specified conditions. Work is now in progress to reform the Mutual Banks Act by making provision for different classes of banks. This would create a more appropriate regulatory framework and give broader access to finance. The Bank also supports all initiatives aimed at finding a balance between facilitating socially responsible behaviour by banks and protecting the stability of the banking sector. Internal administration In view of the importance of maintaining an overall stable financial environment, a Financial Stability Department was established in the Reserve Bank. The primary aim of this department is to assess and promote the stability of the banking and financial system in South Africa. The main functions of the new department are to identify, analyse and research any potential threats to and weaknesses in the financial system, and to make policy proposals on and encourage changes that will support the stability and effectiveness of the financial system. Another administrative change arose from the majority decision by shareholders to delist the Bank from the JSE Securities Exchange SA, with effect from 2 May 2002. The new listing requirements of the JSE Securities Exchange SA as well as the unique role and structure conferred on the South African Reserve Bank in terms of its Act, made it evident that the Bank would no longer be able to trade its shares on this exchange. The shareholders’ decision led to the establishment of an Over-the-Counter Share Transfer Facility on 3 June 2002, to provide for trading in the Bank’s shares. This facility operates as a closed auction and is administered by the Bank. Satisfactory progress has been made with a process of Bank-wide business continuity planning to ensure that the Bank can continue functioning and meeting its obligations in the event of any interruption or disaster. All the Bank’s departments, branches and subsidiaries are participating in preparing the best possible response to a threat to normal operations. In the field of information and communication technology, several initiatives resulted in lower costs, greater efficiency and new interactive ways of doing the Bank’s business. These included the establishment of a generic facility for receiving data electronically from external associates, enhancing the balance-of-payments system to enable the direct reporting of all cross-border transactions, collecting data online for economic research and creating a new Internet website for the Bank. The Bank’s new cash management strategy (Project Imali) was successfully implemented during the past financial year. The branches of the Bank now provide a full and comprehensive bulk cash-handling service to the private banks. This service has been extended to the Mpumalanga and Limpopo provinces on a contractual basis. Project Bataki, the project aimed at revising the banknote series, has made good progress. Consultations with all stakeholders on developing the preferred technical and security features for the current banknotes will commence in the near future. The problems with dye-stained notes arising from ineffective dye-staining devices have been successfully addressed. With the co-operation of the manufacturers and users of such systems, a new industry standard has been developed and implemented. This will make these notes unusable, which should discourage robbery and theft. Major progress was also made with the reduction of settlement risk in the payment system when agreements were concluded with the payment clearing houses. After intensive consultation with the banking industry, same-day settlement now generally takes place. Real Time Line settlement is effected directly via the SAMOS system and batch settlements forwarded from Bankserv are settled before the following day. Only interbank borrowing and lending, and the final square-off between banks, are done the next day. These changes have aligned South African payment practices to the principles of internationally accepted payment systems. The Committee of Central Bank Governors in the Southern African Development Community made satisfactory advances supporting regional economic integration. In particular, notable progress was made in the fields of payment, clearing and settlement systems, information and communication technology, legal and operational frameworks for central banks and exchange-control policies. The Reserve Bank has also engaged in technical co-operation and advice to a number of central banks in Southern Africa as well as in other African countries, such as Rwanda. In addition, the Bank was actively involved in initiatives to establish closer monetary and economic co-operation in Africa through participation in the Association of African Central Banks. In keeping with the objective of transforming the composition of the Bank’s staff to reflect the demographics of the country, an important milestone was reached in the past financial year when the total black staff complement exceeded the white staff complement for the first time since the inception of the Bank in 1921. This confirms the Bank’s commitment to achieving its objectives for staff transformation by 2005, in accordance with the plan submitted to the Department of Labour in terms of the Employment Equity Act, No. 55 of 1998. Despite this progress, further efforts will be made to achieve gender and race representivity at all seniority levels. We want the Bank’s staff to reflect the diversity and unity of South Africa. Extensions to the Bank’s head office building, which started in 2001, are progressing satisfactorily and will be completed in 2003. Once completed, the building will meet the Bank’s requirements for additional office space and for parking and conference facilities. The conference facilities will also be made available for use by the public, which should contribute to the improvement of activity in the Pretoria central business district. Acknowledgements All these changes to ensure the efficient functioning of the Reserve Bank could not have been accomplished without the help of a number of people and institutions. In conclusion, I therefore wish to express my appreciation to everyone who contributed to the success of the Reserve Bank in overcoming the challenges of the past year. I wish to thank the Presidency in particular, the government in general and Parliament for supporting the work of the Reserve Bank. In addition, I wish to express my appreciation to the Board of Directors of the Reserve Bank, including the deputy governors, for their commitment and undivided loyalty. Mr J H Cross, Senior Deputy Governor, left the service of the Bank at the end of his term for health reasons and Mr I J Moolman retired. Both of them made valuable contributions to the work of the Bank and the Board, for which we are deeply grateful. Finally, I wish to thank the staff of the Reserve Bank for their professionalism, excellent performance and continued loyal support. | south african reserve bank | 2,002 | 9 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Pretoria National Press Club, Pretoria, 8 October 2002. | T T Mboweni: Monetary policy making in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Pretoria National Press Club, Pretoria, 8 October 2002. * * * Today I have decided to make some remarks about monetary policy, monetary policy and making in South Africa. Whilst I am fully aware that most of you would like to know about the future developments in interest rates, I will however disappoint you since there will be no “open mouth operations” today. What I thought of doing was to take you systematically through the steps which leads the Monetary Policy Committee to take decisions on monetary policy. I have made the rather crude assumption that most of you are not monetary economists - I am using Yusuf Abramjee as my benchmark! 1. What is monetary policy? Let us start from the beginning and consult The New Oxford Dictionary of English. It says on page 1193 that, “Monetary: adjective of or relating to money or currency “(1998 Edition). Therefore by deduction, monetary policy must be actions or decision “relating to money or currency”. This is not very helpful at all. And so let us check some textbooks to see what they say monetary policy is. Burda and Wyplosz, in Macroeconomics A European text, p13 say that “Monetary policy is directed at influencing interest and exchange rates, and more generally at conditions in financial markets and their links with the real economy”. So Burda and Wyplosz focus on interest rates, exchange rates, conditions in the financial markets and the impact on the real economy. This goes some way towards explaining monetary policy. But to the ordinary citizen this might be confusing. Frederick Fourie, writing for third year and perhaps honours students says in his book, How to Think and Reason in Macroeconomics, that monetary policy is defined as “All deliberate steps of the monetary authority (central bank) to affect monetary aggregates (money supply), the availability of credit, and interest rates, in order to influence monetary demand, income, production prices and the balance of payments. This a little more helpful. I would have said that monetary policy is about the deliberate decisions by the central bank to influence short-term interest rates. Or put simply, monetary policy relates to the decisions by the central bank on interest rates. Interest rates by definition will affect a whole range of variables in the economy: money supply, credit, demand, income, production prices, asset prices, the exchange rate, balance of payment, investment, inflation, etc. The central issue therefore is interest rates. 2. What are the instruments available for monetary policy? There has been a lot of talk recently by many people, including people who are supposed to be in the know (but have shown themselves to be ignorant), about the need for the central bank to use other instruments to fight inflation instead of interest rates. The primary source of the confusion about the existence of other instruments is to be found in people thinking about credit ceilings, open market operations, the repo rate and cash reserve requirements. Let me deal with each one of these below. 2.1. Credit Ceilings Credit ceilings are quantitative limits on credit extension by banks. Each month every bank has to submit a detailed balance sheet to the Registrar of Banks. Credit ceilings can impose a freeze on each bank’s total credit extension, or it can limit the growth in credit extension to a certain value such as one per cent per month. Penalties can be imposed on banks extending too much credit. This method of controlling bank lending and money creation was used in South Africa from 1965 to 1972 and 1976 to 1980. The results were disappointing. Economic agents found ways around the credit ceilings. Non-bank companies with surplus funds started lending it directly to companies with deficits, and friends started lending to each other. Politicians also started to intervene, pleading for lifting of the credit ceilings on non-commercial grounds for certain types of borrowers or activities. 2.2. Open Market Operations Open market operations involve the buying and selling of government paper (bonds and Treasury Bills) by the Reserve Bank in order to achieve or support its monetary policy objectives. By selling government bonds, the Reserve Bank causes money market liquidity to tighten and money supply to decline - the money paid over to the Reserve Bank is withdrawn from the financial system. On the other hand, conditions are eased and liquidity is injected if the Reserve Bank purchases government bonds. This is really about the implementation of monetary policy and this has been used on an ongoing basis in South Africa. 2.3. The Repo Rate The Reserve Bank’s repurchase rate is the interest rate which the Reserve Bank charges banks when they borrow funds from the Reserve Bank. Banks borrow some money from the Reserve Bank on a more or less continuous basis - for instance, when they need notes to fill their automated teller machines. The Reserve Bank lends funds to the banks at an interest rate called the repurchase rate or repo rate. Currently it amounts to 13,5 per cent per annum. Because the Reserve Bank is the ultimate source of currency in our economy, the interest rate at which it supplies funds to the banks serves as a benchmark for the banks ‘ other interest rates. They set their deposit rates below the repurchase rate, and their lending rates above the repurchase rate. For instance, with the repurchase rate currently at 13,5 per cent, banks tend to offer around 12 per cent per annum on one-year fixed deposits while their prime overdraft rate amounts to 17 per cent per annum. The repurchase rate gets its name from the fact that the Reserve Bank only lends out funds against good security. What in fact happens is that a bank that wants to borrow from the Reserve Bank must first acquire a government bond (or Treasury Bill or Land Bank bill) - a financial instrument of the highest quality, backed by the government. It then brings the government bond to the Reserve Bank, which temporarily buys the bond - say at a price of a million rand. In the process a million rand in funding is provided to the bank. At the same time the private bank agrees to buy back or repurchase the bond at a given price seven days later. A rate of 13,5 per cent per annum means about 0,26 per cent per week, so that the private bank would have to pay the Reserve Bank around R1,0026 million after one week to repurchase the bond. The Reserve Bank therefore earns around R2 600 in interest on the loan. Through the repo rate the Reserve Bank can therefore influence all short-term interest rates. If the Reserve Bank senses that inflation is accelerating and is being accommodated by an abundant supply of money and credit, the Bank’s Monetary Policy Committee would raise the repo rate. This would lead to higher lending rates, causing people and firms to cut back on their borrowing and spending. With less credit and money available, inflation would be reined in. 2.4. Cash Reserve Requirements Banks are required to keep a certain proportion of the deposits which they attract on deposit with the Reserve Bank. Currently, for every R100 in funding which the banks attract on their liability side, they have to keep R2,50 on deposit with the Reserve Bank. This funding therefore is not available to lend out. The higher the cash reserve requirements, the tighter credit conditions are made. In South Africa the cash reserve requirements have been adjusted from time to time, although it does not currently constitute a high-key instrument of monetary policy. It operates subject to constraints; if the cash reserve requirements are set at too high a level, banks would lose business offshore and also to domestic nonbank financial intermediaries. The central bank has really one instrument to fight inflation in monetary policy terms. That instrument is the repo rate - interest rate/short term. Anybody who has discovered another is welcome to advice us. My email address is: [email protected]. All technically sound suggestions are really welcome. In the meantime, the 100+/- economists at the central bank are convinced that repo rate is the only weapon we (the Central Bank) have in combating inflation. 3. What is the primary objective of monetary policy? The primary objective of monetary policy is price stability. This is the position adopted by many central banks around the globe. The achievement and maintenance of price stability is the best contribution that monetary policy can make to the growth and development of the South African economy. We have no other primary monetary policy objectives. I will return to this a little later. 4. What then is our monetary policy framework? We announced the adoption of the inflation targeting monetary policy framework in February just over a year ago. The formal adoption of an inflation targeting framework indicated a shift from the previous informal policy framework. In the past, monetary policy had embraced an eclectic approach in which recognition was formally given to a medium to longer-term stance of monetary policy by monitoring developments in a number of financial aggregates and not only money supply and bank credit extension. The eclectic approach to monetary policy was applied during the 1990s, against the background of explicitly articulated guidelines for money supply growth. This framework recognised that the Reserve Bank had to combat inflation, as outlined in the Constitution and the Reserve Bank Act. However, since the Bank’s policies had their most direct impact in the area of money and credit, intermediate guidelines were set for growth in money supply. It was argued that if money supply growth could be contained, too much money would not be chasing too few goods, and inflation would be brought under control. While formally it was stated that broad money supply growth should fall in the range of 6 to 10 percent per annum (since the mid-1990s), in practice the Bank adopted a relatively flexible approach where these guidelines were indeed treated as guidelines only. A further guideline for growth in total bank credit extension of around 10 percent was also adopted. But when these guidelines were exceeded by considerable margins, this was on occasion tolerated without strong policy adjustments, on the basis of developments in other variables. In practice it was quite apparent that growth in the money supply could sometimes be a misleading indicator of current and future inflation. Accordingly, a number of other variables were also analysed in deciding upon the appropriate monetary policy stance. These included the pace of growth in the banking sector’s credit extension, movements in consumer price and production price inflation, domestic production and expenditure, the balance of payments and exchange rate situation, and the fiscal policy stance. The inflationary potential of developments in all these and many other variables was assessed on an ongoing basis. Accordingly, growth in money supply was not really the pivotal variable around which monetary policy revolved - although excessive growth in money supply certainly did signal the need for additional caution. However, money supply growth was deemed to be important and was formally recognised as the intermediate target variable. What has since changed? Instead of targeting guidelines for intermediate objectives, the Reserve Bank now directly targets inflation. It monitors and analyses a whole range of factors that can affect the rate of inflation. The inflation rate, or more specifically CPIX, which is the headline consumer price index excluding mortgage costs, has to fall between 6 and 3 percent by the end of the calendar year 2002 and 2003. It is within this target and this monetary policy framework that the South African Reserve Bank will strive to achieve in the short term what we are mandated to do: that is to achieve price stability. Such a framework for monetary policy ensures that monetary policy is transparent, in that the authorities have a definite and measurable aim in their conduct of monetary policy. And at the same time, it should give the citizens of this country an aspect of clarity about the future as it makes clear the Bank’s intentions. In so doing, inflation targeting should also ease the burden and take the “guesswork” out of many of the decisions that businesses have to make when planning for future expansion and investment. It should also provide an anchor for inflation expectations and guide both employers and employees when undertaking forward-looking negotiations. However, it must be emphasised that at least some of the success of the inflation targeting framework rests on whether it is fully understood by labour, business, the private sector and the other sectors of the economy. If these sectors understand that the Bank targets inflation and that it is committed to the chosen target, this will engender public confidence about the Reserve Bank’s monetary policy procedures. I will now turn to the specifics of our inflation targeting monetary policy framework. The Reserve Bank monitors a number of factors that have a direct influence on inflation. These include the growth in money supply and bank credit extension, the changes in nominal and real salaries and wages, the nominal unit labour costs, the gap between potential and actual national output, the exchange rate developments and import prices. The oil price is another factor that has played a major part in domestic inflationary trends of late and one that we have closely monitored. This exogenous factor is one over which we have little control. Another exogenous factor is food prices, which can be volatile as a result of drought or floods. And administered prices, those influenced by government or monopolies including medical and education costs, also have an impact on domestic inflationary trends. In order to monitor these factors, the Reserve Bank has embraced the system of a small core model supported by other models. It has moved away from the single large-scale macroeconomic model, in keeping with international developments. The aim is to keep the core model concise so as to focus on the key economic variables that influence inflation, as I have already mentioned. The core model incorporates some basic assumptions about the economy. It presupposes, among other things, that higher output cannot be achieved in the face of persistently higher inflation and that the level of prices in money terms and the rate of inflation in the longer term depend on monetary policy. The link between the Reserve Bank’s modelling activities and its forecasting process is indirect and far from the mechanical, “black box” approach favoured by scientists. There is no mechanical process in which the forecast directly determines the policy decision. It must be remembered that the econometric models and forecasts are tools to help the Reserve Bank solve economic problems. They are also only one set of tools used in the policy decision-making process. I will illustrate my point by referring to a summary from the Bank of England on the use of models and the Monetary Policy Committee’s responsibilities. This summary encapsulates the philosophy behind the use of models and forecasts at the Reserve Bank. I quote: “In an ever-changing economy, no single model can possibly assimilate in a comprehensive way all the factors that matter for policy. Forming judgements about those factors, and their implications for policy, is the job of the Committee, not something that can be abdicated to models or even modellers. But economic models are indispensable tools in that process.” To return to the broader picture, while inflation targeting forms the framework for the Reserve Bank’s monetary policy, it must be remembered that monetary policy is only a part of macroeconomic policy. The task of macroeconomic policy is to promote economic growth and development, create employment, improve the living conditions of all the people of the country, and eliminate the unjustifiable discrepancies between the disparate average incomes of various groups in the economy. Monetary policy has a narrower focus but it occupies an important component of the foundation upon which the broader goals of macroeconomic policy rest. Monetary policy aims to create and maintain a stable financial environment within which overall economic activity can be expanded, jobs created and poverty reduced. This monetary policy objective is supported by the legal obligations of the Reserve Bank as set out in the Constitution of the Republic and in the South African Reserve Bank Act. Since inflation is our main focus, you may question where the exchange rate of the rand fits into the monetary policy framework? Targeting inflation does not mean that the exchange rate of the rand is ignored. On the contrary, the impact of the exchange rate on inflation is what concerns us and this is what we closely monitor. The impact of the fluctuations in the exchange rate on inflation is carefully considered when we go about the daily task of managing domestic liquidity and determining the repo rate. If signs do emerge of increased inflationary pressures arising from a depreciation of the exchange rate of the Rand, in the absence of any other counterveiling factors referred to above, then monetary policy would have to respond in the appropriate way. 5. What are the institutional arrangements for monetary policy making? Our commitment to transparent monetary policy goes hand in hand with the attempts we have already made in communicating both our intentions and the outcomes of our meetings to the public. The Monetary Policy Committee was set up shortly before South Africa adopted the inflation targeting framework for monetary policy. The 7-member-MPC, as it is known in short, meets four times a year. It first met on 13 October 1999. The task of its meetings is to decide on the monetary policy stance, with a focus on the inflation targets that must be met in the target year. A press conference is held after the two-day meeting has been concluded and the Committee releases a statement fleshing out the developments in the international and domestic economy and the reasons for its monetary policy stance relating to these prevalent developments. The Reserve Bank has also convened Monetary Policy Forums, which as the name suggests, provide a forum for open discussions on monetary policy and general economic developments. The MPFs are held twice a year in the major centres of the country and engage with labour, business, community and other organisations. The Forums also ensure that the views of interested parties are taken into account when determining monetary policy. This endeavour is an earnest attempt on our part to communicate monetary policy and economic issues with the broadest spectrum of people. Unfortunately, to date, these Forums are not that well attended, particularly on the part of the trade union movement. The Reserve Bank also publishes a Monetary Policy Review twice a year to increase the understanding of its conduct of monetary policy. The first Review was published on 19 March 2001 and it described the monetary policy framework in more detail. It also analysed local and international economic developments and the inflationary trends arising from these. The Reserve Bank also publishes its inflation forecasts in the form of a fan chart. The fan chart is used by many central banks to illustrate their inflation forecasts. So-called confidence bands are used to signify varying degrees of certainty for each broadly expected level of inflation. Last but not least, the Reserve Bank regularly reports to parliament on the stance of monetary policy. This is in line with international practice and this is part of our accountability to the citizens of South Africa. 6. What is the monetary policy transmission mechanism? In an inflation targeting monetary policy framework, policy initiatives have to be forward looking. This means that during periods of rising inflationary pressure, the Monetary Policy Committee will have to timeously raise the domestic level of interest rates in order to achieve its objective of maintaining price stability and ensuring that the inflation target is met. Studies suggest a fairly long time lag of between 12 to 24 months for monetary policy to have its main effect on inflation. The monetary policy transmission mechanism describes the sequence of events that are set in motion once interest rates are changed in order to lower inflation. Changes in interest rates affect the economy through various channels. These channels include: Interest rate channel: An increase in the repo rate influences other financial market interest rates. Firms and individuals respond to this change by lowering their expenditure patterns. This lower level of demand affects output and will eventually feed through to lower rates of inflation. Exchange rate channel: Rising interest rates are normally associated with an appreciation of the exchange rate. This could also attract foreign investment in the form of a capital inflow. A stronger exchange rate will lead to lower import prices which should contribute towards lower inflation. Money and credit channel: Increased levels of interest rates usually lower the demand for domestic credit. Lower credit extension and money supply will decrease domestic demand and with a time lag inflation. Inflation expectations: Rising levels of interest rates tend to lower future expectations of inflation. These will in turn lower unit labour cost and inflation over the longer term. 7. MPC decision not always understood Despite our efforts at creating transparent and open channels of communication on the conduct of monetary policy and the centrality of inflation targeting, many people in South Africa are still fixated on the fluctuations in the exchange rate of the Rand. Questions will be asked of me not about changes in consumer prices. But, almost certainly, questions will arise when the exchange rate depreciates. Together with this, the Monetary Policy Committee’s decisions are misunderstood from time to time. One of those times was on the last MPC meeting when we decided to increase the repo rate. We gave the following reasons, and I quote: “The developments that have so far led to higher inflation are therefore mainly exogeneous or costpush factors, which cannot be directly influenced by changes in the level of short-term interest rates. At present there are no signs of excess spending or production capacity constraints, while fiscal discipline has been maintained by the authorities. It is, however, always important to take into consideration that cost-push and excess monetary demand factors are interacting elements or different aspects of the same process, rather than totally separate causes of different processes. Autonomous cost-push or exogeneous factors cannot on their own lead to an inflationary process if they are not accommodated by a monetary expansion. When autonomous price increases occur without increases in the money supply, bank credit extension and inflationary expectations, such increases are self-terminating. But when they are supported by accommodating monetary developments, inflationary pressures will become self-perpetuating.” “As already indicated, inflationary expectations are already very high. Moreover, growth over twelve months in the broadly defined money supply (M3) amounted to 17,4 per cent in July 2002. Although this growth rate was lower than the 20,6 per cent recorded in May 2002, the reduction was to a large extent due to increased tax collections, which reduced the private sector’s deposits with banks included in M3 while raising government deposits which do not form part of money supply. It is also true that a large part of this increase in M3 was the result of increases in long-term deposits, which are less likely to be related directly to aggregate nominal spending on goods and services. The narrower defined monetary aggregates, however, also rose significantly. To the extent that the deposits at banks could be used to purchase goods and services, they are an indication of possible spending that may exceed the economy’s production potential in the future, and therefore create inflationary pressures.” “The growth over twelve months in bank credit extended to the private sector slowed down moderately from a high level of 15,6 per cent in January 2002 to 11,7 per cent in July. Measured from quarter to quarter, growth in credit extension to the private sector fell from 19,6 per cent in the first quarter of 2002 to only 1,9 per cent in the second quarter. This considerably decreased rate of credit expansion was mainly the result of a reversal in the leads and lags in the payments for and receipts from foreign transactions. Earlier borrowing associated with these international trade transactions was mostly repaid in the second quarter when the external value of the rand strengthened. It therefore reflected a slower rate of credit extension to the corporate sector. Credit extended to households by banks hardly seems to have been affected by the increase in interest rates during 2002 and continued to rise rapidly.” “In view of these accommodating monetary developments, the Monetary Policy Committee has decided to increase the repurchase rate by a further 100 basis points to 13,50 per cent with effect from 13 September 2002. It is expected that this will lead to similar adjustments in deposit and lending rates in the domestic market. Although this will mean that interest rates in South Africa have been increased by 4 percentage points from the beginning of the year, this will in fact bring the banks ‘ real prime overdraft rate back to approximately the level prevailing during the first few months of 2002. The banks’ real twelve-month deposit rate before taxation will amount to only approximately 2 per cent if it is adjusted by this increase. The inflation-adjusted yield on long-term government bonds in July 2002 came to only 1,2 per cent.” 8. The inflation picture today Inflation continues to be dominated by the sharp depreciation of the rand towards the end of 2001. The depreciation of the exchange value of the rand and an attended surge in food prices have continued to push price increases higher. Since April 2002 international crude oil prices generally moved beyond the level of US$25 per barrel and exerted further upward pressure on the domestic price level. Developments in the labour market also started to add to the momentum of price growth. E.g., increases in total unit labour cost (i.e. wage increases adjusted for productivity changes in the formal non-agricultural sector) have risen to levels above the targeted inflation rate for the economy. The year-on-year growth in unit labour cost accelerated, on balance, from 2,4 per cent in the second quarter of 2001 to 6,2 per cent in the second quarter of 2002. Influenced by such external shocks and by the endogenously generated growth in labour cost, year-on-year inflation in production prices accelerated from 8,2 per cent in November 2001 to 15,4 per cent in August 2002. Month-on-month increases in the prices of domestically produced goods exceeded the 1 per cent mark on all but three occasions in the past 11 months. Consumer price increases followed suit. Headline inflation (reflecting increases in the prices of all consumer goods and services, including the cost of mortgage financing) picked up from 4,0 per cent in October 2001 to 11,6 per cent in August 2002. CPIX inflation (i.e. when the cost of mortgage financing is excluded from the overall basket of consumer goods and services) accelerated from a year-on-year rate of 5,8 per cent in September 2001 to 10,8 per cent in August 2002, and during 2002 it became apparent that the increase in prices was not only due to rising food prices. CPIX excluding food prices increased from 5,7 per cent in December 2001 to 8,4 per cent in August 2002. Inflation has undeniably moved to higher levels, clearly warranting a monetary policy response to avoid the entrenchment of higher inflationary expectations. Despite the timeous monetary policy responses by the Reserve Bank, expectations of higher future inflations nevertheless developed. The findings of the inflation expectations survey of the Bureau for Economic Research at the University of Stellenbosch show that in the third quarter of 2002, the average expectation for CPIX inflation in 2002 was 8,5 per cent. Looking further ahead, the average expectation was that CPIX inflation would only decline to 7,6 per cent in 2003 and to 7,0 per cent in 2004. Expected inflation is therefore well above the upper limit of the inflation-target range set by government, leaving little scope for complacency in the struggle against inflation. Inflation outlook Despite the continued rise in consumer and production inflation the inflation outlook has improved significantly. The consensus forecast of most economists and market analysts is that inflation will reach a peak in the fourth quarter of this year and then slow down quite rapidly during the course of next year. These forecasts are based on the restrictive monetary policy stance that the authorities have adopted since January 2002 and the continued fiscal discipline that has been applied. A number of other factors also favour a decline in inflation, such as no signs of excess demand in the domestic economy, excess production capacity, an undervalued exchange rate of the rand and the fact that international inflation pressures have become even more subdued. The Reserve Bank’s latest projection for CPIX-inflation also suggests that inflation will peak above the 10 per cent level during the fourth quarter of 2002. This, of course, might imply that the inflation target of 3 to 6 per cent for the calendar year 2002 might not be achieved. As soon as all the information for calendar 2002 has become available, the Bank will comment on the inflationary path going forward. The Bank’s projection further indicates that CPIX-inflation will decline to below the 6 per cent upper limit of the target range by the second half of 2003. As with all projections, there are nevertheless serious risks that some of the assumptions on which they are based may not be realised. The major risk to this forecast is the current tension surrounding Iraq and the effect that this could have on oil prices. In the case of a war it is generally expected that oil prices could rise sharply, in which case this will throw our assumptions into disarray. A stronger or weaker than expected performance of the exchange rate would also add to the risk that the actual CPIX-inflation outcome may be below or above the central projection. The outlook remains significantly improved. I thank you. | south african reserve bank | 2,002 | 10 |
Speech delivered by Dr X P Guma, Deputy Governor of the South African Reserve Bank, on behalf of Mr T T Mboweni, Governor of the South African Reserve Bank, at the launch of the labour markets and social frontiers publication series, 15 October 2002. | X P Guma: Monetary policy transparency and openness Speech delivered by Dr X P Guma, Deputy Governor of the South African Reserve Bank, on behalf of Mr T T Mboweni, Governor of the South African Reserve Bank, at the launch of the labour markets and social frontiers publication series, 15 October 2002. * * * Honoured guests, colleagues of the South African Reserve Bank and members of the media. As you are already aware, formal inflation targeting was introduced in South Africa in February 2000. One of the hallmarks of inflation-targeting is the greater degree of transparency it requires regarding monetary policy. A major determinant in the success of the inflation-targeting framework hinges on whether the Bank's actions are fully understood by and have credibility with labour, business, government and other social players in our economy. I have mentioned this in the past, but I am compelled to stress it again, that monetary policy transparency and openness are essential in order to enhance the understanding and credibility of our policies. This commitment to transparent monetary policy has resulted in numerous initiatives to improve the communication of our policies to the public. In March 2001, the Bank published and distributed its inaugural Monetary Policy Review, which is now published twice a year. We make statements, which are broadcast live on SABC, at press conferences shortly after each Monetary Policy Committee (MPC) meeting. And we simultaneously release a detailed written statement in which reasons for the Bank's stance is explained. Monetary Policy Forums (MPFs) are held twice a year at various venues around the country to create a platform for discussion on monetary policy and general economic developments, both domestically and internationally. The Bank also reports regularly to Parliament on monetary policy. Over and above all of this, I am frequently invited by various organisations to address various groups and forums, ranging from businessmen and women to universities, HIV/AIDS donors and caregivers, and I use every opportunity to bring the Bank and its work closer to the people. Today, I am proud to officially launch another initiative that is ground-breaking for the South African Reserve Bank and which I believe ranks it as a leader among central banks. The Bank realises that the effects of monetary policy impact on labour markets and social development issues. While we acknowledge that sometimes these linkages are not blatant, we cannot rule out the possibility that some of the trickle-down effects are real and warrant more in-depth interrogation. It is for this reason in particular that we thought it necessary in February 2001 to establish a Labour Markets and Social Issues Unit as part of the Research Department. The unit's mandated task is to conduct research into the inter-relationship and interaction of monetary policy with labour markets and social development issues, and to inform the Bank and other relevant partners of their findings. The publication that is being launched here today originates from this unit, in collaboration with numerous internal and external experts and editors. We believe that a wealth of valuable research and information exists amongst independent stakeholders, but the greatest contribution to society is when this information can be shared in a manner that impacts on policy and is accessible to the greater populus in a form that is easily comprehensible. It is hoped that this publication will serve as a ‘melting pot’ in which this purpose may begin to crystallise. Through publications such as this new series, Labour Markets and Social Frontiers, the Bank aims to facilitate a number of objectives. The Bank will engage with broader labour market and social development issues in order to develop a holistic, more integrated knowledge base and policy oversight. This series offers stakeholders the opportunity to share their perspectives on monetary policy vis-à-vis labour markets and social development debates. Through this initiative we are encouraging a wider readership base to include a broader spectrum of labour, community and social partners. We also aim to create an awareness of how monetary policy interacts with labour markets and social development dynamics. A pilot edition of the publication was released in March this year to “test the waters” in a sense. We included a questionnaire to solicit responses about the publication so that it could be improved as a channel of labour and social dialogue and debate. The openness of the Bank is evidenced by the fact that this edition includes four articles from experts outside the Bank. An invitation to submit articles to be published in this initiative is extended to you again today, in a bid to draw wider public research, comments and opinions closer to the Bank and to better inform monetary policy. One cannot say with certainty what the future holds for any organisation, but I am confident that the South African Reserve Bank is progressing steadfastly in its quest to become more transparent to the public. We urge our partners, especially those in labour, business and the social sectors, to support us as we endeavour to strive for the real values of openness, democracy and accountability. It is very easy to make challenging statements in chorus from a distance. What really counts and matters is true commitment. In inviting you to be a part of our publication, Labour Markets and Social Frontiers, we acknowledge that we have heard your cry - we are prepared to take you seriously and we embrace you as we join together to make a concerted effort in making a meaningful difference to all South Africans. Thank you. | south african reserve bank | 2,002 | 11 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Bureau for Economic Research Annual Conference, Cape Town, 7 November 2002. | T T Mboweni: Monetary policy and inflation Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Bureau for Economic Research Annual Conference, Cape Town, 7 November 2002. The references for the speech can be found on the website of the South African Reserve Bank. * 1. * * Introduction There has been a widespread shift among central banks toward a more focused approach regarding inflation since the early 1990s. Countries have increasingly been granting independence to their central banks with a first policy priority being low inflation. There is general consensus that high inflation is associated with bad economic performance and there is recognition by central bankers that policies aimed at systematically exploiting the short-run output/inflation trade-off to increase output beyond potential are in the long-run always ineffective and self-defeating. There seems to be continued uncertainty in some circles as to the Reserve Bank's primary objective. I have mentioned the Bank's primary objective many times before but it seems to need regular restatement. According to the Constitution "the primary objective of the Bank shall be to protect the value of the currency of the Republic in the interest of balanced and sustainable economic growth". By working towards keeping domestic inflation low, stable, and predictable, the Bank contributes towards solid, sustainable economic growth and a higher standard of living for the community. The autonomy and objectives of the Bank are entrenched in the Constitution that specifies that the Bank, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice. The Bank has interpreted this constitutional reason for its existence to mean that it must always strive to achieve and maintain price stability in South Africa. In the pursuance of this objective, the Bank assumes responsibility for, firstly, formulating and implementing monetary policy in such a way that the primary objective will be achieved in the interest of the whole community that it serves. Secondly, ensuring that the South African money and banking system as a whole is sound, meets the requirements of the community and keeps abreast of developments in international finance. Thirdly, assisting the South African government, as well as other members of the economic community of Southern Africa, in the formulation and implementation of macroeconomic policy. And fourthly, informing the South African community and all interested stakeholders abroad about monetary policy specifically, and the South African economic situation in general. In order to avoid global financial crises and the risk of contagion, the international community has been working hard to promote good macroeconomic policies, sound financial systems, and enhanced disclosure so that market discipline can work constructively. To this end, the Reserve Bank participates in the work of the Bank for International Settlements, where central bankers from around the world collaborate in research, and in developing international codes and best practices. The bank also participates in the Financial Stability Forum, an international body that brings together central bankers, regulators, and government officials to address financial stability concerns. It is another example of the Bank's forward-looking efforts to ensure that we are sufficiently prepared to withstand financial shocks should they occur. The Bank also makes available senior personnel for International Monetary Fund missions to work in other countries. Although the functions of the Bank have changed and expanded over time, the formulation and implementation of domestic monetary policy remains one of the cornerstones of its activities. Over the years the Bank has applied various monetary policy frameworks. From February 2000 an inflation targeting framework was adopted. The adoption of this target formally entrusted a single monetary policy objective to the Bank, namely, price stability. Fully-fledged inflation targeting is based on important pillars that include an institutional commitment to price stability, instrument independence, an absence of other nominal anchors, policy transparency and accountability and specifies that fiscal dominance will not be applied. The success of inflation targeting depends strongly on central bank credibility that is derived from the market's belief in the Reserve Bank's resolve and ability to meet the inflation target. South Africa adopted formal inflation targeting for three main reasons. In the first place, it was necessary to find the most credible and transparent monetary policy framework. This came after a period when money aggregate targets had at first proved less closely connected to the inflation rate than expected and the subsequent eclectic monetary policy framework had, among others, proved less transparent than hoped for. Secondly, there was a desire to balance the Bank's independence with more specific accountability. And thirdly, there was a desire to reduce the social and economic costs of high inflation by reducing the inflation expectations of both financial markets and agents in the real economy. In February 2000 it was announced that the Reserve Bank had to achieve an average rate of increase in the CPIX measure of inflation of between 3 and 6 per cent for the year 2002. The CPIX measure was chosen to ensure a wide coverage of consumer items, but without the mortgage interest component that would perversely fall as the Reserve Bank relaxed monetary policy, and vice versa. This inflation target measure was chosen because of the fact that it is the measure that most closely approximates a cost of living index for the wider community. In October 2001 it was announced that the target range would remain unchanged for 2003, and was set at an annual average of 3 to 5 per cent for 2004 and 2005. In the Medium-Term Budget Policy Statement on 29 October 2002 the Minister of Finance indicated that current conditions warranted a reconsideration of the targets. With the approval of Cabinet the target range of 3 to 5 per cent for the year 2004 was accordingly revised to 3 to 6 per cent. Once inflation has returned to the 3 to 6 per cent range, the authorities will consider introducing a lower target again. 2. The importance of the inflation forecast Monetary policy decisions are made on the basis of current and expected developments in a number of variables. These variables are also the main drivers of the Bank's econometric models and the forecasts obtained from these models contribute to the monetary policy decision-making process. The Bank's suite of forecasting models has become an important cornerstone in assessing the prospects for inflation and growth in the economy. The models have enabled the Bank to assess more effectively the risks associated with the predicted outcomes of several variables. The forecasts alone do not indicate how the monetary policy stance should be changed but they are a key source of information for the MPC. The MPC uses a fan chart to assess the risks inherent in the forecast and to communicate to the public the uncertainties that lie ahead (the Bank publishes the fan chart in the six-monthly Monetary Policy Review). The fan chart allows the MPC to focus its discussions on the potential upside and downside of risks lying ahead and more particularly on the possible effect of these risks on inflation. The fan chart clearly illustrates the large degree of uncertainty to which an inflation forecast is subject but also gives an indication of the probability of a particular outcome. 3. Assessment of inflation targeting in South Africa South Africa could not escape the combined inflationary consequences of rising international crude oil prices over the past two years and a sharp depreciation in the exchange value of the currency in the latter part of 2001. Despite these developments, monetary policy has been characterised by more measured and timeous adjustments to the monetary policy stance and greater interest rate stability since the introduction of the inflation-targeting monetary policy framework in South Africa. In assessing the performance of South Africa's monetary policy framework one could first of all ask what advantages or potential benefits were foreseen in adopting inflation targeting. The advantages that were envisaged were that inflation targeting would help to focus monetary policy through pre-commitment by making the objective of monetary policy clear from the outset. It would provide an anchor for expectations of future inflation to influence price and wage setting thereby improving planning in the private and public sectors. Inflation targeting would form part of a formalised, publicly announced, and co-ordinated effort to contain inflation in pursuit of sustainable economic growth and development. And finally, inflation targeting would enhance the accountability and transparency of the central bank to the public. The first important question is whether these advantages have materialised and, more particularly, whether there is any significant evidence of an improvement in inflation performance. If there has been an improvement in inflation performance the next important question is whether this has been achieved at the cost of greater output volatility or not. Ideally one would like to see both a decline in inflation volatility and a decline in output volatility. It is important to remember that interest rate changes are only fully reflected in inflation 12 to 24 months after an adjustment in policy. Furthermore, exogenous shocks complicate a comparative analysis over relatively short periods of time so that a period of at least three to four years would have to transpire from date of first adopting the new framework in order to be able to make a clearer assessment of the effectiveness of the new framework. A few select observations regarding some of the more tangible advantages that have been derived from the new framework in South Africa can nevertheless be made at this stage. Inflation targeting has significantly strengthened the Reserve Bank's mandate to focus on price stability. Monetary policy transparency, accountability and communication have been mutually reinforced with inflation targeting. In previous policy regimes there was no explicit benchmark against which the performance of the Bank could be judged objectively. In the inflation-targeting framework, a specific target range is set for a particular price index to be achieved within a specific time frame. Inflation targeting has also been accompanied by major improvements in the Bank's communication with the public and markets and there has been a significant upgrade in monetary policy transparency. Some examples in this regard are the biannual Monetary Policy Review, the monetary policy statements and the national and regional Monetary Policy Forums. The Monetary Policy Review analyses inflation developments and the factors that impact on inflation. It also provides an assessment of recent monetary policy developments and a discussion of the inflation outlook as well as the Reserve Bank's inflation forecast. The monetary policy forums have become increasingly popular as they provide an opportunity for two-way dialogue on monetary policy. I also appear periodically before Parliament. The fact that the inflation target is decided upon by the Cabinet has served to ensure the correct monetary and fiscal policy mix from the outset. It means that the Cabinet in effect agrees that if fiscal policy is changed, monetary policy would probably also have to change in order to offset any stimulus (or restraint) flowing from fiscal policy. Inflation targeting has in effect introduced a pre-commitment strategy and probably explains why countries that have adopted this particular approach to inflation targeting are less often characterised by public disagreements between the respective fiscal and monetary authorities. Interestingly, every single country that has adopted an inflation-targeting framework has up to the present continued to adhere to it. In South Africa the inflation target has strengthened forward-looking inflation expectations in most sectors of the economy and therefore contributed to a weakening of the weight of past inflation. Although some commentators remain stubbornly backward-looking and more than a few journalists initially continued to predict the monetary policy stance on the back of the most recent CPIX or PPI data, inflation expectations dampened significantly with the new policy strategy and CPIX inflation fell from a peak of over 8 per cent in August 2000 to below 6 per cent in October 2001. Some economists and a number of journalists had continued to focus on the "unrealistically" narrow and low inflation target of the Reserve Bank but at the same time had stressed the need for unions to moderate wage demands to avoid increases in unemployment. This in itself contributed to a more forward-looking approach to wage outcomes in general and, throughout much of last year, wage moderation and productivity gains served as important cushions that absorbed some of the inflationary impact of the currency depreciation. A number of critics of the new framework have argued that inflation targeting is an untested framework, as no major adverse shocks have put strain on the achievement of low and stable inflation in many inflation-targeting countries. This is incorrect as many inflation-targeting countries are small open economies that have been subject to severe shocks in the aftermath of the 1997 Asian crisis. The combined adverse financial and terms-of-trade shocks suffered by Australia, Chile, Israel and New Zealand, among others, led to major exchange rate depreciations in these countries which significantly tested the attainment of their inflation targets. Although inflation in these countries initially accelerated again in the aftermath of currency depreciation, they weathered this storm successfully and recorded less-than-expected pass-through from exchange rate depreciation to inflation. The inflation-targeting policy framework provides a fair measure of flexibility for the Bank. As in other countries that target inflation, the policy allows for some discretion in the case of serious supply shocks to avoid costly losses in terms of output and jobs. In this regard Svensson writes: "In practice ... [central banks] avoid causing this instability to other variables than the CPI, by adopting a more gradualist approach. They do not attempt to take inflation back to target as fast as possible. Instead they ... set monetary conditions such that the inflation projection hits the target at a longer horizon than the shortest possible ... in this sense ... inflation-targeting central banks have made the choice to pursue flexible rather than strict inflation targeting." Svensson, E.O. 1997. Inflation targeting in an open economy: strict or flexible inflation targeting? Discussion Paper Series, G97/8. Reserve Bank of New Zealand, November. 4. The growth and inflation outlook for South Africa During the past two years the world economy has experienced its most significant slowdown since the early 1990s. Although the South African economy proved to be relatively resilient last year, in the aftermath of September 11 and in the months leading up to December it was hard to find much optimism among professional economists, business people, investors and ordinary consumers. Fortunately, on the growth front things have turned out better than expected. Real GDP growth for the year 2001 was just over 2 per cent and even if this is less than is required for robust job creation and per capita income growth, it is certainly significantly higher than the growth registered by our most important trading partners and many other economies that had been affected far more severely by the slowdown in the world economy. Moreover, many professional forecasters now expect at least a moderate recovery in the world economy through the end of the year and beyond, while growth in the 2 to 3 per cent range is widely forecasted for the South African economy this year. South Africa's near-term growth prospects are encouraging and official estimates for the first two quarters of this year exceeded expectations. Preliminary indicators for a number of sectors, for example agriculture, manufacturing, electricity, construction and services, look relatively promising for the second half of 2003. Both the leading and coincident business cycle indicators have in recent months provided an encouraging outlook on the back of the strengthening performance of component indices. The exchange rate developments should also continue to provide a major boost in activity to the export and import-substitution sectors and these sectors should receive a further boost by the anticipated upturn in global activity and an associated strengthening in commodity prices. Export performance remains a pivotal aggregate to engender more robust growth this year and the strength of this contribution to growth will depend on the pace of recovery in the world economy. The budget for 2002/03 envisages a slightly more expansionary stance and an increase in the budget deficit to GDP ratio. It allows room for additional spending on targeted social welfare services, including HIV/Aids prevention and treatment, and on economic infrastructure. In addition, lower taxes have provided tax relief mainly for low and middle-income earners and have brought personal and company tax rates closer together. The fiscal and monetary policy mix therefore augurs well for better economic performance this year. The economy nevertheless remains vulnerable to concerns about South Africa's longer-term growth prospects and high priority must continue to be given to structural reforms that can make substantive progress in lowering unemployment and raising living standards. In particular, we continue to face the challenges of high unemployment, a low savings level and a high HIV/Aids infection rate. It is therefore of paramount importance that we address the daunting challenge of ensuring that South Africa's rich natural and human resources are employed for the benefit of all, promoting overall and strategic human resources development, improving social conditions, and alleviating poverty. The South African authorities are persevering with structural reform efforts that are essential for higher sustainable growth and employment and have identified a number of key areas of policy concern, such as the trade regime, competition policy, privatisation and public expenditure policies. Despite these concerns, South Africa's credit rating has improved by 2 points in the latest country credit ratings. One of the reasons is that South Africa is generally seen as getting things right and a process of differentiating South Africa from bad performers seems to be underway. It is important that we continue to build on this increasingly favourable rating and further distinguish ourselves from countries that have discredited themselves in the eyes of the international investment community. This will not only call for lower and more stable inflation in the years ahead, but we must also continue to ensure domestic financial stability by continuing to strengthen the infrastructure for the domestic banking system and financial markets. This means focusing on aspects such as further enhancing astute supervision of banks and other financial institutions, ensuring that all the proper market rules are in place, bedding down the appropriate legal framework, accounting and auditing standards as well as a reliable system of credit information on individual borrowers. Turning to inflation prospects, there had been no indication during the first half of last year of any impending upward movement in inflation. South Africa, in line with most of its trading partners, had experienced a slowdown in economic growth during the first half of 2001, but both fiscal and current account performance was strong and inflation was falling. There had been sustained fiscal rectitude and very strong revenue growth with the resultant favourable budget deficit to GDP outcome for fiscal 2001/02. As a result of improved macroeconomic performance and prospects in general, South Africa earned investment grade status on its external sovereign debt from Moody's in November 2001 while default risk spreads on South Africa's external sovereign debt narrowed by some 130 basis points during the course of the year. Given the fact that we are in an inflation-targeting framework, the Reserve Bank therefore does not have any intermediate targets or guidelines as was the case before the year 2000. The four measured and timely increases in short-term interest rates so far this year to counter the inflation spiral were entirely appropriate but inflation expectations have nevertheless continued to harden somewhat. The presence of some excess capacity in the economy should however help limit price pressures, but much also depends on movements in unit labour costs. It is still too early to assess the eventual second round inflation outcomes of recent unit labour cost developments in South Africa although it is apparent that the 2002 inflation target might not be attained. The findings of the most recent survey of inflationary expectations reflect the changed expectations of respondents. The indexation of wages in a number of important pay settlements also raises concerns about the eventual second-round effects of recent large price increases and the Bank will, as always, vigilantly monitor the situation in the months ahead. I emphasised in a recent speech that interest rate decisions by the MPC are conditioned by prevailing demand pressures, currency and labour cost movements and other indicators of inflationary conditions. In view of the relatively long transmission lags between interest rate changes and inflation, it is important that corrective measures are timeous and measured without seriously jeopardising the economy's growth performance. Flexible inflation targeting implies that the Bank should avoid severe corrective action to bring inflation in 2003 or any of the subsequent years to within the target range at significant cost to the real economy. At the same time, however, the Bank must ensure that any second-round inflationary pressures that would jeopardise the target for 2003 and beyond are contained. The recovery currently underway in the economy also appears to be sufficiently strong to have weathered the impact on output of the timeous and measured interest rate increases during 2002. 5. Conclusion We hold the view that South Africa's economic prosperity will be enhanced by a price stability approach to monetary policy and that the inflation-targeting framework is the most appropriate to achieve this objective. Economists and policy makers alike have debated the merits of inflation targeting at length and the experience in other inflation-targeting countries suggests that we can expect that South Africa's monetary policy framework will continue to evolve. Although some economists think that a monetary policy based on price stability will compromise economic growth, many governments and central banks internationally have come to recognise that inflation destroys an economy's potential since there is no long-run trade-off between inflation and unemployment. The monetary authorities in South Africa share the latter view and will continue to make decisions based on international best practice. They are furthermore committed to further improve the process of monetary policymaking on the basis of continued research and experience. | south african reserve bank | 2,002 | 11 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the dinner for Heads of Foreign Missions, Pretoria, 10 December 2002. | T T Mboweni: A review of economic and financial developments in South Africa during 2002 Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the dinner for Heads of Foreign Missions, Pretoria, 10 December 2002. * * * Mr El-Herfi, Acting Dean of the Diplomatic Corps, Ambassadors, High Commissioners, Heads of International organisations, Senior management of the Department of Foreign Affairs, Senior management of the Reserve Bank and honoured guests, all protocol observed 1. Introduction Integrating dinner with discussions of finance is not unfamiliar to central bankers. The key ingredients are good food and brevity and relevance of the discussion. I will do my best to adhere to the latter two ingredients. The former is out of my hands. 2. The global economy in 2002 The developed countries were already experiencing a slowdown in economic activity in 2001 when the events of 11 September shocked the world. Transport and tourism in particular were hit very hard, with some fallout continuing to this day. World growth in 2002 has been subdued and for the full year is expected to amount to around 2,8 per cent, slightly better than the 2,2 per cent recorded in 2001 but still way below the 4,7 per cent recorded in 2000. Alongside the uninspiring growth performance, however, inflation has been very low. In Japan prices are in fact falling, while in the Euro area the latest average inflation rate is 2,2 per cent. In the United States, inflation is running at 2,0 per cent. Beyond the lacklustre world growth and low inflation, there were a number of key events in 2002. Argentina's one-to-one peg of the peso to the American dollar, that had led to a significantly overvalued peso, collapsed. Against the one-to-one rate at the end of last year, the current exchange rate is 3,54 peso per dollar. The Argentinian economy has been contracting, while their inflation rate has accelerated to more than 40 per cent. Brazil experienced some problems, partly related to the country's high government debt and its linkages with troubled Argentina. IMF funding is helping to soften the adjustment process. In the Northern reaches of the American continent, the demise of Enron led to disillusionment with corporate governance and accounting practices. This has led to a greater awareness of the need for sound structures and practices, revised codes of conduct and a sharpening of regulation. And, closer to home, there were unfavourable climatic conditions in large parts of Southern Africa together with policies in some of our neighbouring countries which disrupted food production. As a result, the region is becoming dependent on large-scale imports of food. 3. The South African economy in 2002 The exchange rate of the rand has been at the centre of most discussions of economic developments this year. Against a basket of currencies the rand lost 34 per cent of its value during 2001 - mostly in the final two months of the year. Its gyrations were the topic of an official enquiry led by Judge Myburgh. Not surprisingly, it was found that quite a number of factors could have contributed to its sharp depreciation. Some of these factors reinforced each other, causing an exceptional overshooting of the exchange rate. At one stage importers speeded up payment for imports, afraid that they would otherwise have to pay even more rand for their import consignments, while at the same time exporters delayed repatriating their export proceeds, expecting that by doing so they would be able to exchange their foreign earnings for even more rand later on. Of course, this could not last indefinitely. With imports becoming horrendously expensive and with South African exports extremely price-competitive, supply and demand fundamentals came to the fore and the exchange rate had to turn around. From the beginning of 2002 to date the rand has appreciated by 24 per cent against a basket of currencies. To illustrate what happened to the rand's international purchasing power, in terms which may be diplomatically familiar: a 25 pound dinner in a London restaurant would have set a South African diplomat back R280 at the beginning of 2001. Just before Christmas 2001, it would have cost the diplomat R500. Today, the same meal's bill will amount to R360. Looking back at 2002, the competitiveness gained by the South African economy on account of the (overdone) exchange rate depreciation helped to smooth domestic production and income during a period of general weakness in the world economy. Import substitution progressed and South African exports penetrated various markets quite successfully. This was helped along by improved market access. In this regard, the Africa Growth and Opportunity Act of the United States should be mentioned, along with the European Union Free Trade Agreement and the Southern African Development Community Free Trade Agreement. Most importantly, numerous South African companies are reorienting their strategies, aiming to structurally raise their share of output flowing to the export market. In the process, upcoming markets such as China and India are also receiving due attention. Tourism is also doing well in spite of, and perhaps even because of, the unease following the September 11 attacks. South Africa is a pleasant destination. The number of non-residents visiting South Africa rose from 4,8 million in the first 10 months of 2001 to 5,3 million in the same period of 2002. Visitor numbers from virtually all countries have increased significantly, with the exception of Argentina - the worsening of the exchange rate in that instance caused a decrease from 13 000 persons in the ten months to October last year to 4 000 this year. Under these circumstances, South Africa maintained a healthy growth rate in the first three quarters of 2002. It seems likely that growth in real gross domestic product this year will amount to around 3 per cent, compared to 2,8 per cent in 2001. It is also heartening that the growth is spread across virtually all sectors of the economy. A further gratifying aspect of the economy's current performance is the acceleration in real fixed capital formation, so necessary to boost the future production potential of the economy. From a contraction in 1999, real fixed capital formation reversed to 0,8 per cent growth in 2000, 3,6 per cent growth in 2001 and 7,6 per cent year-on-year growth in the third quarter of 2002. Once again, the acceleration is fairly widely spread over the various sectors of the economy. The accusation is often heard that South Africa grows, but without creating jobs for the huge number of unemployed people. However, in the second quarter of 2002 our quarterly surveyed non-agricultural employment series picked up, rising by about 0,6 per cent. This may be early days, but it stands in welcome contrast to the declining trend in such employment recorded since 1989. Sadly, the 2001 fall in the external value of the rand caused a strong surge in inflation in 2002. This was first and foremost visible in production prices, which accelerated from a twelve-month rate of increase of 7,8 per cent in September 2001 to double-digit rates right from January 2002, peaking at 15,4 per cent in both August and September. In October it abated somewhat to 14,6 per cent. Consumer price inflation took longer to pick up. Twelve-month CPIX inflation accelerated from 5,8 per cent in September 2001 to double-digit levels from August 2002, reaching 12,5 per cent in October. Both at the production and consumer level, food price inflation picked up dramatically, reaching maximum year-on-year levels of 30 and 20 per cent respectively. This was related to the exchange rate depreciation coupled with the need to import grain into the Southern African region. In the face of these inflationary forces, and given the imperative to work inflation down again to the 6 to 3 per cent target range, the South African Reserve Bank responded by tightening monetary policy. On each occasion, in January, March, June and September 2002, the Reserve Bank's repurchase rate was raised by one percentage point, leading to corresponding increases in the interest rates charged by commercial banks. The banks' prime overdraft rate for instance rose from 13 per cent at the beginning at the year to 17 per cent at present. At that level, the public is clearly feeling the impact of monetary policy. Our assessment is that this will be sufficient to bring inflation down in a fairly dramatic fashion during the course of next year. But dishing out this medicine doesn't make the Bank very popular. Partly in reaction to the tighter monetary conditions, growth in credit extension has come down from a twelve-month rate of 15,6 per cent in January 2002 to 8,8 per cent in October. Growth in M3 has been more sticky, receding from 19,7 per cent to 17,8 per cent over the same period. This still doesn't leave any room for complacency, but calls for ongoing scrutiny of all available information about our economy. An extremely positive element of our financial situation is the reduction in the Reserve Bank's exposure to foreign exchange rate risk, as captured in the decrease in the our net open foreign currency position (NOFP). This has receded from US$23,2 billion in September 1998 to $4,8 billion at the end of 2001 and $1,7 billion at present. At the same time, South Africa's foreign exchange reserve level is quite strong at around 20 weeks' worth of imports, double as much as 5 years ago. It is my pleasant duty to also point out that South Africa's government finances are in a healthy shape, with tax revenue again exceeding earlier projections and the deficit before borrowing for 2002/03 now projected to amount to only 1,6 per cent of GDP. Less pleasant to point out are the setbacks to our banking system in early 2002. One troubled bank's business was eventually sold off to other institutions, while a second medium-sized bank was acquired by one of the big four banks. This episode tested numerous depositors' and bankers' nerves to the extreme; many elderly investors now choose to keep their deposits with more than one institution, which is a wise move. 4. Financial markets South Africa's financial markets are robust, liquid and well-developed. Turnovers remained brisk in 2002 to date. In the bond market, for example, the value of turnover in a single month is approximately equal to South Africa's annual gross domestic product of one trillion rand. Non-residents also take a keen interest in these markets. In an average month non-residents buy more than a R100 billion in bonds and R18 billion in shares on our bourses. They of course usually sell bonds and shares of a roughly equal amount, but some net inflow or outflow is recorded from month to month. During the first half of 2002 nonresidents bought a net amount of R13 billion in shares and bonds on the South African formal exchanges, but sold R17 billion during the third quarter. Further net sales in October were followed by net purchases in November. Predicting foreign portfolio capital flows is clearly dangerous, only to be surpassed by bargaining on net inflows from that source. South African share prices performed well up to May 2002, but then fell back sharply, partly in sympathy with foreign bourses as Enronitis took hold. In rand terms, the JSE overall price index is currently 10 per cent down on its value at the end of last year. Nonresidents, because of the 24 per cent stronger exchange rate of the rand, nevertheless made substantial profits on the JSE in foreign currency terms. Those who had invested in South African bonds or real estate in early 2002 of course recorded even better returns, since in contrast to shares those asset prices also rose handsomely in rand terms. But beyond these events on the formalised exchanges involving portfolio capital flows, South Africa has an important role to play in the area of foreign direct investment. In particular, numerous direct investment projects into other parts of Africa are being undertaken, fitting in under the broad NEPAD initiative. South Africa's involvement ranges from the Mozal smelter in Mozambique to SAA's participation in Tanzania, and includes hotels, factories, cellphone operators and shops in numerous countries on the African continent. South Africa's investments in Africa at the end of 2000 exceeded R24 billion. Other continents are also attracting the attention of South African companies that are leaders in their respective fields and some of these companies have sought listings on foreign exchanges. Companies like the resources giants Anglo American and Billiton, the financial services companies Investec and Old Mutual, the brewer SABMiller and Sappi, the pulp and paper company now have global reach and are making their presence felt beyond their home market. 5. Conclusion In short, then, the South African economy is in fairly good shape, with the exception of the inflationary consequences of the 2001 exchange rate depreciation. And the four interest rate increases as well as the notable appreciation of the rand in 2002 will in due course brake the inflation spiral decisively. While my address tonight focused on broad macroeconomic trends, it is worthwhile to stress that the macroeconomy is built up from the microeconomic decisions and actions of millions of participants. Real life happens at the microeconomic level. As diplomats you will know that it is your individual encounter with the businessperson or potential tourist that counts - where interest in South Africa or in your country is either nurtured, or nipped in the bud. A sparkling, enthusiastic, well-informed diplomat is a catalyst forging friendship and economic ties across borders. Indifference or ignorance sabotages these linkages. Accordingly, I would like to challenge you to continue deepening your knowledge of our country, its people, its economy, its incentives, rules and regulations, its magnificent places. True expert knowledge takes many years to build up, plus a lifetime of ongoing study to maintain. But it enables one to sparkle, to catch the attention of the key investor or potential tourist, to make things happen. I wish you well in 2003 and beyond in sparkling for your fraternal countries, forging links that are crucial to our mutual economic success and our ability to understand and appreciate one another. Once again it is our honour and privilege to host you at this function which has become one of the highlights of the calendar of the South African Reserve Bank. May the friendships between South Africa and your countries continue to go from strength to strength. Thank you. | south african reserve bank | 2,002 | 12 |
Lecture by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Department of Economics, University of Stellenbosch, Stellenbosch, 6 March 2003. | TT Mboweni: Inflation, growth and employment opportunities Lecture by Mr TT Mboweni, Governor of the South African Reserve Bank, at the Department of Economics, University of Stellenbosch, Stellenbosch, 6 March 2003. * 1. * * Introduction Members of the Portfolio Professors, Staff, Students, Ladies and gentlemen and Select Committees on Finance, Deputy vice-chancellor, It is very pleasant to be on this side of the beautiful Hex River Mountains and to speak to you on a number of issues right at the core of central banking. The accusation is often heard that central bankers have narrowed the world down to inflation, and do not have an open mind on any other matters. Not true! The way in which these matters come together - the principles behind their interaction - will be central to my talk to you today. 2. The magnitude of the challenges facing our economy Starting with a longer-term picture of inflation, it is a well-known fact that the double-digit inflation which reigned from 1974 to 1992 left considerable scars on our economy. Its redistributive impact was nasty, with the buying power of the most vulnerable groups in society, the poor and the elderly, in particular being undermined. The plight of a pensioner who retired twenty years ago using interest on a fixed deposit to provide for himself or herself is illustrated by the cost of a basket of consumer items which cost R100 in early 1983. The cost of that basket shot up to R380 in early 1993, and currently amounts to R815. Although inflation has receded to single-digit levels and has averaged around 7,8 per cent per annum over the last ten years, this is still enough to very significantly erode the living standard of the most vulnerable groups in our society over time. Some distortions therefore remain, leading to frictions and misallocation of resources. High unemployment continues to characterise the South African labour market. Based on the responses of a representative sample of 30 000 households sampled in the February 2002 Labour Force Survey, Statistics South Africa puts the official unemployment rate at 29,4 per cent. The absolute number of the unemployed amounts to 4,7 million people. And these are people who are looking for jobs - it does not cover those who have given up. The opportunity cost to our economy is huge: even if each of them would only produce goods and services to the amount of R650 per month (the equivalent of the minimum wage in the lowest-paying areas), their combined output would amount to almost R40 billion per annum - almost as much as the value actually added in our entire agriculture, forestry and fishing sector. Disillusionment and desperation often accompany unemployment. Unemployment insurance - soon to be expanded to more sectors - can help to relieve some of the symptoms, but what is of course needed is the creation of a sufficient number of sustainable job opportunities to absorb the unemployed. To this end, most economists agree that sustained real GDP growth of around 5 to 6 per cent per annum is needed. Whereas South Africa barely managed to record an average growth rate of 1,5 per cent per annum during the 1980s, this has indeed accelerated to around 3 per cent per annum since 1994. Nevertheless, a significant and sustained further improvement is needed. The question is how? And in what way could monetary policy contribute towards such stronger growth? 3. Inflation and growth: is there a trade-off? Can more growth (and the other side of the coin, less unemployment) be bought by allowing more inflation? This question has interested economists a lot since 1958 when A W Phillips and R G Lipsey published their analysis of the relation between unemployment and the rate of change of money wages in the United Kingdom from 1861 to 1957. Empirical evidence indicated the existence of an inverse relationship between wage inflation and unemployment. This implied that an inflationaccommodating monetary and fiscal policy stance - an easy-money policy - could be used to reduce unemployment. However, this relationship turned out to be fragile at least and quite false at worst. Firstly, empirical evidence which accumulated in numerous countries increasingly undermined the Phillips curve theory as inflation accelerated but the hoped-for reduction in unemployment either failed to materialise or did not last for long. Secondly, economic theories were developed which explicitly incorporated learning behaviour. Assuming adaptive expectations it could be shown that "the" Phillips curve (with the unemployment rate on the horizontal axis and inflation on the vertical) would shift upward over time. The true picture would then consist of a short-term Phillips curve where the trade-off holds for a while, but a long-term Phillips curve which is vertical. Some rational expectations models went further, and implied that stimulatory monetary and fiscal policies would be fully expected and reflected in prices without having quantity effects. This would mean that there would be no short-term Phillips curves, just a long-term vertical relationship. Looking at South African empirical information in this regard, there are unfortunately severe data problems. The data on registered unemployment (people registering as unemployed in order to receive unemployment insurance payouts) is patchy and where available, not consistent over time. As far as the Labour Force Surveys are concerned, they only started in 2000 and have a six-monthly frequency. But assuming growth in real GDP is the mirror image of unemployment, adequate data of high quality is available to investigate the proxy relationship - that between inflation and real GDP growth. This relationship turns out to be very loose. On a few occasions there are signs of the expected short-term relationship, with higher growth accompanying higher inflation, but most of the time it doesn't seem to persist. Over the long term, no trade-off seems to hold. In fact, it is noteworthy that from 1982 to 1992 average inflation amounted to 14,6 per cent against average real GDP growth of 0,7 per cent, while from 1992 to 2002 inflation averaged 7,6 per cent per annum and real growth 2,7 per cent. The lower inflation, the better economic growth. This runs against the logic of the Phillips curve, but makes perfect sense for central bankers who tend to stress the deadweight losses flowing from high inflation. An uncertain environment with high inflation is certainly not conducive to a true reading of price signals and relative scarcities, brisk fixed capital formation and sound resource allocation in general. (Some observers would of course argue that both the low growth and the high inflation of the 1970s and 1980s were caused by outside factors such as various supply side shocks. Correlation doesn't prove causality. And so the debate will continue…) Pursuing this line of reasoning further, a number of studies covering a large number of countries have been done, inter alia by IMF officials, to estimate the rate of inflation above which the distortions introduced by inflation really start to drag the real growth rate of the economy down. Not surprisingly, these studies come up with different answers. Growth-destroying inflation starts at low single digits, high single digits or (at most) slightly above the ten per cent mark, depending on the methodology used. A little inflation may be good, for example making it easier to lower real prices and wages in industries experiencing more competition without having to lower nominal prices and wages. However, it must be pointed out that low inflation should not solely be pursued because it is conducive to sustainable economic growth. It should also be pursued because equity, fairness and development in the broadest sense would be sacrificed if inflation were left to spiral upward. 4. What is currently happening to inflation, growth and employment? It is by now well-known that the South African government has set a target of 3 to 6 per cent for CPIX inflation. In 2002, the actual outcome was 10 per cent. While disappointing, this outcome was not unexpected in the light of the 34 per cent depreciation of the nominal effective exchange rate of the rand during 2001. It fed higher rand prices for imported products into the inflation spiral. In order to brake these inflationary forces, the Reserve Bank therefore raised its repurchase rate on 4 occasions from January to September 2002, on each occasion by 100 basis points. The 2001 depreciation of the rand was fairly soon reflected in production prices. Twelve-month production price inflation accelerated from a low point of 7,8 per cent in September 2001 to a doubledigit rate of 11,5 per cent in January 2002 and eventually reached a maximum of 15,4 per cent in both August and September 2002. Consumer prices tend to lag a bit behind production prices, and this is indeed what happened again: Twelve-month CPIX inflation accelerated from a low point of 5,8 per cent in September 2001 to double-digit rates from August 2002 and recorded a recent highest level of 12,7 per cent in November 2002. Food prices played an important role in this process. At the production price level twelve-month food price inflation peaked at around 30 per cent, while at the consumer level it peaked at around 20 per cent. For key food items like maize, Southern African production fell below demand, driving prices towards import parity - which meant very high levels in rand terms during most of the past 18 months, given what had happened to the exchange rate. But year-on-year inflation rates can be deceptive, making it worthwhile to also analyse shorter-term price movements. One way of doing so is to calculate the percentage change from quarter to quarter in the relevant price index, and then to annualise it. Calculated in this way, production price inflation shot up to 25,8 per cent in the first quarter of 2002, but receded during the course of the year to only 5,0 per cent in the fourth quarter. Consumer prices were much more sticky; annualised CPIX inflation on balance accelerated from 11,5 per cent in the first quarter of 2002 to 14,5 per cent in the final quarter. By January 2003, however, the month-to-month rate of CPIX inflation reflected some moderation flowing through from some of the slowdown in production prices; it receded to an annualised rate of 6,0 per cent. At that time the recent appreciation of the rand had swung the month-to-month rate of production price inflation around to an annualised rate of decline of 6,4 per cent. It is not only in Japan where prices can decline! But I should hasten to add that there is no comparison between Japan's long-term price deflation and South Africa's short-term decline in production prices which is so closely related to exchange rate movements. How do inflation prospects look going forward? To some extent this has already been dealt with in the Reserve Bank's Monetary Policy Review of October 2002. It projected that CPIX inflation would peak towards the end of 2002 (which it did), and then would decline fairly dramatically during the course of 2003 (which also seems to be in progress). The disciplined monetary policy stance and continued sound control over the government finances were already set to reign in the inflation spiral, and are now receiving some additional help from the relatively strong exchange rate - stronger than had been incorporated in the central scenario of the October 2002 projections. New projections will of course be tabled at the forthcoming Monetary Policy Committee meeting, to be held on 19 and 20 March. Some downward rigidity in inflation should always be expected with various ratchet effects, sticky nontradeables' prices and the like, but the resolve of the MPC to steer inflation through difficult terrain to within the 6 to 3 per cent target range should not be underestimated. Doing all the right things and the things right as far as macroeconomic policy is concerned, with enhanced stability, clear medium-term policy frameworks, and adequate transparency and accountability, confidence is growing and fixed investment expenditure is rising. Furthermore, the rising investment expenditure is spread over many industries. This bodes well for future growth. The transition from volatile real GDP growth that did not quite match population growth in the 1980s to more consistent growth of around 3 per cent per annum in recent years is very significant. As the consistent track record grows, the athlete is likely to graduate to the stage where 3 per cent is much too pedestrian. Declining employment numbers have since 1989 been recorded in the core formal sectors of the South African economy. These numbers are not comprehensive; while it inter alia includes government, manufacturing and mining, it for instance doesn't include industries such as computer programming. But it is broad enough to make it worthwhile to note that core formal sector employment turned around in the second quarter of last year, growing at an annualised rate of 1,8 per cent, followed by 2,4 per cent in the third quarter. While two swallows do not make a summer, it nevertheless represents good news. 5. A note on lags in monetary policy In monetary policy formulation we are acutely aware of the long and variable lags inherent in monetary policy. We have to assess the current economic situation and economic problems at hand as comprehensively and quickly as possible. And we cannot simply look out of the window like a rain forecaster to get an initial feel for the situation. A huge amount of statistical work, including large-scale surveys of economic agents in various sectors, has to be done to get the facts on the table. Then we have to decide which policy instruments to use and to what extent. Utilising inputs from economic researchers, the Monetary Policy Committee deliberates on issues and after thorough debate takes a decision. Next we have to implement those instrument changes. With operational departments that are well-geared, this element of monetary policy is usually quick and clean. But then, of course, the economy has to respond to the new instrument settings. Many things can only be speeded up to a certain point. Even with the utmost dedication and effort, a comprehensive picture of the economic situation can only be tabled about two months after the end of the quarter concerned, although many individual bits of information are available and are analysed earlier on. The MPC process itself is fairly quick, taking two days. Monetary policy changes can generally be implemented almost immediately. The really frustrating part is the "outside lag". This is generally held to be about 18 to 24 months. When the MPC senses an imminent acceleration in inflation and raises interest rates to counter it, private sector banks usually raise their own interest rates within days. However, with so many transactions already irrevocably in the pipeline and with many economic agents not very sensitive to interest rates, credit extension and expenditure are slow to react. Eventually they do, of course. It is usually only at that time, when expenditure slows down significantly, that price and wage setters start to discover real resistance to further increases. It could easily be 18 months or longer from when policy interest rates are raised to when it fully works through and moderates the inflation rate. In this world of long lags, credible inflation targeting seems a useful mechanism to shorten the outside lag and perhaps moderate the magnitude of the interest rate changes required to achieve a particular outcome. If there is no doubt that the authorities are committed to the inflation target and will in the end prevail, economic agents are likely to set their prices and wages at levels readily reconcilable with the inflation target, and are likely to view deviations from the target as temporary. Less interest rate medicine is likely to be required with such a forward-looking expectations formation process. Less sacrifice would therefore be required to get to the inflation target range and to remain there. But this could only work if the central bank is fully committed to the inflation target, is independent and willing to use its policy instruments to the full extent needed, and if all economic agents know this. In cricket, one-day games have risen in popularity as the tempo of life has accelerated. Most people simply do not have five days to watch the traditional kind of match. So things have been speeded up; without it, the Cricket World Cup tournament would have taken ages to complete. It seems preferable to also speed up the tempo at which inflation unwinds and returns to our 6 to 3 per cent target range, working along the lines of the forward-looking expectations process described previously. While I have no doubt at all regarding the Reserve Bank's independence and commitment to achieving the inflation target, the lag structure in economic agents' response will be most interesting. May we have a one-day match rather than a marathon! 6. Conclusion Low inflation and financial stability support sustainable economic growth, development, equity and employment creation. They are not in opposition to it. While some short-term trade-offs cannot be denied, allowing inflation to take root has dire long-term consequences. CPIX inflation is already in deceleration mode, and the Reserve Bank will vigorously ensure that it ends up in the 6 to 3 per cent target range. Thank you. | south african reserve bank | 2,003 | 3 |
Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, at the Merrill Lynch Macro Day, Johannesburg, 25 March 2003. | Ian Plenderleith: The aim and operation of monetary policy Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, at the Merrill Lynch Macro Day, Johannesburg, 25 March 2003. * * * I was honoured and delighted to have the opportunity to join the South African Reserve Bank as a Deputy Governor at the start of this year. As still very much a newcomer to the South African scene, I thought I might take this opportunity to share of few of my early impressions of the South African economy - and specifically of the operation of monetary policy, which is the particular responsibility of the Reserve Bank I should say at the outset that these impressions are very positive. There is, in my view, a great deal to be admired in the performance of the economy, and in the contribution monetary policy is making to promoting that performance; and in parallel, a great deal of progress is being made in pressing ahead with structural reform, across a wide front, in order to ensure that the economy can fulfill its potential in the future. Perhaps the most remarkable achievement that strikes me in the economic sphere is that the South African economy has continued to achieve steady and sustained growth over the past few years despite the global economic slowdown in the surrounding world economy. As the world economy has moved into slowdown over the past two years or so, the South African economy has continued to grow at around 3% - not, to be sure, as fast as one would hope to achieve in a more favourable world environment, but nonetheless a great deal better than many other economies have experienced. The current cyclical upswing in the South African economy, which began in September 1999, has now been in progress for 3½ years; and, looking ahead, the prospects are encouraging for the economy to continue to grow. How has this been achieved? There are no doubt many contributory factors, but I think an important one is the coherent and responsible macroeconomic policy framework which the authorities have steadily and consistently pursued over recent years, covering both fiscal and monetary policy. The fiscal side is not for me, as a central banker, to dwell on. But there is no doubt that the steady commitment the government has shown to keeping the budget deficit to low and manageable levels and to containing the burden of public sector debt has delivered real benefits in terms of a strong and sustainable structure in the public finances. The result, as evident in the Budget last month, is that, as the economy has grown and as revenue collection has strengthened, there has been enhanced scope both to reduce taxes and to continue building up essential spending programmes on a sustainable basis. In the monetary field, on which I want to say a little more, there has similarly been a commitment to a coherent and responsible framework steadily and consistently pursued. This is the inflation-targeting framework, which mandates the Reserve Bank to keep inflation low in order to deliver broad price stability across the economy as a whole. South Africa is, of course, not alone in setting price stability as the priority for monetary policy. Maintenance of low inflation is the universal aim that central banks around the world are set to pursue. But in pursuing this aim within the framework of an explicit low inflation target, South Africa is very much in the forefront of international best practice. Why this emphasis on low inflation and the commitment to price stability? At one level, the socioeconomic damage that flows from a failure to control inflation is all too evident. High and volatile rates of inflation disadvantage the poor, who are least able to protect themselves from the ravages of inflation, to the benefit of those more able to preserve their standards of living. Inflation disadvantages in particular those living on fixed incomes, often the elderly reliant on pensions or savings. Across the board, inflation will tend to discourage savings and undermine the ability of people to plan their future personal finances on a prudent, long-term basis. By eroding values in a corrosive and insidious fashion, inflation can undermine sociably responsible behaviour and threaten the stability of society as a whole. Not for nothing has inflation been called a silent and invisible thief. In more specifically economic terms, too, inflation is the enemy of long-term sustainable economic growth, weakening the capacity of the economy to achieve the rate of growth of which it is capable. Past history, in South Africa and in many other countries, illustrates this all too vividly. If demand in the economy is allowed to grow faster than the output supply capacity of the economy, the result is inevitably rising inflation. This is because excess demand cannot induce the economy to deliver more output than it is capable of producing: it simply bids up the price of the output the economy can produce, generating inflation. If inflation is allowed to gather pace, the process of reining back excess demand, through higher interest rates, is inevitably more wasteful, in terms of an extended period of growth below capacity, than if timely action is taken by the monetary authorities to keep the pace of demand in line with the supply capacity of the economy. To try to maintain that balance, between demand and supply in the economy, is essentially the task of monetary policy and the aim the central bank is pursuing when it sets interest rates. If it succeeds, inflation will be kept low and the economy can continue to grow at a steady and sustainable rate on a continuing and lasting basis. There is an important corollary of this process. This is that there is not, in any meaningful sense, a trade-off between growth and low inflation. It is not in practice feasible to contemplate living with a somewhat higher rate of inflation, even for a period, in the hope that this would bring higher growth. The reason is that low inflation is not an alternative to growth, but a necessary and essential pre-condition. Without a commitment - made and delivered - to keeping inflation low, we will not achieve on a sustainable basis the growth of which the economy is capable. With low inflation, demand, and hence output, in the economy can continue to grow on a steady and sustainable basis. In pursuing low inflation, therefore, the central bank is aiming for exactly the same goals that we all desire - continuing sustainable growth in output and employment and living standards across the economy as a whole. The inflation-targeting framework in South Africa has a critical role to play in maintaining low inflation. Its strength lies in the fact that its structure contains what I believe to be the four key elements for an effective monetary framework. Let me say a word briefly about each. First, the framework provides for an explicit target to be set for inflation. This is currently that inflation, as measured by the CPIX, should be brought back down to, and held within, a range of 3-6%. The value of setting an explicit target in this form is that it helps to anchor inflation expectations to a low level. Business and industry, and individuals, in making their own financial plans, will hopefully do so on the basis that inflation will be kept in that range over time; and on the basis that, if, as at present, inflation moves outside that range, the policy stance will be adjusted promptly to bring it back within range - as indeed was done last year. Anchoring expectations in this way helps in turn to build low inflation into the fabric of the economy as a whole. The target also, importantly, provides a means, quite properly, of holding the central bank to account for its performance. I shall touch on this last aspect again in a moment. Secondly, the inflation-targeting framework gives the responsibility for achieving the target to the central bank, and specifically to the Reserve Bank's Monetary Policy Committee, acting independently and under a clear mandate to deliver the target. It also gives the MPC the means to achieve the target, through its decision on setting the Reserve Bank's repo rate at each of its meetings. The framework thus ensures that there is a clear allocation of responsibility; and it ensures that interest rate decisions are taken by a competent authority dedicated to the task and acting independently. Thirdly and fourthly, the inflation-targeting framework is one that delivers a high degree of transparency and accountability. Transparency and accountability is achieved through the full statement the MPC issues immediately after each meeting, through the range of publications the Reserve Bank issues setting out its view of developments, and through the public appearances the Governor and his colleagues make in explaining the Reserve Bank's policy activities. I think this is a very important and beneficial part of the process for several reasons - partly because it is right that in a democratic system public agencies should be required to be open and accountable in explaining their activities; partly because that process hopefully helps to maintain public confidence in the performance of the agency and public support for the objective of low inflation; partly because that in turn should encourage business and individuals to conduct their affairs on the basis that low inflation will be maintained; and partly because openness and accountability helps promote a better public debate on the issues. These are all elements that I believe help to strengthen the effectiveness of the inflationtargeting process. This framework has, of course, been tested in the past 18 months by the inflationary shocks the economy has faced from the fall in the value of the rand in the latter half of 2001 and the accompanying upwards pressure on food prices and fuel costs. The steps taken last year to raise interest rates were necessary to prevent these shocks generating a self-reinforcing process of rising inflation. As indicated in the statement issued after last week's meeting of the MPC, there are now signs that the inflationary pressures are beginning to abate and that the outlook for inflation is improving, though there is little room for complacency given the considerable risks we still face. But to return to my initial impressions, what is particularly encouraging, I believe, is that the coherent and responsible policy framework provided by inflation-targeting has demonstrated its ability to address the shocks in a steady and considered manner and, in doing so, has helped considerably to maintain confidence in the economy. This is particularly evident in the international markets, where confidence in the fundamentals of the South African economy has undoubtedly been a factor in the recovery of the rand; and it is evident, too, in the positive attitude to South Africa encountered more generally abroad - notably, for example, in the upgrades that have already been put in place by the rating agencies, with further upgrades in prospect. This, more than anything, - a well-structured policy framework, steadily and consistently pursued - is what has helped the South African economy to continue to grow through the current world slowdown. This is strong evidence that a commitment to low inflation works, in helping to maintain sustainable growth, and that it will help us to achieve the future growth that is essential to enable all of us to develop the huge potential of this fine country. | south african reserve bank | 2,003 | 3 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Times Business Breakfast, Cape Town, 20 May 2003. | T T Mboweni: Recent economic developments in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Times Business Breakfast, Cape Town, 20 May 2003. * 1. * * Introduction Against the backdrop of a weak international economy, the salient recent economic developments in South Africa from the Reserve Bank's perspective are the promising trends in inflation, the slowdown in the pace of domestic economic activity and the behaviour of the exchange rate of the rand. Before we address these issues, however, we would like to briefly reiterate the Bank's mandate and our view of our role in the economic growth process. According to the Constitution, the task of the Bank is to protect the value of the currency in the interest of balanced and sustained economic growth in the country. The overriding objective is therefore price stability, by which we mean achieving and maintaining a low and stable rate of inflation. Within the inflation targeting framework, we have been mandated by Government to achieve an inflation target of 3-6 per cent. Achieving low inflation is not an end in itself: it is important because it is a prerequisite to the growth process. Furthermore, from a welfare perspective, the distributional impacts of high and variable inflation are such that it is generally the poor that are hardest hit by inflation as they are the least able to protect themselves or hedge against this. It is sometimes argued that by focusing on inflation we are not concerned about growth. As I have just stated, our longer-term concern is precisely with economic growth, employment creation and sustainable development. At issue then are short-term growth fluctuations. Although this is not our primary focus, it does not mean that we ignore cyclical movements. Most central banks, even inflation targeting central banks, are concerned with such fluctuations, but central banks may differ in terms of the weight they put on these fluctuations in their reaction function. Some central banks have a dual mandate and therefore have to focus more directly on cyclical growth whereas others, such as in our case, have a single mandate. It is also generally the case that in the early phase of inflation targeting, a greater weight is put on inflation as credibility is built up. Although inflation is our main objective, we are nevertheless sensitive to the real effects of our policy actions. In any event, the current and particularly the expected state of the domestic economy is an important consideration in making monetary policy decisions. The state of domestic demand is an important determinant of inflation, so, although we may not be targeting short-term growth, our monetary policy is not set independently of such developments. 2. Inflation developments As is now well known, the depreciation of the rand during the last quarter of 2001 resulted in a surge in inflation which prevented us from realising our inflation target for 2002. We had been well on course to achieving that target, with CPIX inflation having fallen below the 6 per cent level in September and October of 2001. Since November 2001, inflation accelerated and the average for 2002 was 10 per cent, 4 percentage points above the upper band of the inflation target. Fortunately CPIX inflation appears to have peaked in November of 2002 at 12,7 per cent. Since then we have seen a gradual decline, with rates of 11,3 per cent in February and 11,2 per cent in March. At these levels, we are still significantly far off from our inflation target of 3-6 per cent. However, there are a number of pointers to a sharper decline in the inflation rate over the next few months. Firstly, the quarter-on-quarter figures which give a better indication of the short-term trends show that on an annualised basis CPIX decelerated from 14,5 per cent in the fourth quarter of 2002 to 6,7 per cent in the first quarter of 2003. What was particularly gratifying was that the main driver of inflation in 2002, food price inflation, fell steeply from an annualised rate of 18,7 per cent to only 2,4 per cent over the same period. Secondly, to the extent that the Producer Price Index is an indicator of future consumer price inflation, the prognosis for a significant decline in CPIX inflation is good. The year-on-year all-goods PPI in March 2003 was down to 5,1 per cent, with a lot of impetus coming from the recovering exchange rate of the rand - the imported component of the CPI fell to 0,5 per cent, the lowest rate of increase since May 1998. Measured quarter-to-quarter and annualised, these rates were even more encouraging with negative inflation being recorded. The all-goods PPI inflation was minus 3,6 per cent, while the imported component was minus 10,4 per cent. Thirdly, the forecasting model of the SARB also indicates a sustained decline in CPIX inflation during the course of the year. However, a word of caution is necessary. As we have consistently emphasised, we conduct monetary policy on a forward-looking basis. What our forecasts show, as published in the most recent Monetary Policy Review, is that CPIX inflation is expected to bottom out to average around 5,7 per cent in 2004. These forecasts may of course be superseded by subsequent events, and we will be seeing the latest forecast at the forthcoming MPC meeting. However, most forecasts project a significant slowdown in the pace of at which inflation is expected to fall later in the year or early next year. Bearing in mind that we should be focusing not on the upper end of 6 per cent but more around the mid-point of the target range, even if the latest forecast turns out to be more optimistic with respect to the longer-term outlook, it is unlikely to move right down to the mid-point. Finally, this outlook for inflation is also supported by recent monetary developments. The year-on-year growth rate of M3 decelerated from 12,8 per cent in December 2002 to reach 5,7 per cent in March 2003. The quarter-on-quarter seasonally adjusted and annualised growth rate in M3 decelerated from 6,9 per cent in the fourth quarter to 1,9 per cent in the first quarter of 2003. Similar trends have been observed in the growth rates of the narrower monetary aggregates as well. Growth in credit extension to the private sector from the monetary institutions was also subdued, although the figures were distorted by regulatory and accounting changes of a technical nature which came into effect from January 2003. Although private sector credit extension accelerated to twelve-month growth rates of 13,8 per cent in February and 16,6 per cent in March 2003, adjusting for the reporting changes, these growth rates would have been 9,1 and 9,3 per cent respectively. 3. Recent labour market developments As our MPC statements have emphasised, there are a number of risks to the inflation outlook. One that is emphasised repeatedly is the trend of unit labour costs. In reviewing recent economic developments, we feel it is important to say something not only about unit labour costs, but also about some positive developments on the employment front. We often hear the criticism that inflation targeting is detrimental to growth and employment creation. However we wish to point out that these positive developments occurred within our inflation targeting framework. That is not to say that monetary policy should take credit for employment creation, but rather to illustrate the point that an inflation targeting framework is not necessarily an impediment to employment creation. According to the Survey of Employment and Earnings in Selected Industries by Statistics South Africa, regularly surveyed formal non-agricultural employment rose in the each of the last three quarters of 2002. This resulted in employment gains of about 70,000 workers and follows three years of continuous decline. These positive developments occurred in both the private and public sectors of the economy. In both these sectors, employment rose at a rate of 1,2 per cent in the fourth quarter of 2002. This turnaround in employment trends suggests that employment has begun to be responsive to economic growth and that the restructuring process that characterised the economy since the early 1990s is bearing fruit. The unemployment rate nevertheless remains high at 30 per cent, but there are encouraging signs that it is not increasing. Unemployment remains one of the main challenges facing South Africa and will be addressed at the planned Growth and Development Summit on 7 June 2003 between Government, Business and Labour. The summit will endeavour to formulate sectoral and developmental agreements that foster economic growth and job creation. Although things are looking better on the employment front than they have done for a number of years, the concern for the Bank is the trend in unit labour cost, which plays an important role in the inflation process in South Africa. During 2002, wage settlements have trended higher, in response to the higher inflation. The slowdown in economy-wide productivity growth and rising nominal wage growth resulted in non-agricultural unit labour cost accelerating from a year-to-year rate of 4,1 per cent in 2001 to 7,0 per cent in 2002. Central to our concern is the fact that wage settlements often tend to be set in a backward-looking manner, particularly in the case of multi-year agreements. This acts as a constraint on the downward movement of inflation and leads to so-called inflation persistence. There is evidence that not only wages, but also inflation expectations, are set in a backward-looking fashion. We would like to see wages (and prices) being set in a forward-looking manner, i.e. on the basis of the inflation rate that is expected to prevail over the period for which wages are being set. This will result in a lower sacrifice ratio i.e. the output cost of reducing inflation will be much lower if wages and prices are set in a forward-looking manner on the basis of the inflation target. Of course for this to happen, there has to be credibility that the Reserve Bank will be able to achieve the inflation target. This credibility can only be built up by the Bank achieving the inflation target and having a proven track record of maintaining low inflation. For this reason we are determined to achieve the inflation target. The benefits to the economy will not only be higher long-term growth, but also lower short-term output costs in reacting to unexpected shocks in the future. There is also some evidence of backward-looking behaviour in the formation of inflation expectations. In the survey conducted for the Bank by the Bureau for Economic Research, for example, labour and business respondents in particular appear to adjust their expectations to follow actual inflation, with the expectation that these levels will be maintained over the next three years. If wages and prices are set on the basis of such expectations, inflation will remain higher and the job of monetary policy that much more difficult. 4. Domestic Output and Expenditure Domestically, 2002 was a relatively good year for economic growth. Despite the slowdown in the international economy and the short-lived global recovery, South Africa's growth performance of 3 per cent in 2002 was relatively sound despite the tighter monetary policy stance adopted during the year. However there are signs that economic activity is slowing down. The slowdown can be seen in the quarter-to-quarter annualised growth figures in 2002 which declined from 3,8 per cent in the second quarter to 2,4 per cent in the final quarter. The slowdown in the fourth quarter was mainly due to slower growth in the real value added by the secondary sectors and the fact that there was virtually no growth in the primary sectors of the economy. These sectors appear to have been affected by the recovery in the rand and the continued global slowdown. Overall there was a robust increase of 4,1 per cent in manufacturing output during 2002, but this has tapered off significantly. The latest released data show that although growth between the first quarter of 2002 and the first quarter of 2003 was 0,4 per cent, quarter-on-quarter manufacturing production fell at a seasonally adjusted and annualised rate of 7,4 per cent in the first quarter of 2003. Other indicators, such as the latest Purchasing Managers Index also point to a slowdown in activity. Although there appears to be some slowing down of the economy, there are indications that domestic final demand remains fairly strong. Despite the increase in interest rates over the past year, real growth in household consumption expenditure was unchanged from 2001 at 3,1 per cent although on a quarterly basis there was a decline over the year in durable goods consumption. Government consumption expenditure growth remained relatively strong and increased slightly. From a future growth perspective, the promising aspect of the domestic expenditure growth is the increase in domestic capital formation. Gross fixed capital formation increased in successive quarters, reaching 11,5 per cent growth in the fourth quarter and 6,5 per cent for the year in 2002 compared to 3,2 per cent the previous year. Although part of this was due to the purchases of new aircraft by SAA, the expenditure related to Coega and other projects was also significant. Indications are that because the capital expenditure of all tiers of government is improving, there is greater capacity for delivery, and much-needed infrastructural expenditure is now taking place. The weak international environment and the stronger rand have resulted in a deterioration in the trade account of the balance of payments, which is likely to be reflected in a less favourable current account than in the fourth quarter of 2002 when a surplus of R4,3 billion was recorded. The physical volume of merchandise exports declined by 5,3 per cent in the first quarter of 2003. This, together with a decline in prices of merchandise exports, resulted in the seasonally adjusted and annualised value of merchandise exports falling by approximately 13 per cent over the past quarter, from R295,9 billion in the fourth quarter of 2002 to R257,8 billion in the first quarter of this year. Net gold exports declined from R40,2 billion to R35,6 billion over the same period. The 10,8 per cent decline in imports was insufficient to offset the decline in exports, and this resulted in a contraction of the trade account surplus in the first quarter of 2003 to R32 billion, from R43,1 billion in the final quarter of 2002. Looking at the market activity, the monthly average turnover on the JSE Securities Exchange SA (JSE) during the 12 months ending in April 2003 amounted to R75 billion. This was slightly higher than the monthly average for the preceding 12 months (R70 billion). The domestic equity market performed exceptionally well during the first five months of 2002, benefiting from the sound performance of the gold index. However, by the end of April this year, the monthly average share price level had fallen by 32 percent from its all-time high of 11 686 reached on 22 May 2002. The turnover on the JSE increased from R55,8 billion in January 2002 to R104,2 billion in June 2002. In January 2003 turnover amounted to R61,8 billion, falling to R46,9 billion in April this year. The total annual turnover for 2002 also increased to R842 billion from R607 billion in 2001. Since July 2002, foreign investors became large net sellers of domestic bonds and equities. A net amount of R5,6 billion worth of equities was sold during the calendar year 2002. This trend continued in January 2003, when R3 billion worth of equities was sold in that month. In February 2003, however, foreigners turned buyers of equities and they bought a net cumulative amount of R1,6 billion over the last four months. From the beginning of 2003 to mid-May non-residents sold shares to the value of R1 billion on a net basis. Foreign holdings of domestic bonds also decreased substantially since July 2002. A net amount of R12,7 billion was sold by them over that period. During April 2003, a large net amount of R5,8 billion was bought by foreigners as the interest rate differential brought profitable opportunities to the foreign investors. From the beginning of 2003 to mid-May, non-residents were net buyers of bonds amounting to R1,5 billion. 5. International Economic Developments South Africa's recent economic performance has to be seen against the backdrop of an international economy that continues to move at a sluggish pace. The expectations of an early recovery in the United States and the euro area have receded, and most analysts have downgraded their forecasts for world growth, particularly in the advanced economies. Given that the US is still the engine for world growth, this does not indicate that there will be a general world recovery very soon. The euro area is not seen as a viable alternative engine for growth, and first quarter growth in the region was around zero, with Germany, Italy and the Netherlands recording negative growth. The timing of the recovery is very uncertain, and the more pessimistic forecasts see a low growth scenario for at least another two years. Even the more optimistic forecasts, which see some recovery later this year, have had to continually push out the timing of the recovery against the initial expectation of a recovery in early 2002. Adding to this sobering outlook is the uncertain effect that the outbreak of SARS will have not only on the Asian economies (which was the one region that was expected to show significant positive growth this year) but on the tourist industry world-wide. South Africa will not be immune to this fall-out, and there is already evidence of some decline in tourism, particularly from East Asia. Tourism has been one of the important growth areas of late in the South African economy and during January and February of this year, the number of visitors to South Africa increased by over 8 per cent, compared to the same period last year. This is despite an unfavourable tourist environment of slow global growth and increased fears of travelling. But it is not only tourism that is negatively affected by the slow global growth. The decline in manufacturing output mentioned above is to a large extent a result of declining export volumes. Although part of that is no doubt attributable to the recovery of the rand, the decline in demand due to the global slowdown is significant. The low growth, and in fact fears of deflation in some countries, does mean that we remain in a low inflation international environment, which will help to contain inflation domestically. Similarly, the near conclusion of the war in Iraq has meant that we have returned to a more orderly world oil market, and a major risk factor to our inflation targets has in fact receded. 6. NOFP and Exchange Rate Developments The recent successful government bond issue of Euro 1,25 billion has allowed us to achieve our objective of expunging of the NOFP. The US dollar equivalent of this amount, which was received on 16 May, was delivered against outstanding forward commitments which effectively eliminated the outstanding net open foreign currency position (NOFP) of the Reserve Bank. The net open foreign currency position stood at US$1,2 billion as at the end of March 2003. The exact details of the impact of this, and other transactions, which took place during the month of April and May, will be released in accordance with the Reserve Bank's regular data releases to the market. The outstanding forward book on 30 March 2003 was US$6,6 billion. Probably the most important reason for the Reserve Bank to further reduce the outstanding forward book, now that the NOFP has been eliminated, is to eliminate a source of instability in the South African economy. According to many observers the total elimination of the forward book may contribute to a more stable exchange rate of the rand over time. As and when the forward book has been eliminated, the focus of the Bank will turn increasingly to managing the foreign exchange reserves. Whilst there are a number of reasons for managing foreign reserves more actively, the most obvious reason would be to earn income on foreign currency assets. A higher level of reserves tends to provide a higher degree of comfort to investors from a credit worthiness point of view, and experience has shown that during times of financial market crises, countries with higher reserves tend to be more resilient. Partly because of these positive developments in the NOFP, the international ratings agency Standard and Poor's recently raised South Africa's long-term foreign currency ratings to BBB and a stable outlook. This follows the re-rating by Moody's of South Africa's outlook to positive. This agency cited improved government debt ratios, improved external liquidity, “careful” macroeconomic management and the reduction in the NOFP. Fitch had also previously upgraded South Africa's long-term foreign currency rating to BBB. These improved ratings have already assisted in reducing South Africa's cost of borrowing as seen in the recent government eurobond issue. Of all the recent economic developments, the behaviour of the rand has perhaps attracted the most attention. After depreciating by 0,4 per cent during January 2003 on a weighted average basis, the rand appreciated by 8,2 per cent and 0,4 per cent respectively during February and March, resulting in an increase of 7,5 per cent from the end of December 2002 to the end of March 2003. This followed a 26 per cent appreciation for 2002 as a whole. The nominal effective exchange rate of the rand improved by a further 10,2 per cent during April. More recently however, there has been a sudden reversal and as of yesterday afternoon, the trade-weighted appreciation of the rand since the beginning of the year was just over 5 per cent. Much has been said about the behaviour of the exchange rate over the past two years in particular. The fact that there was pressure to appoint a commission of enquiry into the rand's depreciation implies that there was no obvious reason for such a sharp move in the exchange rate and that the move was clearly overdone. Given that there was a significant overshoot, it is not surprising that there has been a significant recovery. Prior to the depreciation in 2001, there was not a general view that the rand was overvalued. If anything, the current fundamentals are in better shape than they were at that time, so it would not be surprising to see the rand making a strong recovery. Although there can be no doubt that interest rate differentials have played a role in the recent strength of the rand, even market analysts are sharply divided as to the extent of this effect. On the one hand, the currency pessimists argue that it is all a question of interest rate differentials, and that once the Bank starts lowering interest rates, the rand will retrace its steps to significantly weaker levels. On the other hand, the currency optimists point to the fundamentals, and in particular commodity price developments, and argue that the rand is around 'fair value' levels, and that any interest rate reductions will have a marginal effect. Some go as far as to say that there is still substantial scope for further recovery of the rand. Whatever the case may be, the Bank's focus is on the inflation target. The Bank does not have a view on the appropriate value of the rand. Obviously from an inflation perspective, a stronger rand is better than a weaker rand, but as we have emphasised on numerous occasions, it is not Bank policy to intervene in order to influence the level or direction of the exchange rate. What activity there has been was for normal portfolio purposes. Although there are disagreements as to the appropriate level of the exchange rate, there is general consensus that the more important issue is the volatility of the exchange rate. The volatility observed over the past few months is clearly not healthy for the economy. The uncertainty caused by such movements makes investment and export planning extremely difficult. What may seem a profitable venture under one exchange rate scenario, may turn out to be totally unviable should the exchange rate change substantially. Unless the exchange rate is driven by the underlying fundamentals, trying to predict exchange rate movements can be extremely hazardous and adds to the riskiness of investment. Although the expunging of the NOFP was expected to eliminate an important source of volatility in the exchange rate, volatility is however a fact of life for most emerging market economies. In a recent Bank for International Settlements study comparing the experience of 12 emerging market inflation targeters with that of six of their industrial country counterparts, it was found that emerging market economies tend to be relatively more exposed to exchange rate fluctuations for a range of structural and historical reasons. The study concludes however that 'in the longer run,…… improved inflation outcomes, consolidation of policy credibility and economic development can be expected to help reduce some of the vulnerabilities of emerging market economies'. In addition, the study argues that although exchange rate considerations pose a challenge to emerging market inflation targeters, the cost of exchange rate movements are not only of concern to emerging markets. Current experience in Europe and the United States reminds us that having to keep an eye on the exchange rate is also a fact of life in industrial economies, inflation-targeting or not. 7. Conclusion With low or at best moderate growth forecasted in the United States, the euro area and Japan, exports cannot be counted on to continue to lead South African economic growth in the near term. South African exporters will have to focus on improving competitiveness through productivity enhancements. They cannot just rely on the exchange rate. The mining industry and other exporters are crucially important to the South African economy but so are the many industries that source inputs from abroad. The current slowdown observed in the manufacturing sector is not simply a question of a strong exchange rate, but also the weak state of global demand. The bottom line for us at the Bank, however, is that our actions will be guided by the need to achieve our mandate. There are currently promising signs that the inflation rate is on a sustainable downward trajectory. However, monetary policy will be determined by how the Monetary Policy Committee sees the future course of the factors that determine inflation. These factors include not only the state of domestic demand or output, but also the extent to which unit labour costs and inflation expectations react to these factors. On the whole, the outlook for inflation looks good. Thank you. | south african reserve bank | 2,003 | 5 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the City Press/ Peoples Bank Success Club Forum, Jo... | TT Mboweni: Empowerment and the South African economy Speech by Mr TT Mboweni, Governor of the South African Reserve Bank, at the City Press/ Peoples Bank Success Club Forum, Johannesburg, 6 August 2003. * * * 1. Introduction Ladies and Gentlemen. Thank you for inviting me to speak at this forum. I am told that this platform often provides for robust debate and I am always pleased to participate in such debates. My remarks today will, however, probably not add as much fuel to the fire as you might have hoped. Nevertheless I am pleased to be here this evening to make a contribution to what should be an ongoing general discussion about the economy of South Africa. 2. Domestic output and expenditure South Africa's growth performance of 3 per cent in 2002 was relatively sound given the continued underlying weaknesses in the international economy. However, the quarterly GDP growth rate which decreased to 1,5 per cent in the first quarter of this year from 2,4 per cent in the fourth quarter of last year confirmed a slowdown in domestic economic activity. Although manufacturing production grew by 2,7 per cent between the first quarter of 2002 and the first quarter of 2003, on a quarter-on-quarter basis it fell at an annualised rate of 0,3 per cent in the first quarter of 2003. Other indicators also point to a slight slowdown in activity in certain sectors. But there are indications that domestic final demand in both the government and consumer sectors remains fairly robust. A promising aspect of this is the increase in domestic capital formation in recent quarters. Gross fixed capital formation increased by 8,3 per cent in the first quarter of 2003, after reaching 11,6 per cent in the fourth quarter of 2002. Indications are that because the capital expenditure of all spheres of government is improving, there is greater capacity for delivery, and much-needed infrastructural expenditure is now also taking place. On the whole, both domestic and global improvements in growth seem to be on the horizon. 3. Inflation developments The depreciation of the rand during the last quarter of 2001 resulted in a surge in inflation which prevented the Bank from realising the inflation target for 2002. Fortunately CPIX inflation peaked in November last year at 11,3 per cent and there has been a significant decline ever since, with the latest rate for June down to 6,4 per cent. Although still above the target range of 3 to 6 per cent, the Bank's forecasts indicate that inflation should be within the range in the third quarter of this year and remain comfortably within the band in 2004. There are a number of factors that support the outlook for a sustained reduction in inflation. Firstly, the quarter-on-quarter figures, which give a better indication of short-term trends, show that on an annualised basis CPIX decelerated from 12 per cent in the fourth quarter of 2002 to 2 per cent in the second quarter of 2003. What was particularly significant was that the main driver of inflation in 2002, food price inflation, fell steeply from an annualised rate of 17,7 per cent to only 1 per cent over the same period. Secondly, producer price inflation, which tends to lead consumer price inflation, has fallen from a peak of 15,4 per cent in August 2002, to 2,3 per cent. The imported component of the PPI in June was down to minus 3,4 per cent, and the domestic component was down to 4,4 per cent. Thirdly, weak global growth and inflation developments mean that South Africa remains in a low inflation international environment, which will help to contain inflation domestically. Finally, the improved inflation outlook is supported by other factors such as the relatively low levels of capacity utilisation, a responsible fiscal policy, lower money supply growth and the continued recovery of the 1/5 rand. The improvement in the inflation outlook enabled the Monetary Policy Committee to reduce interest rates by 150 basis points at its last meeting in June. The major threat seen to the inflation target is the trend in unit labour cost, which plays an important role in the inflation process in South Africa. During 2002, wage settlements trended higher as inflation rose. According to the Survey of Average Monthly Earnings by Statistics South Africa, nominal remuneration per worker increased by 10,6 per cent in 2002 and by 10,0 per cent in the year to February 2003. The slowdown in economy-wide productivity growth and rising nominal wage growth resulted in non-agricultural unit labour cost accelerating from a year-to-year rate of 4,1 per cent in 2001 to 7,0 per cent in 2002. Our concern is that wage settlements tend to be backward-looking, particularly in the case of multiyear agreements. Wage increases that are consistently above the actual inflation rate constrain the downward movement of inflation and interest rates. The Bank would like to see wages and prices being set in a forward-looking manner, on the basis of the inflation rate that is expected to prevail over the period for which wages are being set. This will not only ensure a faster decline in inflation, but also a lower cost in terms of output and employment. On balance, the inflation outlook is indeed promising. 4. Balance of payments The current slowdown observed in the manufacturing sector is not simply a question of a recovering exchange rate, but more significantly the weak state of global demand. South African exporters will have to focus even more on improving competitiveness through productivity enhancements. The slowdown in exports, combined with a relatively buoyant import demand due to increased investment expenditure, resulted in a current account deficit of R6,8 billion (approximately 0,6 per cent of GDP) in the first quarter of 2003. This followed a surplus of R4,3 billion in the fourth quarter of 2002. The most recent trade figures, however, suggest that although the current account deficit is likely to persist in the second quarter, it is not a major cause for concern. The financial account also recorded a deficit of R4,2 billion in the first quarter which reflected in part activities of non-residents in the share and bond markets. During the first quarter of this year, nonresidents' total net sales of shares and bonds amounted to R7,6 billion. In the second quarter however, non-residents were net purchasers of shares and bonds amounting to R10.9 billion. 5. Reserves management The South African Reserve Bank is responsible for managing the country's foreign reserves outside of the reserves held by private sector banks. The role of foreign reserves held by a central bank has changed considerably since the early 1970s. Under the Bretton Woods system of fixed exchange rates, which was in place until the early 1970s, countries had to accumulate reserves in order to maintain fixed exchange rates. Later on, many countries, including South Africa, adopted floating or flexible exchange rate regimes where reserves were used to smooth temporary fluctuations in the exchange rate. With the adoption of an inflation-targeting monetary policy framework in 2001, South Africa has abandoned the almost archaic practice of aggressive intervention in the foreign exchange market with the purpose of influencing the level of the rand's exchange rate. In addition, the Bank and the National Treasury made a concerted effort to eliminate the negative net open foreign currency position (NOFP) from a high of –$23,2 billion in September 1998. This goal was achieved in May 2003 and opened the way towards steadily increasing the Bank's reserves. At the same time, the Bank also streamlined its reserve management structures and processes. As at 30 June 2003, the gross foreign exchange reserves of the Bank amounted to US$7,7 billion. Of this, US$6,5 billion consisted of foreign exchange, mainly US dollar, and US$1,2 billion consisted of gold. The Bank's borrowed reserves (foreign loans) amounted to US$2,9 billion. The net reserves therefore amounted to US$4,8 billion. Given the level of reserves and an oversold forward foreign exchange book to the amount of US$3,7 billion as at 30 June 2003, the positive NOFP of the Bank amounted to US$1,1 billion, with the negative position having been expunged during May 2003. In managing its reserves, the Bank strives to balance three main objectives. The most important objective is to preserve the capital value of the reserves. The level of the Bank's reserves is closely 2/5 monitored by the international financial community and contributes to South Africa's overall rating as a stable and safe investment destination. Therefore, any erosion of the capital value of reserves will not only dent the general perception of the Bank's ability to manage its reserves, but will also harm perceptions about South Africa as a country. The second objective is to have adequate liquidity to enable the Bank to meet its day-to-day foreign exchange commitments without incurring significant penalties arising from liquidating investments. The Bank needs foreign exchange on a daily basis for its own transactions and commitments to its correspondent banks, to provide to its clients, such as the National Treasury, and to manage liquidity within the domestic money market as part of its implementation of monetary policy. The third objective is to earn a market related return on the Bank's gold and foreign exchange reserves within a framework of acceptable risks. Although the main objective of a central bank is not to maximise profits, it should still generate sufficient income to cover its operational costs and to facilitate the implementation monetary policy. In order to balance the Bank's objectives of having adequate liquidity for its daily foreign exchange commitments and earning an acceptable return on the investment of its reserves, the foreign exchange part of the reserves was divided into two broad tranches, namely a liquidity tranche and an investment tranche. The main purpose of having a liquidity tranche is to have sufficient foreign exchange available for the Bank's daily foreign exchange transactions. The size of the liquidity tranche has to be sufficient to provide for all operational requirements of the Bank, and also to enable the financing of unpredictable cash flows. The stable portion of the Bank's reserves over time, that is the portion that is not required for day-today cash needs, was allocated to the investment tranche of the reserves. This tranche is used to increase the return on the Bank's reserves. A portion of the investment tranche is managed by a number of external fund managers and another portion is managed internally. Investments are subject to conservative investment guidelines in order to limit fund managers' risk exposures, and the results are measured against pre-defined benchmarks at regular intervals. A risk-management section within the Financial Markets Department continuously monitors the returns and risk exposures of both the internally and externally managed portfolios and promptly follows up any negative deviations. 6. Exchange rate developments The behaviour of the rand continues to perplex many observers. Following the 26 per cent recovery of the nominal effective exchange rate during 2002 as a whole, the rand continued on its recovery path, albeit characterised by periodic volatility. In recent weeks the rand has remained relatively stable, and as of this morning the trade-weighted appreciation of the rand since the beginning of the year was 13,3 per cent. The behaviour of the rand has continued to confound many pessimists who argue that there is insufficient evidence which supports the recent value of the rand. The depreciation of the rand in 2001 was clearly overdone. Prior to that, there was not a general view that the rand was overvalued. If anything, the current fundamentals are now in better shape than they were at that time, so it should not be a surprise that the rand is making such a significant recovery. Although there can be no doubt that interest rate differentials have played a role in the recent recovery of the rand, even market analysts are sharply divided as to the extent of this effect. Although many argue that if interest rates come down lower in South Africa, the rand will retrace its value to significantly lower levels, others point to the fundamentals, and in particular commodity price developments, and argue that the rand is around 'fair value' levels. It is perhaps significant that even though the recent decline in the repo rate exceeded market expectations, the rand in fact strengthened following the announcement of the rate cut. The focus of the South African Reserve Bank, however, is on the inflation target. The Bank does not have a view on the appropriate value of the rand. Obviously from an inflation perspective, a stronger rand is preferable than a weaker one, as we have emphasised on numerous occasions. 7. Progress with employment equity at the Bank Turning to empowerment and equity issues, the Bill of Rights, as detailed in the Constitution of the Republic of South Africa, has served as an incentive for transformation in all aspects of South African 3/5 society. And the Bank has been sensitive to developments concerning transformation issues since the advent of democracy in 1994. By the time the Employment Equity Act was promulgated in 1998, the Bank had already begun to plan the interventions necessary to achieve employment equity. The Reserve Bank as an employer of more than 300 people is required to comply with the requirements of the Employment Equity Act, (No. 55 of 1998). The Bank has prepared its employment equity plan. The objectives of the employment equity plan reflect a balance in the Bank's approach between achieving compliance with the requirements of the Act and achieving enhanced performance through embracing the spirit of equity. According to the plan by 2005 the Bank intends to have at least 50 percent black employees and 33 percent female in all categories. The Bank has already attained an overall representation of 50 percent black in its workforce and has exceeded its target for female representation. A special unit, the Vulindlela Unit, was formed in 2000 to oversee the employment equity process. At this time there were only three black people in general management. Today the number stands at 41 this represents a 25 percent increase in the number of blacks in general management in less than five years. The Bank has also made serious strides in the employment of female managers in the past five years. When the process of transformation was started in 1998, there were only two females in general management - now there are 19 women in general management constituting 30 percent of total managers. The Bank has developed more than twenty new staff policies over the last three years to ensure the Bank keeps abreast with the pace of transformation. This refers not only to transformation in terms of race and gender, but also to the transformation of processes and systems and the way in which issues are approached in the Bank. Existing policies have also been extensively audited to rid them of discrimination. But the journey has only just begun. There are many miles ahead and we cannot afford to rest. 8. The South African Reserve Bank's procurement approach The Bank is likewise committed to furthering the necessary objective of affirmative procurement and has made significant strides in affording previously disadvantaged individuals (PDIs) greater opportunities for involvement in contract work for the Bank. The Bank applies a targeted procurement policy which is effected through a supplier database which is maintained on the Bank's website. All interested companies were invited in the year 2000 to register on the database and this registration process is ongoing. You can register your company online through the Bank's website www.reservebank.co.za. Registration allows the Bank to pre-qualify companies before a request for a quotation (RFQ), a request for a proposal (RFP) or a tendering process is initiated. The Procurement Committee, which is the custodian of the Procurement Policy, is mandated to ensure that every purchase, where applicable, takes into account the imperative of affirmative procurement. In pre-qualifying suppliers, the Bank has certain selection criteria, which seek to highlight the composition of the companies' Board of Directors, shareholders and the management structures. In particular, the focus is on the involvement of previously disadvantaged individuals, notably women, black people, and people with disabilities. Price, ability to deliver and quality of service, are also major components of our adjudication and selection processes. Large companies that operate in the broad business sector but do not have an adequate black empowerment component, are encouraged to form joint ventures with emerging black companies in order to comply with the Bank's requirements. One of the Bank's recent experiences in the procurement process has been the newly completed extensions to its head office building. This project has amounted to R250m. Among the criteria taken into account for the selection of the contractors were financial considerations; the companies' transformation strategy and commitment to transformation; capability and composition of the organisation and supervisory staff. I am happy to announce that the project was completed timeously and the outcome is a state-of-the-art office block and conference centre. 9. The banking sector and transformation The broader transformation issues affecting South Africa have touched the financial sector too. The banking sector started a process towards developing a Transformation Charter on 20 August 2002 at 4/5 the Nedlac Financial Sector Summit. Discussions have been extended to cover the entire financial sector and organisations currently involved include the banks, life officers, short-term insurers, retirement fund managers, the securities exchange, the unit trust funds, the fund managers and representatives of black interests in the sector. The broad principles for transformation have been agreed on, and targets are currently being considered for various categories of transformation. These include ownership transfer, employment equity, procurement, access to financial services, low-income housing finance, SME finance, agricultural finance and infrastructure finance. Of critical importance for the South African Reserve Bank is that the Charter should assist rather than hamper the stability of South Africa's banking and financial sector which is one of the important responsibilities of the Reserve Bank. The Bank Supervision Department at the Bank uses a risk-based approach to supervision and is of the opinion that the Transformation Charter should contribute to these risk management principles. The critical challenges for black business in the financial sector are to ensure equitable empowerment within the context of a stable and growing sector, that maintains and solidifies its international standing. A critical category within this is that of ownership transfer. This is currently being considered very carefully and will encompass both direct and indirect ownership of financial institutions by black people. Another issue in the transformation arena is the involvement of black auditing firms in the auditing of banks. Because of the importance of banks in the financial system, several requirements are placed on audit firms before they may engage in the audit of a bank. These requirements are necessary and onerous because of the highly specialised nature of banking activities and include issues such as experience and resources, and these are seen to be preventing black audit firms from participating in the audits of banks. The Bank Supervision Department and the Financial Services Board have embarked on a project to investigate possible options on how to engage smaller black audit firms in the audits of banks and other financial institutions. Options being considered include the subcontracting of parts of an audit to smaller empowerment firms so that they are able to gain the appropriate experience required to audit banks and financial institutions. The South African Reserve Bank is leading by example in this regard. Our Bank is now audited by PriceWaterhouseCoopers, Deloitte and Touche and SizweNtsaluba VSP Inc, the latter being a black auditing firm. 10. Conclusion Indeed it has been my pleasure to participate in this forum. I hope I have shed some light on the issues that are currently occupying the efforts of the South African Reserve Bank. It is correct to say that ultimately the functions of the Reserve Bank are to make a contribution towards an environment which would see the growth and prospering of a black business class; the improvement in economic and social conditions of the majority of our people; and the maintenance of macro-economic stability for growth and employment creation. Thank you. 5/5 | south african reserve bank | 2,003 | 8 |
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 83rd ordinary general meeting of shareholders, Pretroria, 26 August 2003. | T T Mboweni: Overview of the South African economy Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the 83rd ordinary general meeting of shareholders, Pretroria, 26 August 2003. * * * Introduction The South African Reserve Bank achieved considerable success on many fronts under difficult economic conditions during the past year. In the monetary field, prompt action during 2002 helped to restrain inflationary expectations as well as to maintain international confidence in the country’s commitment to responsible macroeconomic policies. The strength of international confidence is reflected in the recovery in the rand’s international value, which was a major factor in reining back inflationary pressures. In the process, the oversold net open foreign reserve position (NOFP) was finally expunged in May 2003. Against this background, it has been possible to lower interest rates in recent months. Price stability, on the basis of permanent low inflation, is an essential precondition for the economy to be able to achieve sustainable potential growth rates and thereby deliver lasting improvements in living standards for all sectors of our society. The Bank therefore remains dedicated to its task of keeping inflation within the target range, and will continue to be ready to take prompt action whenever necessary to that end. In the banking sector, financial stability has been restored after the serious liquidity problems experienced in the first half of 2002. The banking sector remains soundly capitalised and well managed, and significant progress has been made in the further application of international best practices in banking supervision. The highly-developed structure and international competitiveness of the country’s financial system as a whole remains a significant national strength. In the administration of the Bank, costs were reduced significantly and in a number of instances departments were restructured, streamlined and staff numbers reduced. The international economic environment The global economic recovery remains weak and fragile. Having improved towards the end of 2001 and during the first half of 2002, global economic activity suffered a setback in the second half of 2002 when business confidence was detrimentally affected by revelations of corporate accounting malpractices, further declines in equity values and the threat of war against Iraq. In the first half of 2003 equity prices generally began to rise and the war in Iraq was concluded without severely impacting on oil production. Yet growth in most of the large industrial countries failed to meet earlier expectations. Although household spending was resilient, business investment in most advanced economies remained low. Lingering political uncertainties arising from the war in Iraq, the outbreak of Severe Acute Respiratory Syndrome (SARS) and the excess capacity in many manufacturing sectors, inhibited the expansion of investment. Consumption expenditure was supported in the USA and Europe by firm property prices and the willingness of households to incur debt. The increasing household debt burden, low personal sector saving and the widening current-account deficit of the United States, pose a threat to the strength and sustainability of the world economic recovery. In addition, economic growth in other advanced economies could be curtailed by structural problems such as inflexible labour and product markets and imbalances in welfare systems. The economic growth rates of emerging-market economies diverged considerably during 2002 and the first half of 2003. Growth on the whole was quite robust in Asia and in the transition economies in Europe, while it was moderate in Africa and weak in Latin America. The strong growth in Asia was mainly the result of substantial inflows of foreign direct investment and the stimulation of intra-regional trade by the rapid economic expansion in China. European transitional economies benefited from increased and more diversified exports, while the growth in Africa was negatively affected by factors such as political instability, a severe drought in the northern and southern parts of the continent and the HIV/Aids pandemic. Financial constraints and socio-political events were mainly responsible for the low or negative growth of countries in Latin America. As could be expected under these circumstances, unemployment increased in most advanced economies as well as in Latin America and Africa. Employment creation in emerging-market economies remains one of the most pressing challenges facing the world to ensure the maintenance of stability and the reduction of poverty. This requires the orderly removal of structural impediments to promote skills and create employment opportunities. Such steps should facilitate the task of monetary authorities when external shocks disturb the economies. With the exception of parts of Latin America and some countries in Africa, global inflation remained low. Small increases in prices were recorded despite a marked rise in oil and other international commodity prices during 2002. In the first half of 2003 the rate of increase in international commodity prices levelled off and contributed to the global disinflationary trend. Japan and a few other countries in Asia actually experienced a decline in the aggregate level of prices in 2002 and the first half of 2003. The low inflation in the world is assisting South Africa in combating domestic inflation. The combination of low economic growth, increased unemployment and disinflation generally led to the adoption of expansionary monetary and fiscal policies in advanced economies. Interest rates were brought down to very low levels in most developed countries and fiscal deficits widened. However, these measures were unable to prevent some major corporate defaults. Although this exerted pressure on the world financial system, institutions were generally able to cope with the situation. Japanese banks were affected by bad debts and low profits and some banks in Europe also encountered problems. Insurance companies and pension funds fared worse than banks. Of further concern is the volatility experienced in exchange rates and its effect not only on the financial sector, but also on real economic activity. In particular, the US dollar has weakened substantially, which could have major repercussions for the world economy. Domestic economic developments The weakness of the US dollar was a major factor in a significant recovery in the external value of the rand. Having declined by 34 per cent on a trade-weighted basis during 2001, the nominal effective exchange rate of the rand recovered by 24 per cent in 2002 and by a further 12 per cent up to the end of July 2003. The performance of the rand was also related to South Africa’s inherent economic strength and to the sound and consistent macroeconomic policies pursued by the authorities. Improved international perceptions of these strong fundamentals were reflected in a significant narrowing in spreads on internationally-traded South African bonds, and was recognised by higher ratings of the country by two major international rating agencies, which further underpinned the rand’s recovery. The positive sentiment in the market was supported by attractive domestic interest rates and an increase in the country’s terms of trade. Similarly, the real effective exchange rate of the rand recovered markedly since the beginning of 2002. This index, which reflects the trade-weighted exchange rate of the rand deflated by the production price differential between South Africa and its main trading partners and competitor countries, rose by an estimated 16 per cent over the eighteen-month period up to the end of June 2003. Even after this increase the level of the real effective exchange rate of the rand was still below the index values of early 2000, i.e. before the currency market turbulence. This indicates that South African producers are fairly price competitive, but the profitability of their international transactions has, of course, fluctuated considerably over the past three years. Domestic output could not escape the impact of the still subdued global economy. Growth in real gross domestic product slowed down from 3½ per cent in the first half of 2002 to 3 per cent in the second half and 1½ per cent in the first half of 2003. This deceleration in economic growth was spread across most sectors, with agriculture output actually contracting in the first half of 2003. The slower growth was accompanied by an increase in aggregate employment in the formal non-agricultural sectors of the economy in 2002. An employment gain of 54 000 workers was recorded. However, preliminary indicators point to a loss in employment opportunities in the first half of 2003. Over the same period, productivity growth receded while the average remuneration per worker rose at an estimated annualised rate of 10 per cent. As a result, nominal unit labour cost continued to increase at a rate above the upper limit of the inflation target band of 6 per cent. The decline in the rate of economic growth was due to a fall in the volume of exports, whereas domestic demand continued to increase strongly. The level of short-term interest rates seems to have had little effect on domestic demand. The rate of increase in domestic final demand declined only marginally from 4 per cent in 2002 to 3½ per cent in the first half of 2003. The annualised growth in real gross domestic expenditure nevertheless remained at 4½ per cent in the second half of 2002 and in the first half of 2003. Growth in real household consumption expenditure slowed only slightly from an annualised rate of 3 per cent in the second half of 2002 to 2½ per cent in the first half of 2003. The sustained high growth in consumption expenditure was made possible by relatively strong increases in personal disposable income as well as by a rise in household debt. Household disposable income benefited from higher salaries and wages, improved social transfers from government and income tax reductions. At the same time, the low level of the debt-to-income ratio of households and expectations of imminent reductions in interest rates encouraged some households to incur debt. Real household consumption expenditure accordingly retained a large part of its earlier buoyancy at the cost of a significant increase in debt. The ratio of household debt to disposable income was nevertheless still relatively low at 53 per cent at the end of June 2003. The steadfast growth in household consumption expenditure was accompanied by an annualised increase in real government consumption expenditure varying from quarter to quarter between 3½ and 4 per cent throughout the past year. These growth levels have been maintained since the beginning of 2001 and signify the greater emphasis on service delivery in government’s fiscal strategy. The rate of increase in real fixed capital formation picked up during 2002 and reached an annualised level of 9 per cent in the second half of the year. This rate then receded to a still high 8 per cent in the first half of 2003, brought down by a decline in the fixed investment of the agricultural sector associated with lower profits of farmers because of the marked drop in the prices of some key agricultural products. Other sectors continued to spend large amounts on the replacement of obsolete capital equipment and the development of new ventures. This demonstrates that positive expectations and sound fundamentals can sometimes carry more weight in fixed investment decisions than the level of short-term interest rates. In contrast to the continued strong growth of domestic demand, exports performed less well. In fact, the volume of exports of goods and non-factor services declined by 1½ per cent in 2002 and by a further 2½ per cent in the first half of 2003. With the exception of receipts from tourists visiting South Africa, the exports of other goods and services were negatively affected by the decline in global economic activity. In 2002 the decline in the volume of exports coincided with an increase in the volume of imports. Despite a decrease in crude oil imports, the volume of total imports continued to increase in the first half of 2003. The terms of trade strengthened in both 2002 and the first half of 2003, while net dividend and interest payments declined. These developments could nevertheless not prevent the balance on the current account from reverting from a surplus in 2002 to a deficit of 1 per cent of gross domestic product in the first half of 2003. This deficit was more than neutralised by a financial inflow from the rest of the world consisting mainly of foreign direct investment, borrowing by the South African government in international capital markets and net inflows of other portfolio capital. As a result, the gold and other foreign reserves of the country rose from US$12,6 billion at the end of 2001 to US$18,5 billion at the end of June 2003. On the monetary and financial fronts, the main developments during the past eighteen months can be summarised as follows: 1. The rate of increase in the monetary aggregates slowed down significantly. For instance, the growth in the broadly defined money supply (M3) measured over periods of twelve months declined from around 19 per cent in the early part of 2002 to less than 13 per cent in December 2002 and to single-digit rates during most of the first six months of 2003. The weaker demand for money reflected a slowdown in inflation and a weaker growth in real income. 2. The public’s demand for bank credit remained resilient. Having declined from 12,5 per cent in June 2002 to 7,8 per cent in December, the twelve-month growth rate in banks’ total loans and advances to the domestic private sector picked up again to 12,7 per cent in June 2003. The continued buoyancy in the demand for bank credit by the private sector was supported by relatively low debt levels, expectations of a decline in interest rates and ongoing increases in the prices of houses, flats and townhouses. 3. The money market continued to be relatively liquid. The Reserve Bank mainly used foreign exchange swaps, Reserve Bank debentures and reverse-repurchase agreements to drain surplus liquidity, while the phasing out of the banks’ vault cash holdings forming part of their required cash reserves also contributed towards this end. The daily liquidity requirement of banks was maintained at around R11 billion by these measures. 4. Short-term interest rates began to move downwards from April 2003. Having increased by about 400 basis points in conjunction with the repo rate during the first nine months of 2002 and then stabilising at this higher level for the next six months, short-term rates declined by approximately 200 basis points up to the end of July 2003. 5. Private-sector companies made increased use of the primary bond market to finance activities. With subdued share prices and the cost of funding in the money market higher than in the bond market, several companies issued bonds. The outstanding value of privatesector loan stock listed on the Bond Exchange of South Africa therefore increased from R29 billion in June 2002 to R42 billion in June 2003. 6. Long-term bond yields trended downward from late March 2002, reflecting the market’s favourable view of the long-term prospects for inflation and the impact of a small publicsector borrowing requirement. In combination with the high level of short-term interest rates, this led to a sharply inverted yield curve. However, after the reduction in the repo rate in June 2003, the shape of the yield curve began to normalise. 7. The recovery in the external value of the rand was mirrored to a considerable extent by movements in share prices on the JSE Securities Exchange South Africa. Expectations of the impact of the exchange rate of the rand on corporate profitability, together with the gloomy international sentiment among equity investors, led to a marked decline in domestic share prices. From a high point on 22 May 2002, the all-share price index declined by 37 per cent to a recent low point on 25 April 2003. Subsequently, share prices recovered by 20 per cent to the end of July. Public finance A more expansionary fiscal policy stance has been adopted by government since the 2001 Budget, while the policy remained supportive of lowering inflation and promoting stability. This cautious expansionary fiscal stance is set to be maintained over the medium term to increase the long-term growth capacity of the economy. Government’s main goal is reducing unemployment and ensuring that economic growth and development benefit all communities. In accordance with this policy stance, government’s deficit was well-contained in the fiscal year 2002/03. The non-financial public-sector borrowing requirement amounted to only 1 per cent of gross domestic product in that year. This was made possible by continued strong growth in revenue collections and considerable discipline applied to government expenditure. On account of the low deficit and a downward revaluation of foreign-currency denominated loans, the ratio of government’s outstanding debt to gross domestic product declined from 46 per cent at the end of March 2002 to 41 per cent at the end of March 2003. Monetary policy Monetary policy was dominated in the past year by having to respond to the inflationary pressures arising from exogenous shocks in the form of a substantial depreciation in the external value of the rand in late 2001 and a sharp rise in international oil prices. These shocks were mainly responsible for a surge in the twelve-month rate of increase in the consumer price index for metropolitan and other urban areas excluding interest on mortgages (CPIX) from a low of 5,8 per cent in September 2001 to a peak of 11,3 per cent in October and November 2002. The twelve-month rate of increase in the all-goods production price index also rose from 7,8 per cent in September 2001 to a level of 15,4 per cent in August and September 2002. As a result, the Monetary Policy Committee was obliged to increase the repo rate by 400 basis points in total during the first nine months of 2002. These increases were prompted by the fact that the inflationary pressures, which were at first mainly confined to rising food and energy prices, became more broadly based and in the end not only influenced the prices of goods but also the prices of services which are not directly affected by exchange rate developments. The increase in the repo rate was further based on factors such as rising inflation expectations, increasing nominal unit labour costs and high growth in money supply and bank credit extension. The Monetary Policy Committee concluded at its meeting in November 2002 that the level of interest rates was appropriate to avert an inflation spiral. Although it was still unclear at that time whether inflation had peaked, the repo rate was kept unchanged because a number of developments indicated that inflationary pressures could begin to abate. These included a decline in the quarter-to-quarter production price index from 26,0 per cent in the first quarter of 2002 to 11,2 per cent in the third quarter; a strengthening in the external value of the rand; a decline in international oil prices; slower growth in bank credit extension; and a deceleration in the pace of growth in the more broadly defined money supply aggregates. Given the time lag between a change in monetary policy and its ultimate impact on inflation, the increases in the repo rate were unable to prevent the breaching of the inflation target of 3 to 6 per cent for 2002. In South Africa it is estimated that it takes between 18 and 24 months for a change in shortterm interest rates to fully impact on the rate of increase in consumer prices. In 2002 the rate of increase in the CPIX averaged 9,3 per cent, or 330 basis points above the upper limit of the target. Apart from the direct monetary policy steps that were taken during 2002, the Minister of Finance announced in October that the inflation target of 3 to 5 per cent for 2004 and 2005 would be adjusted and that the target for 2004 would be set at 3 to 6 per cent. Subsequently, it was announced that the target for 2005 would remain at this level and that the target for 2006 would be made public in October 2003. These announcements were made in recognition of the fact that the exogenous shocks had thrown the downward path of inflation off course and that an excessively tight monetary policy with high short-term costs in terms of output losses should be avoided as far as possible. By the time of the March 2003 meeting of the Monetary Policy Committee it was clear that the rise in inflation had been contained. The twelve-month rate of increase in CPIX had fallen to 9,3 per cent and that of the production price index to 6,2 per cent. In addition, the growth in money supply and bank credit extension had come down to single-digit levels and the rand had recovered remarkably in the second half of 2002. Despite this more positive picture, some other developments caused the Monetary Policy Committee to remain cautious about changing the policy stance prematurely. In particular, the Committee was influenced by the fact that the meeting took place on the day that the war in Iraq started. At that stage it was uncertain what the impact of the war would be on the global economy, and more specifically on oil prices. Other considerations that led to the decision to keep the repo rate unchanged included concerns about the level of wage settlements, rising unit labour costs, large increases in some administered prices and a forecast that CPIX inflation would be close to the upper limit of the inflation target in 2004. At its June 2003 meeting the Monetary Policy Committee was confronted by a revision of the inflation figures by Statistics South Africa. Although the turning point and the pattern of change between the previous and the revised monthly series coincided fairly closely, the revision brought about almost a 2 percentage point lower than originally estimated year-on-year increase in the CPIX for the early months of 2003. The revision affected the inflation outlook as well as the Reserve Bank’s forecast. Taking this revision and more recent economic developments into consideration, the Bank’s forecast indicated that the inflation rate would move within the target range during the second half of 2003 and would come close to the mid-point of the target range in 2004. A number of other factors also influenced the decision to reduce the repo rate by 150 basis points at this meeting. First, the end of the war in Iraq had brought greater stability to the oil market. Second, it was clear that the exchange rate of the rand was maintaining its recovered levels in spite of continued volatility. Third, there were clear signs that inflation pressures emanating from abroad would remain weak. Finally, inflation expectations had declined in South Africa and domestic conditions generally favoured disinflation. Another development at this meeting was the decision to increase the number of meetings of the Monetary Policy Committee from four to six per year. The previous decision to limit the number of scheduled meetings to four was prompted by the argument that the meetings should coincide with the availability of quarterly data. However, this led to long intervals between some meetings. It was therefore decided that even if the latest quarterly data were not available at each meeting, there should be enough high-frequency statistics to take informed decisions. More frequent meetings should have the added advantage of reducing the fear of sudden and unexpected interest rate adjustments, and in this way promote monetary policy transparency further. On 14 August 2003, the Monetary Policy Committee announced a further reduction of 100 basis points in the repo rate to a level of 11 per cent. This decision was taken because the decline in the inflation rate continued to be in line with the Reserve Bank’s projections and the inflation outlook generally remained favourable. However, the Committee expressed concern about the high rates of increase in some administered prices, the level of wage settlements, the continued strong performance of domestic demand and the acceleration in money supply growth in the second quarter of 2003. Exchange rate policy Exchange rate policy was left unchanged in the past year. As in the preceding year, the determination of the external value of the rand was left to the market and the Bank did not intervene in the foreignexchange market to affect the exchange rate. Although the Bank would prefer to have a strong rather than a weak rand from an inflation perspective, it does not have a target for the exchange rate. As has been emphasised on numerous occasions, it is not the Bank’s policy to intervene in the market to affect the level or the direction of change of the exchange rate of the rand. The exchange rate of the rand was quite volatile during the past year. Unfortunately, this seems to be a fact of life for most emerging-market economies and even for some of the more advanced economies irrespective of the monetary policy frameworks that they have adopted. Although the Bank would, of course, prefer to have greater exchange rate stability, fluctuations in the external value of the rand are unavoidable in the current international monetary system of generally floating exchange rates. We know from experience that even if the rand was pegged to another currency or to a basket of currencies, it would still float against most currencies and fluctuate widely at times. The authorities can only aim at creating underlying economic conditions that are conducive to exchange rate stability. One of the factors that has contributed to the large fluctuations of the rand in the past has been the large oversold NOFP of the Bank. The Bank’s stated objective has been to eliminate this open position, which stood at US$ 23,2 billion at the end of September 1998. During the past year the Bank purchased fairly modest amounts of foreign currency in the market at appropriate times, and also delivered the proceeds of the government’s global eurobond issue of US$ 1,25 billion in May 2003 against the oversold forward exchange book of the Bank. These transactions converted the oversold NOFP of US$ 1,8 billion in mid-2002 to an overbought position of US$ 0,9 billion at the end of July 2003. Having removed this perceived vulnerability, the price discovery process in the foreign-exchange market has been displaying a better two-way trading pattern. With the oversold NOFP now expunged, the Bank has shifted its focus to reducing its oversold forward book and to seeking over time to strengthen the official foreign exchange reserve position. The balance on the oversold forward book stood at US$ 4,1 billion at the end of July 2003, compared with US$ 7 billion at the time of the previous annual meeting of the Bank. In accordance with the policy of a phased and gradual dismantling of exchange controls, the Minister of Finance announced further exchange control relaxations in his Budget Speech on 26 February 2003. These included a new dispensation for offshore portfolio investments, a mechanism for unwinding the pool of emigrants’ blocked funds and an exchange control amnesty. Stability in the banking sector The liquidity problems experienced by smaller banks and the eventual erosion of the deposit base of some of the bigger banks in the first half of 2002, were resolved in a satisfactory manner during the past year. In this process, however, certain consequences for the banking industry could not be avoided. The activities of two of the larger banks, Saambou Bank Limited and BoE Bank Limited, were merged with those of the big domestic banks. In addition, the reluctance of depositors to place funds with smaller banks caused some of these banks to cancel their banking registrations, while others redesigned their ownership structures and downsized their balance sheets. The turbulence experienced in the banking sector therefore resulted in a consolidation of activities before a return to stability was achieved. At the end of June 2003, approximately 83 per cent of total deposits by the public landed in the vaults of the big four banks. These changes have also made it more difficult to start new banks or for small banks to remain in business. This could affect the availability of operational capital for new entrepreneurs, which is highly essential for economic development. Small banks are often more willing than bigger banks to finance high-risk ventures because they are more versatile and can more easily target niche markets. Despite these developments, South Africa’s banking system remains sound. Banks operating in the country are well capitalised, with an average risk-weighted capital adequacy ratio of 12,4 per cent at the end of June 2003. Moreover, 35 banks holding 98 per cent of total banking assets have capital adequacy ratios exceeding the statutory minimum of 10 per cent. The liquidity of the banking sector was also generally adequate. The average daily amount of liquid assets held in June 2003 exceeded the minimum requirement by about 20 per cent. Growth in the total assets of banks moderated appreciably during 2002, but grew rapidly in the first six months of 2003 because of changes in regulatory and accounting practices that require many off-balance sheet items to be included in balance sheets. However, the quality of assets remained high. Non-performing loans amounted to nearly R25 billion at the end of June 2003, which represented only 2,6 per cent of total loans and advances. The provisions made by banks for non-performing loans were also adequate. Although household debt to disposable income rose in the first half of 2003, this ratio is still well below the average of the preceding five years. The ratio of corporate debt to profits, which is an indication of the debt-servicing capacity of businesses, increased from 5,4 per cent in the second quarter of 2002 to 6,4 per cent in the second quarter of 2003. This ratio is above the average of the past five years, probably because of a decline in corporate profits as well as an increase in corporate debt. Banks continue to be managed well. The average efficiency ratio improved in the past year, as did the return on equity and assets. A special independent investigation concerning corporate governance has confirmed that South Africa’s leading banks are committed to high standards of management. The banks adhere broadly to international best practice. Certain suggestions were nevertheless made to improve the functioning of banks. The major deficiency that the investigation encountered was that some of the boards of banks are too big to operate cohesively. It was therefore suggested that the size of boards should preferably be restricted to 16 members and that the number of executive directors should ideally not exceed four. Although continued vigilance is required to ensure that banks comply with evolving standards, there are no major concerns in this regard. Banks are well on course to bringing their risk-management systems and data models in line with what could be required for compliance with Basel II in 2007. This new capital accord is a radical reform of the previous one and will have an impact on banks in areas such as regulatory capital, credit and operational risk management, and data and disclosure requirements. Banks are positive about complying with the new accord and regard it as a strategic challenge. The application of the new framework will require the re-engineering of supervision processes and organisational structures. In collaboration with other supervisors, the Bank is developing an implementation strategy for Basel II. Following international corporate failures, accounting and auditing standards have been revised or are being overhauled. As part of the ongoing endeavours to ensure the quality and transparency of financial reporting, a shift was made during the past year away from historical cost to fair value accounting of financial instruments, i.e. the application of Accounting Statement AC 133. As indicated earlier, this led to a substantial increase in the reported total assets of banks. A Ministerial Panel for the Review of the Accounting Professions’ Bill is revising the regulations applicable to auditors and accountants. Although all these standards are aimed at promoting the integrity of financial markets and institutions and ensuring stability, there is some concern about the management of the transition and the ultimate cost of complying with the increase in legislation that affects banks. Preparing for Basel II is in itself a considerable task. Combined with the onerous requirements of new anti-money laundering and antiterrorist funding legislation, corporate governance standards and impending community reinvestment legislation, it increases the risk that banks could lose sight of their main business objectives. Non-bank financial institutions may also not escape this burden. South Africa’s recent accession to the Financial Action Task Force (FATF) on money laundering will affect the operations of almost all financial firms. Another challenge facing the banking sector is to provide broader access to affordable financial services. A large portion of the population still does not have access to banking facilities. The challenge of broadening access to finance has to be addressed with deference to the regulatory objective of achieving a high degree of economic efficiency and consumer protection in the economy. This will require a balance between the introduction of changes to achieve the objective of greater participation and the maintenance of financial stability. The financial sector is in the process of developing a Financial Sector Black Economic Empowerment Charter to promote increased black ownership of and access to financial firms. As in the case of the Mining Charter, the key elements of the Financial Sector Charter are likely to include ownership, career and procurement opportunities, and human resources development. We support this process. Moreover, ever since the attacks on the World Trade Centre on 11 September 2001, the need for multilateral co-ordination to ensure continuity in financial systems has been high on the agenda of the banking sector. The Bank has assisted in the establishment of a Financial Sector Contingency Forum for such contingency planning. A key objective of the forum is to identify crisis events that may threaten the stability of the South African financial sector and to develop appropriate plans, mechanisms and structures to mitigate such potential threats and manage crisis events. Regional economic co-operation The promotion of regional economic co-operation in Africa generally and in the Southern African Development Community (SADC) more specifically continues to form part of the major activities of the South African Reserve Bank. The Bank fully supports the New Partnership for Africa’s Development (Nepad) goals of accelerated growth and sustainable development, poverty eradication and reversing the marginalisation of Africa in the globalisation process. We will continue to play an active role towards the realisation of these ideals. The Bank has also participated actively in the Committee of Central Bank Governors in the SADC region during the past year. The major initiatives undertaken included the establishment of a Common Monetary Area Cross-border Payment Oversight Committee; the implementation of a cross-border foreign exchange recording system in Namibia, Swaziland and Zimbabwe; significant progress in the harmonisation of national payment systems, information and communication technology capacity, banking supervision and exchange control; and agreement on the promotion of the focus on price stability as an appropriate and realisable target of macroeconomic convergence as a prerequisite for monetary integration. Internal administration In order to achieve the objective of price and financial stability and to ensure that all activities are conducted efficiently, a number of changes were again made to the internal administration of the Reserve Bank in the past year. In particular, the reduction of costs without loss of productivity received high priority. Staff and operational costs were thoroughly scrutinised to minimise expenses. A moratorium was placed on appointments with effect from 1 August 2002 to reduce staff numbers. Moreover, voluntary early retirement packages were also offered during April 2003 to 282 staff members aged 50 and older to curtail costs. A total of 173 responses have been received to date, of which 114 staff members indicated that they accept the offer. A number of initiatives were launched in the area of information and communication technology focusing on cost reduction and improved efficiency. The renewal of the mainframe and the improved management of the network infrastructure will result in significant cost saving over time, address future capacity requirements and improve the availability and reliability of the Bank’s infrastructure. In reviewing the implementation of the Bank’s cash handling strategy, the average overnight notesheld-to-order limit for commercial banks was increased, the service arrangements for Mpumalanga and Limpopo provinces were terminated, and a levy was introduced on banknotes deposited and withdrawn by banks. The Bank’s seven branches have met all the distribution and circulation requirements of banks and the cash industry. The overall productivity of the branches has kept track with established requirements and their processing of banknotes averaged 95 per cent of the installed capacity. Strategies to combat the counterfeiting of banknotes and coin are being developed. In line with international best practice, the Bank will enhance the security features of banknotes in the near future to deter counterfeiting. A decision has also been made to introduce a new R5 coin in response to the counterfeiting of such coins. Significant progress has been made to strengthen the Bank’s ability to oversee the safety and soundness of the payment system and to strengthen its regulatory framework. In aligning South Africa’s payment system practices and arrangements with international developments, discussions have taken place with domestic banks and the Continuous Linked Settlement Bank in London. The aim is to reduce foreign exchange settlement risk through the synchronisation of the settlement of the two legs of a foreign exchange transaction in a single time zone. The Bank also entered into negotiations with the Bankers Services Company (Bankserv) to determine the feasability of transferring the ownership and operation of the SARB-link network to Bankserv to reduce costs. In a further effort to avoid duplication and save costs, the former Money and Capital Market Department and International Banking Department were merged into one new department, the Financial Markets Department. The merger reflected the increased integration of South Africa into global financial markets, which made a distinction between domestic and international financial markets less relevant. The merger had the added benefit of facilitating and improving the co-ordination of monetary policy implementation, while allowing for a more efficient allocation of human resources. Cost saving was also an important objective in the operations of the Bank’s subsidiaries. As a result of the current and projected low domestic and international demand for coin, the staff of the SA Mint Company (Pty) Limited was reduced by some 40 per cent through a combination of natural attrition, early retirements and a retrenchment programme. In addition, the management of the SA Mint was restructured to improve efficiency. In the SA Bank Note Company (Pty) Limited marketing was intensified to increase capacity utilisation. The marketing initiatives paid off with the award of two further banknote printing contracts from African countries. The training and development of staff continue to be important objectives of the Bank. In this regard the South African Reserve Bank College again played a major role by offering a variety of learning programmes. The various departments also put considerable effort into on-the-job training of staff members. The Bank is further committed to achieving its objectives for staff transformation by 2005, and reports annually on its progress to the Department of Labour in terms of the Employment Equity Act, No 55 of 1998. In keeping with the decision of the shareholders on 25 April 2002 to terminate the listing of the Bank on the JSE Securities Exchange South Africa, an Over-the-counter Share Transfer Facility for trading Reserve Bank shares was established. This facility has delivered the desired results and 87 registrations in respect of 240 237 shares were effected up to 31 March 2003. Finally, the extensions to the head office building, which were started in 2001, were completed. The building now meets the Bank’s requirements in respect of office space, parking and conference facilities. Staff members who had to work in other buildings or who had to be relocated to other premises for the duration of the building alterations, have been moved back to the head office building. Acknowledgements All these improvements in the functioning of the Reserve Bank could only be achieved with the help of other persons and institutions. In conclusion, I therefore want to thank everyone who assisted the Bank to accomplish its objectives. In this regard I have to name the Presidency, the Government and Parliament for their support of our work. I also wish to express my appreciation to the Board of Directors of the Reserve Bank, including the deputy governors, for their commitment to the Bank. In particular, I want to thank Dr M T de Waal, who retired from the Board, for his contributions over the past years. Last but not least, I want to thank the management and staff of the Bank for the outstanding way in which they performed their duties. They have responded with vigour to all the challenges we have encountered and have demonstrated commitment and high professionalism in performing their work. This is a truly remarkable institution to be associated with. Thank you. | south african reserve bank | 2,003 | 9 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BIS/SARB Reserve Management Seminar dinner, South African Reserve Bank, Pretoria, 2 September 2003. | T T Mboweni: Inflation targeting in South Africa Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the BIS/SARB Reserve Management Seminar dinner, South African Reserve Bank, Pretoria, 2 September 2003. * * * It is my pleasure to welcome you, our guests and Reserve Bank personnel, to a dinner I gladly host in your honour. I know that you have formally been welcomed to the Reserve Bank this morning by Mr Plenderleith. But at a seminar of this stature, co-hosted by our good friends at the Bank for International Settlements, I, as Governor, felt it correct to re-iterate a warm welcome. I am especially delighted that we are able to co-host this reserve management seminar as I believe that all of us can learn from each other's experiences regarding this important central-bank function. I know you have had a long day at the seminar and, I believe, a productive one, so I shall keep my speech brief. I have chosen not to focus on reserve management in the South African Reserve Bank, as the topic was covered to some degree in the seminar this afternoon, but rather to talk to you briefly about inflation targeting. As you probably know, inflation targeting, initially adopted by New Zealand in 1990, has been the choice of a growing number of central banks in both industrialised and emerging countries. As on November 2000, authors Mishkin and Schmidt-Hebbel had counted 19 inflation-targeting countries. Since then, the numbers have increased. Precisely by how many is debatable and will depend on the precise definition of inflation-targeting countries but I note that the merits of inflation targeting continue to be debated in the US. Inflation targeting in South Africa was formally introduced on 23 February 2000 with the announcement of a 3 to 6 per cent target for 2002. At that time, CPIX inflation - the rate we target stood at 7 per cent. (Just for your information, we define CPIX as the CPI excluding the interest cost of mortgage bonds, for the historical metropolitan and other urban areas.) The target range of 3 to 6 per cent set was an ambitious one. Whilst there may be debates today about whether the target range was set at the correct level, it is important to note that for both the credibility of the central bank, as well as the management of expectations in respect of inflation being a problem, the target range had to be set at a level which would properly demonstrate commitment to lowering inflation. In spite of the above-mentioned quite ambitious target, by September 2001, twelve-month CPIX inflation had decelerated to 5,8% per cent and many analysts thought that the 2002 target would be met fairly easily. To say the least, circumstances changed! The exchange rate depreciation of some 37 per cent in 2001 - that is another interesting story! - mostly in the closing stages of the year, was significantly responsible for pushing up CPIX inflation up to a peak of 11,3% per cent in November 2002. On 12 September 2002, the Reserve Bank's Monetary Policy Committee had announced the fourth and final 100 basis points increase for the year of the Bank's repurchase rate. As you may well imagine, I was not everyone's most-favourite Governor! Fortunately, inflationary pressures have abated, partly related to the rand's appreciation since December 2001 and as reflected in the year-on-year change in CPIX falling to 6,6 per cent in July 2003, and the MPC has seen fit to lower the repo rate. On 14 August 2003, following the most recent meeting of the MPC, the repo rate was further reduced by 100bp to 11 per cent effective from 15 August 2003. (Should there be anyone amongst you interested in the factors weighing on this decision, I refer you to the statement of the Monetary Policy Committee which is on the Reserve Bank website). Whilst a Governor is certainly more popular during a declining interest-rate cycle, rest assured there were critics who felt that the Bank had not been bold enough and should have, at least, reduced the repo rate by 150 basis points! Technically, what the Reserve Bank is doing could more accurately be described as inflation-forecast targeting. Given the roughly 12 to 24-month lag between interest-rate changes and their having their full impact felt on inflation, the repurchase rate is set at a level judged to be consistent with bringing inflation to within the target range within an 12- to 24-month time horizon. I am referring to the intricacies of the transmission mechanism, the clear understanding of which represents the single biggest challenge for any inflation-targeting central bank. Inflation targets of 3 to 6 per cent for 2004 and 2005 have been set by the Government, and guide current policy formulation. Given the lags, current policy changes clearly have virtually no impact on the 2003 inflation outcome; the focus is further ahead. With the CPIX again approaching the target range, it is relatively easily to somewhat superficially argue the merits of an inflation-targeting regime. Some disadvantages of inflation targeting must, however, be acknowledged. Whilst easily understood in terms of its objective, it is a complicated approach, more demanding and more difficult to implement than a monetary framework based on targeting monetary growth or a more discretionary framework. It implies greater reliance on forward indicators of inflation and a continuous assessment of the relationship between the instruments of monetary policy and the inflation target. Where forecasts turn out to be wrong, even if for completely unforeseeable reasons, the central bank's credibility could be impaired. Of course, the counterargument being that it simply makes visible the uncertainty that would remain hidden in other monetary-policy frameworks. Inflation targeting, if pursued at any costs, runs the risk of inefficient output stabilisation. Significant supply shocks to the economy such as sharp oil price movements, could require very large monetary-policy adjustments to bring inflation back inside the target range within the stated time horizon. For such exceptional events, some discretion and patience in re-achieving the target range should be allowed for. In this regard I wish to confirm that the Reserve Bank generally views it inappropriate to resort to the escape clause, and would rather provide an explanation to any deviation from the target range once the final outcome of the CPIX average for that year had been published. This view is held so that the market has no doubt regarding the Bank's vigilance and commitment to achieving its targets. Indeed, following the CPIX average for the year 2002, which could only be calculated early in 2003, where the average exceeded the target, an explanation was provided in the Monetary Policy Review document of April 2003. (The bi-annual Monetary Policy Review is also available on our website). The advantages of inflation targeting are also worth highlighting. Firstly, transparency - the concept is easily understandable, with the ultimate policy objective translated into an explicit target value. Secondly, inflation targeting provides enhanced clarity about the objective of monetary policy, which is conducive to sound planning in both private and public sectors. Thirdly, the framework provides for improved accountability of the Reserve Bank. It eliminates the need to rely on a stable relationship between the money stock and inflation, which has become increasingly difficult to identify; inflation targeting enhances economic policy co-ordination with government and the central bank both publicly committed to the same inflation target. And lastly inflation targeting provides an anchor for inflation expectations and price and wage setting, thus reducing the friction which arises from widely divergent inflation expectations. May I conclude with the comment that, whilst inflation targeting is certainly no panacea, the Reserve Bank still regards it as the most appropriate framework for achieving relative price stability. I quote from our Annual Economic report 2003, released last week: “Sound and consistent price signals are invaluable in directing resources towards their most efficient uses”; achieving this goal is, we believe, our most important contribution we can make towards optimal economic growth and development. Finally, I also, as Governor, thank the BIS most sincerely for their invaluable role in co-hosting the seminar. Our relationship with the BIS is excellent and we have derived much value in our interaction with this much-esteemed institution over many years. I hope you, as delegates, will extract maximum value from the expertise which is available to be shared. May you all safely return home, and your return on your FX assets be stable and gratifying! I thank you. | south african reserve bank | 2,003 | 9 |
Speech by Ian Plenderleith, Deputy Governor of the South African Reserve Bank, at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, 29 August 2003. | Ian Plenderleith: Is monetary policy different in Africa? Speech by Mr Ian Plenderleith, Deputy Governor of the South African Reserve Bank, at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, 29 August 2003. * * * A good deal of attention has been directed in recent years to the very interesting and germane question of how far the challenges facing central banks in conducting monetary policy in emerging market economies differ from those facing their colleagues in developed countries. Are the very evident differences, for example in economic and social structure, in the pace of change and in exposure to shifts in the global economy, so significant as to require a difference in approach to conducting monetary policy? If so, what are the material differences and what adjustments do they require policymakers to make, in focus or in process? In particular, can inflation targeting, which was adopted with such good effect by a vanguard of (mainly) developed countries in the early-1990s, deliver similar beneficial results for the larger phalanx of emerging market economies who followed suit in the late-1990s? The purpose of this contribution is not to add to the burgeoning theoretical literature, but to offer some observations from practical experience of both worlds. That experience needs some disclaimer at the outset. Thirty years of wrestling with British monetary policy at the Bank of England certainly does not entitle one to claim any extended track record of success, though the last ten years went a lot better than the previous 20. Equally, six months (so far) contributing to the conduct of monetary policy in South Africa is far too narrow a span to allow one to claim any first hand expertise in the distinctive circumstances of emerging market economies. But the privilege of serving successively on the Monetary Policy Committees of two such different countries is given to relatively few central bankers and it has been fascinating to try to assess whether monetary policy really is different in Africa. What strikes one initially, in moving from a developed to an emerging market economy, is the remarkable similarity in the monetary policy process. This, on reflection, perhaps ought not to be surprising, given the effort the international community has invested in recent years in promulgating standards of international good practice for the conduct of macro-economic policy. In terms of the structure of the policy framework, one obvious common feature is the critical importance of government establishing a disciplined and coherent framework for fiscal and monetary policy to work in mutual support, so that weakness in the public finances does not undermine monetary discipline and so that the commitment to low inflation is seen to be embedded as a key feature of the government's overall economic strategy. Another common feature is the need for the central bank to be able to act independently in pursuing low inflation, and to have the technical expertise and professional competence to do its job and command public confidence. Yet another common feature is the need for the country to have a reasonably developed and competently-regulated financial system. In all these respects South Africa scores highly, as indeed international scrutiny through visiting IMF/World Bank missions has confirmed. In process, too, the procedures through which monetary policy are conducted are remarkably similar. There are differences, but they are essentially ones of form, rather than substance. Thus, as in other inflation-targeting countries, the inflation target is set as a key government economic objective. A structured Monetary Policy Committee in the central bank meets at regular, pre-announced intervals to take a considered decision on interest rates, enabling policy-makers to step aside from their day jobs for 36 hours and concentrate on a communal review of the monetary outlook. The emphasis, as elsewhere, is on a forward-looking assessment, weighing uncertainties and risks in the unknown future. Also, as elsewhere, the process is surrounded by lively public debate as to what monetary action should be taken, with market commentators showing commendable lack of reticence in arguing their views. Key to the value their contributions can add is the high degree of transparency in the process. In South Africa, as elsewhere, communication and explanation are key elements in monetary policy achieving its behavioural effects, and also critical features in the process by which the central bank is, quite properly, held accountable for its actions. All these elements, then, look and feel remarkably similar to a central banker migrating from an advanced developed country to an emerging market economy. What is, of course, fundamentally different is the economic, social and cultural environment in which the policy process has to be operated. This difference in the environment could simply be regarded as a feature that raises the level of uncertainty facing policy-makers as to what is going on in the economy - a difference in degree, but not such as to make the challenges different in kind in any fundamental way. A higher level of uncertainty can in fact matter a lot in itself, in making policy-makers less confident of their judgements and more inclined to wait and see. But there are grounds for arguing that the distinctly different environment in emerging market economies goes further in its implications for the way in which monetary policy has to be operated. Four possible effects can be identified. First, because they are undergoing significant structural change, many emerging market economies may be more vulnerable to shocks than fully-developed economies. Of course, all economies experience shocks, but the frequency and scale may be greater in emerging market economies. These shocks can have their origin in the domestic economy (a poor crop) or arrive unexpectedly from overseas (higher oil prices). Either way, they are difficult enough to handle if they impact on the demand side, but more often the emerging market central banker has to grapple with sharp movements in cost pressures on the supply side. The orthodox response to shifts in supply conditions is to accept the first-round effect on prices and concentrate monetary action on heading off second-round impacts that can otherwise generate an inflationary cycle. This may be conceptually clear, but in practice it is a hideously difficult distinction to have to translate into monetary decisions. It is a good discipline in these circumstances to remind oneself regularly that higher interest rates will not help to make the maize crop grow higher. South Africa's experience in 2001-02 is a good case in point. A precipitate and largely inexplicable fall in the exchange rate in the latter part of 2001 combined with higher fuel costs and increases in domestic food prices to deliver a severe inflationary shock. The central bank's response, to raise interest rates in progressive steps in 2002, was exemplary and appears to have worked well, with inflation now falling steadily back towards target range as the shock recedes. But the consequences were to make the central bank's task of embedding low inflation in the fabric of the economy much more challenging, because of the inevitable questions this experience raised as to whether, faced with such shocks, monetary policy really could achieve permanently low inflation. That it can, and is doing so, is now gaining wider acceptance, as reflected in continuing evidence of falling inflationary expectations. But it has required, alongside carefully-timed monetary tightening, a strong effort by the central bank to communicate its determination. The prevalence of supply-side shocks would thus seem to be one area in which emerging market economies may face particular challenges in operating monetary policy. Another may arise from the impact of the exchange rate. Movements in exchange rates may have a relatively larger impact in emerging market economies, and their currencies may be more exposed to underlying volatility. Certainly, recent experience in South Africa suggests that the recovery in the rand over the past year has been an important factor in containing inflation. In part this recovery has reflected the general weakening in the dollar, and factors such as higher commodity prices have also been an influence. But the currency's recovery has also been an important channel by which monetary tightening worked its way through to the economy. If the relationship between interest rates and exchange rate movements were predictable, the effectiveness of the exchange rate transmission channel would be helpful to monetary policy. But in practice this relationship remains rather inscrutable. Moreover, the fact that emerging market currencies are subject to volatility resulting from shifts unconnected with the country itself, such as the recent substantial adjustments by the dollar and the euro, means that movements in the exchange rate can have impacts on domestic monetary conditions that can be both large in their effects and impossible to anticipate. Of course, it can always be argued that in these circumstances the central bank should try to moderate movements in the exchange rate in greater or less degree. But the instruments available, for example through capital controls or official intervention, if maintained for any period, do not have at all an encouraging track record and may have counter-productive side-effects by impeding desirable structural adjustment or actually increasing exchange rate volatility. The appropriate remedy is to stick to the fundamentals, focusing monetary action determinedly on low inflation while taking into account impacts from the exchange rate as one amongst a range of relevant influences. But it needs to be recognised that these impacts may be particularly significant for emerging market economies. A further distinctive feature is more straightforward, but can easily be overlooked - that policy-makers in emerging market economies tend to have less information available to them about developments in the economy. This is essentially a form of resource constraint. It applies to statistics, where relevant series may be available less frequently, or in less comprehensive or disaggregated form, or simply less reliable. In South Africa, what was in origin a relatively minor distortion in the compilation of the CPI produced a downward revision, when it was discovered, of nearly 2 percentage points in the 12-month rate of inflation. This at least had the merit of being a rare example of a good news shock. Such events are not unique to emerging market economies: the UK and others have experienced problems with important statistical series from time to time. But diverting scarce resources to statistical compilation is inevitably a problem in an economy where the relevant skills are often a key constraint on economic development as whole. The same applies, too, more generally to knowledge of the transmission mechanism: understanding of functional relationships across the economy is bound to be less secure when the structure of the economy is undergoing rapid change. The existence of a large informal economy further complicates the task. This leads to a fourth implication for monetary policy in an emerging market economy. This is the critical role played by confidence in, and the credibility of, the policy framework. This has both a domestic and an international dimension. Domestically, there is a critical need to win public acceptance of the value of low inflation and public confidence in the determination and ability of the central bank to achieve it. Internationally, confidence that the policy framework will be adhered to can have a powerful influence on investment inflows and on the exchange rate. These factors are, of course, crucial to monetary policy in any country. But the task of buttressing them is the more challenging in emerging market economies because the track record of commitment is relatively much shorter. These can be argued to be some of the distinctive challenges faced by monetary policy-makers in emerging market economies. Are they, however, sufficiently distinctive as to require any fundamentally different approach in the conduct of monetary policy? The answer, to quote Evelyn Waugh, has to be, “Up to a point, Lord Copper.” They are not different in kind from the factors which central banks in any country have to face. But they do perhaps play a more predominant part in the monetary policy judgement in emerging market economies than elsewhere. This suggests two final observations. First, because of the uncertainties, central banks in emerging market economies may understandably tend to be relatively cautious in adjusting their policy stance, in the sense of spacing adjustments in relatively smaller steps over more extended periods. No central banker need ever apologise for being regarded as being cautious. But it does mean that, even in circumstances in which there may be a case for contemplating more bold action, the balance of risks may argue against such an approach. Secondly, given the challenges, can an inflation targeting framework realistically be expected to deliver the desired results in the emerging market context? If the various distinctive features identified above - periodic unexpected shocks, exchange rate volatility, imperfect information sources and public confidence that is not yet fully robust - occurring in whatever combination, result in the central bank missing its target for any extended period, there is of course a danger that the credibility, or even the feasibility, of the process could be called into question. But arguably, it is precisely in these circumstances that the clarity an inflation target can be most helpful, and powerful, in communicating the central bank's policy intentions. That the challenges are formidable is not a reason for stepping back from clarity. It is, instead, a powerful reason in favour of the clarity of an inflation target can deliver, reinforced by effective communication by the central bank, consistency in its conduct of policy and transparency in explaining its actions. In this broader perspective, the fundamentals of monetary policy are not, in any meaningful way, different in Africa. | south african reserve bank | 2,003 | 9 |
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Town Press Club, Cape Town, 29 September 2003. | T T Mboweni: Review of the South African Reserve Bank and its activities 1998-2003, a preliminary assessment Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Cape Town Press Club, Cape Town, 29 September 2003. * 1. * * Introduction Ladies and gentlemen. I thank you for this invitation to interact with you once again. We certainly live in interesting times and much has changed in the world over the past five years. These changes have also affected the South African Reserve Bank as much as any other institution which has a domestic and international focus. We constantly face new challenges and new circumstances in which to conduct our work. The fact that the SARB has risen to meet these challenges says much about the fact that it is an international institution par excellence. 2. International developments There has been two key developments over the last five years that have brought wide-ranging changes to the global social, economic and financial order. The first was the introduction of a single European currency. After decades of preparation, the Euro was introduced as a single currency on 1 January 1999 and Euro banknotes and coin were introduced on 1 January 2002. This currency change-over in Europe firmly established the European Central Bank (ECB) as the single monetary policy authority for participating countries of the European Union. The introduction of the Euro was an eventful episode in the history of Europe. Firstly, the United Kingdom, Sweden and Denmark elected not to adopt the Euro as their national currency on 1 January 2002, although they are member countries of the European Union. Secondly, the Euro/US dollar exchange rate has shown large swings since January 1999. After reaching a high of just over €1 = US$1,18 some four days after its introduction in January 1999, the exchange rate of the Euro subsequently dropped by nearly 30 per cent to just below €1 = US$0,83 by October 2000. The second major event was the attacks on the United States on 11 September 2001. These attacks highlighted a potential systemic risk to financial institutions worldwide in the event of a prolonged disruption of their operations. Multi-lateral co-ordination to ensure business continuity in the financial industry has received considerable attention since these attacks, and South Africa and the SARB are glad to be involved in these initiatives. The Bank has played an active role in the establishment of a Financial Sector Contingency Forum, which is responsible for the identification and management of potential crisis events that might threaten the stability of the South African financial sector. The Bank has also made satisfactory progress with its own business continuity planning to ensure that the head office and branch activities would continue functioning in the event of any disruption. The attacks of 11 September 2001 have also contributed to increased international economic uncertainty, which has in turn resulted in lower economic growth in developed economies. The monetary policy focus in developed economies shifted from containing inflation to avoiding unnecessarily and undesirably low inflation. This has brought new terminology to the vocabulary of central bankers and economists. 3. Domestic developments Although 1998 is a mere five years ago, so much has changed in South Africa in the interim that a brief reflection on that year is called for. By 1998, our democracy was only four years old and South Africa was still re-integrating into the international arena. However, it was already obvious then that the country’s sound macro-economic policies were delivering the desired results. After a period of double-digit inflation covering the largest part of the 1970s and 1980s, inflation was in single-digits in 1995. It has averaged around 7,8 per cent per annum over the last decade. The national government was also achieving success with its sound approach to fiscal policy. While the deficit before borrowing reached a high turning point of 7,3 per cent of the gross domestic product (GDP) in the 1992/93 fiscal year, it equaled 3,7 per cent of GDP for the 1997/98 fiscal year and declined further to 2,8 per cent of GDP in the 1998/99 fiscal year. Owing to the reduction in its deficit before borrowing, it was clear by 1998 that the national government had managed to slow down the growth in government debt to sustainable levels. Not only had government proven by 1998 that it could avoid a debt trap, but it had also successfully reprioritised expenditure and consolidated the fiscus. The introduction on 9 March 1998 of the repurchase system of accommodation and liquidity provision to banks marked a significant change in the country’s accommodation system with the repo rate replacing the previous Bank rate. In the five years since its introduction, changes have been made to the repo system to improve the transmission mechanism of monetary policy. The most important of these changes was introduced with effect from 5 September 2001, the date from which the SARB introduced a fixed repo rate to eliminate any ambiguity from monetary policy signals, which might have arisen under the previous flexible repurchase rate system. In 1998 we also experienced the downside of international economic and financial integration: financial turbulence in a number of south-east Asian economies. Although South Africa could not escape at the time the negative consequences of such financial turmoil, it became obvious during that period that sound policies, rather than crisis management, yield the best results in the long run. This has been a guiding principle for the SARB in the implementation of policy over the past five years. South Africa barely managed to record an average growth rate of 2,0 per cent per annum during the 1980s, but this has since accelerated to around 3 per cent per annum since 1994. Despite the recent slowdown in the international economy and the short-lived global recovery, South Africa’s growth performance of 3 per cent in 2002 was relatively sound. After peaking in the first half of 2002, South Africa’s real GDP then slowed down to an annualised 1,5 percent in the first half of 2003. 4. Policy issues A number of policy issues have occupied the attention of the SARB over the past five years in dealing with these economic and financial developments. The most important of these are the adoption of an inflation target as the anchor for monetary policy; the reconsideration of the Bank’s role in the foreign exchange market; the elimination of the oversold net open foreign currency position (NOFP); and the handling of distressed banks by our bank supervision department. Although the functions of the SARB have changed and expanded over time, the formulation and implementation of monetary policy has remained the centrepiece of our activities. The Bank has used different monetary policy frameworks over time, such as credit ceilings and credit controls in the 1960s and 1970s, money supply growth targets from the middle of the 1980s, money supply growth guidelines by the early 1990s, an eclectic monetary policy from the middle 1990s and inflation targeting since 2000. Successive mission statements of the Bank confirm a fundamental commitment to low inflation. The initial mission statement, published in 1990, entrusted the protection of the internal and external value of the rand to the Bank. This was changed by the middle 1990s to the protection of the value of the rand. In 1999 the mission was reformulated as the achievement and maintenance of financial stability. In February 2000, an inflation target set by the government was introduced as the anchor of monetary policy. This entrusted a single ultimate monetary policy objective to the Bank: price stability. For targeting purposes inflation is measured as CPIX (CPI excluding interest on mortgages) and the first target range (for 2002) was set at 3 to 6 per cent. The same target range applies to now. Achieving an inflation target through the use of monetary policy became the overriding objective. The objective is clearly set as low inflation, and the short-term interest rate (the repo rate), the instrument used for monetary policy, is adjusted exclusively for the achievement of this objective. It follows that interest rates should and will be adjusted once it becomes clear that inflation will be outside the target range in the period ahead if left unchanged. Movements in interest rates over the period under review confirms this approach. In 1998 the prime overdraft rate of the banks started the year at 19,25 per cent. In March it was lowered to 18,25 per cent. However, as the emerging-markets crisis made itself felt, prime rose to a maximum of 25,5 per cent in August and September 1998 as one of the policy measures used to contain the decline in the exchange rate of the rand during that period, before starting to decline during October. For the year as a whole it averaged 21,8 per cent. The exchange rate also depreciated strongly in the second half of 2001. Interest rates were also increased early in 2002, but with a different objective. This increase was caused by the need to contain the negative inflationary side effects of the lower rand, rather than to support the exchange rate at any given level. The medicine worked, bringing inflation and expected inflation down. This made policy relaxation possible. At the beginning of 2003 the prime overdraft rate was 17 per cent, before being lowered gradually to 13,5 per cent at present, giving an average rate of 16,3 per cent for the first eight months of the year. An important development since 1998, coinciding with the adoption of inflation targeting, was the establishment of a Monetary Policy Committee with responsibility for deciding on the monetary policy stance. The establishment of this Committee has contributed significantly to the removal of the myth that monetary policy decisions and reasons for such decisions are clouded in secrecy, taken by an invisible decision-maker not accountable to anybody. The Committee deliberates on recent economic and financial developments and members reach consensus on the appropriate policy stance to be adopted. The Committee’s consensus decision is communicated by means of a detailed policy statement delivered at a media conference. This approach should enhance the public understanding of and transparency in the monetary policy process. The media has an important role in communicating with the general public. If the public does not understand that interest rates are adjusted with the achievement of the inflation target (and, therefore, price stability) in mind, the actions of the central bank will be clouded in mystery and the public is unlikely to support the Central Bank. Since 1998 the SARB has also played its part in the improvement of the communication of monetary policy decisions and progress towards the successful achievement of the inflation target. The Bank’s Monetary Policy Forums in the nine provinces are now well-established and facilitate open discussions on monetary policy and general economic developments. The Bank’s regular reporting to Parliament on recent economic and financial developments is also a well-established part of its accountability to the citizens of South Africa. In addition, since March 2001 the Bank publishes a bi-annual Monetary Policy Review, which includes a fan chart of the Bank’s inflation forecast. Since 1998 the Bank has been remarkably successful in containing inflation despite exchange rate instability and the international financial turmoil of 1998 referred to earlier. CPIX inflation averaged 7,1 per cent for 1998 and only rose from a twelve-month rate of 6,5 per cent in February to 7,6 per cent in October 1998 before starting to decelerate again. During that period, tight monetary policy helped to contain inflation. The gradual waning of inflation in 2000 and 2001 was interrupted when inflationary pressures mounted in the wake of the sharp depreciation of the rand towards the end of 2001. Essentially driven higher by the cost-raising effects of the depreciated exchange value of the rand, CPIX inflation rose from year-on-year rates of approximately 6 per cent during the second half of 2001 to 11,3 per cent in October and November 2002. Initially, CPIX inflation accelerated mainly on account of the sharp increases in the prices of food products which were largely related to the depreciation of the rand. In subsequent months, the rise in CPIX inflation became more broadly based. The rise in non-food CPIX inflation resulted from higher rates of increase in the prices of housing services, furniture and equipment, medical care and health expenses, new and used vehicles, and transport running costs. The inflationary momentum which had built up in the course of 2002, was moderated by a more conservative monetary policy stance and the recovery of the exchange value of the rand since about the middle of 2002. Inflationary pressures therefore waned in the final months of 2002 and the first half of 2003. By January 2003 CPIX inflation has already declined to 10,0 per cent and receded to 6,3 per cent in August 2003. CPIX is expected to recede to within the target range in the immediate (before December 2003) future. The exchange rate of the rand has shown large swings over the past five years. In 1998 the exchange rate of the rand averaged R5,53 to the US dollar. On 28 August 1998 (with the Russian default on their debt signalling what was probably one of the worst moments in the emerging-markets crisis) it reached its weakest point during that year of R6,67 per dollar. After a period of relative stability in 1999 and 2000, a sharp depreciation in the exchange rate of the rand occurred during the second half of 2001. During that period the nominal effective exchange rate of rand depreciated by 34 per cent, before recovering early in 2002. Subsequently the rand has been remarkably steady, and for the eight months January to August 2003 the average exchange rate of the rand amounts to R7,90 per US dollar. The elimination of the oversold NOFP was the Bank’s third major policy challenge over the past five years. The Bank’s latest Annual Economic Report mentions that “a milestone was reached on 16 May 2003 when the NOFP of the Reserve Bank recorded its first-ever positive balance, having been in an oversold dollar position of more than US$23 billion as recently as 1998”. This remarkable achievement has received surprising little media coverage, but allows the Bank a shift in focus to the reduction of its oversold forward book and increasing the official foreign exchange reserves position. The fourth policy issue, namely the responsibility for banking supervision, has also seen a number of developments. With the performance of this function come also a number of responsibilities. This was evidenced by events early in 2002, when satisfactory solutions had to be found for the financial difficulties experienced by a number of smaller banks and two relatively large ones (Saambou Bank and BoE Bank). In the event the SARB acted in accordance with international best practice and successfully avoided systemic risk and panic about the soundness of the South African banking sector. Commercial banks have an extremely important role to play in maintaining financial stability in any economy. Financial stability is extremely fickle, and unfortunately often more easily lost than restored. No central bank can maintain or restore the public’s trust in the financial system without the cooperation of commercial banks and the public. It should always be remembered that the central bank has at heart the best interests of the financial system as a whole. No country, bank or financial system can afford a systemic banking crisis. 5. Internal management issues The SARB has had a clear commitment to the transformation of its staff complement and work processes over the past five years. I announced in my first address as Governor at the ordinary general meeting of the Bank held on 24 August 1999 that “… a beginning has been made in drawing up a human resources plan which will deal with progressive employment equity in the workplace by promoting equal opportunities and fair treatment”. A year later shareholders were informed that the Bank’s transformation plan “endeavours to achieve a staff complement comprising a minimum of 50 per cent Black people and 33 per cent females by 2005”. Last year shareholders were informed that “in keeping with the objective of transforming the composition of the Bank’s staff to reflect the demographics of the country, an important milestone was reached in the past financial year when the total black staff complement exceeded the white staff complement for the first time since the inception of the Bank in 1921”. As in many other areas of responsibility, the Bank is also proud of the progress made with the transformation of its staff complement over the past five years. 6. Conclusion Indeed over the past five years, many challenges were faced head-on by the Bank. Important milestones were achieved and the stage is now set for further improvements in our work. Of immediate importance is the achievement of the inflation target, maintaining banking stability and transforming our staff complement further. There are many more challenges ahead. Thank you. | south african reserve bank | 2,003 | 10 |
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